This article is adapted from a feature story that originally appeared in AsianInvestor's Spring 2020 edition, which was published just as the coronavirus had begun to spread across the world. 
 
Taiwan's exchange-traded funds (ETFs) have been growing apace over the past two years, courtesy in the main from demand of local life insurers for offshore bond products.
 
But there are reasons for the bond ETF market growth to moderate this year. And coronavirus concerns are not the only reason.
 
Taiwan's Financial Supervisory Commission (FSC) has introduced a set of new bond ETF restrictions to maintain market stability, believing it isn’t healthy for onshore fund houses to rely too much on selling one type of product. The new rules are also to control insurers’ investment risks, Serene Hsieh, director for financial services ratings at Taiwan Ratings, told AsianInvestor.
 
As such, there may be less supply of bond ETFs in the market this year, while insurers’ allocation level will be about the same, she said.
I wouldn’t be surprised if the regulators put in more rules to further safeguard investors and mitigate risks. However, it would be more a question to the regulators as to how and when further rules would be introduced.
“I wouldn’t be surprised if the regulators put in more rules to further safeguard investors and mitigate risks. However, it would be more a question to the regulators as to how and when further rules would be introduced,” said Jackie Choy, director of ETF research for Asia at Morningstar.
 
Until that happens, however, the drivers of bond ETFs look set to be strong. Insurers in Taiwan do not have any other suitable investment vehicle to gain offshore exposures, a general manager of a global fund house who declined to be named told AsianInvestor. The fund house does not issue any bond ETFs in Taiwan.
 
One impact of the regulator’s restrictions is that the insurers cooperate more over investing in new bond ETFs. The inability of one insurer to take up most of an ETF means that it will likely need one or two peers to assist it, and as a result the product will not be as tailor-made for any insurer’s particular needs. But that’s unlikely to prove a major hurdle, given that Taiwan’s life insurers all have similar duration requirements, added Kelvin Kwok, analyst for Asia financial institutions group at Moody’s. 
 
The bond ETFs are also more favourable in terms of concentration than bond mutual funds, in which insurers can only invest a maximum of 10% of assets under management. Moreover, bond ETFs have higher tax incentives. Their ability to let insurers gain overseas exposure and have a large say in the type of assets they get access to mean their interest will remain strong, Donna Chen, founder and president of Taipei-based market research house Keystone Intelligence, told AsianInvestor.
 
GOING DEFENSIVE
 
Then there’s the economic environment. Taiwan insurers are preparing for an economic downturn, which they originally anticipate to take place next year, but has arrived earlier than expected due to the spread of the coronavirus.
 
As part of their preparations, many have started to de-risk their investment portfolios and gradually reduce their exposure to listed stocks. But bond ETFs offer a good, defensive and liquid option, the unnamed general manager said.
 
The upshot of this is that bond ETFs look set to remain very much in demand, despite the set of new restrictions. The overall market size of bond ETFs in Taiwan grew from $33.2 billion as of August to $45.6 billion in January, according to Keystone Intelligenc. It could see another $30 billion of new issuance during 2020, predicted the general manager. 
 
That may prove to be a rate of growth that the regulator is more comfortable with. Ultimately, the FSC is tightening the screws on bond ETFs to ensure that the segment grows at a pace the industry can keep abreast with, Pigott said.
 
Certainly, fund managers remain keen to issue new ETFs, because insurers still want them. That is likely to ensure the supply of instruments remains at similar levels, said Kwok. 
 
“There was explosive growth last year...the growth rate will definitely not be that strong in this year because the base has become larger. The new rules will have an impact too...But insurers will still have appetite [for the ETFs] because they have the need to invest overseas,” he said.
 
THE NEW RULES FOR FORMOSA BONDS 
 
Aside from bond exchange-traded funds, Taiwan’s insurance companies have liked to buy into Formosa bonds, or foreign currency-denominated bonds issued by overseas companies in Taiwan. The deals enabled local insurers to gain much-wanted overseas exposures in the local market, to obtain higher investment returns.
 
The bonds made their debut in 2013, but have typically not been regarded as overseas investments, enabling insurers to invest as much as they want. This was primarily because the authorities wanted to promote the development of such bonds when it was first started, Serene Hsieh, director for financial services ratings at Taiwan Ratings, told AsianInvestor.
 
Issuance of Formosa bonds has been robust up to the point when news emerged that the regulator was mulling to introduce a limit on it. There were 100 Formosa bonds totalling $30.78 billion issued in July 2018 since the beginning of the year. Over the whole of 2017 there were 125 deals worth $40.31 billion, Dealogic data shows.
 
As insurers’ investments in Formosa bonds soared, the Financial Supervisory Commission stepped in. It stipulated in late 2018 that local insurers’ allocations in Formosa bonds would be included in the calculation of overseas investments, which altogether cannot exceed 65.25% of an insurer’s investable assets. It effectively capped the lifers’ investments in such bonds.
 
The rule change was designed to prevent an excessive overseas exposure for insurers at a time when foreign exchange risks were rising. In addition, the Taiwan government wants to redirect investment funds to help support local companies and stimulate the domestic economy, Hsieh said.
 
However, regulators may be disappointed to see life insurers have been turning to bond exchange-traded funds to gain offshore exposure instead of investing more in the local market.