IF 2018 was an annus horribilis for Asia’s fixed income market, 2019 turned out to be the opposite. As the US Federal Reserve reversed course, investors basked in the warmth of benign central banks, posting double-digit returns in some Asian local bond markets.
At a forum organized by The Asset Events late last year in association with HSBC Global Asset Management, Cecilia Chan, chief investment officer, fixed income, Asia-Pacific for the asset manager with US$85 billion of funds under management (for Asian fixed income), expects the Fed’s loose monetary policy to continue with little chance of tightening in the foreseeable future. Under this scenario, she believes, the environment for fixed income investing should remain constructive.
Indeed, for Hong Kong-based investors, it has been a solid year investing in Asia’s local currency bond markets with the Philippines posting a 21.4% year-to-date return to the end of December (FX hedged to Hong Kong dollar), followed by Thailand, 13.4%; and Indonesia, 9.5%. On an unhedged basis, US dollar return was even more stunning with the Philippines’ 28.1%; Thailand’s 22.5%; and Indonesia’s 18.2%.
In contrast, the investment returns for Hong Kong dollar bonds, at 2.9% for the same period, paled in comparison to neighbouring markets, and lagged behind returns for USD government bonds, which produced a positive 6.8%, and Europe’s 6.9% (in Euro).
How then to enhance the attraction of the Hong Kong dollar bond market was the focus of the discussion at the forum of issuers, investors and the regulator, the Hong Kong Monetary Authority (HKMA). It is not for lack of participants that’s for sure, with issuers and investors eager to increase their participation by issuing and investing more.
Chicken-and-egg
“We want to issue more (in Hong Kong dollar), but bankers tell us, we don’t have enough demand to do a public deal,” laments Vincent Chow, group treasurer at Hong Kong Electric. “The situation does not improve on a private placement basis. I did a print (private placement) yesterday. It was for HK$300 million (US$38.3 million). I am still waiting for my bankers to come back to me and see if there could potentially be an upsize.”
His worry seems rather odd when juxtaposed against investors’ view. “The Hong Kong dollar market is obviously very important to us,” points out Benjamin Rudd, chief investment officer at insurer Prudential Hong Kong. “Like all asset owners, we have local currency liabilities. We have a clear preference, where possible, to hold an asset that matches the currency of our liabilities.”
Indeed, Rudd explains that from an insurance perspective the progression and the future introduction of RBC (risk-based capital) by Hong Kong’s Insurance Authority (IA) will be a key catalyst to continue that structural demand for Hong Kong dollar bonds. “We were historically Solvency II. We always tend to have much greater preference to make sure we have that currency, and as much as possible, duration hedge as well.”
Chow suggests the market suffers from a chicken-and-egg problem. “We love to issue more but there are not enough investors,” he notes. “But then from an investor’s perspective, there is not enough issues in terms of breadth and tenor. If I were an investor, I would tell my bankers, ‘hey look, you always give me these few names. I am full on limits already’.”
This problem adds to the issue of the lack of liquidity making it harder to develop the market. “The reality is that as an insurance company, we tend to buy and hold because we are very afraid that if we sell it, we can’t buy it back again,” Rudd shares. “This means we have to buy more of something else.”
Encouraging diversity of issuers
The challenge therefore is how to create liquidity by promoting a diversity of issuers in the Hong Kong dollar bond market. Rudd, for example, wonders if the low funding cost from issuing Hong Kong dollar bonds could attract Chinese corporates to raise capital. “They (Chinese corporates) clearly don’t mind issuing Hong Kong dollar equity. But they don’t seem to want to issue in Hong Kong dollar debt. And I wonder where is the explanation for that?”
HSBC’s Chan shares a reality of the lack of genuine demand and mandate for high-yield Hong Kong dollar bonds from dedicated Hong Kong dollar portfolios across the board. “I am thinking the type of investors that we have are all for investment grade. I don’t have, at the moment, any Hong Kong dollar-based portfolios that are allowing us to significantly invest in high-yield [bonds].”
“But that could be part of the chicken-and-egg problem,” responds Rudd. “We have Chinese high-yield bond exposure which is swapped back into Hong Kong dollars. You are right there is simply no point for us to have a Hong Kong dollar bond high-yield mandate because basically we will only be sitting on cash for the next five years.” The non-existence of high-yield issuance in Hong Kong dollar bond feeds the absence of Hong Kong dollar high-yield mandate which in turn sends market signals back to high-yield corporates that there is no market for their bond issuance.
