1 An Overview of Corporate Bond Markets and Policy Issues S. Ghon Rhee K. J. Luke Distinguished...

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An Overview of Corporate Bond Markets and Policy Issues

S. Ghon RheeS. Ghon RheeK. J. Luke Distinguished Professor of Finance K. J. Luke Distinguished Professor of Finance

Executive DirectorExecutive DirectorAsia-Pacific Financial Markets Research CenterAsia-Pacific Financial Markets Research Center

University of HawaiUniversity of Hawai‘‘ii

Workshop on Developing Corporate Bond Market in APEC Economies August 6-8, 2004 Shanghai, China

Asia-Pacific Financial Markets Research Center, University of Hawaii

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Bonds Outstanding in 2002 -

(in US$ Billion)

Public Private Total % of World

Total

European Union 4,941.3 7,662.0 12,603.3 29.1 Euro area 4,235.3 5,836.2 10,071.5 23.2 France 790.8 998.5 1,789.3 4.1 Germany 860.0 2,344.6 3,204.6 7.4 Italy 1,208.3 818.3 2,026.6 4.7 United Kingdom 474.1 1,384.3 1,858.4 4.3

North America 5,043.6 14,786.0 19,829.6 45.7 Canada 499.1 315.8 814.9 1.9 United States 4,544.5 14,470.2 19,014.7 43.9

Japan 4,841.9 2,163.2 7,005.1 16.2 Emerging market countries 1,467.0 1,057.1 2,524.1 5.8

Asia 657.8 814.9 1,472.7 3.4 Latin America 472.5 179.6 652.1 1.5 Middle East 5.4 13.5 18.9 0.0 Africa 47.7 20.8 68.5 0.2 Europe 283.6 28.3 311.9 0.7

World 16,531.2 26,826.4 43,357.6 100.0 Source: International Monetary Fund, Global Financial Stability Report 2003 .

Debt Securities


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US$ billion

%US$

billion%

US$ billion

%US$

billion%

US$ billion

%

China, People's Rep. of 143.9 26.6 195.3 27.5 253.4 29.0 208.3 24.3 412.4 37.4

Hong Kong, China 50.3 9.3 57.1 8.1 60.9 7.0 63.3 7.4 44.6 4.0

Indonesia 5.7 1.1 10.1 1.4 9.8 1.1 7.5 0.9 56 5.1

Korea, Rep. of 238.3 44.0 306.4 43.2 375.4 43.0 381.4 44.5 380.9 34.5

Malaysia 36.0 6.6 41.5 5.9 63.9 7.3 72.5 8.5 82.7 7.5

Philippines 15.8 2.9 25.0 3.5 24.2 2.8 24.5 2.9 21.9 2.0

Singapore 29.0 5.4 36.8 5.2 44.8 5.1 56.8 6.6 57.6 5.2

Thailand 22.8 4.2 36.8 5.2 40.8 4.7 42.7 5.0 47.3 4.3

East Asia 541.7 100.0 709.0 100.0 873.1 100.0 856.9 100.0 1103.4 100.0

Source: Dalla, I. 2003. Harmonization of Bond Market Rules and Regulations in Selected APEC Economies, Asian Development Bank.

20022000 20011998 1999

East Asian Bond MarketsOutstanding Domestic Bonds (in US$ Billion)


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Financial Sector Profile 2002

US$ Billion

%GDPUS$

billion%GDP

US$ billion

%GDP

China, People's Rep. of 412.4 33.3 463.1 37.4 2073.3 167.6Hong Kong, China 44.6 27.4 463.1 284.1 677.9 415.9Indonesia 56.0 32.3 30.1 17.4 114.4 66.0Korea, Rep. of 380.9 82.5 215.7 46.7 608.6 131.9Malaysia 82.7 86.9 122.9 129.1 135.0 141.8Philippines 21.9 28.4 18.2 23.6 46.0 59.7Singapore 57.6 63.8 101.6 112.5 209.6 232.2Thailand 47.3 37.4 45.4 35.9 136.8 108.2Total 1103.4 45.5 1460.1 60.2 4001.6 165.0

Germany 1743.9 87.6 686.0 34.5 3859.3 193.9Japan 6748.0 169.0 2069.3 51.8 6685.9 167.5United Kingdom 1064.0 68.3 1800.7 115.6 5001.4 321.2United States 16272.6 155.8 11009.8 105.4 6979.5 66.8

Bonds Equities Banks

Sources: Bank for International Settlements (BIS); Deutsche Bank; IFS; World Bank; World Federation of Stock Markets.


