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Development of the Debt Market

by Joseph Yam, Chief Executive, Hong Kong Monetary Authority

(Keynote Address at the Asian Debt Conference, reprinted in the HKMA Quarterly Bulletin Issue No.12)

14 July 1997


  1. Thank you very much for inviting me to speak at this Asian Debt Conference. Judging from the presence of this large and distinguished group of market professionals, there certainly is much interest in the development of debt markets in the Asian Region. I feel very encouraged by this.
  2. As some of you may recall, the Hong Kong Monetary Authority (HKMA) and the World Bank co-hosted the Emerging Asian Bond Conference in June 1995. Perhaps I should start today by picking up from where I left the subject then. In concluding the speech I delivered at that Conference, I said that:
    • "The term 'emerging markets' is a good adjective for markets which begin to develop. It is certainly not a label we would like to continue to carry in the coming decades. Ten years later, we may still be discussing the untapped potential of our markets. Alternatively, we may gather again to share each other's success. Which of these two scenarios will materialize will depend on what the policy makers, regulators and market participants in Asia decide to do."
  3. Two years have elapsed since. So this conference provides a very good opportunity to take stock of how the debt markets in the Asian Region have fared, and to reflect further on the development strategy.

Economic Background

  1. Let me first recap briefly the favourable factors for the development of the debt markets in the Asian Region as highlighted in the 1995 World Bank study. These factors include:
    • rapid economic growth - forecast to be 7.7% per annum between 1994 and 2004;
    • high savings rates of over 30%;
    • huge amount of investment required to sustain the rapid growth, estimated to be around US$8 trillion between 1994 and 2004; and
    • increasing reliance on debt financing to meet investment needs, from 9% of gross domestic fixed investment in 1994 to 26% in 2000-2004.
  2. The favourable macroeconomic trends depicted in the World Bank Report have become more evident since 1995. While the strength of the US dollar, to which many of the regional currencies are formally or informally linked, has some adverse effect on the export competitiveness of some economies, IMF data show that Asia as a whole churned out an enviable growth rate in the GDP of 8.2% in real terms in 1996. The IMF forecast much the same growth rate for 1997, which continues to be substantially higher than the 2.6% economic growth forecast for the major industrial economies.
  3. As pointed out in the World Bank Report, investment in infrastructure, capital intensive manufacturing and housing will need to expand to sustain the rapid growth of the East Asian economies. Adhering to the principle of fiscal prudence, I expect that governments in the Region will continue to refrain from incurring large fiscal deficits to finance these investment needs. There is thus a fundamental issue of efficiently channelling private sector savings into productive investments. The development of the debt market therefore assumes a strategic role in this context.
  4. Recent experience in Thailand underlines the importance of this. The debt market can also be quite a stabilizing force in the economy. Stability of the Thai economy and its currency has been adversely affected by an over-reliance on short-term foreign borrowing for investment activities and the over-extension of property-related lending by banks and non-bank financial institutions. Had there been a mature debt market to mobilize efficiently long-term domestic or foreign savings to meet long-term investment needs, the reliance on short-term foreign capital, which is inherently volatile, would have been reduced. Likewise, the liquidity risk in financing long-term investment, such as infrastructure and property development, with short-term funding can also be minimised. I am glad to hear of the Thai Government's announcement on the creation of a mortgage corporation to enhance the liquidity of long term property loans, amongst other things.