Ironically, being one of the most developed markets in Asia, the edge of the Hong Kong dollar bond market could also be the barrier to attract foreign issuers and investors. Mushtaq Kapasi, chief representative at International Capital Market Association (ICMA), explains: “The impression (of the Hong Kong dollar bond market) is that the Hong Kong dollar is pegged to the US dollar, so there is very little currency risk. It is a relatively small market and a very efficient market. So perversely, there are very few opportunities in the market unlike the other emerging markets. I think the sophistication, the stability and the lack of risks in the Hong Kong dollar bond market in a way become disincentives for people to enter the market.” In other words, the efficiency of the Hong Kong dollar bond market has left no room for arbitrage.
Injecting liquidity
The lack of liquidity in secondary-market trading, a common problem faced by all local currency bond markets, has been on the radar of regulators. Last year in July, the Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP), in which HKMA is an active member, launched a new securities lending programme to cope with the problem.
According Kyle Hung, head of external division at the Hong Kong Monetary Authority, the programme will lend its underlying securities to eligible borrowers for their treasury management purposes or satisfy the liquidity and capital requirement.
“The motivation for the launch of the securities lending programme is to improve the liquidity of the regional bond market, particularly liquidity in the underlying facilities, and potentially unlock the hold-to-maturity portfolios of securities held by institutional investors,” Hung notes. As of the end of September, the securities lending programme, launched in July last year, had US$158 million of securities lent to borrowers and recallable on demand.
Investors welcome such an initiative from the HKMA. “I think exercises like that are very important in terms of breeding that liquidity and institutional usage of repo,” Rudd says. “This is the blood of the bond market at the end of the day. Efforts like that I think should really be encouraged and are absolutely crucial if that could get real momentum behind it. That creates a lot more institutional interest in the market.”
Outside the box
To create further demand for Hong Kong dollar bonds, Chan suggests additional regulatory guidelines for pension funds. “I am thinking outside the box. In the MPF (Mandatory Provident Fund) portfolio, there is a minimum currency requirement in Hong Kong dollar exposure of 30%. If there is a guideline of 30% limit on currency exposure for minimum requirement, it would be interesting to see if there is a minimum requirement for Hong Kong dollar bond exposure. If that is happening, I suppose Hong Kong pension funds can show some leadership in terms of how to manage their money.”
As indicated by Prudential’s Rudd, the introduction of RBC for insurance companies in Hong Kong will naturally drive their demand for Hong Kong dollar bonds. At present, the IA in Hong Kong is currently developing its capital framework toward an RBC regime that is consistent with the principles issued by the International Association of Insurance Supervisors. The RBC framework is expected to substantially change the capital framework set from the Hong Kong Insurance Ordinance.
In essence, an RBC would require insurance companies to have an asset which matches the liabilities in terms of duration and currency. “What that means is that for an insurance company like ourselves, we have a lot of Hong Kong dollar liabilities as we underwrite a lot of Hong Kong dollar insurance policies,” Rudd elaborates. “We would have a very clear preference to hold Hong Kong dollar assets with a certain duration. That will actually drive the demand before the implementation of RBC because we cannot change our portfolio overnight. Such measure will have a structural pickup in terms of demand for Hong Kong dollar assets.”
Setting a benchmark
To boost the demand for Hong Kong dollar bonds even more, the Hong Kong government can also take a more active role in setting a benchmark yield curve. In general, both issuers and investors are longing for more issuance, especially on a longer tenor basis. “We want to buy a 30-year bond. We may never sell it, so we can’t really help with the liquidity. But in terms of the actual demand for these assets, that will be there. It is not only because of RBC but also the fact that the Hong Kong insurance business continues to grow,” adds Rudd. However, without the Hong Kong government pricing a 30-year bond, it is nearly impossible for the market to single-handedly and fairly price a bond with a comparably long tenor.
It will need to be a collective effort on the part of all participants to build a more robust Hong Kong dollar bond market going forward. Regulators can play a vital part including adjusting investors’ appetite via guidelines, to offering longer-tenor paper to help develop a yield curve for Hong Kong dollar paper. When these actions will come to fruition though, only time will tell.