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Two Major Questions on Bond Market Development

1.1. Why are bond markets so small in Why are bond markets so small in Asia?Asia?

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

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

Rhee, 1993, “Fixed Income Securities Markets in Rhee, 1993, “Fixed Income Securities Markets in

Six Dynamic Asian Economies”Six Dynamic Asian Economies”


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Five Underlying Reasons (I)1.1. Controlled or administered interest ratesControlled or administered interest rates

Low effective yields without reflecting current Low effective yields without reflecting current market conditionsmarket conditions

Reliance on captive demandersReliance on captive demanders Illiquid secondary marketIlliquid secondary market

2.2. Dominance of banking sector over capital Dominance of banking sector over capital markets markets

Heavy reliance of bank short-term loans by private Heavy reliance of bank short-term loans by private corporationscorporations

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


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Five Underlying Reasons (II)

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

Statutory restrictionsStatutory restrictions Government regulations Government regulations Banking sector’s resistanceBanking sector’s resistance Poor credit ratings of issuers Poor credit ratings of issuers

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

5.5. Under-developed market infrastructureUnder-developed market infrastructure


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1.1. Lack of Benchmark Yield CurvesLack of Benchmark Yield Curves

2.2. Limited Supply of Quality Bond Limited Supply of Quality Bond InstrumentsInstruments

3.3. Captive Nature of the Primary MarketsCaptive Nature of the Primary Markets

4.4. Small Investor BaseSmall Investor Base

5.5. Fragmented Regulatory StructureFragmented Regulatory Structure

6.6. Inadequate Market InfrastructureInadequate Market Infrastructure

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

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

Six Major Impediments in Developing Bond Markets


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Lack of Benchmark Yield Curves (I)

Operational Reasons for Government Operational Reasons for Government Bond IssuesBond Issues1.1. To Finance Fiscal DeficitsTo Finance Fiscal Deficits

2.2. To Sterilize Large Capital InflowsTo Sterilize Large Capital Inflows

3.3. To Provide benchmark yield curvesTo Provide benchmark yield curves

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

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


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

Introduction of the Fungible Issue and Introduction of the Fungible Issue and Reopening SystemsReopening Systems Benchmark-designated Bond Issues have Benchmark-designated Bond Issues have

identical maturities and coupon ratesidentical maturities and coupon rates By adopting the reopening system, Korea By adopting the reopening system, Korea

expanded the size of bond issues of the expanded the size of bond issues of the same maturities. same maturities.


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The Effect of the Reopening System in Korea

Volume of Benchmark Issues

0

1

2

3

4

5

6

7

Non- fungible 2000.10월 2001 2002 2003

volu

me

(tril

lion

won

)

Volume of Benchmark Issues

3.5 times

greater


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Lack of Benchmark Yield Curves (II): China’s Example a.a. Deposit interest rates are serving as Deposit interest rates are serving as

benchmarkbenchmarkb. MOF sets a range of bidding spreads

at the primary market auctionc.c. Why very little differences are Why very little differences are

observed between savings bonds and observed between savings bonds and book-entry bond yields?book-entry bond yields?

Savings Bonds:Savings Bonds: Syndicated UnderwritingSyndicated UnderwritingBook-Entry Bonds:Book-Entry Bonds:

Uniform Price Auction MethodUniform Price Auction Method


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Fragmented Regulatory Structure (I) Malaysia in Pre-Crisis Period:Malaysia in Pre-Crisis Period:

Bank Negara vs. Securities CommissionBank Negara vs. Securities Commission

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

a. Dual Supervisory Structure of Primary Marketa. Dual Supervisory Structure of Primary MarketT-Bonds and E-Bonds: T-Bonds and E-Bonds: MOFMOFF-Bonds:F-Bonds: PBOCPBOC

b. Dual Supervisory Structure of Secondary Marketb. Dual Supervisory Structure of Secondary MarketInter-Bank Market:Inter-Bank Market: PBOCPBOCOver-the-Counter (OTC) Market:Over-the-Counter (OTC) Market: PBOCPBOCExchange Market:Exchange Market: CSRCCSRC


