The name is Bond: Hong Kong in search of bond market diversification

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Hong Kong dollar denominated long-term bonds are among those increasingly sought by the local market.

(Credit: Chris Lusher)

Hong Kong based portfolio managers from institutional to retail are seeking a diversification in their asset management and investment opportunities. In terms of the local bond market, there is a demand for a larger range of time commitment options, as well as a broader and deeper scope for investment.

Public sector bonds fall under numerous categories including government bonds (e.g. iBonds, Sukuks, Silver Bonds), Exchange Fund Bills and Notes (EFBNs), bonds issued by statutory bodies (e.g. HK Airport Authority) and bonds issued by government-related corporations (e.g. Bauhinia Mortgage-Backed Securities Limited).

Private sector bonds (i.e. corporate bonds, green bonds) are known to be more diverse, and comprised approximately 39% of the total outstanding Hong Kong dollar debt instruments at the end of 2015. Bonds from both sectors are traded in an ‘Over the Counter’ (OTC) market via telephone, email, etc. (less transparency and regulation), while bonds such as EFBNs are listed and traded on the Hong Kong stock exchange (HKEx). EFBs have tenors at or below 12 months, while EFNs have tenors from 2-years up to 10-years.

According to a paper by The British Chamber of Commerce in Hong Kong (BCC), traditional availability of Hong Kong debt securities from 1996 to 2013 comprised of 88% fixed rate notes under a 5-year maturity date, showing how financial markets were and still are skewed towards short-term debts. The short-term nature of these bonds hinders long-term business or government investment providing only low interest rates, low duration (index for interest-rate risk) and earlier maturity dates.

Short term bonds and higher coupon rates cause cost and debt management to be burdensome for borrowers/issuers, due to higher annual interest payments and shorter maturity (time until debt payment). With lower coupon rates, long-term bond issuers can better manage their lower cost of borrowing and can be protected from monetary shocks suffered by short-term borrowing. On the contrary, long-term bonds have higher duration, causing investors to be prone to interest-rate rise or fluctuation, directly and inversely affecting the market price of the bond.

With the issuance of longer-term bonds, asset managers who tend to focus on Hong Kong’s equity market will be incentivised to invest in the debt market promoting growth. Presently, long-term insurance and pension companies commit to long-term borrowing when dealing with customers, for example life insurance companies have to payout after a period of decades. Therefore, profile managers look for longer term investment opportunities, especially HKD denominated debt for protection against currency fluctuations, due to uncertainty of the future USD and HKD peg relationship. According to the BCC paper, Hong Kong currently has the lowest Local-to-Foreign Currency Bond issuance ratio in Asia at 59% to 41%, with USD denominated bonds dominating long-term bond options.


‘General’ bonds

In terms of government initiative, The Hong Kong Monetary Authority (HKMA) implemented the Government Bond Programme (GB) in 2009 with the objective of meeting the demands of institutional and retail investors seeking stable investments, with AAA government credit rating. In 2011-12 the government launched the iBond program which targets local retail investors, with a recent issuance size of HK$10 billion in 2015. This issuance was met with a record high number of applicants where 9-15% of successful applicants were first time investors, showing the strong confidence level in the local market investor base.

When receiving per annum interest rates from a 3-year iBond (every 6 months), the higher of the floating rate and fixed rate of 1% is used. Floating rate notes (FRNs) protect investors from rising interest rates as the market price of the bond decreases, FRNs tend to have a maximum cap and a minimum floor so investors know what the minimum interest paid will be. Additionally, stimulating growth in instruments such as interest rate swaps (interest rate cash flow exchange between two parties), deepens and strengthens financial markets.

More recently, the Hong Kong government issued HK$ 2.5 billion worth of 5-year Government Bonds, under the Institutional Bond Issuance Programme. The bid-to-cover ratio was 2.57, with HK$ 6.43 billion received through tender applications. Showing a strong demand towards safe AAA government investment, the resulting annual yield is 1.197%.


Diversification on its way

Silver bonds are government issued bonds with a 3-year tenor, limited to and targeting residents above the age of 65 with a valid Hong Kong Identification Card. Furthermore, the applicants must not be residing within the US or Canada. On 12 August, the first issue of HKD 3 billion was made, with a minimum principal amount of HKD 10,000 when applying. There is no secondary market for silver bonds to be traded, though the bond can be sold back to the government with unpaid interest.

Alternatively, the green bond market is expanding at outstanding levels, primarily due to the commitments made by countries globally during the COP21 in Paris. China’s environmental targets within its current five-year plan will cost an approximate two trillion yuan (HK$ 2.26 trillion) per year to fund. This opens the opportunity for Hong Kong to become the financial hub for these projects. Green bond issues are specific to funding projects that have a positive impact on the environment, rather than just ‘borrowing cash’ as the function of most current bonds are.

A local example of a green bond was the USD 300 million issued by Xinjiang Goldwind science & technology where the majority of the funds are going towards the research and construction of renewable and energy efficient technologies. This 2015 issued bond is on a 10-year tenor, and was met with strong investor demand.

Furthermore, to develop the islamic finance platform, USD denominated Sukuks (Islamic bonds) were issued under the GB programme (AAA credit rating) with interest removed as it is against Sharia law. Instead, investors receive a portion of profits earned by the associated asset, with the first issuance by the government of US$1 billion in 2014, comprising of 5 and 10-year tenors. Orders were received from the Middle East, Asia and Europe from private banks, banks, fund managers, central banks, supernationals, etc.

Meanwhile, as stated in a BCC report presentation, RMB bonds (a.k.a ‘Dim Sum Bonds’) is a higher yielding market compared to HKD and USD denominated bond markets. RMB bond issuance sizes are larger than HKD issues, contributing to higher market liquidity in the RMB bond market. They also tend to have short-term maturity dates predominantly under 3 years. With the increase in Chinese ownership of companies in the Eurozone, Euro denominated bond issues are also widely used among Chinese Corporates.

On 16 May 2017, with the collaboration between the People’s Bank of China and the HKMA, they announced the launch of Bond Connect, a cross-border platform that connects Hong Kong and Mainland China’s bond markets, allowing institutional overseas investors to trade in the Mainland bond market. Settlements are conducted through multiple accounts opened by HKMA’s Central Moneymarkets Unit (CMU), providing overseas investors with greater flexibility and convenience as the procedures and compliance requirements will be relatively relaxed. According to the press release by HKMA, mainland China has the world’s third largest bond market with an outstanding value of approximately RMB 65 trillion and an overseas investor holding of 2%. This attracts foreign investors, and promotes the demand for Hong Kong’s financial services including asset management, risk management, etc. This supports Hong Kong’s role as an international financial centre, and an intermediary for capital flows between Hong Kong and the mainland.

In brief, as reported by a South China Morning Post article, local bond issuer credit rating pre-2006 ranged from AAA to AA-, while current credit ratings range from A to BB which shows deepening and development of the local bond market. Credit Rating Agencies should be incentivised to rate smaller Hong Kong companies and issues to increase market transparency and development of the market. The advancement of financial technology (FinTech) will encourage market development, as OTC markets rely on FinTech for data management (i.e. Systems and applications for risk, portfolio and collateral management, trading platforms, price reporting, etc.).

In short, Investment in a more developed and diverse (including variance of time commitment options) bond market brings reduction in overall risk, funding towards numerous sectors of the economy spurring growth and development, stability of investments for investors and government, and growth in OTC markets positioning Hong Kong as an attractive regional financial hub. Also, the increase in total outstanding dollars in Hong Kong will deepen the marketplace.


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