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“Market” Perspective for Asian Bond Market DevelopmentYUJI NAKATA

Head of Fixed Income Division - Asia Pacific

Nomura International (Hong Kong) Limited

Joint ABAC/PECC Conference

Taipei, 10 May 2004

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What is the Bond Market for? Lessons from 1997 Asian Crisis

Generally agreed:

Development of a new channel of capital flow in the region is the key to,

1) dissolve the “double mis-match” of tenor and currency

2) facilitate intra-regional circulation of abundant liquidity accumulated in Asia

What can a bond market do for this challenge?

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Banking System vs. Capital

Markets Channels can be various but should adopt the market mechanismFinancial Sector Profile, 2003 Sep

US$ %GDP US$ %GDP US$ %GDPbillion billion billion

China 479.8 34.0% 472.2 33.5% 2,432.6 172.5%

Hong Kong 45.5 28.5% 619.2 388.2% 232.3 145.6%

Indonesia 51.7 24.3% 47.3 22.2% 115.8 54.4%

Korea 432.1 68.9% 256.2 40.8% 600.6 95.8%

Malaysia 92.5 89.7% 150.5 145.9% 121.8 118.1%

Philippines 18.9 23.8% 22.2 27.9% 42.3 53.4%

Singapore 56.4 61.2% 135.5 147.1% 96.7 105.0%

Thailand 54.8 36.9% 81.5 54.8% 139.5 93.8%Total 1,231.7 43.5% 1,784.6 63.0% 3,781.5 133.5%

Germany 1,933.3 77.8% 841.5 33.9% 3,555.8 143.1%

Japan 7,714.9 171.8% 2,746.5 61.2% 4,154.1 92.5%

United Kingdom 1,167.8 63.5% 2,110.3 114.7% 2,695.7 146.5%

United States 17,522.9 157.8% 12,763.8 114.9% 9,646.1 86.8%

Sorces: BIS, World Federation of Exchange, IFS, CEIC

BanksEquitiesBond

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What are the “Market”

perspectives?

Liquidity

Liquidity is a nature of the “market”

Exchange

The “market” functions to exchange goods and money

Place

The “market” is a conceptual place, if not a physical place

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Liquidity

A liquid market is a market where a large volume of trades can be immediately executed with minimum effect on price

“Tightness”, “Depth”, “Resiliency”

Prerequisites for liquid market: Competitive environment Standardized specs of products and process Minimum transaction costs, i.e. tax Heterogeneity of market participants Core instrument/product as a source of liquidity

Liquidity provides price transparency, risk transferability, hedging capability, etc.

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CORE MAEKETCORE MAEKET

PERIPHERAL MARKETSPERIPHERAL MARKETS

GOVERNMENT BONDGOVERNMENT BOND

CORPORATE BOND/ ASSET BACKED SECURITIESSYNDICATED LOANS/ DERIVATIVES etc.

CORPORATE BOND/ ASSET BACKED SECURITIESSYNDICATED LOANS/ DERIVATIVES etc.

Develop government bond market as a core liquidity provider for each bond market

Liquid government bond market sets force benchmark yield curve, based on which all other fixed income instruments are priced

Implication for Asian Bond Market Development

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Implication for Asian Bond Market Development

Considerations for developing liquid government bond market: Size

Large issue size, concentration in key maturities, and control outstanding Tax

Should be minimized to reduce transaction costs and to avoid fragmentation of the market

Short sale Regulation, repo market, practice of good fail

Heterogeneity of market participants Open to foreign investors

Role of Government, Central bank and Primary Dealers Last resprt, commitment and benefit

Nomura Group supports the local bond market development through TA

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Exchange Capital Markets function to exchange financial products for

money

=Capital markets effectively transfer risk and return of a financial product from one investor to another

Standardization

Customization

trade offtrade off

Higher severalty

Higher severalty

Lower severalty

Lower severalty

Liquidity lowLiquidity low Liquidity high

Liquidity high

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Securitization to effectively transfer Risks

Major risks of fixed income products

Interest Rate risk

Credit risk

Securitization is an effective tool to change credit risk profile of assets to meet investors’ needs

Segregating assets from originators

Pooling assets to achieve diversification and improve liquidity

Credit enhancement by over-collateralization and subordination

A bridge between banking system and capital markets

Financial technology to facilitate corporate restructuring

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Case Study – Primary CLO

Aegis One Bhd

(Issuer)

Servicer

HSBC

Portfolio Mgr. Trustee

Senior Bond

Investors

Junior Bond

Investors

Originator

Corporate Borrowers(Obligors)P&I

Loan Agreements

ABS

Monitors Portfolio Administers

Portfolio

ABS Proceeds

Loan Assignments

Aegis One Bhd

The largest ever Malaysian domestic CDO was priced and closed in Nov 2002, which securitized a portfolio of twenty-five newly originated loans with an average balance of RM40 million to a diversified pool of investment grade corporates.

The Dilemma: Local banks flushed with liquidity but with a preference for top tier corporates. Lower grade credits rank low on internal credit scoring system meaning difficulty in obtaining financing and subsequently slowing down the economic recovery.

The Solution: A Primary CLO to provide liquidity to the corporate sector to help spur economic growth and provide the necessary diversification and structural subordination that can alleviate investor concerns of taking on lower rated credits.• Allowed lower grade corporates to achieve an efficient cost of funding

via the capital markets.

• A fully transparent portfolio, independent portfolio manager, no ramp-up period, listed obligors and conforming loan facilities were all features incorporated into the transaction due to Nomura’s numerous investor discussions.

• In comparison with the three prior CDO transactions executed in the domestic markets which had taken between six months to a year, approval from the Securities Commission was delivered in just three months!

• A transaction that has benefited all parties involved: Arranger (with Nomura as technical advisor) has established a niche for itself in the developing CDO market and gained a broader client baseObligors have been able to raise funding at rates and terms competitive to the loan market but without the need to secure guarantees of any formInvestors are able to buy into the “Malaysia Story” at a significant yield pickup over comparables whilst being protected by the structural mechanisms afforded by a CLO structure.

• An innovative landmark transaction that has meant, the Issuer, rating agencies and investors through the process of education being moved significantly up the learning curve.

A Malaysian Landmark

Tranche Type Rating Amount (RM) CouponLegal

MaturitySenior Fixed AAA 900,000,000 5.20% 2007

Junior Variable Private 100,000,000 16.00%* 2007

* Expected IRR on a no default basis

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Off-shore Market Off-shore Markets exist in Asia, i.e. Hong Kong, Singapore, Tokyo,

Labuan, etc. but none of them is dominant Positives and Negatives

A loophole from domestic policy makers’ point of view? Or an incubator for the regional bond market?

Off-shore market to function as an incubator for the regional bond market

“out-out” vs. “out-in” Financial Hinterland and infrastructure Arbitrage opportunity to attract heterogeneous investor

base Professional vs. amateur FX & money market, benchmark yield curve, primary

issuance, derivatives

Long-term commitment of governments and private sector are inevitable

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