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Fragmented Regulatory Structure (II) Consolidated Regulatory Consolidated Regulatory

Agencies: Agencies:

Thailand, Korea, Taiwan, SingaporeThailand, Korea, Taiwan, Singapore

Indonesia at Present: Indonesia at Present: Financial Services Authority (or Otoritas Jasa Financial Services Authority (or Otoritas Jasa Keuangan, OJK)Keuangan, OJK) under plan to replace under plan to replace

Capital Market Supervisory Agency (BAPEPAM)Capital Market Supervisory Agency (BAPEPAM)


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Expansion of Investor Base (I)

Key Groups of InvestorsKey Groups of Investors Banks, Insurance Companies, Public and Private Banks, Insurance Companies, Public and Private

Pension Funds, Mutual FundsPension Funds, Mutual Funds International InvestorsInternational Investors Individual InvestorsIndividual Investors

A diversified and heterogeneous investor base A diversified and heterogeneous investor base promotes liquidity and stabilizes market promotes liquidity and stabilizes market demanddemanda.a. Insurance Companies and Pension Funds are Insurance Companies and Pension Funds are demanders of long-term, low risk bond demanders of long-term, low risk bond instrumentsinstrumentsb.b. Mutual Funds are demanders of short-term bond Mutual Funds are demanders of short-term bond

instrumentsinstruments


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Expansion of Investor Base (II)Policy Measures for Developing a Broader-Policy Measures for Developing a Broader-Based Market focus onBased Market focus on Moving bond instruments out of bank asset Moving bond instruments out of bank asset

portfoliosportfolios Direct access to retail and/or foreign investorsDirect access to retail and/or foreign investors Structural reform of pension and retirement fundsStructural reform of pension and retirement funds Reform or creation of mutual funds (especially Reform or creation of mutual funds (especially

bond funds)bond funds) Diverse Types of Bond InstrumentsDiverse Types of Bond Instruments


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

Municipal BondsMunicipal Bonds $1,943.3 $1,943.3 ( 8.62%)( 8.62%)Treasury SecuritiesTreasury Securities 3,720.9 3,720.9 (16.51%)(16.51%)Mortgage-Backed SecuritiesMortgage-Backed Securities 5,344.0 5,344.0 (23.72%)(23.72%)Corporate BondsCorporate Bonds 4,542.7 4,542.7 (20.16%)(20.16%)Federal Agency BondsFederal Agency Bonds 2,654.0 2,654.0 (11.78%)(11.78%)Money Market*Money Market* 2,588.0 2,588.0 (11.49%)(11.49%)Asset-Backed Securities Asset-Backed Securities 1,758.5 1,758.5 (7.76%)(7.76%)

TotalTotal $22,531.4 $22,531.4 (100.00%)(100.00%)* * includes Commercial Papers, Bankers Acceptances, and large includes Commercial Papers, Bankers Acceptances, and large Certificates of DepositsCertificates of Deposits

Unit: US$ BillionUnit: US$ Billion

Source: US Bond Market AssociationSource: US Bond Market Association


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

Municipal BondsMunicipal Bonds none none ( 0.00%)( 0.00%)Treasury SecuritiesTreasury Securities $21.73 $21.73 (45.87%)(45.87%)Mortgage-Backed SecuritiesMortgage-Backed Securities none none ( 0.00%)( 0.00%)Corporate BondsCorporate Bonds 9.43 9.43 (19.91%)(19.91%)Government Agency BondsGovernment Agency Bonds 6.06 6.06 (12.79%)(12.79%)Money MarketMoney Market n.a. n.a. (n.a.)(n.a.)Asset-Backed Securities Asset-Backed Securities none none ( 0.00%)( 0.00%)

TotalTotal $47.37 $47.37 (100.00%)(100.00%)



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

Municipal BondsMunicipal Bonds $8.28 $8.28 ( 1.40%)( 1.40%)Treasury SecuritiesTreasury Securities 121.43 121.43 (20.52%)(20.52%)Mortgage-Backed SecuritiesMortgage-Backed Securities n.a. n.a. ( n.a.)( n.a.)Corporate Bonds*Corporate Bonds* 168.03 168.03 (28.31%)(28.31%)Government Agency Bonds**Government Agency Bonds** 295.43 295.43 (49.78%)(49.78%)Money MarketMoney Market n.a. n.a. (n.a.)(n.a.)

