Importance of Domestic and Regional Bond Market Development - Emerging Markets: Formulation of Strategies for entering d

1. Importance of Domestic and Regional Bond Market Development- Emerging Markets: Formulation of Strategies for entering domestic and international bond markets 6th UNCTAD Debt Management ConferencePresentation by Dr. William Willms, Director Asian Development Bank 21 November 2007

2. 2 Table of Contents Section 1: Overview of ADB and its Public and Private Sector Operations Section 2: Formulation of Bond Issuance and Domestic Bond Market Development Strategies Section 3: Bond Market Development in Asia Section 4: Asian Bond Market Initiative (ABMI) APPENDIX

3. 3 Section 1: Overview of ADB and its Public and Private Sector Operations

4. 4 ADB Overview Mission: Improving the welfare of the people in Asia and the Pacific by helping developing member countries in sustainable economic growth Members: 67 members, 48 from the region and 19 from other parts of the globe Legal Status: International Organization with diplomatic status Offices: In 22 member countries in Asia with HQ in Philippines Key modalities to promote growth: Lending to member countries Policy dialogue Technical assistance for policy/regulatory development Investment in private sector companies Volumes: ~$6 billion annually (loans & equity), $180 million (Technical Assistance) Rating: �AAA� by S&P/Moody�s/Fitch

5. 5 ADB�s Unique Positioning ADB is a unique international financial institution Public sector activities and private sector operations are under one roof Solely focused on Asia Synergy between policy work and private sector investments Policy dialogue with governments on the enabling environment for private sector investments ADB can catalyze private sector resources for specific projects/transactions Focus areas of Public Sector Departments: Banking and Financial Sector Infrastructure Development Social Sector Focus areas of Private Sector Operations Department: Infrastructure (Infrastructure Division) Financial Institutions (FIs) and Capital Markets (Capital Markets and Financial Sectors Division)

6. 6 Section 2: Formulation of Bond Issuance and Domestic Bond Market Development Strategies

7. 7 Government Bond Issuance and Development of Government Securities Market are intrinsically linked Government bond issuance activity is key to Fund fiscal deficits and smooth consumption or investment and to build FX reserves Development of domestic bond markets - create benchmark issues and yield curve for valuation of sovereign credit risk Important to take holistic view when tapping bond markets Fiscal perspective Assess need and ability to develop Domestic Bond Market Implications of International Market exposure for whole economy like (i) effects on cost of foreign borrowing for entire economy; (ii) country`s creditworthiness, and (iii) FX exposure

8. 8 Importance of Domestic Bond Market Development of domestic bond market is key to: Financial Stability as shown during the Asian Financial Crisis by reducing foreign currency exposure and improving financial intermediation Dispersion of Risks: Avoiding concentration of intermediation uniquely to banks Efficient Allocation of Resources: Market interest rates reflect opportunity cost of funds at given maturity Efficient Pricing: Increase price competition instead of relying on banks only Corporate Funding: Create possibility of matched currencies Domestic Savings: Stimulate domestic Savings Reduce Cost: liquid and deep government bond market will over time reduce debt service cost Reduces risk of Government relying too heavily on (monetary) central bank funding Deep money and bond markets influence effectiveness on Central Bank`s monetary policy

9. 9 Successfull Development of Government Securities Market depends on Enabling Environment� Not always necessary Government has no budget deficit Country not large enough to support necessary infrastructure Other options available (private placement of securities; development of retail market; regional solutions) Efficient bond markets are characterized by Competitive market structure Low transaction costs Low levels of fragmentation Robust and safe market infrastructure High level of heterogenity among makrert participants Concentrate first on Establishment of basic prerequisits Credible and stable Government Sound fiscal and monetary policy Effective legal, tax and regulatory infrastructure Adequate settlement arrangements Liberalized financial system with competing intermediaries

10. 10 � and Formulation of a Sustainable Debt Issuance Strategy Market-oriented Funding Strategy Market determined interest rate Strategy taking into account (i) size of country; (ii) matched macroeconomic policy framework and issuance denomination; (iii) development of institutional investor base Broad market access and fairness Close coordination of debt management/fiscal and monetary policy makers Create prudent risk management mechanism (quantify/qualitfy and regularly monitor and measure Market, Liquidity, Roll-over, Credit, Settlement and Operational Risks) Development of primary market structure Establish efficient sales procedures (auctions, retail schemes, tap sales, and/or syndication) in light of investor base and state of financial system development Determine how technology can be used to create new distribution channels Determine merits for usage of primary market dealers Consider regional integration and cooperation issues

11. 11 Certain Issuance Considerations Define optimal Issuance Features Bond Features: Fixed vs. Floating; Maturity; Denominaiton; Size; Redemption Scheme Timing: External environment like emering market credit spreads and developments in mature bond markets and domestic environment Borrowing Cost: Appropriate spread over used benchmark and market comparables Placement: Liquidity considerations and Investor Base as well as bond placement issues (public/ private and underwritten/best efforts/coupon floors) Rating: Investor requirements and rating agency selection Advisors: Associated issuance cost and appointment of third-party Lead Arranger and Legal advisors Domestic versus International Issuance Cost of borrowing Avoidance of Crowding-out Debt Service and Repayment of Principal Ability

