Information about Asia and the Pacific Asia y el Pacífico

Chapter 4. Bond Markets: Are Recent Reforms Working?

Ratna Sahay, Cheng Lim, Chikahisa Sumi, James Walsh, and Jerald Schiff
Published Date:
August 2015
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Information about Asia and the Pacific Asia y el Pacífico
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Mangal Goswami, Andreas Jobst, Shanaka J. Peiris and Dulani Seneviratne 

Main Points of this Chapter

  • Sovereign bond markets in most of emerging Asia have deepened and become more efficient as foreign and institutional investor participation has increased, leading to yield compression without significantly greater volatility in normal times.

  • Corporate bond markets have undergone a “quality transition,” with a greater diversity of issuance resulting in a widening of access to finance.

  • Emerging Asian financial systems are starting to fire up as the corporate bond market develops into an alternative and viable nonbank source of corporate and infrastructure funding (that is, as a second engine next to the banking sector).


It has now been a decade since the Association of Southeast Asian Nations (ASEAN) launched a major effort to develop its domestic bond markets and the larger two Asian emerging market economies—China and India—started to open up their bond markets to foreign investors. That makes it a good time to take stock, see what has been accomplished, and assess whether local bond markets have become an integral element of the financial sector architecture and are able to act as an alternative source of funding (“spare tire”) if other parts of the financial system become impaired.1 An evaluation of progress towards a “twin engine” financial system with both a robust bank lending and corporate debt financing channel is important because much emphasis was placed on developing domestic bond markets in the aftermath of the Asian crisis of the late 1990s. Bond funding was seen as an alternative financing channel to banks, a channel that is less prone to currency and maturity mismatches and less vulnerable to volatile capital flows. More recently, corporate bond markets have been seen as a vehicle for funding the large infrastructure needs of Asian emerging markets, as highlighted in Chapter 8.

The sweeping regulatory reforms and policy initiatives have had a profound impact on the efficiency of local bond markets. Emerging Asian bond markets have successfully managed to overcome the “original sin” problem by shifting from foreign-currency- to local-currency-denominated bond issuance and have extended the maturity of their sovereign debt profiles to reduce vulnerabilities to attendant risks.2 This chapter considers in depth the determinants of sovereign bond yields from a supply-demand perspective as they act as a benchmark for the pricing of corporate bonds. The key findings are the following:

  • ASEAN sovereign bond markets have seen a significant broadening of the investor base, including institutional investors and foreign participants, resulting in a significant rise in liquidity and a reduction in borrowing costs.

  • Market deepening and greater foreign participation in ASEAN markets have not led to significant yield volatility in normal times, although sovereign bond yields are susceptible to spikes in global risk aversion.

  • The Chinese and Indian sovereign bond markets are large, with high turnover but a captive domestic investor base, and capital account restrictions have limited the role of foreign investors.

Corporate bond markets have grown rapidly in emerging Asia; however, their recent development has been uneven. In most ASEAN countries, the development of corporate bond markets is held back by limited issuance despite rising interest from institutional investors. Chinese and Indian markets, meanwhile, have seen more limited participation by foreign investors alongside gradual institutional reforms. To evaluate the transformation of corporate bond markets in the region, we undertake a firm-level analysis, which reveals that it has become easier for firms to access external finance:

  • Emerging Asian corporate bond markets have undergone a “quality transition,” marked by repeat issuance and more diversified supply. With lower barriers to entry, smaller issuers are increasingly accessing domestic markets while larger issuers have become more adept at using market funding as part of a broadening of their sources of funding.3

  • Corporate bond markets are developing into a mature funding channel that corporations can use when other parts of the financial system come under stress and credit supply remains constrained as banks adjust to new regulations on capital, liquidity, and derivatives. However, corporate finance in emerging Asia remains heavily dependent on bank lending. A well-functioning and liquid bond market could help diversify the region’s funding sources and enhance the resilience of its financial systems.4

With the investor base likely to expand as foreign investors devote an increasing portion of their portfolios to emerging market assets, and as demographic changes (and financial liberalization in China) drive regional savings patterns, bond markets in emerging Asia could grow much more rapidly during the coming decade. However, a number of challenges remain to reduce issuance costs and improve liquidity. In particular, derivatives markets that tend to enhance secondary market trading and help hedge risks remain a work in progress. These barriers also tend to drive market activity offshore, which may raise prudential concerns and the risk of spillover from offshore to onshore markets.

Also, the global financial crisis has shown that local currency debt markets in emerging markets are quite susceptible to the vagaries of global shocks. However, the recovery following the crisis was notable, notwithstanding the “taper tantrum” in May 2013 when the Federal Reserve announced its intention to begin tapering its asset purchase program. The tapering of asset purchases by the Federal Reserve since January 2014 has been less disruptive than expected thus far, with investors exhibiting greater differentiation across markets. The latter development places a premium on further market deepening, as well as on maintaining consistent macroeconomic and macroprudential policies.

This chapter examines the reasons for developing bond markets in emerging Asia; sheds light on the depth, liquidity, and pricing of local bonds in Asian emerging markets; and assesses the impact of foreign participation and market development on local currency sovereign spreads. It then focuses on the corporate bond market and other metrics of development, which suggest that a remarkable transformation of ASEAN and emerging Asian corporate bond markets is indeed under way, especially if firm-level data are examined in greater detail. Finally, it reviews the impediments to market development as well as the nexus of the bond and derivatives (and offshore) markets.

Why Develop Bond Markets?

Across the globe, emerging markets have placed great emphasis on developing their bond markets in recent years (IMF 2005). Why have they done so? In large part, because emerging markets have heavy investment requirements, and bond markets play an important role in financing large infrastructure projects. Such projects tend to be risky and take time before they yield returns; however, bond markets can spread these risks over a large number of holders of securities. Moreover, because bond contracts (unlike loans) are designed to be traded, they allow investors to transfer credit risks to others, even before the projects are completed. The combination of these characteristics—the scope for risk sharing and risk shedding, both within and across national boundaries—means that bond markets complement banks, which are constrained by limits on the scope of their cross-border activities and the extent to which they can transform maturities.

Beyond these general principles, there are particular reasons why Asian emerging markets, particularly ASEAN members, have put so much emphasis on developing bond markets since the Asian financial crisis. These reasons stem from the consensus diagnosis of what happened in 1997. According to this view, the Asian crisis can be traced in large part to several underlying problems in national financial systems (Eichengreen 2006):

  • Dependence on bank funding—Financial systems were extremely bank-centric, which meant that most of the risks were concentrated in the banking system—and there was no alternate channel of intermediation that could be used if the banks once again encountered difficulties.

  • Maturity and currency mismatches—Borrowing had suffered from a double mismatch, since long-term, domestically oriented investment projects were being funded through short-term, foreign-currency borrowing.

  • Capital account vulnerabilities—Countries in the region were perceived to be excessively dependent on volatile capital inflows, a situation that struck many observers as ironic since the region had an abundance of domestic savings.

Observers further argued that all three of these problems could be solved by developing domestic bond markets. Vibrant bond markets would create another financing channel, a spare tire that firms could use if banks once again encountered difficulties. And because domestic bonds would be on longer maturity terms and in local currencies, they would eliminate the double mismatch problem. Finally, with more active domestic bond markets, firms could reduce their dependence on foreign capital flows that were very volatile, particularly in Asia.

Based on this diagnosis, emerging Asia has put considerable effort into developing its bond markets (Guonan, Remolona, and Jianxiong 2006). For example, the ASEAN+3, which comprises the ASEAN countries plus China, Japan, and Korea, created the Asian Bond Markets Initiative, which established working groups to study the issues and make recommendations, many of which have been adopted by individual countries. The launch of the Asian Bond Fund-2 in March 2005, a regional local-currency-denominated bond fund, resulted in the introduction of a Pan Asia Bond Index Fund and a Fund of Bond Funds with eight country subfunds open to investment by the public. The Asian Development Bank (ADB) also initiated a study program and created the AsiaBondsOnline database so that researchers and market participants could easily find key information about local currency markets.5 Meanwhile, the Executives’ Meeting of East Asia Pacific Central Banks created pan-Asian bond funds to facilitate regional investment. The Asian Bond Market Forum was set up in September 2010 by the ASEAN+3 countries as a common platform to foster standardization of market practices and harmonization of regulations related to cross-border bond transactions in the region. The 2011 formation of the Credit Guarantee and Investment Facility, a trust fund of the ADB, is expected to support the issuance of corporate bonds.

