Following the launch of Asian Bond Fund 1 last year, which is targeted at Central Banks, the Executives' Meeting of East Asia-Pacific Central Banks is now working on the second stage of the development of the Fund: to develop listed and passively managed bond funds that can also be opened to retail investors.
The Asian financial crisis highlighted the importance of developing a deep, liquid and mature bond market in the region. Such a market can play an important role during crisis times when the other channels of financial intermediation - the banks and the equity markets - falter or fail. Diversity also enhances efficiency in financial intermediation and promotes economic growth and development.
Given the concern about over-reliance on bank financing as the major channel of financial intermediation, Asian economies have been promoting the development of the bond market. Indeed, there has been considerable growth in the bond markets in the region. At the end of 2003, the total market capitalisation of domestic bond markets in eight Asian economies (Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand) was equivalent to 47% of the combined GDP of the economies, more than double the 20% at the end of 1995. Over that eight-year period, the combined share of bond market in total financing grew from 11% to 19%. But these latest numbers are still low compared with the corresponding ones of developed markets. There is therefore a lot of room for the Asian bond markets to grow and contribute further to financial stability and efficient financial intermediation.
Among the factors still inhibiting further development is the high transaction cost for investors, particularly the retail investors. It is understandable that market makers of debt that lacks secondary market liquidity would charge a relatively high transaction fee, in the form of price spreads or service charges, or both. Even for bond funds of higher liquidity, particularly those involving active management, transaction fees can still be prohibitively high for retail investors.
In view of this, there may be a case for the development of listed and passively managed bond funds. Listed funds are traded on the stock exchanges at a price determined by supply and demand, and so there is no bid-offer spread. Furthermore, the management fee of a passively managed fund would be lower than that of an actively managed fund since the fund manager is only required to undertake passive portfolio re-balancing based on a pre-determined benchmark index. In addition, investors can easily assess the performance of the fund manger by comparing it with the performance of the benchmark. It is with these considerations in mind that the Hong Kong Monetary Authority, as Chairman of the Executives' Meeting of East Asia-Pacific Central Banks (EMEAP) Working Group on Financial Markets, is steering the next stage of development of the Asian Bond Fund (ABF).
Readers may recall that EMEAP launched the US dollar denominated ABF, or ABF1 around this time last year. While ABF1 is a close-ended fund and is confined to the investment of EMEAP central banks only, the EMEAP Group intends that the ABF2 would be opened to investment by private sector investors when conditions permit. ABF2 would offer low-cost index-driven bond funds, including individual country funds and a Pan-Asian Bond Index Fund, for private sector investment. Together they would provide investors with the flexibility to invest in the Asian bond markets of their choice, as well as the convenience of having a well-diversified exposure to bond markets in Asia in one instrument. It is expected that ABF2 would raise investor and issuer interest in the Asian bond markets, generating liquidity and broadening participation in the long term.
ABF2 is intended to be managed against a family of transparent, replicable and credible bond market indices, which by themselves would be an important piece of financial architecture. For instance, the indices can be adopted by private sector fund managers as benchmark indices for their fixed income products. Derivative products can also be structured around these indices, generating additional liquidity and trading activity to the underlying bonds.
Bond funds on offer under the ABF2 initiative may be exchange-traded if conditions permit. Exchange-traded bond funds (ETF) are new to the region, but have become a fast growing fund category in the US and Canada. ETF can make the price discovery process more transparent, as a bond ETF would essentially trade like a stock - listed on an exchange, and traded centrally, with price quotes transparent to all.
In addition to the above benefits to regional bond market development, the ABF2 can act as a platform for addressing regulatory and other hurdles in bond market development. Individual EMEAP economies can leverage on the interest and momentum generated from the collective investment in ABF2 to further develop their domestic bond markets, for instance, through working with relevant authorities to identify and minimise the legal, regulatory, and tax hurdles in their markets.
Joseph Yam
19 August 2004
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