An overview of corporate bond markets and policy issues
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An Overview of Corporate Bond Markets and Policy Issues. S. Ghon Rhee K. J. Luke Distinguished Professor of Finance Executive Director Asia-Pacific Financial Markets Research Center University of Hawai ‘ i Workshop on Developing Corporate Bond Market in APEC Economies August 6-8, 2004

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An Overview of Corporate Bond Markets and Policy Issues

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An overview of corporate bond markets and policy issues

An Overview of Corporate Bond Markets and Policy Issues

S. Ghon Rhee

K. J. Luke Distinguished Professor of Finance

Executive Director

Asia-Pacific Financial Markets Research Center

University of Hawai‘i

Workshop on Developing Corporate Bond Market in APEC Economies

August 6-8, 2004

Shanghai, China

Asia-Pacific Financial Markets Research Center, University of Hawaii


Bonds outstanding in 2002

-

Bonds Outstanding in 2002

(in US$ Billion)

Asia-Pacific Financial Markets Research Center, University of Hawaii


East asian bond markets

East Asian Bond Markets

Outstanding Domestic Bonds (in US$ Billion)

Asia-Pacific Financial Markets Research Center, University of Hawaii


Financial sector profile 2002

Financial Sector Profile 2002

Asia-Pacific Financial Markets Research Center, University of Hawaii


Two major questions on bond market development

Two Major Questions on Bond Market Development

1.Why are bond markets so small in Asia?

2.Why hasn't the secondary market developed in economies with large primary market?

OECD Workshop on “Debt Securities Markets in the Dynamic Asian Economies,” September 8, 1992 in Hong Kong

Rhee, 1993, “Fixed Income Securities Markets in

Six Dynamic Asian Economies”

Asia-Pacific Financial Markets Research Center, University of Hawaii


Five underlying reasons i

Five Underlying Reasons (I)

1.Controlled or administered interest rates

  • Low effective yields without reflecting current market conditions

  • Reliance on captive demanders

  • Illiquid secondary market

    2.Dominance of banking sector over capital markets

  • Heavy reliance of bank short-term loans by private corporations

  • Requirement for collateralization or guarantees by financial institutions for corporate bond issues

Asia-Pacific Financial Markets Research Center, University of Hawaii


Five underlying reasons ii

Five Underlying Reasons (II)

3.Limited supply of long- and short-term fixed income securities

  • Statutory restrictions

  • Government regulations

  • Banking sector’s resistance

  • Poor credit ratings of issuers

    4.Limited Institutional Investor Base & Lack of Individual Investors’ Participation

    5.Under-developed market infrastructure

Asia-Pacific Financial Markets Research Center, University of Hawaii


Six major impediments in developing bond markets

Six Major Impediments in Developing Bond Markets

1.Lack of Benchmark Yield Curves

2.Limited Supply of Quality Bond Instruments

3.Captive Nature of the Primary Markets

4.Small Investor Base

5.Fragmented Regulatory Structure

6.Inadequate Market Infrastructure

Complacency Prevailed!

ADB High-Level Policy Dialogue on East Asian Financial Crisis, March 1999

Rhee, 2000, “Rising to Asia’s Challenge: Enhanced Role of Capital Markets”

Asia-Pacific Financial Markets Research Center, University of Hawaii


Lack of benchmark yield curves i

Lack of Benchmark Yield Curves (I)

Operational Reasons for Government Bond Issues

1.To Finance Fiscal Deficits

2.To Sterilize Large Capital Inflows

3.To Provide benchmark yield curves

  • Concentration of new issues in limited standard maturities enables their use as benchmarks

  • Spreading few benchmark issues across a range of maturities leads to a “benchmark yield curve”

Asia-Pacific Financial Markets Research Center, University of Hawaii


A recent success story of korea liquidity increase in benchmark bond issues

A Recent Success Story of Korea: Liquidity Increase in Benchmark Bond Issues

Introduction of the Fungible Issue and Reopening Systems

  • Benchmark-designated Bond Issues have identical maturities and coupon rates

  • By adopting the reopening system, Korea expanded the size of bond issues of the same maturities.

Asia-Pacific Financial Markets Research Center, University of Hawaii


The effect of the reopening system in korea

Volume of Benchmark Issues

The Effect of the Reopening System in Korea

3.5 times

greater

Asia-Pacific Financial Markets Research Center, University of Hawaii


Lack of benchmark yield curves ii china s example

Lack of Benchmark Yield Curves (II): China’s Example

a.Deposit interest rates are serving as benchmark

b.MOF sets a range of bidding spreads at the primary market auction

c.Why very little differences are observed between savings bonds and book-entry bond yields?

