Developing Bond Markets in Asia

inSight

07 Jul 2005

Developing Bond Markets in Asia

The launch of the ABF Pan Asia Bond Index Fund, a key component of the Asian Bond Fund 2 Initiative, opens a new chapter in the development of bond markets in Asia.

This week saw the inauguration of the ABF Pan Asia Bond Index Fund (PAIF), with a listing on the Hong Kong Stock Exchange. This is the second listed bond fund under the Asian Bond Fund 2 Initiative (ABF2). Two weeks ago, we witnessed the listing of the first ABF2 bond fund, the ABF Hong Kong Bond Index Fund, in Hong Kong. In the next couple of months, the other seven ABF2 funds will also be launched in their respective markets. This historic ABF2 Initiative provides food for thought on three topics of current interest: the promotion of bond market development in Asia; central bank co-operation; and private-sector and public-sector co-operation.

There is no shortage of savings in Asia. The total foreign exchange reserves held by the EMEAP Group*of central banks now exceeds US$2 trillion. The bulk of the savings are invested in low yielding financial instruments in the US and other G7 markets before being recycled back to Asia in other forms of investment. This is a reflection of the underdevelopment of capital markets in Asia, which hinders effective intermediation between savings and investments in the region. A deep and broad bond market will play an important part in overcoming this structural defect. More specifically, there is a need to improve the availability of domestic-currency fixed-income products in Asia and increase the accessibility of these products to investors.

The PAIF and other component funds of the ABF2 are designed precisely to meet these objectives. The PAIF is a convenient and low-cost product that will facilitate investor participation. As a passively managed bond fund, the management fee and expense ratio of the PAIF are substantially lower than those of actively managed funds. The listing of the PAIF means that it can be bought and sold easily through exchange brokers in the same way as equity shares.

The PAIF also encourages cross-border investment in fixed-income instruments. While a fully integrated bond market in Asia may still be some way off, a pan-Asian investment product such as the PAIF will help the pooling of savings within and outside the region for investment in domestic currency bonds. For instance, when an investor buys units of the PAIF, the fund manager will then use the money received from the investor to purchase bonds in the eight underlying markets in Asia. In this way, the savings can be channelled to markets in Asia. In the longer term, we expect that the increased demand for bonds in Asia will result in more competitive pricing, making bonds more popular as an alternative means of financing to complement bank credits and equity financing.

The ABF2 Initiative is also a milestone in central bank co-operation. With seed investment from all 11 members of the EMEAP central banks and the peer support and encouragement so generated, the Initiative has helped accelerate regulatory reforms in several markets in the region. For example, the PAIF is the first foreign institutional investor to have access to the interbank bond market in Mainland China. And Thailand and Malaysia have provided withholding tax exemptions to foreign investors investing in local currency bonds. The ABF2 Initiative has also provided the impetus for securities regulators in these jurisdictions to develop their rules and regulations to cater for the launch of new bond fund products.

The ABF2 Initiative has not only utilised expertise within the central banks, it is also in many ways a public-private sector initiative. The use of private sector fund managers, an independent index provider and a custodian has brought together the market expertise to turn a concept into viable investment products.

While the US$2 billion investment from the 11 EMEAP central banks is only a small amount compared with the more than US$1 trillion bond market in Asia, the ABF2 Initiative helps to lay a solid foundation for further development of bond markets in the region. Looking ahead, the bond markets in Asia have a great deal of potential to grow, not only in terms of size but also in depth and breath. We look forward to the launch of similar products and fixed-income derivative products by the private sector.

Lastly, as a word of caution, the PAIF and the other ABF2 funds are managed by their respective managers, and investors should consider all risks before investing in these funds, as with other investment products. The trading price of the PAIF and other funds may rise or fall according to the demand and supply of the units of the funds in the market, while the net asset value of the funds may fluctuate in tandem with price movements of the underlying bonds. Furthermore, the trading price of the units of the funds on the stock exchange may not conform to the net asset value of the funds at all times given that they are determined by separate mechanisms.

 

Joseph Yam

7 July 2005

 

* EMEAP is a forum of central banks and monetary authorities in the East Asia and Pacific region established in 1991. EMEAP's primary objective is to strengthen co-operation among its members. The 11 members include the Reserve Bank of Australia, People's Bank of China, Hong Kong Monetary Authority, Bank Indonesia, Bank of Japan, Bank of Korea, Bank Negara Malaysia, Reserve Bank of New Zealand, Bangko Sentral ng Pilipinas, Monetary Authority of Singapore and Bank of Thailand.

 

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Last revision date : 07 July 2005