Recent Developments

  1. Let me now try and take stock of recent developments in the debt markets of this Region. Let me once again make use of the convenient acronym which I introduced in my June 1995 speech. This is B I R D S or birds, with "B" standing for "benchmark", "I" for "infrastructure", "R" for "rating", "D" for "demand" and "S" for "supply".
  2. I am pleased to say that there have been encouraging developments on all these fronts. On benchmarks, considerable efforts have been made by many Asian economies to expand and improve their government debt issuance programmes, in part with the aim of building up a more reliable benchmark yield curve. This is essential to facilitate the pricing of issues by issuers and traders in the primary and secondary markets. In Hong Kong, we have successfully extended the Hong Kong dollar benchmark yield curve to the 10-year area with the introduction of 10-year Exchange Fund Notes in October 1996. Elsewhere in the Region, the Philippines and Singapore have issued government debt securities with a tenor of 10 and 7 years respectively. Extending the benchmark yield curve is only part of the equation. For benchmarks to be meaningful, they must be determined in a competitive market environment and not administratively by the government, as has been the case in some debt markets in the Region. In this context, commendable efforts have been made by some economies to enhance the reliability of the benchmark yields. The People's Bank of China and the Bank of Korea, for example, introduced a competitive bidding method for government bonds in 1996 and the Bank of Thailand has put in place a more regular borrowing programme.
  3. On the infrastructure of the debt market, notable progress has also been achieved, particularly in respect of the clearing and settlement system. Many of the economies in the Region, including Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore and Thailand have already developed central securities depositories which provide some form of centralized, computerized book entry clearing and settlement system for debt securities. In Hong Kong, our CMU system has gained in sophistication through a seamless interface with the real time gross settlement (RTGS) payment system implemented in December 1996. The CMU now provides both real time and end of day delivery versus payment (DvP) service for Hong Kong dollar debt securities. Many economies in the Region, including Korea, Singapore and Thailand have introduced or are in the process of planning or implementing RTGS which is expected to provide similar DvP functionality to enhance the security and efficiency of the clearing and settlement of debt securities. The adoption of the latest technology will enable the infrastructure of Asian debt markets to match if not surpass that in many developed economies.
  4. On rating, I am pleased to see that in recognition of the promising potential in the Asian debt markets, international rating agencies have stepped up their presence in the Region. In Hong Kong alone, no fewer than four international rating agencies have opened their offices here in the last couple of years. In Malaysia, a second local credit rating agency has been set up. To some extent, the use of rating agencies has been encouraged by official recognition of ratings for regulatory purposes. In Hong Kong, for instance, we have recognized the ratings of a number of international rating agencies in assessing the eligibility of debt securities for various purposes, first, for the repurchase of securities under our Liquidity Adjustment Facility, our version of a discount window, second, as liquefiable assets for the purpose of satisfying the statutory liquidity ratio in the Banking Ordinance and third, as debt securities qualifying for a concession in profits tax on interest income. These have encouraged issuers to seek formal rating of debt issues. Rated issues now account for more than half of all outstanding Hong Kong dollar debt securities.
  5. On demand for debt securities, this will obviously continue to be underpinned by the high savings rates of this Region. But the way in which savings are organized is important. With the predominant position of the banking and equity markets, the large number of small savers in this Region traditionally have little exposure to, and therefore lack interest in, investing in debt securities. As a result, they have been forced to choose on their own between the low risk and return banking deposit market and the high risk and return equity market, and there is not much demand for debt. I am glad, however, that this is changing. As policy makers in Asia face the major challenge arising from the ageing of the population (according to World Bank's estimates, the proportion of the world's population that is over 60 will nearly double, from 9% to 16% over the next 35 years, and more than half of them will be in Asia), there is now a clear trend towards the institutionalization of savings. With a larger part of the community's savings being handled by professionals who are likely to go for a more diversified investment portfolio, the demand for debt securities will grow. In Hong Kong, for instance, we will be implementing the Mandatory Provident Fund Scheme, which is expected to be a significant source of demand for high quality debt securities.
  6. On the supply side, I am hopeful that the growing demand for debt securities will generate supply, encouraged further by the improvement in market infrastructure and the ability to price issues more accurately with the assistance of reliable benchmarks and ratings. There is in any case continued strong appetite for long term funds to finance long term investment projects, both in the public sector and the private sector. Indeed, there has been rapid growth in the size of the debt market in this Region and the prospects are good. The World Bank study in 1995 forecasts that the combined size of Asian bond markets (excluding Japan) will quadruple within a time span of ten years, from US$338 billion at the end of 1994 to US$1.3 trillion by 2004. This implies an annual growth rate of over 14%. While we do not have comprehensive up-to-date figures on the size of Asian debt markets, gross issues of debt securities in many of the regional markets rose by over 15% in 1995. Domestically, the outstanding amount of Hong Kong dollar debt securities recorded substantial increases of 29% and 43% in 1995 and 1996 respectively.