Countries have undertaken structural reforms to foster the development of capital markets. Many have issued new securities regulations in line with the International Organization of Securities Commissions’ principles and have adopted more modern legal frameworks that address company and insolvency laws through better protection of creditor rights in the event of bankruptcy. Government debt-management programs have become an important part of the reforms. The infrastructure for payment, custody, and settlement systems has been modernized in many countries.6 Bond markets have become more transparent with independent vendors collecting and disseminating information on bond trading and bond pricing, facilitating development of the secondary market. The growth in contractual savings institutions has also offered an alternative to bank savings products, helping diversify personal savings into longer-term savings and to promote capital market development. Pension and social security pools with longer-term investment horizons are starting to mobilize domestic savings. As a result, securities valuations have increased correspondingly, accompanied by further diversification and globalization of the investor base.

China and India have also progressively opened their bond markets to qualified foreign investors, though participation remains limited alongside gradual institutional reforms. The Renminbi Qualified Foreign Institutional Investor (RQFII) scheme was introduced in China in 2002, allowing institutional investors who meet certain qualifications to invest in a limited scope of cross-border securities with an initial cap of $4 billion that, by 2013, had been gradually eased and expanded to $150 billion. Under China’s RQFII initiated in 2011, investors can apply for quotas to use renminbi they hold offshore to invest directly in domestic Chinese assets, from bonds to stocks to money market funds. The RQFII program had been limited to financial institutions in Hong Kong SAR but was expanded beginning in 2014 to include firms in London, Singapore, and Taiwan Province of China. Gradual interest rate liberalization and financial market infrastructure reforms in China have fostered debt market development, albeit with a number of remaining challenges.7 The Indian authorities released regulations for foreign institutional investor investment in debt markets in 2005 with a debt cap of only $1.0 billion to $1.5 billion that was progressively increased to $25 billion in government securities and $50 billion in corporate debt in 2013, which includes a sublimit for infrastructure bonds of $25 billion.

The Securities and Exchange Board of India has also allowed overseas entities to invest in government securities without any auction mechanism since September 2013, relaxing the debt-allocation norms for foreign institutional investors until overall investment reaches 90 percent of the cap on foreign ownership.

Composition, Depth, Liquidity, and Pricing Developments

Since the regional financial crisis of 1997–98, Asian emerging markets have focused considerable attention on developing domestic debt markets to reduce foreign exchange mismatches in their financial systems and to decrease the concentration of credit and maturity risks in banks (CGFS 2007; Turner 2009). Besides building large foreign exchange reserve buffers, much of the effort has gone into local currency bonds since they constitute a significant share of emerging bond markets, especially in Asia (Figure 4.1). The shift from foreign-currency- to local-currency-denominated bond issuance by emerging markets highlights the breakdown of the hypothesis that these economies can typically borrow only in foreign currency, the “original sin” of Eichengreen and Hausmann (1999).

Figure 4.1The Shift toward Local-Currency-Denominated Bonds

(Currency denomination, percent of total)

Source: Turner (2012).

Emerging Asian debt capital markets have grown faster than have many of the mature markets since the turn of the century and are larger than those in other emerging market regions. The rapid growth in Asia’s emerging domestic bond markets has been driven by the strong growth performance and favorable longer-term economic prospects for the region, led by China (Figure 4.2). Investments in local currency bonds indeed fetched handsome returns during 2003–12, particularly when considered on a risk-adjusted basis (Figure 4.3). However, the development of bond markets in Asia faced significant headwinds during the global financial crisis, with a sizable retrenchment as gross portfolio inflows fell precipitously, albeit rebounding sharply, particularly to the ASEAN-5 (Figure 4.4).8

Figure 4.2International Comparison of Domestic Bond Markets

(Includes government and corporate bonds)

Source: Bank for International Settlements.

Figure 4.3High Risk-Adjusted Emerging Market Returns

(Equity and bond market indices, 2004 = 100)

Sources: Bloomberg, L.P.; and Morgan Markets.

Note: GBI-EM = J.P. Morgan Government Bond Index - Emerging Markets; EMBI = Emerging Markets Bond Index; LCY = Local Currency.

Figure 4.4Portfolio Investment Liabilities

(Billions of U.S. dollars)

Sources: IMF, Coordinated Portfolio Investment Survey (CPIS).

Note: ASEAN = Association of Southeast Asian Nations.

Liquidity in the bond markets continues to vary across emerging Asia, but there has been significant financial deepening in many of these markets. The markets in China, Hong Kong SAR, Korea, Malaysia, and Singapore are the most liquid (Table 4.1). Debt managers now preannounce the schedule of issuance and consolidate debt into several large liquid benchmark bond issues at certain maturities across the yield curve (which they reopen if additional funding is required). Most emerging Asian economies have established primary dealers for government securities and have taken steps to develop the funding market for repurchase agreements (repos) and securities lending. In Singapore, the primary dealers are required to participate in auctions, make two-way secondary markets, and provide information to the debt manager. Many of the Asian emerging markets have also reformed their market microstructures by introducing modern trading platforms and by upgrading payment and settlement systems. In general, liquidity in corporate bond markets remains significantly below levels in the government bond markets. However, the volume of turnover in the Chinese bond market, especially the corporate segment, has improved substantially since 2005 as a result of the marked increase in the size of the market, although market liquidity remains fickle.

Table 4.1Domestic Bond Market Liquidity Indicators
CountryValue Traded ($ billion)Turnover Ratio1Bid-Ask Spread (bps)
Hong Kong SAR159111.480.137.3
Sources: Asian Development Bank, AsianBondsOnline, and Asia Bond Monitor.Note: As of end-2013 or latest available as of 2013:Q3. bps = basis points.

Turnover ratio is defined as value of bonds traded over average amount of bonds outstanding.

Despite advancements, liquidity in local bond markets dried up during periods of stress, such as the taper episode when expectations of monetary tightening in the United States caused considerable portfolio outflows. Secondary market liquidity in many ASEAN markets is still very much dependent on foreign investors.9 Trading is often still bunched in certain maturities, leading to market segmentation. This, coupled with a concentration of buy-and-hold investors in domestic bond markets, continues to inhibit liquidity. The 2013 decline in liquidity in some emerging Asian markets, as highlighted by rising bid-ask spreads (Figure 4.5), appears to have contributed to making local bond yields more sensitive to global risk aversion (measured by the VIX)10 in these markets (IMF 2014), albeit less so than in other emerging markets. The less liquid markets are generally characterized by a narrow investor base, insufficient infrastructure, low market transparency, and lack of timely information on bond issuers (Gyntelberg, Guonan, and Remolona 2006; ADB 2013a). For example, both Indonesia and the Philippines put in place frameworks for primary dealership and debt management with preannounced issuance schedules, but secondary market liquidity continues to be tenuous, with few players prepared to continuously provide bid/ offer quotes. While the role of market makers is central to increasing liquidity and secondary-market trading, it is unclear how the extraterritorial application of new regulations (for example, the Dodd-Frank Act and the Volcker Rule) will affect such activity in the Asian local bond markets. Anecdotal evidence shows that dealers have reduced their inventories ahead of the new regulations, which negatively affected their market-making ability. One key policy initiative has been to ensure that trading data are captured and disseminated but, given that most bond trading is over the counter (OTC), transparent trade data are not always available to all market participants, although that may soon be changing.

Figure 4.5Change in Liquidity Patterns in Emerging Asia

Sources: Bloomberg, L.P.; and IMF staff calculations.

Note: CHN = China; HKG = Hong Kong SAR; IND = India; IDN = Indonesia; KOR = Korea; MYS = Malaysia; PHL = the Philippines; SGP = Singapore; THA = Thailand; TWN = Taiwan Province of China.

The investor base in Asia has become broader and deeper with the emergence of domestic institutional investors (Ghosh 2006). These investors hold a sizable share of the outstanding local currency bonds, led mostly by banks, but other institutional investors such as pension funds, life insurance companies, and mutual funds have also increased their investments in local debt as their assets have grown. Demographic changes, pension reforms, and the larger role played by nonbank financial institutions, including institutional investors, have supported the increase in size and diversity of the investor base (Figure 4.6). Malaysia is a good example, where actively managed publicly mandated or related provident funds provide an important source of retirement savings and liquidity to debt markets (Figure 4.7). In Thailand, contractual savings institutions have become the dominant investors in local currency bonds, partly owing to the incentive provided by the deduction from taxable income of contributions to retirement mutual funds and long-term equity funds. In contrast, investment restrictions on Indian pension and insurance funds that are captive sources of finance for government securities have held back participation of these funds in the corporate bond market. Insurance penetration is also low in India and in many ASEAN countries, including Indonesia, the Philippines, and Vietnam.

Figure 4.6A More Diverse Investor Base in Emerging Asia

(Domestic investor base, billions of U.S. dollars)

Source: Standard Chartered Research.

Figure 4.7Growing Pension Fund Assets

(Percent of GDP)

Sources: CEIC Data Co., Ltd.; Economist Intelligence Unit; IMF, World Economic Outlook; and Investment Company Institute.

Note: IND = India; IDN = Indonesia; MYS = Malaysia; PHL = the Philippines; SGP = Singapore; THA = Thailand; TWN = Taiwan Province of China.

