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Nearly 10 years later, the results of the regionÆs collective efforts are that Asian local currency bond markets are enjoying unprecedented growth, attracting interest from global investors who have been struggling to generate returns from traditional û and even alternative û sources.
Setting the stage
Two specific initiatives, the Asian Bond Market Initiative (ABMI) and the Asian Bond Fund 2 (ABF2), set up by the regionÆs leading central banks, have paved the way for market development and will continue to fuel the regionÆs growth.
ABF2, in particular, is a prime example of the steps taken to increase access to Asian bonds. Launched in 2005, ABF2 encourages a more efficient allocation of capital by providing direct, low-cost, diversified access to Asian local currency bond markets through a family of nine bond-index tracking funds. To enhance investor participation, these funds are structured as exchange-traded funds (ETFs), which are traded like ordinary shares on stock exchanges.
Among these funds, ABF Pan Asia Bond Index Fund (PAIF) offers investors a diversified portfolio of local currency government and quasi-government bonds in China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore and Thailand. PAIF is managed by State Street Global Advisors and listed on the Stock Exchange of Hong Kong under the stock code 2821.
An efficient and mature bond market provides alternative sources of funding when banks and equity markets fail, reducing over-reliance on short-term foreign currency loans. A mature bond market also provides an opportunity to trim financing costs by bringing intermediation closer to home.
Today, AsiaÆs bond markets are still only a fraction of the size of those in more mature economies. Data from the Bank for International Settlements and the Asian Development Bank value outstanding local-currency Asian bonds at less than $2 trillion, compared with about $22 trillion of American bonds and $7 trillion of Japanese bonds. However, growing issuance, large-scale market reforms, infrastructure improvements and an increasing availability of derivatives are setting the stage for faster growth in the Asian markets.
WhatÆs more, most Asian bond returns, taken relative to their volatilities, compare favorably against their United States Treasury bond counterparts on a market-by-market basis.
Despite these positive factors, several challenges still exist in the effort to promote stability and diversification in these markets û from the variety of entrance requirements in each market, to the lack of a universal infrastructure needed to trade, clear and settle transactions, to a lack of liquidity and price transparency. Addressing these challenges will help to broaden access to the market, and ensure continued growth.
Liquidity plays a critical role in the development of local bond markets. The multitude of currencies in Asia presents an obstacle to developing active cross-issuance in the regionÆs bond markets, hurting liquidity. The issue has led to a debate about which currency should be used for the cross-issuances of bonds. One option that could be considered would be to create a small number of baskets of Asian currencies reflecting regional investment patterns that are easily quoted and traded.
Another hurdle relates to turnover and transaction costs in the bond markets, the two primary aspects of liquidity. Turnover indicates activity relative to overall market size. Transaction costs refer to the difference between buy and sell prices, capturing the impact of establishing and shedding bond positions.
Securities in Asian bond markets are typically held by a limited number of institutional investors for a long time. When combined with such factors as over-the-counter trading, limited pricing sources, and a lack of standards on how to value illiquid securities, the result is a lack of price transparency in the secondary markets.
This lack of transparency in pricing contributes to wide bid-ask spreads, making transactions unnecessarily costly and inefficient to investors.
Asian governments might consider requiring more immediate post-sale price disclosure from large investors and establish a better information framework for liquid and illiquid bonds. Ex-post pricing discovery encourages more competitive pricing and increases investorsÆ confidence that they can access them.
As transparency enhances market efficiency and fosters investor confidence, foreign investors will become more comfortable participating, which will in turn encourage more participation from foreign investors in the local Asian bond markets, which will help to enhance their liquidity.
A secure settlement system is a prerequisite for any financial market. InvestorsÆ confidence in the market, both in terms of volume and quality, is a function of a system that operates at a reasonable cost with good risk management mechanisms.
This poses an immediate challenge in Asia, where each country has its own settlement arrangements for different types of instruments, and participation in these systems generally is limited to locally regulated participants.
To enhance efficiency in settlement, these fast-growing markets need to accelerate the linkage of domestic settlement and payment systems in order to facilitate cross-border investments. For example, several Asian countries have adopted trading and RTGS/DVP (Real Time Gross Settlement/Delivery Versus Payment) systems on a transaction-by-transaction basis. Standardization of the systems among the countries to a common system platform û and linking these systems to a regional clearing and settlement intermediary û would help promote and support cross-border investment and settlement.
The promotion of global accounting standards is a key initiative that needs to be undertaken by countries to enhance the development of Asian bond markets. Currently, the lack of consistent accounting and disclosure standards across Asia results in high administration costs to investment service providers that support the ongoing operating and financial reporting requirements of bond funds.
Consistent accounting standards promote transparency and, as a result, investor confidence with accuracy, robustness and comparability across regions, as well as helping remove barriers to international capital flows by establishing greater uniformity in financial reporting requirements for participants in the capital markets.
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