Strategic Issues

  1. So things seem to be going well for the debt markets in the Asian Region. But let us not be complacent and indulge too much in these encouraging developments. I think we still have a long way to go before the full potential of our debt markets could be realized. We should therefore continue to monitor closely developments with a view to identifying areas where improvements are called for. I have taken the view, at least for Hong Kong, that there is a facilitating role for monetary authorities to play in this, particularly in setting benchmarks and building the market infrastructure, akin to the involvement of governments in setting construction standards and building highways as part of the physical infrastructure. So I hope I will not appear to be too interventionist if I also today bring out two related and quite strategic areas for consideration by those with a keen interest in this subject.
  2. The first one is the familiar issue of liquidity. Asian debt markets have generally lower liquidity compared with those of the developed economies, and low liquidity obviously inhibits the further development of these debt markets. In the case of Hong Kong, while we have been successful in developing the Exchange Fund Bills and Notes programme into one of the most actively traded government securities in the world, liquidity of private sector issues is still relatively low. Investors who buy and hold still account for a large part of the investor base.
  3. Enhancing market liquidity is indeed one of the major challenges for those developing debt markets in Asia. Our experience in Hong Kong suggests that one useful way is to put in place an effective market making system with an effective trading platform. Many of you are already familiar with the market making system for our Exchange Fund paper which, as I mentioned just now, is responsible for making the Exchange Fund debt market one of the most liquid government debt markets in the world. This market making system has, as you know, been extended to debt issued by the Mass Transit Railway Corporation under the Note Issuance Programme arranged on their behalf by ourselves, and secondary market liquidity of those paper has never been a problem. The Airport Authority has a similar need for the issue of debt and we are therefore developing a similar Note Issuance Programme for them.
  4. To further enhance the liquidity of private sector issues in the secondary market, the CMU will introduce a securities lending programme later this year. The programme will enhance the liquidity of CMU debt securities by providing a mechanism to utilize securities held by long term investors for short-term use by the more active market participants. Under the programme, market participants who are prepared to act as market makers of private sector issues will be allowed to borrow securities from other CMU members to cover their short positions. The programme will also help to achieve two other objectives. First, it will improve the settlement efficiency of CMU instruments as securities made available by borrowing through the programme will help to reduce the chance of settlement failure. Secondly, it increases the attractiveness of CMU instruments to investors by enhancing the yields for the lenders.
  5. Whilst these are interesting initiatives which may be of use for others wanting to enhance liquidity in their own debt markets, one inhibiting factor on liquidity in any market is the actual size of that market. If the critical mass is not there, these initiatives may be of limited use. Yet if one looks at the Asian Region, one sees a rather fragmented picture insofar as the debt markets are concerned. Perhaps this is because of the geographical fragmentation of the Asian Region. In South East Asia you see a cluster of predominantly domestic debt markets barely serving domestic needs. Even with the most sophisticated market infrastructure and market making system, liquidity may still be a problem simply because the markets themselves are small.
  6. This brings me to the second strategic issue that we should address in developing debt markets in this Region. I believe that there is a need for debt markets to break through geographical or national boundaries. Assuming that financial liberalization for those concerned has progressed to a stage whereby there is no longer any significant inhibition to financial intermediation on an international basis, one should try and internationalize domestic debt markets or at least refrain from discouraging their internationalization. There are funds out there in this rich Asian Region and beyond, seeking investment opportunities. Afterall, Asia has very high savings rates and official foreign reserves are very substantial. When the conditions are right, these funds could be attracted to debt markets in this Region. Here I speak as the manager of over US$80 billion of official reserves, combining the Exchange Fund and the Land Fund, and I know that my counterparts in other economies with large reserves also think along the same lines. But of course the right conditions do not come by easily. The pre-condition of financial liberalization itself has been fraught with difficulties as the associated volatility of capital flows and the sometimes unpleasant implications on monetary stability have to be dealt with. However, it is widely accepted that more effective financial intermediation on an international basis, not necessarily limited to just through the debt market, is clearly of long term benefit to the Region.