Savings Bonds:Syndicated Underwriting

Book-Entry Bonds:

Uniform Price Auction Method

Asia-Pacific Financial Markets Research Center, University of Hawaii


Fragmented regulatory structure i

Fragmented Regulatory Structure (I)

  • Malaysia in Pre-Crisis Period:

    Bank Negara vs. Securities Commission

  • China at Present: Fragmented Regulatory Structure of Government Bond Markets

    a. Dual Supervisory Structure of Primary Market

    T-Bonds and E-Bonds: MOF

    F-Bonds:PBOC

    b. Dual Supervisory Structure of Secondary Market

    Inter-Bank Market:PBOC

    Over-the-Counter (OTC) Market:PBOC

    Exchange Market:CSRC

Asia-Pacific Financial Markets Research Center, University of Hawaii


Fragmented regulatory structure ii

Fragmented Regulatory Structure (II)

  • Consolidated Regulatory Agencies:

    Thailand, Korea, Taiwan, Singapore

  • Indonesia at Present:

    Financial Services Authority (or Otoritas Jasa Keuangan, OJK)under plan to replace Capital Market Supervisory Agency (BAPEPAM)

Asia-Pacific Financial Markets Research Center, University of Hawaii


Expansion of investor base i

Expansion of Investor Base (I)

Key Groups of Investors

  • Banks, Insurance Companies, Public and Private Pension Funds, Mutual Funds

  • International Investors

  • Individual Investors

    A diversified and heterogeneous investor base promotes liquidity and stabilizes market demand

    a.Insurance Companies and Pension Funds are demanders of long-term, low risk bond instruments

    b.Mutual Funds are demanders of short-term bond instruments

Asia-Pacific Financial Markets Research Center, University of Hawaii


Expansion of investor base ii

Expansion of Investor Base (II)

Policy Measures for Developing a Broader-Based Market focus on

  • Moving bond instruments out of bank asset portfolios

  • Direct access to retail and/or foreign investors

  • Structural reform of pension and retirement funds

  • Reform or creation of mutual funds (especially bond funds)

  • Diverse Types of Bond Instruments

Asia-Pacific Financial Markets Research Center, University of Hawaii


Fixed income securities in the us market as of march 2004

Fixed-Income Securities in the US Market (as of March 2004)

Unit: US$ Billion

Municipal Bonds$1,943.3 ( 8.62%)

Treasury Securities 3,720.9 (16.51%)

Mortgage-Backed Securities 5,344.0 (23.72%)

Corporate Bonds 4,542.7 (20.16%)

Federal Agency Bonds 2,654.0 (11.78%)

Money Market* 2,588.0 (11.49%)

Asset-Backed Securities 1,758.5 (7.76%)

Total $22,531.4 (100.00%)

* includes Commercial Papers, Bankers Acceptances, and large Certificates of Deposits

Source: US Bond Market Association

Asia-Pacific Financial Markets Research Center, University of Hawaii


Fixed income securities in thailand as of december 2003

Fixed-Income Securities in Thailand (as of December 2003)

Unit: US$ Billion

Municipal Bonds none ( 0.00%)

Treasury Securities $21.73 (45.87%)

Mortgage-Backed Securities none ( 0.00%)

Corporate Bonds 9.43 (19.91%)

Government Agency Bonds 6.06 (12.79%)

Money Market n.a. (n.a.)

Asset-Backed Securities none ( 0.00%)

Total $47.37 (100.00%)

Asia-Pacific Financial Markets Research Center, University of Hawaii


Fixed income securities in korea as of december 2003

Fixed-Income Securities in Korea (as of December 2003)

Unit: US$ Billion

Municipal Bonds $8.28 ( 1.40%)

Treasury Securities 121.43 (20.52%)

Mortgage-Backed Securities n.a. ( n.a.)

Corporate Bonds* 168.03 (28.31%)

Government Agency Bonds** 295.43 (49.78%)

Money Market n.a. (n.a.)

Total $593.52 (100.00%)

* 75% of Corporate Bonds are Asset-backed securitites

**Includes: Monetary Stabilization Bonds, National Housing Bonds, Foreign Exchange Stabilization Bonds, Subway Construction Bonds, Industrial Financial Debentures, Financial Bonds, KAMCO Bonds

Source: MOFE, Korea (2004)

Asia-Pacific Financial Markets Research Center, University of Hawaii


Building bond market infrastructure

Building Bond Market Infrastructure

1.Competitive Auction System among Primary Dealers for Government Bond Issuance

2.Hedging Instruments for Interest Rate Risk

3.Credit Rating Culture

4.Clearing and Settlement System

5.Over-the-counter Market Trading System

6.Inter-Dealer Broker System

Asia-Pacific Financial Markets Research Center, University of Hawaii


Issuing techniques of government bonds

Issuing Techniques ofGovernment Bonds

  • Fixed Price Public Subscriptions

    Underwriter consortium utilized

  • Private Placements

    In the absence of well-functioning secondary markets

  • Tap Issues

    Sold directly into the secondary market through branch network of banks or securities companies

  • Auctions

    Multiple price auction vs. Uniform Price Auction

Asia-Pacific Financial Markets Research Center, University of Hawaii


Multiple vs uniform price auction method

Multiple- vs. Uniform-Price Auction Method

Multiple-price auction method

a.Successful bidders pay the prices they bid

….…..“winner’s curse”

b.Bidders tend to shade their bids below the maximum that they are actually willing to pay

Uniform-price auction method

a.All successful bidders pay the same price for a given security

b.Hence, some successful bidders may pay a lower price than they actually bid.

