Capacity Building for Asian Bond Market Development

1. Capacity Building for Asian Bond Market Development November 4-6, 2005 Shanghai, China Noritaka Akamatsu The World Bank

2. Agenda • Macroeconomic backgrounds and objectives • The current state of the markets in the region. • Challenges and strategy • Capacity building

3. Macroeconomic backgrounds • High level of savings but with significant variance among the economies. • from 19.5% in the Philippines to 47.1% in Singapore. • High level of investment needs particularly in infrastructures to sustain the high growth. • Growing intra-regional trade in goods and services. • Growing theoretical possibility to mutually hold regional currencies. • Possibility to use a basket of regional currencies?? • Money and bond market as a place to manage regional currency exposures.

4. Objectives • Better utilize the regional savings for regional development to reduce the risk of currency and maturity mismatches. To do so, • develop the domestic debt markets to mobilize long-term savings in domestic currency to finance infrastructures and businesses that generate returns in domestic currency; and • Enable cross border investment and trading of the bonds to recycle the regional savings for regional investments.

5. The current state of the region’s bond markets • Disparity in the level of development of the domestic markets and the institutional investor sectors. • Domestic debt is greater than external debt in mostcountries. • Domestic debt is mostly local currency denominated. • Public debt securities dominate total fixed income markets in a few countries. • Fixed rate bonds dominate most markets, and most are mid to long term maturities (an Asian characteristic). • Negligible cross border investment and trading of local currency bonds.

6. Challenges • Further develop domestic debt market. • Harmonize and standardize the domestic bond markets in the region. • Policy coordination among member countries. • Managed liberalization of capital account control. • Mutual recognition of relevant laws and regulations. • Building a regional settlement network. • Building guarantee facilities for credit enhancement among regional members. • Building an investor base.

7. Strategy? • Need to identify and sort out intermediate objectives. • Government debt, sub-sovereign debt and corporate debt are different animals (e.g., trading, disclosure, listing, credit rating, guarantee, etc.). • Markets for USD / Euro / Yen-denominated bonds and domestic currency-denominated ones are different. • Need to develop a roadmap. • Domestic market development is a necessary but not sufficient condition for regional integration. • Identify intermediate objectives that can be achieved through the domestic market development and those that are required for regional integration. • Need leadership at the regional as well as national levels.

8. Capacity building – 1Domestic public debt market • Emerging markets: • Enhance the government treasury and debt management to build benchmarks. • Emerged markets: • Build sub-national debt market with a sound contingent liability management framework and capacity at the central government level. • MOF or public debt management office need to build the capacity.

9. Capacity building – 2Harmonization & standardization • Taxation of capital income and financial transactions should be rationalized and reasonably standardized not to distort the flow of funds. • Avoid imposing withholding tax on foreign investors whose income is taxed again in their home countries. • Accrual and market value-based accounting should be the basis of prudential rules and risk management. • Accounting and tax rules should support securitization and asset backed securities (ABSs). • Off-balance sheet transactions and “true sale” of assets particularly in economies with a Civil Code legal tradition. • Tax and accounting authorities need to work with the securities regulator and market participants.

10. Harmonization & standardizationRegulation • Regulations should avoid inadvertently imposing unnecessary inflexibility or irrational restrictions or on investment in and trading of bonds. • Investment and prudential regulations for insurance and pension funds. • Review rules regarding the investment in bonds denominated in local currencies of the region. • Insurance and pension regulators need to work on the insurance companies, pension funds and asset managers as well as their counterparts in the region.

11. Harmonization & standardizationTransaction standards • Transaction conventions should be standardized in line with international practice (i.e., BMA-ISMA standards). E.g., • quoting convention, yield calculation method, trading units, trade agreement format, settlement cycles, settlement instruction format, master repo agreement, etc. • Trade association or SRO of market participants needs to work on this and coordinates with their counterparts in the region.

12. Capacity building – 3Policy coordination • Capital accounts of member countries need to be liberalized to allow money to flow reasonably freely across the border but with due regard to countries with structural weaknesses in the balance of payments. • Hong Kong, Korea, Singapore, Indonesia and Japan have no capital account controls regarding cross border bond investment and trading. Other economies in the region have some restrictions particularly regarding outbound investment. • MOFs and Central Banks in the region need to coordinate.