Growth in the mutual fund industry throughout Asia has been broad based. Mutual funds have allowed households to hold local currency bonds in more liquid and easily tradable units. Mutual funds tend to trade actively in response to changes in market conditions, thereby bringing additional liquidity to local markets (Turner 2009). Hong Kong SAR and Singapore lead this industry because of their roles as regional financial centers, with more than 50 percent of their assets derived from foreign capital inflows. The rapid growth of mutual funds in other Asian economies such as India, Korea, Malaysia, Thailand, and Taiwan Province of China has been largely dependent on domestic factors, including rising incomes and the broadening of the domestic investor base (Figure 4.8). The mutual fund industry is still stymied by a nascent investment culture in emerging Asia, which is weighed down by the regulatory structure, a lack of independent pricing and valuation, and weak investor education and safeguards. For instance, mutual funds have so far played a limited role in the development of India’s corporate bond market, in which 80 percent of the debt mutual funds are owned by corporations with limited retail participation.

Figure 4.8Growing Mutual Fund Assets

(Percent of GDP)

Sources: CEIC Data Co., Ltd.; Economist Intelligence Unit; IMF, World Economic Outlook; and Investment Company Institute.

Note: IND = India; IDN = Indonesia; MYS = Malaysia; PHL = the Philippines; SGP = Singapore; THA = Thailand; TWN = Taiwan Province of China.

The increasing participation of foreign investors has been one of the main structural changes in the Asian domestic debt markets since the global financial crisis (Figure 4.9). The secular increase in the proportion of portfolios allocated to emerging market assets by developed country institutional investors has been underpinned by a more favorable risk-return profile. Foreign participation has largely been through institutional investors such as banks, mutual funds, pension funds, hedge funds, asset management firms (that manage these assets on behalf of pension plans), and sovereign wealth funds (IMF 2014). Assets under management for dedicated emerging market bond funds, particularly local currency bonds, have also risen significantly. Even though the global financial crisis led to a decline in foreign investor demand for emerging market assets, most Asian countries have seen renewed foreign interest and foreign participation that is now above precrisis levels (Figure 4.9).11 Countries such as China and India, which have traditionally had relatively closed capital accounts, are also gradually easing limits on government securities holdings by qualified foreign institutional investors. This easing will likely attract more long-term institutional investors as well as mutual funds and hedge funds that are sensitive to global risk aversion (IMF 2014). This chapter assesses the impact of foreign inflows on sovereign bond yields and their volatility in emerging Asia, given that global institutional investors are likely to allocate a greater share of their portfolios to emerging markets in the long term, while the unwinding of unconventional monetary policies in advanced economies presents short-term challenges. A preview of the stylized facts suggests rising liquidity and, thus, lower bond yields in emerging Asia as a result of greater foreign participation that does not appear to have been associated with higher volatility except during times of heightened global risk aversion (Figure 4.9).

Figure 4.9Foreign Participation and Sovereign Bond Yields

Sources: Asian Development Bank, AsianBondsOnline; Bloomberg, L.P.; country authorities; IMF, International Financial Statistics database, Global Financial Stability Report (various issues); and IMF staff estimates.

1 Foreign holdings as a percent of total local currency bonds.

The development of corporate bond markets in Asia remains uneven (Figure 4.10). Those in Hong Kong SAR, Korea, Malaysia, and Singapore are the largest and most developed, followed by Thailand, while those in Indonesia, the Philippines, and Vietnam have lagged behind (Figure 4.10). The corporate bond market in China has grown rapidly because qualified foreign banks have been allowed to trade and underwrite corporate bonds in the interbank market without the approval of the China Securities Regulatory Commission. The commission also improved access for small and medium-sized businesses by allowing bond issuances of less than 500 million renminbi.12

Figure 4.10Uneven Development of Emerging Market Corporate Bond Markets

(Percent of GDP)

Source: AsianBondsOnline.

Note: Data for 2013 are as of December 2013 or latest available. CHN = China; HKG = Hong Kong SAR; IDN = Indonesia; KOR = Korea; MYS = Malaysia; PHL = the Philippines; SGP = Singapore; THA = Thailand; VNM = Vietnam.

Derivatives markets in the region have grown and internationalized to provide hedging tools for portfolio investors. This development has been driven mostly by very strong growth in OTC markets (BIS 2013). Though difficult to measure, foreign investors’ access to Asian capital markets through derivatives instruments (OTC derivatives and structured notes) also boosted capital inflows before the global financial crisis (CGFS 2009). Offshore trading of emerging market currencies has surged, with a significant increase in foreign exchange turnover ratios for many of the emerging Asian countries. This surge has been led by the Chinese renminbi, and trading of emerging market currencies has been positively related to the size of cross-border financial flows (BIS 2013). Of the five main types of derivatives (foreign exchange, interest rate, equity,13 commodity, and credit), growth has been strongest in the trading of foreign exchange derivatives,14 followed by exchange-traded equity derivatives15 and some OTC interest rate contracts (Figure 4.11). Foreign exchange derivatives (outright forwards, foreign exchange swaps, and foreign exchange options) account for a significant part of the total daily turnover. This major contribution of foreign exchange derivatives to the growth in emerging market currencies turnover is consistent with the view that hedging demand and speculation by foreign portfolio investors—who are interested in mitigating the exchange rate risks of their local currency investments or speculating on currency movements—has grown in importance (BIS 2013). However, the following factors have hindered the development of comprehensive derivatives markets:

Figure 4.11Turnover of Foreign Exchange and Interest Rate Derivatives in Emerging Asia

(Daily averages, billions of U.S. dollars)

Source: Bank for International Settlements, Triennial Central Bank Surveys.

Note: Excludes Japan, Australia, and New Zealand.

  • Deficiencies in prudential regulation and supervisory oversight (for example, capital rules, disclosure requirements, and accounting rules)

  • Operational infrastructure (for example, market trading, clearing, and settlement systems; and sound risk management)

  • Limited market participation by domestic and foreign institutional investors, as well as banks

The inadequate environment for derivative trading has stifled progress, particularly for interest-rate derivatives markets, the development of which has been constrained by the insufficient liquidity of the underlying government bond yield curve. Some derivatives instruments, such as forward rate agreements and interest rate futures and options, which are critical for addressing the risk-management issues raised by the growing market determination of interest rates through liquid bond markets, are entirely absent in some countries. Given that OTC derivatives continue to be the largest component of the derivatives sector in Asian capital markets (excluding Japan), regulatory requirements mandating margin requirements for non-centrally cleared OTC derivatives will likely pose additional challenges to the development of the derivatives market in Asia. Also, market participation of institutional investors in interest rate derivatives markets is fairly constrained, thus encumbering the sufficient supply of counterparty lines.16

Foreign Participation and Bond Yields in Emerging Asia

There has been limited empirical analysis of the determinants of local currency bond market yields in emerging Asia, in general, and even less of the role of foreign investors. Previous studies on emerging markets have generally focused on explaining the determinants of sovereign foreign currency spreads (Gonzalez-Rozada and Levy-Yeyati 2006). Even the empirical evidence of the factors affecting long-term interest rates on government debt in mature markets has focused on domestic fundamentals, with little or no attention paid to foreign participation (Caporale and Williams 2002; Daniel 2008; and Laubach 2009). There is growing evidence, however, that global factors have an increasingly pronounced effect on government securities markets in mature markets. The availability of global funds has made the demand for sovereign securities more dependent on global investors’ preferences, although country-specific risk factors may play a smaller role in Group of Seven countries (Kumar and Okimoto 2011). The IMF’s (2009)Global Financial Stability Report shows that portfolio debt flows, in addition to the standard macrofinancial factors highlighted in the literature, play a significant role in determining bond yields in both mature markets and emerging markets. Agur and Demertzis (2013) find a fundamental shift in local currency bond markets since the global financial crisis. Up to the crisis, these bond markets were mainly driven by domestic interest rates, but postcrisis, the elasticity of local currency bond yields with respect to U.S. Treasury yields has more than quadrupled. In addition, Peiris (2013) estimates that a 1 percentage point increase in foreign participation in local currency bond markets in emerging market economies has reduced bond yields by about 6 basis points, on average, controlling for other factors.

