Keynote Address by Mr Heng Swee Keat, Managing Director of the Monetary Authority of Singapore at The EMTA Forum, 1 November 2006
Ladies and Gentlemen,
1 Good afternoon. It is my pleasure to address you today. Let me extend a warm welcome to all of you, especially to our foreign guests. I am delighted that EMTA has chosen to hold your inaugural Asian meeting in Singapore, and thank you for this privilege of addressing this prominent gathering of experts. As you know, we recently held the Singapore 2006 IMF/World Bank meetings. The turnout was a record, as financial institutions and investors all over the world showed keen interest in understanding developments in Asia, and the implications for financial markets.
2 Today's seminar will delve into yet another topic of much interest - the Asian bond market. I will focus my remarks on the domestic bond markets, which are undergoing strong growth and exciting developments. To give some perspective, I will briefly review the past developments and the current state, and venture some views on how the market will evolve in the future.
3 Outside of Japan, Asian domestic bonds did not exist as an asset class before the 1997 crisis. While a market for government and central bank notes did exist, this was small, amounting to about US$600 billion or 20% of Asia's GDP. In contrast, the US and Europe had debt markets that were several hundred percent of their GDP. Not only was the Asian market small, but it was illiquid. There was no readily accessible primary market that private borrowers could tap. Nor was there active trading on the secondary market as most securities were held to maturity.
4 Without a viable domestic bond market, most Asian corporates relied on bank loans for their debt financing. The presence of fixed or semi-fixed exchange regimes encouraged corporates to borrow in foreign currencies, which exposed them to exchange rate risks. When the financial crisis broke in 1997, this exacerbated the initial loss of confidence, and the contagion spread rapidly across sectors and countries, resulting in bank failures and corporate insolvencies.
5 Following the crisis, many Asian countries worked on developing a local bond market to provide an alternative source of financing for borrowers. Individually, countries built the basic infrastructure for a bond market - a robust government yield curve, a primary dealer system, public offering processes, and settlement and custody facilities. Collectively, they worked to integrate the markets through the Asian Bond Market Initiative (ABMI) and to promote interests in the bond market through the Asian Bond Funds.
6 This brings us to the present. Compared to the state of Asian bond markets in 1997, today's market is significantly bigger and more liquid. In 1997, the size of the market was less than US$600 billion or about 20% of GDP. Now, it has more than quadrupled to US$2.7 trillion, or 45% of GDP. Roughly 40% of the market is in China, a quarter in Korea, 15% in ASEAN and 10% in India. A recent investment bank research noted that should one construct a global emerging market local currency bond index using market capitalization, Asia will take up the largest component, accounting for more than half of the index.
7 Besides market capitalization, the character of the market has also changed. In 1997, most of the issuance came from governments and financial institutions. A domestic corporate bond market did not exist in most Asian countries. Now, it amounts to US$360 billion. As the investor base becomes more sophisticated, the securities issued have also become more complex. In Singapore, more than half of private issuance last year was in the form of structured debt, such as CMBS, ABS and credit-linked notes.
Challenges for the Asia Bond Market
8 Have we therefore succeeded in building a vibrant Asian bond market? Not yet. It would be more accurate to characterize the Asian bond market as still a work in progress. While we have come a long way, and some countries have gone further than others, much remains to be done. Allow me to suggest the improvements we need to work on, under two broad themes - liquidity and accessibility.
9 Liquidity. The level of market liquidity varies from country to country. For government bonds, the bid-ask spread ranges from 2-3 basis points for Korea and Singapore, to 4-8 basis points for Malaysia and Thailand, to more than 10 basis points in Indonesia. The level of liquidity is much better than most emerging markets in Latin America and Eastern Europe. But compared to the developed markets, where bid-ask spreads are generally below 1 basis point, there is still room for improvement.
10 To some extent, liquidity depends on the size of the market. Hence, as the Asian bond market continues to grow, liquidity will gradually improve. But size alone is not enough. We need other measures to improve liquidity. First, we need to improve price transparency. Greater price transparency will draw in more participants, encourage more trading and ultimately lead to a deeper market. For this reason, many Asian countries have or are considering moving their bond markets to multilateral platforms, which can broadcast both pre- and post-trade prices in a timely way.
11 In Singapore, the Singapore Government Securities e-platform which was launched in July last year was very well-received. Within a couple of months, the level of foreign participation in the market almost tripled, from about 5% to 13%. Since then, Thailand has also launched an electronic platform; Indonesia and Malaysia are in the midst of building theirs; and Korea and Hong Kong have announced that they are studying plans for a platform.