12. 12 Government Securities and Yield Curve Considerations Establishment of domestic Government benchmark yield curve is� Key building block for development of liquid bond market and overall credit curve Basis for pricing other fixed income instruments, i.e. key building block for the development of other segments of the financial market (e.g. FX hedging etc) Provides valuable information about expectations of likely macro economic developments and market reactions to monetary policy Issuance of Benchmark Securities driven by Concentration on popular standard maturities (3-6 months and 2, 5, 10 years) to create liquidity But necessity to Build the Curve (spreading benchmark issues across range of maturites) Certain issuance size needed for liquidity but to be balanced with frequency in case of small market Establish buy-back and re-opening programs Actions to prevent manipulation Keep it simple (Treasury bills and bonds; fixed over floating) and aim for standardization (to avoid market fragmentation) Consolidate wide spread public entity issuance

13. 13 Section 3: Bond Market Development in Asia

14. 14 Lessons learnt from the 1997/98 Asian Financial Crisis Asian Crisis culmination of a twin crisis� Currency Crisis: due to volatile capital flows Banking Sector Crisis: due to rising volume of bad loans � crystalized certain key financial risks Large account deficits financed by unhedged short-term (foreign) capital inflows Excessive realiance on commercial banks for domestic financing (especially when banks are inadequately supervised and lack prudent risk management capacity) Doube mismatch problem (currency and maturity mismatches created by borrowing short term in foreign currency to finance long-term local currency investment) Development of DOMESTIC and REGIONAL BOND MARKETS key to regional financial stability Reduce the double mismatch problem (currency and maturity) Reduce over-dependence on bank borrowing and diversifying financial risks Provide alternative sources of financing for (long-term) private and public investment Provide alternative mode of wealth holding for Asian households Reduce information asymetries

15. 15 Issues and Challenges going ahead for fully developed local bond markets across region Lack of liquidity especially for corporate bonds in both primary and secondary markets Lack of diversified investor base � the more investors the more trading activity Lack of hedging instruments such as currency swaps Lack of investor confidence in legal and judical systems to hold and enforce contracts No reliable benchmark yield curve to price long term risk Bond issuances are not regular and often all or parts of tender issues are rejected to keep interest rates on Government bonds low Market infrastructure is immature with weak clearing systems and settlement systems Lack of readily available public information which limits market`s ability to assess credit quality Lack of timely information which would typically generate market reaction and market acitivy Lack of post trade transparency which helps to reduce differences in spreads and promotes liquidity

16. 16 Key Policy Recommendations for ASEAN+3 Countries Enhance Market Efficiency Remove policy distortions that effect efficient allocation of savings Strengthen regulation and supervision of financial sector � introduction of international accounting and disclosure standards Need to develop benchmark yield curves Improvements in market infrastructure to enhance transparency and security of transactions (appropriate issuance and bidding modalities and delivery and settlement systems) Create measures to enhance Secondary Market liquidity Rationalization of taxes needed � abolish any ad hoc tax treatment Revise/issue new laws, rules and regulations to adapt to dynamic global market Key is well-defined plan to develop the government and corporate bond markets For example Malaysia � Capital Market Master Plan Philippines � Capital Market Development Plan Thailand (Appendix)

17. 17 Section 4: Asian Bond Market Initiative (ABMI)

18. 18 Introduction to ABMI Overview Initiative endorsed by the ASEAN+3 Finance Ministers Meeting in August 2003 in Manila, Philippines ABMI aims to develop efficient and liquid bond markets in the ASEAN+3 region Participation of countries in the initiative is on a voluntary basis ADB as Focal Point and Facilitator Focal Areas Facilitate access to market via a wider variety of bond issues in Asia Enhance domestic market infrastructrue for bond issuance Enhancing Regional Market Infrastructure: (i) regional settlement and clearing system; (ii) strengthening local rating agencies; (iii) regional credit guarantee mechanism Working Group 1: New Securitized Debt Instruments Working Group 2: Credit Guarantee and Investment Mechanisms Working Group 3: FOREX Transactions & Settlement Issues Working Group 4: Rating Systems

19. 19 Further ADB efforts in improving local bond markets include.. Technical assistance and policy advice addressing impediments to domestic bond market development and creating the enabling environment and supporting market infrastructure For example Thailand Capital Market Program Securitization Law program in PRC, Kazahkstan, Phlippines Non Performing Law Initiative in the Philippines, India, Malaysia, PRC Provision of (partial/full) credit and political risk guarantees Issuance of ADB bonds in local currencies to promote national and regional bond market development Support of reginal cooperation through Asian Bond Market Initiative (ABMI)

