WOULD IT BE somewhat nerdy to assert that I’ve always had something of a soft spot for the Taiwan bond market? If it is, then I’ll put my hand up, but at least it no longer seems such a bizarre object of affection: the market in Taiwan for offshore currency issuance is on fire, and it’s even threatening to usurp the once-ballooning Hong Kong Dim Sum market as the favoured venue for renminbi bond sales from offshore entities.
In the case of Taiwan’s Formosa bond market – onshore issuance in a foreign currency – the island’s financial regulators have acted cannily by opening up the market to onshore investors. For years Taiwan has been awash with dollar liquidity, and financial institutions have struggled to find local assets offering a halfway decent return.
The country’s biggest bond investor is the Taiwan postal savings agency, which owns a big chunk of the country’s government bond debt. The perennially cashed-up life insurers own around half of Taiwan’s outstanding government bonds. There’s cash everywhere, and these investors have been forced to book yields as low as 2% at high duration due to the paucity of viable alternatives.
That has been good news for Taiwan’s corporate leaders. But the same kind of risk aversion that has long plagued the Japanese market has stifled the emergence of a corporate bond market at the lower levels of the credit curve, and it’s been hardly worth investors’ effort to book a Single A corporate bond that is profoundly illiquid and yields barely more than govvies. Deals in this space have been – and still are – held to maturity.
OVER THE YEARS, the somewhat desperate quest for yield pushed Taiwanese institutional investors into racier structures, and the island developed a reputation for structured products that didn’t always have a happy ending.
I doubt that the blokes at the postal agency or the lifers got too excited when the European Bank for Reconstruction and Development set its sights on Taiwan’s domestic market in the early 2000s and brought a series of deals, with the longest tenor set at seven years. Tough to feel you’re getting ahead of the game when you’re offered a spread of 26bp over governments.
The EBRD got all creative with a series of inverse Quanto floaters and managed to swap back to its typically parsimonious supranational funding rate of Libor minus 25bp. Were any of them still on the books today, they would doubtless be looking rather good, given that they pay coupons which rise when US dollar Libor falls.
A bond fund crisis in 2004 marked an end to some of the riskier products, and structured finance got a bad name again in 2008, when big lifer Shin Kong took a US$24m whammy on a CDO called Lenox ABS. Funny how the flashier the name, the dodgier the product. At least that’s what I’ve come to perceive over the years.
So it was time for a rethink, and the authorities tweaked the rules of the game at just the right time.
They did this by reclassifying foreign currency Formosa bonds from foreign entities as domestic rather offshore investments. That helped tremendously. This is because Taiwan’s life insurance companies and mutual funds are unable to invest more than 45% of their portfolios in offshore products. With lifers aiming to beat a 4% hurdle rate, and finding it impossible onshore without the alchemy of structured products, it’s unsurprising that they had all hit that 45% ceiling a long time ago.
The authorities tweaked the rules of the game at just the right time
THEY CAN NOW happily invest in bonds issued by foreign entities and which might even be traded offshore because the regulators classify the debt as local. Frankly I think it was a stroke of genius: it doesn’t increase the onshore leverage of Taiwan Inc by one jot, and there are no inflationary pressures to be dealt with by the central bank given that the issuance is in foreign currency.
And happily, there existed the perfect storm, whereby issuers could find the ready bid from all that onshore liquidity desperate for a home with a bit of yield on it and manage to swap the proceeds back at a competitive rate.
Renminbi and dollar yields have always been lower in Taiwan than in other offshore centres thanks to that captive liquidity, and the basis was doing the right thing too. It was, let’s coin the cliché, a win-win for all parties involved.
The market today is not quite as good as it has been for most of the past year since the regulatory change came into force. It seems investors are getting more ambitious with their return hurdles, while overseas issuers can’t quite meet their post-swap funding targets when the basis and the investors’ demands are taken into consideration.
Well, you never know. Something might have to give, but I’m not about to view the surge in Formosa bond issuance as a flash in the pan.
The most interesting aspect in all this was pointed out to me last week by a Hong Kong-based DCM head. He noted that one of the most interesting (dare I stand in the nerd’s corner and say exciting?) aspects of the Taiwan bond market has been its ability to absorb long tenors.
So 30-year issuance is easily placed in Taiwan and moreover, call options are also embraced. He suggested that if it all goes nasty in US Treasury land when the Fed finally tightens, Taiwan could provide a safe haven for long tenor US dollar issuance. If that happens, I reckon my fondness for Taiwan’s bond market will not have been misplaced.