The literature on the determinants of bond yield volatility in emerging markets is even sparser. Early studies using time-series techniques were conducted on bond yield volatility in advanced economies (for example, Borio and McCauley 1996), but subsequent research in this area has generally focused on implied volatility based on option pricing (Brooks and Oozeer 2002). However, derivatives markets in emerging economies are generally not sufficiently developed for information on bond price volatility to be extracted. Previous studies on emerging markets have generally analyzed whether there has been volatility contagion (for example, Andritzky, Bannisters, and Tamirisa 2007) but again focused on determinants of sovereign foreign currency spreads. Azis and others (2013) employ multivariate generalized autoregressive conditional heteroscedastic (GARCH) models to show that significant shock and volatility spillover effects from market volatilities are more influenced by their own price dynamics in emerging Asia; in some other markets (for example, China, Indonesia, Korea, and Malaysia), the direct shock and volatility spillovers from global financial conditions remain significant. However, capital flows cannot be explicitly identified as the likely key transmission channel for contagion and spillovers.17

Following Peiris (2013), we estimated a GARCH (1, 1) model of sovereign bond yields in emerging Asian economies during 2000–13 using a comprehensive set of macro-financial variables, including foreign portfolio flows. The econometric analysis was based on a standard reduced-form specification for a GARCH model with the following mean equation:18

in which Lr denotes nominal yields on the benchmark long-term government bonds for country i for each month t between January 2000 and June 2013; Infl is the inflation rate, b is the fiscal deficit in percent of GDP, D is the level of gross general government debt in percent of GDP, GDP is real expected GDP growth (to control for the country’s cyclical position), USr is the U.S. long-term nominal Treasury bond yield (uncovered interest parity), VIX the implied volatility of options on the U.S. S&P 500 index (to control for global risk aversion), and FP is foreign portfolio bond flows as measured by EPFR Global.

Foreign portfolio inflow volatility and the VIX are also introduced in the form of multiplicative heteroscedasticity in the conditional variance equation in the following form:

in which σt2. is a measure of volatility of the nominal long-term local currency government bond yield for each sample county. Therefore, the sign on γ provides an estimate of the impact of the contemporaneous foreign portfolio flow volatility in the domestic government bond market on yield volatility, although the magnitude of γ is not comparable across countries given the conditional volatility measure used.19

The time series results for monthly data from 2000 show that greater foreign portfolio inflows significantly reduce yields in nearly all emerging Asian countries, controlling for the standard domestic yield determinants in the literature, as well as for U.S. interest rates and global risk aversion (Table 4.2). Overall, both domestic and global factors played nearly equal roles in yield determination in emerging Asia during the past decade but with global factors and capital flows playing a large role during the global financial crisis and “taper” episode, as expected (Figure 4.12). However, capital flow volatility (modeled as a GARCH conditional variance with a simple autoregressive mean equation for capital flows) and the VIX do not significantly increase yield volatility in any country (Table 4.2). This result suggests that sovereign bond yields are susceptible to global interest rates and risk aversion over and above the behavior of foreign portfolio flows (possibly related to local-investor portfolio reallocations or an expectations channel) but that foreign portfolio flow volatility and the VIX do not contribute to yield volatility beyond their level impact. The insignificant impact of foreign portfolio flow volatility and the VIX on bond yield volatility reinforces the value of financial deepening emphasized in IMF (2014) by lowering the sensitivity of bond yields to the VIX, because there does not appear to be an additional volatility transmission channel from external factors. Lower inflation, public debt, and deficit levels reduce bond yields, highlighting the importance of maintaining sound domestic fundamentals that can help counteract the potential external spillovers during times of global stress.

Figure 4.12Determinants of Sovereign Bond Yields in Emerging Asia

Source: IMF staff estimates.

Note: D = general government gross debt in percent of GDP; FP = foreign portfolio bond flows; GDP = real GDP growth expectations; Infl = Inflation rate; USr = U.S. long-term nominal treasury yield; VIX = Chicago Board Options Exchange Market Volatility Index.

Table 4.2Determinants of Bond Yields in Emerging Asia
Domestic FactorsExternal FactorsVariance Equation
Taiwan Province of China0.118***0.038**0.025***0.005***0.161***−49.099−0.006
Source: IMF staff estimates.Note: D = general government gross debt in percent of GDP; FP = foreign portfolio bond flows; GDP = real GDP growth expectations; Infl = inflation rate; USr = U.S. long-term nominal Treasury yield; VIX = Chicago Board Options Exchange Market Volatility Index.*p < .1; **p < .05; ***p < .01.

A Fundamental Transformation

This section presents the results of a firm-level analysis that reveals that it has become easier for firms to access corporate bond markets.20 There are many ways to assess the quality of a bond market, but perhaps the most important metric is its usefulness to potential borrowers. For example, a bond market may be irrelevant to most firms because it is highly concentrated, dominated by a handful of large firms that act as price setters, or requires high fixed costs that can only be absorbed by large issues. These high fixed costs limit market access or raise the cost of capital for smaller firms that have fewer financial resources and insufficient scale. Thus, the usefulness of bond markets could be limited because firms’ issues would need to be “significant,” defined here as a size that accounts for a large proportion of their balance sheets. The analysis also examines whether the corporate bond market has developed into a “spare tire” that firms can use when other parts of the financial system come under stress.

Firm-Level Analysis

Bond market development can be seen as following an evolutionary pattern. Initially, when the market is at a very early stage, only a few firms will be sufficiently large or financially well regarded (with a long track record and audited public accounts) to issue bonds. Moreover, because there are sizable fixed costs to issuing bonds, and because firms want to establish liquid benchmark issues, initial issuance volumes are normally large relative to firm balance sheets. Over time, however, as markets mature and economies develop, barriers to entry decline, which decreases concentration ratios and the relative significance of individual issuances to both individual issuers and the overall market. Markets will no longer be dominated by a few large issuers, or a few large bond issues, since more and more firms are able to issue and diversify supply (“quantity transition”). In addition, the significance of bond issues will also tend to decline, partly because as issuance becomes routine, firms are likely to issue more frequent smaller amounts rather than occasional large amounts. Moreover, as the administrative costs of issuance decline, minimum amounts will become small relative to the size of growing balance sheets (“quality transition”), especially for firms that access debt markets to support expansionary strategies. The lower administrative costs will also allow smaller firms to access capital markets for funding via bond issuance. In the conceptual representation of an evolutionary pattern (Figure 4.13), the market starts off in the second quadrant, with a high concentration of issuers and a high significance of individual issuance relative to the size of balance sheets. Gradually, as the market develops, it moves into the third quadrant, with low concentration and low significance.

Figure 4.13Bond Market Development Matrix

So Much for Theory

What is the evidence for emerging Asia? Some key indicators are provided in Tables 4.3 and 4.4, which show fundamental data on local currency issuance by nonfinancial private sector firms since 2000.21 The focus of the analysis is on selected ASEAN economies; China, Hong Kong SAR, and Korea as regional benchmarks; and Brazil for comparative purposes.22 In these markets, some clear progress toward a greater diversity of issuers since 2000 can be seen. The issuance amounts as well as the number of both issues and issuers have been increasing steadily. The average maturity, however, has shortened somewhat in smaller markets but noticeably lengthened in those more developed markets that continued to record high rates of growth, such as Malaysia and Korea.

Table 4.3ASEAN and Selected Emerging Market Countries: Characteristics of Local Currency Corporate Bond Issuance, 2000–13
IndonesiaMalaysiaPhilippinesSingaporeThailandBrazilChinaHong Kong SARIndiaKorea
Issuance (In billions of U.S. dollars)
Average Maturity (In years)
Sources: Bloomberg, L.P.; Moody’s KMV; national stock exchanges; Worldscope; and authors’ calculations.Note: The country data are based on the country of domicile of the registered issue. Thus, transactions placed in other jurisdictions for reasons of efficient market access are not attributed to the issuer’s country. This is particularly important for the issuance of bonds in Hong Kong SAR by firms from mainland China. These “dim sum bonds” are denominated in Chinese renminbi rather than the Hong Kong dollar.
Table 4.4ASEAN and Selected Emerging Market Countries: Evolutionary Characteristics of Local Currency Corporate Bond Issuance, 2000–12
IndonesiaMalaysiaPhilippinesSingaporeThailandBrazilChinaHong Kong SARIndiaKorea
Concentration of Issuance Volume
Concentration of Issuer Assets
Sources: Bloomberg, L.P.; Moody’s KMV; national stock exchanges; Worldscope; and authors’ calculations.Note: The country data are based on the country of domicile of the registered issue. Thus, transactions placed in other jurisdictions for reasons of efficient market access are not attributed to the issuer’s country. This is particularly important for the issuance of bonds in Hong Kong SAR by firms from mainland China. These “dim sum bonds” are denominated in Chinese renminbi rather than the Hong Kong dollar. The concentration measures of each issuer i out of a total of N issuers in each country (based on the issuance amount and total assets reported at the time of issuance) are defined as “market share” using a normalized version of the Herfindahl-Hirschman Index (HHI), which is specified asHHIissuer=ΣNi(total assetsiΣNitotal asseti)2(1ΣNitotal assetsi)1(1ΣNitotal assetsi)×100,(1)andHHIissuance=ΣNi(issuance volumeiΣNiissuance volumei)2(1ΣNiissuance volumei)1(1ΣNiissuance volumei)×100,(2)respectively. The higher the value of the HHI, the more concentrated the market

Pairing the conceptual approach to bond market evolution with relevant concentration metrics supports the broad empirical observations for the region. Figures 4.14 and 4.15 illustrate the interaction of issuer assets (relative to those of other issuers) and the balance sheet significance of issuance in a two-dimensional representation of firm-level data for each sample country. In this way, it is possible to assess whether the presence of new issuers has also resulted in greater economies from bond issuance.