20. 20 ADB efforts in improving transparency and information dissemination � Asian Bond Online Asian Bonds Online Website (http://asianbondsonline.adb.org) Launched May 15, 2004 � a one-stop information site on ASAEAN+3 bond markets Completed studies of working groups can be downloaded from this site 2000 vistor sessions per day Unique Features of Asian Bonds online Free access (to leading bond market indicators comparable across the ASEAN+3 economies) Updated Government Policies and Regulations How to buy bonds (providing investors the step-by-step mechanics of buying and trading government and corproate debt securities covering the entire ASEAN+3 economies) Asian Bond Glossary Asian Bond Monitor A bi-annual (April/November) publication

21. 21 ADB efforts in establishing domestic yield curves � ADB`s Local Currency Bond Issuance Program ADB providing benchmark issues in various domestic markets Samuari bonds in the 1970s opening up the Japanese capital markets Philippines (2005), Malaysia (2005/2006), People`s Republic of China (2005), India (2005), Inonesia (2006), Thailand (2005/2006), Kazahkstan (2007) Newly established Asian Currency Note Program (under English law and ADB MTN Documentation Various domestic bonds planned Funds raised are used as matched re-financing for local currency lending activities of ADB`s Private Sector Department in Asia Emerging Markets

22. 22 ADB�s Private Sector Department`s Role in Capital Market Development: Example of a Securitization

23. 23 Progress and Trends: Looking ahead for Asia`s bond markets Emerging East Asian bond markets are expanding rapidly Excluding Japan, local currency bonds have increased from USD 448 billion in 1996 to over USD 2.8 trillion as of December 2006 Growth in corporate bond market fuelled by demand for annuity by contractual savings institutions Growth in government bonds spurred by Strong infrastructure spending Sterilization requirement Asia`s debt markets will continue to attract global investors if they develop risk based regulatory environment Improve risk hedging options Adopt measures to improve risk management Improve market infrastructure (including securitization markets)

24. 24 Appendix

25. 25 Need for Regional Bond Market as Key Lesson of Financial Crisis Development of regional bond market key to regional financial stability as they can Reduce the double mismatch problem (currency and maturity) Reduce over-depence on bank borrowing and diversifying financial risks Provide alternative sources of financing for (long-term) private and public investment Provide alternative mode of wealth holdings Asian households Reduce information asymetries Hongkong, China; Singapore; Taipee,China and Korea have developed succesfully domestic bond markets

26. 26 Some considerations for international issuance

27. 27 Thailand : Measures taken to develop bond market Building a benchmark yield curve Primary dealers are assigned to submit end of the day indicative quotes for Government Bonds for yield curve construction) Anouncing government debt issuance calender In order to enhance continuity, predictability, and transparency of bond issuance Developing and electronic bidding process Online bidding instead of receiving bids on paper (since 2003) Introducing non-competitive bidding system Since 2007 for certain investors - their effective yield curve will be equal to the weighted average accepted yield of th competitive bids resulting in wider investor base Allowing foreign entities to issue bath bonds (ADB first issuer) Broadening investor base Education of retail investors and MOF issuance of savings bonds as an alternative investment instrument for retail investors, while non-resident investors are tax-exempt for returns

28. 28 Thailand : Measures taken to develop bond market (cont.) Developing Hedging instruments Derivatives Market Act in 2004 (Futures Exchange Market) Centralizing the securities depository and clearing and settlement system Since 14 May 2006, the depository of public debt securities has been migrated from the BOT to the Thailand Secuirties Depository (TSD) Prior to that, the clearing of government bonds has been at BOT and corproate bonds at TSD Centralization will help efficiency and reduce costs Encouraging corproate bond issuance Securities and Exchange Comission (SEC) as capital market regulator has been making efforts in pushing through regulations for securitization and streamlining the process for corproate debt securities issuance E.g. the SEC filing and credit rating have been waived for debt issues with an offer amount not exceeding 100 million baht and with transfer limit of not more than 10 holders Expand shelf-filing to include investment grade long-erm bonds

29. 29 ADB as Guarantor in Securitizations: Full credit Wrap ADB�s triple-A rated guarantee benefits both issuers and investors by lowering overall financing costs, improving marketability and liquidity, diversifying portfolios, and adding credit strength to assets, structures and countries ADB�s financial guarantee is an unconditional and irrevocable promise to investors that they are paid the full amounts due to them under bonds, should the issuer fail to pay Principal and interest repayments will be made by the issuer according to the original schedule when the securities were issued An ADB Wrap provides the ultimate structural protection When a bond is guaranteed (or insured/wrapped) by ADB, it automatically receives a triple-A rating regardless of its true, underlying transaction (shadow) rating ADB typically requires the underlying transaction rating to be investment grade by one or two rating agencies (S&P, Fitch and Moody�s) Alternatively provision of principal only guarantees or political risk insurance (Four point insurance: Expropriation, Transfer and Convertibility, Political Violence, Breach of Contract)

30. 30 Case Study: Kazkommertsbank Series 2007 New Features

31. 31 Contacts