  7. What I think we need is a platform that would facilitate cross border trades in debt securities within the Region. I see this as a two-stage process. The central banks and monetary authorities in the Region should, working closely with market participants, first bring their debt market infrastructure, particularly their domestic central securities depository and clearing systems, and the all important payment systems up to internationally acceptable standards. In this context, I am glad to see the positive response of the Asian Development Bank to my suggestion of devoting more resources to assist economies in the Region to enhance their financial infrastructure. As a second step, we should build a network linking the domestic central securities depositories in the Region for clearing cross border trades in securities in Asian time. The linkage of domestic depositories will facilitate trading and holding of Asian bonds by domestic participants, hence enlarging the investor base and broadening the market to create the critical mass for the Asian debt markets to play a truly meaningful role. If, at the same time, or even separately, payment systems of economies in the Region move onto the RTGS platform, as we did at the end of last year, and are also linked up, then cross border trades in debt securities, or indeed other financial assets, at least at the wholesale level, could be settled on a DvP basis, reducing settlement risks and creating an important component of what I referred to earlier as the right conditions for large international investors to invest in debt markets in the Region.
  8. Cross border linkages of domestic central securities depositories in the region can take two different forms. As a first option, a multi-access central depository and clearing system may be established as a separate entity to serve as a hub for linking domestic depositories in the Region. As an alternative, a group of domestic depositories can be connected by bilateral linkages to form a network. This is the concept of Asiaclear which we have been promoting.
  9. The HKMA is now in discussion with other regional central banks on this issue. My view is that an evolutionary approach starting with bilateral linkages is the pragmatic way forward. It is more practical taking into account the different stages of development of the domestic central securities depositories in the Region. It would be difficult and time-consuming to organise a multilateral network from scratch as it involves a large number of central banks and domestic depositories, and there is no practical experience in cross border linkages in the region. Premature consideration of more complicated features, for example the opening of cash accounts, may also cause unnecessary concern to potential participants. The central banks may worry about disturbances to their payment systems. The commercial banks may also worry about competition from the central securities depositories. On the other hand, a network of bilateral linkages is easy and quick to set up as it mainly involves each participating central securities depositories becoming a member and opening an account with each participant in the network. The membership of central securities depositories in the network is flexible. It can start with a few depositories of financial centres which are at a similar stage of development in their debt markets. Other depositories may join later at a pace comfortable to them. Moreover, the framework and procedures developed for the initial cross system linkages can be replicated for new participants thereby expediting the process of subsequent expansion of the network.
  10. In pursuit of this bilateral linkage approach, the HKMA has agreed in principle with the Reserve Bank of Australia to establish a bilateral linkage between CMU and the Reserve Bank Information and Transfer System. HKMA is also discussing with the Reserve Bank of New Zealand and the People's Bank of China on the establishment of similar links. We welcome other central banks in exploring the establishment of such links with us.
  11. Ladies and gentlemen, I earlier drew the analogy of the financial infrastructure with the physical infrastructure. We built highways to move people and goods safely and efficiently, but we do not pay as much attention to the building of financial highways so as to move money safely and efficiently. We built airports and planes to fly people, again safely and efficiently, around and across international boundaries to enhance their mobility so that they can interact with each other for their mutual benefit. Why do we not do as much for money or capital, the mobility of which from one market place to another arguably is of equal importance? We in the HKMA have taken the initiative and made a start in this effort, and have got quite a lot of our colleagues in central banking and multilateral institutions interested. I hope on the next occasion when there is another major conference on debt markets in the Asian Region we will be able to see further progress.
Last revision date: 1 August 2011
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