Figure 4.14ASEAN and Selected Emerging Market Countries: Corporate Bond Issuance Relative to Total Assets Conditional on Issuer Concentration, 2012

Sources: Bloomberg, L.P.; Moody’s KMV; national stock exchanges; Worldscope; and authors’ calculations.

Note; The bivariate density function for each country plots the ratio of the issuance amount over total assets of each issuer (x-axis) (“balance sheet significance”) and the market share of each issuer’s assets relative to total assets of all issuers (y-axis) (“concentration of issuers”), which spans the two-dimensional grid of joint probabilities (defined as the integral over the unit square [0,1], z-axis) following Jobst (2013). The market share of each issuer is based on a rescaled, normalized Herfindahl-Hirschman Index (HHI), which is specified as



HHIi,t=(total assetsi,tΣNitotal assetsi,t)2(1Nt)1(1Nt)×100,(4)

for a total number N of issuers i in a given year t. The closer the value to zero, the less concentrated the respective market based on the size of issuers. The market share of individual issuer assets represents the deal-by-deal representation of the “concentration of issuer assets” as shown in Table 4.3. For Hong Kong SAR and the Philippines, the number of observations was insufficient (due to limited availability of both total assets of issuers and issuance volume). For issuers with multiple issuances, the same issuer concentration is shown relative to the balance sheet significance in the bivariate density functions. The country data are based on the country of domicile of the registered issue. Thus, transactions placed in other jurisdictions for reasons of efficient market access are not attributed to the issuer’s country. This is particularly important for the issuance of bonds in Hong Kong SAR by firms from mainland China. These “dim sum bonds” are denominated in Chinese renminbi rather than Hong Kong dollars.

Figure 4.15ASEAN and Selected Emerging Market Countries: Stylized Concentration of Issuers and Significance of Issuance, 2000 and 2012

Sources: Bloomberg, L.P.; national stock exchanges; Moody’s KMV; Worldscope; and author’s calculations.

Note: The ellipses show the (stylized) placement of the highest joint incidence of issuer concentration and balance sheet significance for each country based on the bivariate kernel density functions shown in Figure 4.14 and Annex Figure 4.1.1 (for Indonesia, Malaysia, and Thailand). The size of the ellipses indicates the relative size of bond issuance relative to other countries. ASEAN = Association of Southeast Asian Nations; BRA = Brazil; CHN = China; HKG = Hong Kong SAR; IND = India; IDN = Indonesia; KOR = Korea; MYS = Malaysia; PHL = Philippines; SGP = Singapore; THA = Thailand.

Overall, bond markets throughout the region matured. As illustrated in Figure 4.13, most countries moved toward the third quadrant (“low concentration, low significance”). More specifically, we find the following:

  • Issuance in bond markets has become more diverse. The concentration of supply in most markets has decreased with the influx of new issuers. Especially in countries that have experienced rapid expansion of their domestic bond markets, such as China and India, concentration—whether measured by issuance (for example, a few large bonds) or by issuers (for example, a few large companies)—dropped to the levels of Hong Kong SAR and Korea, which are home to the most mature bond markets in the region (see Tables 4.3 and 4.4). Moreover, by the end of 2012, the concentration level in China declined to that observed in Brazil, which has one of the largest primary bond markets of any emerging market country. But market concentration in the Philippines (as well as in Malaysia and, to some extent, Thailand if only issuer concentration is considered) remained high.

  • Wider and deeper bond markets have also reduced the significance of new issuance (relative to each issuer’s balance sheet size) as funding sources become more diversified. In many countries (with the exception of Indonesia and Thailand), the balance sheet significance of issuance has significantly declined since 2000. A slower decline in Singapore (similar to that in Brazil) can be explained by the marginal increase of diversity achieved from new issuers (with below-average balance sheet assets) in an already very mature market. In Figure 4.15 (and in Annex Figure 4.1.1, which gives a historical perspective on the market evolution of Indonesia, Malaysia, and Thailand), the center of each ellipse represents the largest density of the joint probability distribution of concentration and significance for each country in 2000 and 2012. The size of each ellipse represents the relative issuance volume (in 2000, Indonesia has two ellipses because it had two distinctive peaks in its probability distribution). After controlling for issuer concentration, Malaysia and Korea show high significance only for many smaller issuers, whereas in Indonesia (and, to a lesser extent, Singapore) issue sizes tend to be more significant even for large issuers (see Figure 4.13). That is, the average issuance volume relative to issuer balance sheets tends to be higher in countries with less developed bond markets and few larger issuers, as the theory would predict. However, this observation might also occur in more mature markets if many smaller issuers with small issue sizes raise the relative importance of larger issuers for the concentration measure (see Table 4.4).

Currently, the state of development, especially in many emerging Asian countries, is encouraging and is not at all far from that in Korea and Brazil—at least as measured by the concentration of issuers and the economic relevance of issuance. A decade ago, only the largest and best-known firms were able to issue bonds, and therefore, their issues dominated local markets. Gradually, however, more firms have been able to issue bonds, thereby creating broader markets. This qualitative progress has culminated in two critical developments. Two ASEAN-5 countries, Malaysia and Thailand, have decisively entered the third quadrant. However, more progress is needed in diversifying the issuer base in Indonesia and the Philippines, and in ensuring that issuance becomes a more routine method of financing operations.

The New Spare Tire

Amid the depths of the global financial crisis, domestic bond issuance by firms surged. For years, the stock of emerging Asian corporate bonds outstanding had been stagnating relative to Asia’s economic growth. But in the second quarter of 2009, the stock of outdated corporate bonds increased by nearly 10 percent quarter-over-quarter in the ASEAN-5 and by more than 20 percent quarter-over-quarter in emerging Asia, excluding China. In the third and fourth quarters of 2009, there was a further large increase. By the end of 2009, ASEAN-5 and emerging Asian local currency corporate bond issuance was higher than the previous peak, reached in 2007, and roughly double the normal level.

This surge was striking for a number of reasons. To begin with, as noted earlier in this chapter, ASEAN-5 firms typically do not rely much on bond issuance for funding. Moreover, the surge took place in the middle of a severe recession, when private sector investment had fallen sharply. So, firms had little need to issue bonds to finance investment projects; they were not initiating projects and they were slowing down the ones that were already under way. Nor were firms forced to issue bonds just to sustain themselves; corporate profitability actually held up reasonably well during the recession.

What explains the issuance boom? The primary factor appears to have been a reaction to changes in bank behavior. Normally, bank-centered financial systems maintain lending ties to their clients, even during difficult times. But this was not a normal downturn. Even though liquidity in the Asian banking systems was ample and capital adequacy was never in doubt, Asian banks nonetheless followed their Western peers and became more cautious after the Lehman Brothers bank-ruptcy. They tightened their lending standards and reduced their prime lending rates much more slowly and partially than the rate of decline in policy and bond interest rates. Even though sovereign and corporate bond yields widened, they remained below prime lending rates in many markets (Figure 4.16). This allowed many firms to continue to raise funds for new projects, refinance maturing liabilities, or even prefund some borrowing requirements. The relatively lower bond yields and continued corporate bond issuances encouraged firms to turn to the capital markets while reducing their use of bank credit (see Figure 4.17). In fact, adding both bank credit and corporate bond issuance together, total credit to the corporate sector actually declined in the first half of 2009 in the ASEAN-5 countries. So, the bond issuance was not “additional”—firms were substituting one form of financing for another. In other words, the domestic bond market acted precisely as reformers had originally hoped it would: it became the “spare tire” that corporations could use if the bank financing channel were to be impaired.

Figure 4.16Spreads between Lending Rates and Yields

Sources: Asian Development Bank, AsianBondsOnline; Bloomberg, L.P.; CEIC Data Co. Ltd.; Haver Analytics; and IMF staff calculations.

Figure 4.17ASEAN-5 and Emerging Asia: Local Currency Corporate Bond Issuance and Corporate Lending

Sources: Bank for International Settlements; CEIC Data Co. Ltd.; Haver Analytics; and IMF staff estimates.

Note: ASEAN-5 includes Indonesia, Malaysia, the Philippines, Singapore, and Thailand.