Asia-Pacific Financial Markets Research Center, University of Hawaii


Issuing techniques of among oecd members

Issuing Techniques ofamong OECD Members

  • Uniform Price Auction

    Finland, Italy, Netherlands, Norway, and Switzerland, UK, US

  • Multiple Price Auction

    Australia, Austria, Canada, Japan, Sweden, UK

  • Tap Issue

    US, UK, Germany, Canada, and most of OECD members, but not Japan

Asia-Pacific Financial Markets Research Center, University of Hawaii


An overview of corporate bond markets and policy issues

Asia-Pacific Financial Markets Research Center, University of Hawaii


Hedging instruments for interest rate risk

Hedging Instruments for Interest Rate Risk

A.Most Asian economies are trading bond futures (for long-term interest rate hedging) and short-term interest rate futures

B.Exceptions:

China, Indonesia, Philippines, and Thailand

Asia-Pacific Financial Markets Research Center, University of Hawaii


Bond rating culture regional bond rating agencies

Bond Rating Culture: Regional Bond Rating Agencies

Number of Domestic Adoption of IAS Statements

CountryCredit Rating Agenciesby Stock Exchanges

Australia Open to Global CRAsYes

China 6No

Hong Kong SAR Open to Global CRAsYes

Indonesia 2No

Japan3 & Open to Global CRAsYes

Korea 4Yes

Malaysia 2Yes

Philippines 1No

Singapore Open to Global CRAsYes

Taipei,China1Yes

Thailand2Yes

Viet Nam To be established No

Asia-Pacific Financial Markets Research Center, University of Hawaii


Clearing and settlement

Clearing and Settlement

Government BondsCorporate Bonds

AustraliaReserve Bank InformationFinancial Transactions Recording and

and Transfer SystemClearanceSystem

ChinaGovernment Securities SD&C

Depository Trust & Clearing Co.

(for Inter-bank market)

Securities Depository and

Clearing Co. Ltd. (SD&C)

(for Exchange Market)

Hong KongCentral MoneyMarkets UnitCentral Clearing & Settlement System

JapanBOJ Financial NetworkJapan Securities Depository Center

System (BOJ-NET)

Japanese Government Bond

Clearing Corp.

SingaporeGovernment Book-Entry System Debt Securities C&S System

Asia-Pacific Financial Markets Research Center, University of Hawaii


Bond trading systems order vs quote driven trading

Bond Trading Systems: Order- vs. Quote-Driven Trading

  • Pre-trading negotiations and personal relationships among bond dealers are critically important

  • Automated trading system cannot offer these relationship

  • Korea Stock Exchange’s Experience

  • Thai Bond Dealing Center’s Role:

    A bond exchange, an inter-dealer broker, or a center for compiling bond price information?

Asia-Pacific Financial Markets Research Center, University of Hawaii


Korea stock exchange s experience

Korea Stock Exchange’s Experience

Korea Stock Exchange (March 1999) introduced an inter-dealer broker system for government bonds trading.

Trading Volume ($ billion)OTCKSE

1999167234

2000 170 20

Lesson: Individual negotiations on OTC market cannot be replaced by impersonal auction system

Asia-Pacific Financial Markets Research Center, University of Hawaii


Role of inter dealer brokers

Role of Inter-Dealer Brokers

  • Brings market makers together

  • Disseminates trading information to the market

  • Promote secondary market liquidity, depth, transparency

  • Earns commission for arranging trades at pre-agreed fees

  • Unlike market makers, no positions are taken by IDBs

    Adopted by: Most East Asian Economies

    (Singapore, Hong Kong, Thailand, Korea)

Asia-Pacific Financial Markets Research Center, University of Hawaii


Looking forward what do we need in asia

Looking Forward: What Do We Need in Asia?

  • Promotion of Asset-Backed Securities

  • Development of Mortgage-Backed Securities

  • Establishment of Credit Guarantee and Enhancement Programs for Small- and Medium-Size Enterprises

  • Financial Autonomy for Municipal Government Development of Municipal Bond Markets

  • Promotion of Creditor Right and Streamline Corporate Bankruptcy Proceedings

  • Legal Framework for Bond Borrowing and Lending to Promote REPO Markets

Asia-Pacific Financial Markets Research Center, University of Hawaii


Thank you for further references please visit http www2 hawaii edu rheesg

Thank You!For Further References,Please visit http://www2.hawaii.edu/~rheesg

Asia-Pacific Financial Markets Research Center, University of Hawaii


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