TotalTotal $593.52 $593.52 (100.00%)(100.00%)* * 75% of Corporate Bonds are Asset-backed securitites 75% of Corporate Bonds are Asset-backed securitites**** Includes: Includes: Monetary Stabilization Bonds, National Housing Bonds, Foreign Monetary Stabilization Bonds, National Housing Bonds, Foreign Exchange Stabilization Bonds, Subway Construction Bonds, Exchange Stabilization Bonds, Subway Construction Bonds, Industrial Financial Industrial Financial Debentures, Financial Bonds, KAMCO BondsDebentures, Financial Bonds, KAMCO Bonds



Source: MOFE, Korea (2004)Source: MOFE, Korea (2004)

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Building Bond Market Infrastructure

1.1. Competitive Auction System among Competitive Auction System among Primary Primary Dealers for Government Bond Dealers for Government Bond IssuanceIssuance

2.2. Hedging Instruments for Interest Rate Hedging Instruments for Interest Rate RiskRisk

3.3. Credit Rating CultureCredit Rating Culture

4.4. Clearing and Settlement SystemClearing and Settlement System

5.5. Over-the-counter Market Trading SystemOver-the-counter Market Trading System

6.6. Inter-Dealer Broker SystemInter-Dealer Broker SystemAsia-Pacific Financial Markets Research Center, University of Hawaii

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Issuing Techniques ofGovernment Bonds

Fixed Price Public SubscriptionsFixed Price Public SubscriptionsUnderwriter consortium utilized Underwriter consortium utilized

Private PlacementsPrivate PlacementsIn the absence of well-functioning secondary marketsIn the absence of well-functioning secondary markets

Tap IssuesTap IssuesSold directly into the secondary market through Sold directly into the secondary market through

branch network of banks or securities companiesbranch network of banks or securities companies

AuctionsAuctionsMultiple price auction vs. Uniform Price AuctionMultiple price auction vs. Uniform Price Auction


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Multiple- vs. Uniform-Price Auction Method

Multiple-price auction methodMultiple-price auction method

a.a. Successful bidders pay the prices they bidSuccessful bidders pay the prices they bid…….…...….. “winner’s curse” “winner’s curse”

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

Uniform-price auction methodUniform-price auction methoda.a. All successful bidders pay the same price for a All successful bidders pay the same price for a

given securitygiven securityb.b. Hence, some successful bidders may pay a lower Hence, some successful bidders may pay a lower

price than they actually bid. price than they actually bid. Asia-Pacific Financial Markets Research Center, University of Hawaii

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Issuing Techniques ofamong OECD Members

Uniform Price AuctionUniform Price AuctionFinland, Italy, Netherlands, Norway, and Finland, Italy, Netherlands, Norway, and Switzerland, UK, USSwitzerland, UK, US

Multiple Price AuctionMultiple Price AuctionAustralia, Austria, Canada, Japan, Sweden, Australia, Austria, Canada, Japan, Sweden, UKUK

Tap IssueTap IssueUS, UK, Germany, Canada, and most of US, UK, Germany, Canada, and most of

OECD OECD members, but not Japan members, but not Japan


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Auction Methods: Government-Issued Securities

Japan United States United Kingdom

Uniform-Price Auction

None All Treasury Securities

Index-linked

Bonds

Multiple-Price Auction

All JGBs 20-Year Bond:

Competitive Auction Only

2-, 4- and 6-Year Bond: Both Competitive and Non-competitive Auction

5- and 10-Year Bond: Syndicated Underwriting

None All Securities other than Index-linked Bonds


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Hedging Instruments for Interest Rate Risk

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

B.B. Exceptions:Exceptions:China, Indonesia, Philippines, and China, Indonesia, Philippines, and

ThailandThailand


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Bond Rating Culture: Regional Bond Rating Agencies

Number of Domestic Number of Domestic Adoption of IAS Statements Adoption of IAS Statements