Where was the demand for these bonds coming from? Much of the demand appears to have come from overseas as global risk appetite began to revive with the asset purchases by the Federal Reserve and the stabilization of financial systems in advanced economies, and as prospects in emerging markets began to appear to be better than those in the West. As a result, inflows into emerging market debt funds resumed in May 2009 and quickly reached levels approaching the peak of the 2005–07 global boom. In short, the ASEAN-5’s and emerging Asia’s domestic bond markets were able to become a spare tire during the Great Recession—one of Asian policymakers’ key original objectives in developing debt markets in the aftermath of the Asian crisis of the late 1990s.

Challenges to Bond Market Development

Institutional Investor Base

The legal and regulatory framework for nonbank financial institutions should be strengthened. This applies particularly to insurance companies, mutual funds, and pension plans. Full, or at least partial, funding of pension plans—as opposed to pay-as-you-go approaches—would create additional pools of financial capital, potentially expanding and diversifying the investor base.23 Even in public-led pension systems, outsourcing tranches or a share of funds to private fund managers would be positive, as has been demonstrated in India. In several Asian countries examined in a study by the ADB (2013a), the concentration of the investor base resulted in a sizable portion of local currency bonds held in “buy-and-hold” portfolios. This, in turn, had an adverse effect on market liquidity, constraining trading by the market’s largest investors. Although foreign investors, notably hedge funds and banks, are active in trading emerging market local currency bonds, overall trading remains relatively modest. Pension fund portfolio diversification has improved in recent years, but in many Asian countries asset allocations are still heavily concentrated in government securities. Pension funds’ asset allocations have been dictated by regulations on their investments that follow rigid criteria set by law or regulatory limits that could be progressively eased. The resulting concentration of exposures in a particular segment of the market has had a negative effect on market liquidity. Development of the mutual fund industry could raise market liquidity and reduce the hold of bank-dominated intermediation. However, the mutual fund industry in Asia generally suffers from lack of an investment culture, instances of fraud, cumbersome or inadequate regulatory structures, improper or inaccurate pricing, and poor investor safeguards (ADB 2013a). From a regulatory perspective, the investment management industry has to have sound governance structures, investment policies, and monitoring frameworks.

Foreign investors continue to face impediments in accessing debt markets in the region. Based on surveys conducted by the ADB (2013b), foreign investors find Singapore, Korea, and Malaysia the easiest markets in which to invest, followed by Thailand. Access to local debt markets in the Philippines and Indonesia is somewhat more difficult. The most challenging countries to gain access to are China and India. In China, for instance, foreign banks, through joint ventures, can trade in bonds and underwrite them on the two regulated bond exchanges. However, these banks mostly remain excluded from underwriting on the interbank market, which is 20 times larger and closed to individual investors (Noble 2013). Access issues could partly explain why Asia’s contribution to global GDP far exceeds the global share of investment in Asian emerging markets. This disparity implies that global institutional investors are significantly underweight in

Asian assets in their investment portfolios. A rough calculation can provide some perspective: for instance, a 1 percent increase in global institutional investors’ allocations to Asia would result in capital inflows of about $600 billion, although not all of this would be invested in local currency bonds.

The key impediments facing foreign investors include capital controls, taxation, and weak institutional structures (Table 4.5). Barriers that most directly affect foreign investors include capital controls, investor registration rules, limits and administrative procedures on foreign exchange transactions, availability of foreign exchange hedging instruments, withholding of taxes, and cross-border clearing and settlement systems. Despite some capital account liberalization measures, countries such as China and India allow only licensed foreign institutional investors to hold and trade domestic securities; strict limits are placed on nonresident participation. With the exception of Malaysia and Singapore, most Asian emerging markets impose withholding taxes on interest earned from local bonds by foreign investors. The prospective inclusion of Indian government securities in benchmark indices, such as the JPMorgan Government Bond Index-Emerging Markets Global Diversified Index, can provide significant impetus for inflows into government debt markets and thus reduce yields. At the same time, the exclusion of the Philippines, owing to limited benchmarks and tax issues, hinders the secondary market liquidity of Philippine bonds. Lower foreign participation in corporate bond markets could also be traced to foreign investor concerns about appropriate pricing caused by weak corporate governance, transparency issues, and uncertain bankruptcy and resolution frameworks. For instance, market participants view the recent first default in the corporate bond market and a very public default on a trust loan in China as important steps in addressing moral hazard. The effective pricing of risk requires tolerance for occasional losses or haircuts on interest-bearing financial instruments, such as corporate bonds or wealth management products, without a formal principal guarantee. More generally, across emerging Asia, defaults need to be resolved more predictably via bankruptcy proceedings rather than treated as idiosyncratic events to be dealt with through a sharing of losses among stakeholders largely independent of their position in the capital structure of the borrower.

Table 4.5Accessibility, Taxation, Funding, and Hedging

Kong SAR
Holding and buying local bondsLimitedYesYesLimitedYesYesCustodianYesLimited
Nonresident accessVia QFIIYesYesVia QFIIYesYesYesYesYes
Foreign exchange restrictionsYesNoNoYesYesVery FewYesNoYes
Withholding tax (nonresident)Only cropNoYesYesYesNoYesNoOnly crop
Capital gains tax (nonresident)NoNoYesYesOnly cropNoOnly cropNoOnly crop
Funding and hedging instruments
Developed repo marketsYesYesYesYesLimitedYesNoYesLimited
OTC Instruments
IR swapsYesYesYesYesYesYesYesYesYes
Foreign exchange swapsYesYesYesYesYesYesYesYesYes
Foreign exchange forwardsYesYesYesYesYesYesYesYesYes
Exchange-traded instruments
IR futuresNoYesYesNoNoYesNoYesNo
Foreign exchange futuresNoNoYesNoNoNoNoNoNo
Liquid NDF marketYesNoYesYesModerateModerateModerateNoNo
Up to 12 monthsYesYesYesModerateModerate
Up to 5 monthsLimitedYesModerateILLiquidLimited
Source: ADB (2013b).Note: IR = interest rate; NDF = non-deliverable forward; OTC = over the counter.

Financial Infrastructure

After more than a decade of reform, market infrastructure in emerging Asia compares favorably to that in other emerging markets in several ways:

  • Transparency. All OTC markets in the region, with the sole exception of corporate bond markets in Singapore, have posttrade transparency, mainly as a result of trade reporting obligations imposed by regulatory authorities. As a result, transparency in these markets is aligned with international best practices.

  • Dematerialization of securities and central securities depositories. Dematerialization (or at least immobilization) of securities has become common practice, facilitating the trading of securities as well as trade settlement.

Malaysia and the Philippines have already moved from scrip to a dematerialized system of representation of securities. In Singapore corporate bonds are not required to be dematerialized. In Indonesia not all corporate bonds are dematerialized, and in Thailand both government and corporate debt are legally required to be issued in paper form. In all three countries, however, immobilization has, to a large extent, eliminated the risk of paper securities. However, book-entry systems for government and corporate bonds remain fragmented among different depositories at the local level.

  • Clearing and settlement risks. In all ASEAN-5 countries, wholesale trading usually takes place on a delivery-versus-payment basis, reducing counterparty risk. The implementation of delivery-versus-payment has helped reduce settlement risk; that is, the risk that the seller of securities delivers but does not receive payment for the securities, or vice versa.

However, some consolidation of depository and settlement systems in ASEAN-5 countries would increase market efficiency. Central securities depositories promote efficiency by reducing the number of securities accounts and connections required by investors or traders. Central securities depositories also economize on the cash settlement leg.24 Thailand has a book-entry system for both government and corporate bonds that is centralized in a single central securities depository; Malaysia also has a central securities depository, which captures unlisted bonds issued by both firms and the government. Thus, some countries could explore further consolidation of book-entry systems. In addition, except for transactions with listed corporate bonds in Malaysia, clearing and settlement of transactions with government and corporate bonds does not involve a central clearing counterparty. While not yet a global standard, consideration could be given to moving toward clearing fixed-income markets through central clearing counterparties to minimize settlement risks. Given that the viability of these entities depends on the existence of a minimum trading volume, ASEAN-5 countries might wish to analyze the convenience of central clearing counterparties in a regional context.

Cross-border investors face an additional settlement risk. Settlement of a domestic bond normally involves payment in a local currency. Nonresident investors buying or selling domestic bonds will normally need to purchase or sell local currency. As a result, cross-border investors are exposed to the settlement risk of the foreign exchange trade, in addition to the settlement risk of the bond trade itself. Thus, a key problem for foreign investors is the timing difference between the securities and cash movements, and this difference in timing is compounded by the fact that most foreign exchange deals in the ASEAN-5 countries are transacted against the U.S. dollar, which settles after Asian business hours. Thus, there would likely be a major benefit from a cross-country clearing and settlement arrangement.