13. Capacity building – 4Cross-border settlement • Cross-border investment and trading occurs only within a framework where settlement is “possible,” “efficient” and “secure.” • In a multi-jurisdictional environment, a mutually agreeable legal basis is needed to ensure ownership of securities held in custody in a third country and its transfer. • In a multi-currency environment, a mechanism and an institution may be needed to support settlement in different currencies and cross-border DVP. • Is a CLS Bank needed to support Asian currencies for continuous linked settlement?

14. Cross border settlement • Custody arrangements • Direct access to local CSD, use of local custodian, CSD network, ICSD, global custodian • Central bank vs. private CSD • Central banks can network but cannot realistically compete for consolidation in the foreseeable future. • Private CSDs can compete for consolidation but may take time to materialize. Governance and access are critical. • ICSD (e.g., Euroclear, Clearsteam, etc.) would come only when there is sufficient business. • Domestic custody arrangements need to be consolidated. Central banks, CSDs and global custodians need to cooperate and compete.

15. An incentive? Regional central banks can mutually agree to accept highly creditworthy (sovereign?) bonds denominated in regional currencies as collateral for intra-day overdraft facilities of RTGS systems. • RTGS has become a standard which requires intra-day liquidity. • Enhance collateral value of regional bonds • Need sound prudential rules (e.g., mark-to-market?, haircuts?)

16. Capacity building – 5Non-government debt • Local government and other sub-national debt is critical to finance infrastructure investment. • Implicit and explicit guarantees by the central government create a challenge for sovereign risk management. • Regulation should demand adequate disclosure and credit rating to ensure market discipline for the issuers. • The central government should build an adequate capacity to control, monitor and manage contingent liabilities. • Implicitness of the guarantee should be made reasonably clear in relevant law and regulation to investors across the region.

17. Non-government debt • There should be commonly acceptable rules for public offering across the region. • Corporate bonds offered publicly in one economy should be considered to be publicly offered in the region. • Economies in the region should strive to give mutual recognition to requirements and standards for public offering and issue registration. • There should be commonly acceptable rules for credit rating across the region. • Economies in the region should strive to give mutual recognition to credit rating offered by local credit rating agencies as well as international ones. • Local credit rating agencies should strive to enhance their quality and standards to compete with international CRAs.

18. Capacity building – 6Investor base • Economies differ in the level of development of institutional investor base. • Singapore, Hong Kong, Korea, Malaysia have a large institutional investor base while others’ are still small. • Pension and provident funds need to be developed in line with welfare policy objectives. • Mandatory insurance for auto, housing, etc. • Consider ways to enable participation of individuals in the bond market. • Investment / mutual funds • Smaller denomination bonds • Bank branch network and internet for distribution and possible trading.

19. Credit rating and guarantee • Is there a need of a regional credit rating agency?? • Ownership, governance, commercial viability, competition, lines of business and sources of income, etc. • Promote mergers among local CRAs?? • Credit guarantee based on a commonly acceptable standards would be useful (e.g.., asset backed securities) • Create a regional credit guarantee company like Asia Limited? • If so, need to ensure commercial viability with sufficient capital and sufficient business volume.

20. Asset-backed securities (ABSs) • An APEC initiative. • Disparity in the level of development among markets. • A lot of complex issues in the domestic market where further development is necessary. • Legal (e.g., bankruptcy-remote STP, company vs. trust, etc.), • Regulatory (e.g., prudential rules for the settlor, public offering, trading, etc.), • Accounting, • Taxation (e.g., neutrality on transfer of assets), • Market infrastructure (e.g., asset registration systems.), etc. • Credit guarantee based on a commonly acceptable standards may be useful for acceptance across the region.

21. Conclusions • A complex set of complex tasks. • Need a strong commitment and high level leadership both at the domestic and regional levels to push the agenda forward. • Existing regional initiatives: • ASEAN + 3 • Currency swap arrangement among regional central banks • TAs for domestic market development. • Asia Bond Fund (USD-denominated bonds). • APEC securitization and ABS market initiative • Asia Bond Corporation (ABC) • Enough, too little or too much?