The Asian high-yield bond market has received increased attention in recent years as investors have sought higher yields and excess returns on their capital. Following the emergence from the Asian crisis and the 2001-2002 recession, the expected outperformance of the region's economies promised much for the development of the high-yield asset class. However, despite some growth, the market remains very small compared to the US, and to a lesser extent, the European high-yield markets.
Those were the observations made by Richard Brown, head of credit research for Asia at Schroder Investment Management in a recent report, where he outlines why the market has not developed at a faster pace.
First, he points to the recent economic crisis. High-yield issuance took time to recover from the Asian crisis and the 2001-2002 recession but, as external conditions stabilised and recovered, the market saw increased issuance volume, particularly in 2006 and 2007. However, this momentum was stopped in 2008 as economic conditions weakened; today, the primary market remains virtually closed.
Second, the lack of disintermediation. Similar to the European debt market in the 1990s, many Asian companies are reliant on their banks for access to debt capital. Although the local banks generally provide only short-term finance, the strong lender/borrower relationships ensure ready access to debt capital at, in most cases, attractive rates of interest. The reluctance of companies to pay market rates has limited the base for high-yield issuance.
Third, the lack of private equity transactions. The US and European high-yield markets are a natural source of finance for private equity firms in financing their transactions. However, the relatively limited participation by private equity firms in Asia has limited the high-yield issue base. Brown estimates that less than 10% of public Asian high-yield issues in 2003-2008 related to private equity transactions.
Fourth, an inadequate domestic demand base. He estimates that from 2007 to date circa 50% of demand for Asian high-yield issues was met by investors in the US and Europe. The inability, or unwillingness, of regional investors to secure a higher portion of high-yield credit issued leaves the market exposed to the sentiment of international investors who, in many cases, are less aware of the fundamentals and technicals in the Asian market. This can create demand volatility.
Fifth, residual concerns over governance, transparency and legal protection. The overall level of corporate governance, corporate transparency and legal protection in Asia is below that in the US and Europe. Corporate governance suffers from the lack of an overriding regulatory body and rules vary on a country-by-country basis. Transparency is variable and inconsistent in reporting. In legal protection, creditor rights are, in most jurisdictions, less precise and less established than that received by creditors in the US and Europe.
Despite the slower than-expected market growth, there are several reasons why Brown believes that the market will continue to grow over time:
First, the region's long-term economic growth potential. The economic potential of Asia, and China and India in particular, is well documented. As these Asian countries develop, there will be a rebalancing of economic and political power -- a process accelerated by the current economic recession -- that will serve to attract capital to the region.
Second, improved corporate credit quality. In recent years, stronger economic growth has enabled governments around the region to undertake structural reforms to improve their credit fundamentals. In turn, the improved economic environment enabled Asian companies to strengthen their business and financial profiles thus underpinning corporate credit quality. For example, Asian banks have been more resilient in the current crisis than their Western peers.
Third, the benefits to issuers of bonds. There are several benefits to companies in issuing high-yield bonds; these include a more diversified funding base, a longer-term financing, an increased market profile, cheaper financing than equity and less onerous terms than bank finance.
Fourth, the globalisation of investor portfolios. The slower long-term growth expected in developed markets will continue to push investors to diversify their portfolios into higher-growth markets. The Asian high-yield market should be a beneficiary of this.
Despite the positive fundamental prospects of the Asian economies and increased appetite from global investors, Brown says more will have to be done to attract both issuers and investors.
In order for companies to broaden their debt financing sources, he says they will have to be satisfied that the high-yield bond market is a stable alternative to bank financing. Companies need to know that, when required, the high-yield market will be there to provide support. In the past, there have been examples where the market has been willing to finance companies only to show reluctance to refinance when the market turns. A greater support from the regional investor base would help provide a more stable investor base.
In order for the Asian high-yield market to develop fully, Brown says there will have to be further progress on governance, transparency and creditor rights. There have been some efforts to improve in these areas but bond investors need greater comfort that businesses are being run in a manner appropriate for all stakeholders. In addition, investors would like to see a more balanced issuer base; currently, the high-yield market is skewed towards Chinese and Indonesian issuers.