Some standardization of market infrastructure across ASEAN-5 countries, in line with the Joint Ministerial Statement of the 17th ASEAN Finance Ministers’ Meeting in 2013, by regional finance ministers, would also help promote more intraregional intermediation. Currently, each country has its own market infrastructure; there are no cross-border infrastructure linkages for trading, clearing, custody, or settlement. Furthermore, only local central securities depositories, in Malaysia and Singapore, have links with international central securities depositories.25 The absence of integrated market access and trade processing is a challenge for the region because it increases transaction costs and might deter cross-border investment.26 The 17th ASEAN Finance Ministers’ Meeting in April 2013 encouraged the ASEAN financial regulators and ASEAN exchanges to continue working for the development of an integrated ASEAN capital market. The group also agreed to establish a cross committee to develop a blueprint for the establishment of clearing, settlement, and depository linkages (ASEAN Secretariat 2013). It must be acknowledged, however, that this is a common challenge in many regions that are striving toward greater integration, including the European Union.

The final report of the Asian Bond Markets Initiative Group of Experts (ADB 2010) discusses the development of a cross-border arrangement to address the foreign exchange risk of cross-border bond transactions. It provides a comparative analysis of the benefits of different options for such regional arrangements, in particular assessing the benefits of an Asian international central securities depository in comparison with a central securities depository linkage. It also includes a feasibility study for these two options. A key finding from this study is that multiple legal and regulatory barriers would need to be removed for any option to be operationally feasible. Now, a development plan that combines both government and market efforts is needed.

In the ASEAN-5 region, central clearing counterparties exist in the context of markets operated by the exchanges. However, in most of the Asia and Pacific region, bond trading is mainly over the counter and is settled on a bilateral basis, without the intervention of a central clearing counterparty. The benefits of a central clearing counterparty in managing counterparty risk are clear, but the implementation costs are significant. Central clearing counterparties have sizable fixed costs; thus, a minimum settlement volume is needed to make them economically feasible. In the context of each domestic market in the ASEAN-5, such costs might outweigh the benefits. A stronger business case might exist, however, for a regional market. Thus, when considering a regional central securities depository, Asian countries may also find it useful to consider the implementation of a regional central clearing counterparty.

Cash and Derivatives Market Nexus

Progress in enhancing liquidity and foreign participation in local currency sovereign bond markets provides an opportunity to support the complementary development of both the corporate bond and derivatives markets. A deep and liquid cash sovereign bond market is the cornerstone for all other asset prices, including corporate bonds and various types of derivatives. For example, a deep local currency sovereign bond market makes it easier to price corporate bonds based on issuers’ credit. Once a high-volume cash bond market is established, separate trading of registered interest and principal securities and interest rate swaps is easily started. Then, with the advancement of a secondary market, all the cash flow components needed for financial engineering would become available. Hence, structured finance products that are essential for infrastructure finance in emerging Asian countries would become available. Eventually, with two reasonably liquid interest rate swaps markets, there would be room for basis swaps between interest rates in different currencies. These are the tools essential for hedging currency and duration mismatches. Overall turnover in both foreign exchange and interest rate derivatives has increased significantly in emerging Asia but remains low by advanced economy standards.

Laws and regulations governing the derivatives market need to be revised. Although derivatives contracts in mature markets are structured under tried and tested norms of market practice and governed by a highly developed legal regime, statutory barriers and uncertainty surrounding legal and accounting requirements specific to the creation, trading, and enforcement of derivatives have inhibited the development of derivatives markets in Asia and the Pacific. In many instances, legal codes and accounting rules are silent on all or certain types of derivatives, fail to identify the regulatory jurisdiction over derivatives, or make derivatives contracts unenforceable. Also, restrictive cash market regulation, such as occasional limits on short selling, or limited securities lending such as occurs in Indonesia, the Philippines, and Thailand, have inhibited derivatives trading.

ASEAN-5 countries face challenges in developing local derivatives markets and ensuring their balanced growth in support of local bond markets. While several countries have made large strides in developing the enabling legal environment, regulatory obstacles in other countries hinder capital market development. Example of these obstacles include transaction taxes as well as restrictions on various instruments, on short selling, and on parties to transactions. Appropriate regulation and supervision of institutions active in derivatives markets reduces counterparty risk, discourages trading activity detrimental to market integrity, and minimizes potential threats to financial stability. In addition, problems of limited asset supply have resulted in liquidity-induced market risks such as difficulties in executing securities margin requirements. Liquid collateral, including pricing benchmarks, ensures efficient price formation of derivatives markets in the initial stage of development. Increasingly, however, the depth and liquidity of cash markets themselves have, to some extent, come to depend on the presence of similarly well-developed derivatives markets.

Dealing with Offshore Activity

The rise of foreign interest in domestic bonds has another important ramification—growing offshore activity. Offshore trading of emerging market currencies has continued to rise since the global financial crisis, notably for the Chinese renminbi, the Indian rupee, the Indonesian rupiah, and the Korean won.

International investors could be an important driver of the growing demand for emerging market currencies for hedging and speculation (Ehlers and Packer 2013). In some countries, offshore sovereign bond issuances are significant. The Philippines is one example, where even local currency bonds, such as global peso notes, have been issued offshore. Foreign investors often gain exposure to emerging markets by using various “access products,” such as OTC derivatives, structured securities, or offshore special purpose vehicles. Modes of access include innovative financial instruments such as nondeliverable forwards and other derivatives instruments. Examples of the latter include foreign exchange currency swaps and options. Partly as a result of these activities, derivatives transactions with emerging market assets as an underlying reference have exploded since 2010.

Aside from the obvious benefit of ensuring that counterparty risk is focused on a few familiar, developed market financial institutions, investors stay offshore mainly because of impediments or costs to entering. These impediments include the following:27

  • Limits on access to funding on domestic markets

  • Clearing and settlement protocols and custody arrangements, such as custody controls, directed settlement, and rules on sub-custody28

  • Minimum holding periods

Does any of this matter? Yes, for several reasons. Controls and taxes that drive activity offshore thereby reduce liquidity onshore, impairing price discovery. In other words, they reduce efficiency. They also reduce transparency. For example, national authorities will find it difficult to monitor market developments with much of the activity taking place beyond their jurisdictions, in relatively opaque OTC markets. Indeed, a significant proportion of bonds owned by the domestic financial sector may actually be held on behalf of foreign investors—typically by onshore banks—through derivatives structures.

A shift toward offshore activity may also raise prudential concerns. Offshore markets may be less regulated, and in any case will not be regulated by the home authorities. Moreover, even though controls that aim to isolate domestic markets from those offshore might exist, inevitably firms find ways to arbitrage between the two. As a result, developments in markets offshore can be transmitted onshore. In that case, compensating policy action might prove difficult because national authorities might not have much information on the genesis or the nature of the underlying shock.

For all these reasons, over time it may be beneficial to try to bring such markets onshore. One way to do so would be by reducing or eliminating withholding taxes. Such a measure, however, would raise difficult issues of equity and efficiency. For example, if nonresidents are exempted from withholding tax, practices could emerge such as “coupon washing,” whereby bonds are sold during the coupon payment period—perhaps via repo or securities lending—to investors paying low or zero withholding tax. Alternatively, resident investors might begin to direct purchases through offshore routes to avoid or reduce the cost of with-holding tax. However, abolishing the withholding tax on bonds for all, residents and nonresidents alike, might create a distortion favoring bond markets over equity markets.


Local debt markets in emerging Asia have made significant progress since 2000. Market development reforms and the opening up of markets to foreign investors have helped overcome the “original sin” problem and lengthened debt maturities while enhancing liquidity and market depth. Importantly, corporate bond markets served as a “spare tire” during the global financial crisis, as intended, while the banking system was deleveraging. Meanwhile, the recent corporate issuance boom attests to the development of a “twin engines” financial system. However, corporate bond market liquidity has lagged behind sovereign markets in most of emerging Asia because of weaker foreign participation, as well as concerns about corporate governance and resolution frameworks.

However, greater foreign participation has not only enhanced sovereign debt market liquidity, it has also made yields more vulnerable to changes in global risk aversion. Emerging market assets—in particular local debt markets—came under heavy selling pressure following the Federal Reserve’s announcement of a tapering plan in June 2013. The prospect of higher interest rates, lower global liquidity, and the growth slowdown in emerging Asia, led by China and India, resulted in net outflows of capital along with a deterioration of trading and liquidity conditions. Such concerns were concentrated in the emerging market economies with relatively high external (current account deficit) and domestic (inflation) imbalances. With more flexible exchange rates, policymakers allowed exchange rates to take the brunt of the adjustments along with higher yields. This episode of stress also showed that the domestic investor base (local pensions, mutual funds, and insurance firms) can play a critical role as a shock absorber, highlighting the importance of further financial deepening.

Asian capital markets have broadened and deepened since the global financial crisis, but the following reform efforts are still needed:

  • On pricing benchmarks, most sovereigns have developed the local currency government yield curve (also the credit curve) but liquidity across the maturity spectrum remains fragmented.