12 Second, there should be the ability to short-sell. Admittedly, some regulators are still wary of the whole notion of short-selling. In our view, a market that has both long and short positions is deeper, and ultimately more stable, than one where everyone is long. Short-selling will also encourage relative value plays between securities as well as between markets, thereby leading to more efficient pricings. Even in markets which permit short-selling, more can be done to facilitate the borrowing of securities to deliver.
13 Third, an active derivatives market will lend liquidity to the cash bond market. This could be in the form of futures, as in Korea and India or in swaps, as in Hong Kong and Singapore.
14 Fourth, broadening the investor base will help deepen liquidity. A more diverse pool of investors mean that we are more likely to find buyers and sellers at each price level, thereby deepening the market. Most Asian markets are still dominated by local investors, comprising mostly banks, insurance companies and pension funds. Anecdotal evidence suggests that on average, non-resident investors hold less than 5% of Asian bonds.
15 How do we bring in more foreign participation? This brings me to the second broad theme of improvement - accessibility. After the financial crisis, most Asian economies lifted restrictions on foreign participation in their bond markets. Currently, only China and India maintain limits on foreign holdings, but even then, the authorities are gradually loosening these limits. But I believe we need to go much further - beyond removing barriers to foreign participation, we should be actively facilitating foreign participation, and integrating our markets into the global system.
16 There are several ways we can facilitate these developments. First, in clearing and settlement. Asia does not have a single point of access like Euroclear for Europe and DTCC for the US. So an investor seeking to hold a portfolio of Asian bonds will have to set up individual accounts in each of the Asian countries, with different tax forms and different disclosure requirements, often running into minute details. Some streamlining will certainly be helpful. We should also be removing withholding tax. Apart from Singapore, most markets still charge some form of profit or withholding tax. To facilitate investment in corporate bonds, the existence of good credit rating agencies are important. International rating agencies have a fairly low level of penetration, focusing mainly on large companies that issue in the cross-border market. There is room for greater access for international rating agencies, while local rating agencies need to be more transparent in their rating methodology to gain credibility and acceptance amongst global investors.
17 Let me now turn to future developments. First, Asian bond markets are likely to continue to grow at 10-15% per annum in the next 10 years. This will make it almost US$10 trillion in 2015, about half the size of the US bond market and bigger than the Japanese bond market today. Growth will come from the rise in corporate financing needs, as domestic investments and M&A activities pick up. The average rate of investment in the last 5 years is 25% of GDP, still fairly low compared to the pre-crisis levels of 35%. Growth will also come from household financing, as rising affluence results in more mortgages, hire-purchase and consumer loans. Finally, growth will come from the large infrastructure financing needs in Asia. In the next 5 years, Asia is expected to need to spend up to US$250 billion per year on infrastructure.
18 Second, we can expect the level of foreign participation to increase substantially. This will be driven from both the demand and supply perspectives. On the demand side, foreign investments today are overly concentrated in equities. Including bonds will lead to more balanced portfolios. Conferences, such as this, will help promote better understanding of Asian bond markets. On the supply side, as more countries, including China and India liberalize, access will improve. The current environment of ample liquidity also cannot persist indefinitely, and issuers will have to seek new investors, including overseas investors.
19 Third, we can expect multi-market bond vehicles to proliferate. This could be in the form of ETFs, index-linked notes, bond mutual funds, or collateralized debt obligations. The impetus will come from investors who are looking for a broad exposure to Asian bonds rather than to individual issues. The impetus will also come from investors, who are looking to expand into the more opaque, more fragmented, but potentially more lucrative private debts, such as leveraged loans and SME debts.
Singapore's Position in the Asian Bond Market
20 As you can tell, we are very optimistic about the Asian bond market. We are keen to see the market succeed, because a well-functioning Asian bond market will enhance the overall financial stability in Asia and minimise the chances of another Asian crisis. Singapore is in a strong position to contribute to the development of this market as we have a number of banks hubbed here, with growing activity in cross-border structured securities.
21 I believe Singapore can contribute on 2 fronts. The first front is to work with our fellow regulators in Asia in regional forums like the Asian Bond Market Initiative (ABMI) and the ASEAN Capital Markets Task Force to harmonize market conventions, raise transparency, lower investor barriers and integrate markets.
22 The second front is to enhance the market in terms of liquidity, research and talent. Singapore already has a sizeable pool of liquidity and talent here, which we will work to enhance. We hope greater collaboration among the key players can deepen our knowledge of the Asian environment further.
23 In conclusion, I believe the Asia bond market has come some way since the Asian financial crisis. It is in the midst of a very exciting phase of development. For those of you who are not already involved in this market, I would invite you to take a closer look. And for those who are intimately involved, I hope we could work together to deepen it further. On that note, I wish you a very successful and fruitful conference.