CountryCountry Credit Rating AgenciesCredit Rating Agencies by Stock Exchangesby Stock Exchanges

AustraliaAustralia Open to Global CRAs Open to Global CRAs YesYesChinaChina 6 6 NoNoHong Kong SARHong Kong SAR Open to Global CRAs Open to Global CRAs YesYesIndonesiaIndonesia 22 NoNoJapanJapan 3 & Open to Global CRAs3 & Open to Global CRAs YesYesKoreaKorea 44 YesYesMalaysiaMalaysia 22 YesYesPhilippinesPhilippines 11 NoNoSingaporeSingapore Open to Global CRAs Open to Global CRAs YesYesTaipei,ChinaTaipei,China 11 YesYesThailandThailand 22 YesYesViet NamViet Nam To be established To be established No No


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Clearing and SettlementGovernment BondsGovernment Bonds Corporate BondsCorporate Bonds

AustraliaAustralia Reserve Bank InformationReserve Bank Information Financial Transactions Recording and Financial Transactions Recording and and Transfer Systemand Transfer System ClearanceClearance SystemSystem

ChinaChina Government Securities Government Securities SD&CSD&CDepository Trust & Clearing Co.Depository Trust & Clearing Co.(for Inter-bank market)(for Inter-bank market)

Securities Depository and Securities Depository and Clearing Co. Ltd. (SD&C) Clearing Co. Ltd. (SD&C) (for Exchange Market)(for Exchange Market)

Hong KongHong Kong Central MoneyMarkets UnitCentral MoneyMarkets Unit Central Clearing & Settlement System Central Clearing & Settlement System JapanJapan BOJ Financial NetworkBOJ Financial Network Japan Securities Depository CenterJapan Securities Depository Center

System (BOJ-NET)System (BOJ-NET)Japanese Government BondJapanese Government BondClearing Corp.Clearing Corp.

SingaporeSingapore Government Book-Entry System Debt Securities C&S SystemGovernment Book-Entry System Debt Securities C&S System


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Bond Trading Systems: Order- vs. Quote-Driven Trading Pre-trading negotiations and personal Pre-trading negotiations and personal

relationships among bond dealers are relationships among bond dealers are critically importantcritically important

Automated trading system cannot offer Automated trading system cannot offer these relationshipthese relationship

Korea Stock Exchange’s ExperienceKorea Stock Exchange’s Experience Thai Bond Dealing Center’s Role: Thai Bond Dealing Center’s Role:

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


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Korea Stock Exchange’s Experience

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

Trading Volume ($ billion)Trading Volume ($ billion) OTCOTC KSEKSE

19991999 167167 2342342000 2000 170170 20 20

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


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Role of Inter-Dealer Brokers Brings market makers togetherBrings market makers together Disseminates trading information to the Disseminates trading information to the

market market Promote secondary market liquidity, depth, Promote secondary market liquidity, depth,

transparencytransparency Earns commission for arranging trades at Earns commission for arranging trades at

pre-agreed feespre-agreed fees Unlike market makers, no positions are Unlike market makers, no positions are

taken by IDBstaken by IDBsAdopted by: Most East Asian EconomiesAdopted by: Most East Asian Economies(Singapore, Hong Kong, Thailand, Korea) (Singapore, Hong Kong, Thailand, Korea)


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Looking Forward: What Do We Need in Asia? Promotion of Asset-Backed SecuritiesPromotion of Asset-Backed Securities Development of Mortgage-Backed SecuritiesDevelopment of Mortgage-Backed Securities Establishment of Credit Guarantee and Establishment of Credit Guarantee and

Enhancement Programs for Small- and Medium-Enhancement Programs for Small- and Medium-Size EnterprisesSize Enterprises

Financial Autonomy for Municipal Government Financial Autonomy for Municipal Government Development of Municipal Bond MarketsDevelopment of Municipal Bond Markets

Promotion of Creditor Right and Streamline Promotion of Creditor Right and Streamline Corporate Bankruptcy ProceedingsCorporate Bankruptcy Proceedings

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


Thank You!For Further References,

Please visit http://www2.hawaii.edu/~rheesg


1 An Overview of Corporate Bond Markets and Policy Issues S. Ghon Rhee K. J. Luke Distinguished...

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