  • Market liquidity has improved as the investor base has become more diverse, with a notable increase of foreign investors in local currency bonds. Markets could deepen even further if market makers were to take on a more active role. Secondary market liquidity in most local currency bond markets has been hampered by the limited progress made in funding markets, such as developing the repo and securities lending markets.

  • Market access has eased through progressive capital account liberalization, but impediments remain because of tax treatment and remaining capital controls.

  • The physical market infrastructure (clearing, settlement, and custody) supporting Asian local bond markets has developed significantly but mainly in the larger markets. The infrastructure could benefit from the economies of scale of a regional link. Other impediments to improving the infrastructure include an embryonic legal and regulatory framework for nonbank financial institutions, weak corporate governance, inadequate information provision (including pricing transparency), the lack of hedging instruments, and the absence of a robust framework for asset-backed securitization. Additional barriers that affect both foreign and domestic investors include limited foreign exchange and interest rate hedging instruments, which require regulatory and legal frameworks related to derivatives markets.

Annex 4.1

Annex Figure 4.1.1Indonesia, Malaysia, and Thailand: Corporate Bond Issuance Relative to Total Assets Conditional on Issuer Concentration, 2000–2012

Sources: Bloomberg, L.P.; Moody’s KMV; national stock exchanges; Worldscope; and authors’ calculations.

Note: The bivariate density function for each country above plots the ratio of each issuance over total assets of each issuer (x-axis) (“balance sheet significance”) and a concentration measure of each issuer’s assets relative to total assets of all issuers (y-axis) (“concentration of issuers”), which spans the two-dimensional grid of joint probabilities (defined as the integral over the unit square [0,1], z-axis) following Jobst (2013). The concentration issuers is defined as “market share” based on a rescaled and normalized Herfindahl-Hirschman Index (HHI), which is specified as



HHIi,t=(total assetsi,tΣNitotal assetsi,t)2(1Nt)1(1Nt)×100,(A2)

for a total number N of issuers i in a given year t. The closer the value to zero, the less concentrated the issuer size. The country data are based on the country of domicile of the registered issue. Thus, transactions placed in other jurisdictions for reasons of efficient market access are not attributed to the issuer’s country.


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This chapter builds on a number of related IMF working papers (Gray and others 2011; Felman and others 2011), which were later published in the Asia-Pacific Journal of Economic Literature.

Eichengreen and Hausmann (1999) introduced the term “original sin” to denote the greater tendency of emerging market countries with weak external positions to borrow in foreign currency as a way to overcome international investors’ concerns about higher borrower risk.

However, many of the Asian firms that resort to bond financing prefer private placements since it allows them to save on regulatory costs (for example, registration, prospectus, and disclosure requirements) of public listings.

Also, the cost of borrowing is still the primary determinant of the mode of financing, although maturity and diversification of financing sources are becoming increasingly important considerations.

Nonetheless, data problems remain an issue. In some cases, AsiaBondsOnline data differ widely from those available from other sources, such as the Bank for International Settlements (BIS). Also, data for some variables are not available for all countries, hindering ASEAN-wide analysis.

For example, the Reserve Bank of India uses the Negotiated Dealing System, which was introduced in 2002, as the primary auction platform for government securities. Secondary trading of government securities occurs through over-the-counter, Negotiated Dealing System, or the Negotiated Dealing System–Ordered Matching, which was introduced by the Reserve Bank of India in 2005 and is maintained by the Clearing Corporation of India Limited. In China, the custodianship and settlement of medium-term notes and commercial paper has been moved from ChinaBond to the Shanghai Clearing House.

The regulation of the bond market is fragmented among three government agencies—the central bank, the National Development and Reform Commission, and the China Securities Regulatory Commission. The China Securities Regulatory Commission is pushing ahead with unifying all of the regulators’ separate bond-disclosure, credit-rating, investor-protection, and entry standards (Gang 2014).

The five largest economies in Southeast Asia that make up the Asean-5 are Indonesia, Malaysia, the Philippines, Singapore, and Thailand.

Although access via offshore derivatives markets, notably by foreign banks, can enhance liquidity, it can also lead to the sudden drying up of liquidity when foreign investors withdraw during periods of heightened global risk aversion.

VIX is a trademarked ticker symbol for the Chicago Board Options Exchange (CBOE) Market Volatility Index, a popular measure of the implied volatility of S&P 500 index options.

Available data may understate the importance of foreign investors, since they also use derivatives (including nondeliverable forwards, structured notes, and total return swaps) to take exposures; these derivatives are not easily accounted for.

At roughly $4 trillion, China’s domestic bond market is the world’s fourth largest after the United States, Japan, and France, but its size still lags behind similar markets in advanced economies when compared with the size of the real economy (Noble 2013).

Stock index futures and stock index options are the most widely traded equity derivatives. Index-based derivatives are usually the first instruments to be developed before options on individual assets are introduced.

This is in contrast to other emerging market regions and mature markets, where interest rate derivatives are more commonly traded than are currency derivatives. Currency derivatives are traded in only a handful of emerging market exchanges; the bulk of the trading occurs in the OTC market. In Asia (excluding Japan), active exchange-based trading of currency derivatives occurs only in Hong Kong SAR, India, Korea, and Thailand. Until recently, most of currency derivatives trading took place offshore.

Stock and equity index derivatives activity is concentrated at the organized exchanges, where equity derivatives are the most liquid among all derivatives products. Contract trading volume continued to expand vigorously in the past few years, which testifies to rising liquidity. Equity index derivatives account for the bulk of the trading.

If institutional investors can purchase derivatives, they can hedge risk. However, selling derivatives—as happened with AIG, for example—can clearly lead to problems.

The IMF’s (2014)Global Financial Stability Report highlights the importance of accounting for portfolio capital flows in driving bond yields in emerging markets even while controlling for other external factors, such as global risk aversion, where financial deepening can help dampen the sensitivity of local yields to the VIX.

The inflation rate was included instead of the short-term nominal policy interest rate (to control for the effects of monetary policy on the bond yield term structure) used by IMF (2009) and Peiris (2013) because it provided a better fit in most countries and the two variables were highly correlated during this inflation-targeting period. The ratio of the current account balance to GDP was also considered but was not a robust explanatory variable when foreign portfolio inflows were included in the specification. It was thus excluded given the focus of the analysis on foreign inflows. In most countries, a high degree of multicollinearity between the budget balance and public debt level was found, as expected; therefore, only the public debt level was included in the final results.

Edwards (1998) uses a similar methodology to estimate the impact of volatility spillovers or contagion in Latin America during the “tequila” crisis.

The sample includes ASEAN countries with more-developed bond markets (Indonesia, Malaysia, the Philippines, Singapore, and Thailand) as well as China, Hong Kong SAR, India, and Korea. For comparative purposes, Brazil was included as an emerging market benchmark outside Asia.

Bond issuance (and balance sheet information [total assets]) data were obtained for nine Asian countries comprising five ASEAN countries and four non-ASEAN economies (China, Hong Kong SAR, India, and Korea) as well as Brazil as a global emerging market benchmark. Bond issuance data comprised all local-currency-denominated, nonfinancial private sector transactions during each sample year (2000, 2005, and 2009–13).

Issuance by nonoperating financial companies and special purpose vehicles was not considered. Moreover, multiple tranches of issues and issuers for which no balance sheet size could be determined were excluded from the sample. Thus, the issuance volumes for Hong Kong SAR and Singapore in Table 4.3 are understated. Moreover, the sample sizes for Hong Kong SAR, the Philippines, and Singapore became too small for the detailed (deal-based) analysis in Figure 4.14. The total bond issuance between 2003 and 2012 in Hong Kong SAR and Singapore amounted to about $400 billion and $100 billion, respectively (Le Leslé and others 2014). Issuance is predominantly in local currencies (67 percent in Hong Kong SAR; 77 percent in Singapore). In Hong Kong SAR, private sector debt dominates (64 percent), while in Singapore, government and private debt each account for about half of issuance (47 percent and 53 percent, respectively).

Consolidation of the multipillar pension system, with emphasis on the funded component, would be preferable in China.

For instance, if an investor sells a government bond and invests the proceeds in a corporate bond, a single central securities depository means that the cash flows can net out.

A task force comprised of the central banks of Indonesia, Malaysia, and Thailand, the Hong Kong Monetary Authority, and Euroclear was created in June 2010 to explore gradual harmonization based on a common platform.

As with a single national central securities depository, links between central securities depositories in different countries (or the introduction of an international central securities depository) reduce the need for multiple securities accounts and simplify cash management.

The nature and extent of impediments differ widely from country to country. For example, Malaysia has none of the impediments listed. In fact, Malaysia has made its bond market internationally accessible via international central securities depositories (Euroclear and Clearstream) to enable foreign investors to settle securities transactions without opening a local custodian account.

The cost of appointing a local custodian can make cross-border investments unattractive.

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