Leung: Investors hold positive view on the renminbi in the long term

Liquidity is a major concern for investors when they tap the Asian local currency bond and sukuk markets. It is what these markets need to attract more issuers and thus increase the paper supply.

Many investment managers express strong interest in the Asian local currency bonds because they want to have currency exposure and credit risk diversification, as well as to generate higher yield. Japanese investors like the paper as they are getting yields higher than the 1% they are being offered at home. They have strong yield appetite and they crave for high yield corporate, leveraged loans as well.

“Yield plays an important role in the demand for the Asian local currency bonds,” says Michele Leung, associate director for fixed income indices at S&P Dow Jones Indices. “The five-year Chinese government bonds, for instance, are yielding around 4%, which is much higher than the 2.5% for the US treasuries. Investors continue to hunt for yield and want to have different exposure. Of course, China is a good sovereign risk with a higher credit rating compared with many countries in the region.”

The S&P Pan Asia Bond Index tracks around US$6.6 trillion equivalent of Asian local currency bond issuances September 10 2014 in 10 countries in the region, namely China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand. It’s China sub-index S&P China Bond Index is tracking about 24 trillion renminbi (US$3.9 trillion) worth of bonds, of which 67% are government bonds.

China has doubled the size of its local currency bond market since 2006 and continuously maintains its market share dominance in the region. However, Indonesia and the Philippines have demonstrated faster growth rates during the same period by expanding their markets by more than four-fold and three-fold, respectively.

There are a number of factors driving the growth of the local currency bond markets. For instance, China has been adopting regulatory measures to allow more investors to come into the market and has likewise relaxed the listing criteria.

As Leung points out, the demand for renminbi-denominated bonds is underpinned by the fact that China has a more stable currency compared with say, the Indian rupee and the Indonesia rupiah, although the renminbi has depreciated at the beginning of 2014. But investors still hold a positive view on the currency in the long-term, which is why global investors are still looking to access the China market, she adds.

On the supply side, several countries in the region are expanding their issuer base. Again in China, market access is challenging -- a reason corporates are raising funds in different markets such as in US dollar as they likewise want to diversify their currency exposure.

For fund managers, the key concern for them in tapping the Asian local currency bond markets is the liquidity issue. “I know some of the exchange-traded fund (ETF) providers want to offer exposure to the local currency credit, but liquidity is their main concern,” says Leung. “In China, bonds traded actively in the first and second months following their issuance, after which trading comes to a halt. So it is difficult for the fund managers to source the paper.”

The S&P Dow Jones Indices also tracks the sukuk market through Dow Jones Sukuk Index. Leung notes the sukuk market outside of Malaysia will continue to pick up but in a slow pace. “It will take a time for this market to grow and mature,” she asserts. “While there is interest to invest in sukuk, the key concern is liquidity and it is something that is needed to be addressed.”

To enhance the popularity and acceptance of sukuk as a funding instrument, Leung says regulatory efforts and investor education should continue since sukuk is still considered a new term to many investors. There is also a need to enhance liquidity to attract both issuers and investors into the market. The liquidity threshold for the sukuk is US$1 billion – the level at which an issue gains more traction in terms of liquidity, according to the Dow Jones Sukuk Index.

Leung explains there is a place for sukuk in a market such as Hong Kong, a leading global financial centre that offers various funding avenues, and where highly-rated corporates enjoy easy access to the conventional bond market and the bank loan market. “In my previous shop, whenever we saw a sukuk coming into the market, there was a lot of interest from our high net worth clients. Investors perceived the sukuk as less risky than conventional bonds as the sukuk enforces a collateral structure.”

As tracked by the Dow Jones Sukuk index, the liquidity of the sukuk market in 2013 showed a slight improvement during the year despite a 13% decline in global issuance volume. The average monthly trading volume of 32 of the 39 constituents of the index was US$43 million, par amount, in 2013, up 5.7% from 2012.