Nouveaux riches

Asia’s growing pool of homegrown capital is taking on new significance at a time when policy uncertainty looms over global money flows.

Asia’s growing savings pool is emerging as a key pillar of the global capital markets. Global banks and corporate borrowers now regularly visit Singapore or Taiwan to court investors for their next long-term bond issue, and Chinese outflows have found a natural home in overseas financings that support mainland borrowers’ expansion plans.

While there are questions over the sustainability of this new source of capital, Asia bulls argue that homegrown institutional investors will help protect the region against the next global shockwave.

Chinese borrowers have benefited enormously from local support as they have built their profile in the international capital markets. Mainland Chinese issuers accounted for at least 70% of all new bonds sold in G3 currencies in Asia in the first three months of 2017, driving a record quarter for the region. At US$83bn, G3 issuance from Asia, excluding Japan and Australia, outpaced the previous quarterly record, set in 2014, by 24%.

Debt bankers expect more records to fall this year after more big companies returned to the market with jumbo offerings early in the second quarter, including oil major Sinopec and State Grid Corporation. One banker estimates Additional Tier 1 capital securities from Chinese city commercial banks alone are likely to add another US$20bn to this year’s supply.

Debt bankers expect more records to fall this year. One banker estimates Additional Tier 1 capital securities from Chinese city commercial banks alone are likely to add another US$20bn to this year’s supply.

Much of the growth in demand has come from Chinese investors, who are hungry for dollar assets after a decline in the renminbi and are less concerned about relative value. Chinese bank capital offerings, for instance, rarely attract global funds at a yield of well below 5% when similar securities in Europe offer at least 7%.

Chinese banks are the biggest buyers of overseas Chinese debt, but the life insurance industry is also emerging as a major source of international capital.

Formosa frenzy

Asian life insurance companies are looking to increase their holdings of foreign assets in search of higher yields, driven by high savings rates and low domestic returns. This growth has been most dramatic in Taiwan, where foreign assets as a proportion of total investments soared from 38% in 2011 to 61% in 2016, according to French bank Natixis.

“I have been in the life insurance industry for more than 30 years and have worked in a number of countries including the US, Japan and Korea, but I have never seen this kind of phenomenon before I came to Taiwan, where such a proportion of the investment portfolio is held in foreign currency bonds,” said the chairman of a Taiwanese life insurance company.

“The reason is quite straightforward: the pursuit of yield. Today interest rates are very low but the problem is most insurance companies carry a large proportion of legacy policies that guarantee a very high interest. In order to survive, we have to find a way to make a higher rate of return than we would get by purchasing government bonds in Taiwan.”

Low domestic yields have given Taiwanese lifers an incentive to take offshore credit and currency risk, while the country’s regulators have generally taken quite a relaxed approach, gradually increasing the cap on the amount that lifers are able to invest overseas and introducing several other incentives for them to increase their holdings offshore.

In 2014, Taiwain’s Financial Supervisory Commission passed a bill to exclude foreign currency bonds issued onshore – so-called Formosa bonds – from the 45% limit on foreign investment. This has led to the rapid development of the over-the-counter Formosa bond market, with Taiwanese lifers owning around 80% of all outstanding bonds, according to Natixis.

A host of global borrowers sold bonds in Taiwan in the first quarter of this year, driving a surge in Formosa issuance to US$19.5bn, up 65% on the same period in 2016, according to the Taipei Exchange.

The issuers comprised a mixture of global lenders, such as HSBC, Morgan Stanley and Deutsche Bank, plus a handful of US blue-chip companies, including Apple, AT&T, Pfizer and Verizon Communications.

In February, Verizon Communications issued US$1.48bn 30-year non-call three bonds at 4.95%, the largest print of the year so far, while Apple returned to the market later in the month with a US$1bn 30-year callable, priced at 4.3%.

Japanese outflows

Japanese insurance companies are also stepping up their participation in overseas financings in search of higher returns.

Nippon Life Insurance, the country’s largest private-sector life insurer, has established a structured finance department to invest in domestic and international project financings with an eye on generating greater returns. The insurer aims to invest ¥1.5trn (US$13.77bn) in growth areas including onshore and offshore infrastructure financing over the next four years.

In February it bought a US$100m piece of a loan backing an LNG project in the US in secondary, marking its first overseas project finance investment.

“Negative interest rates made us consider this kind of investments. We decided to pursue opportunities outside Japan in order to secure higher margins and grow our revenue,” said Shinji Kuge, head of the department, in an interview with IFR sister publication Basis Point.

Dai-ichi Life Insurance, the country’s second-biggest private life insurer, invested in a project financing of LNG plants in Qatar and in an offshore wind power financing in Germany earlier this year. It invested over ¥100bn in growth areas, including infrastructure-related loans and aircraft financings in the last fiscal year ending March 31, and aims to add another 20%–30% to that total this year.

In February, Japan Post Insurance, the country’s largest insurer by assets and a unit of state-owned Japan Post Holdings, made its first investment in project debt, committing about ¥10bn alongside Dai-ichi Life Insurance in loans backing two mega solar plants in Japan.

Asia’s deposit-rich banks have also insulated the region from the retreat of global lenders following the 2008 credit crisis and the European sovereign debt turmoil.

Japan’s three mega banks Mitsubishi UFJ Financial Group, Mizuho Bank and Sumitomo Mitsui Banking Corp are now the world’s biggest project finance lenders, accounting for a combined 19% market share in 2016, according to Thomson Reuters data.

Chinese and regional institutions, such as Singapore’s DBS and Australian major ANZ, have also climbed up the league tables for Asian financings. In a reflection of the importance of mainland investors in equity financings, the top three underwriters of Asian IPOs in 2016 were all Chinese institutions. In the competitive market for Hong Kong listings, Haitong Securities was the top arranger in 2016 – a far cry from the days when bulge bracket Wall Street firms dominated proceedings.

Risks rising

While Asian liquidity is reshaping the region’s capital markets, it is also raising some new risks.

Speculative Chinese investors were blamed for recent wild swings in Hong Kong equities, where beauty app Meitu, snack food maker Zhou Hei Ya and construction group BBMG saw their stock prices rocket recently on heavy buying through newly established Stock Connect trading links with the mainland.

Rampant credit growth has also introduced more leverage into the region’s financial system. Total assets of China’s banks are now triple the size of the country’s GDP, the IMF noted in April’s Global Financial Stability Report, while many capital markets investments are also leveraged.

“The Chinese authorities have continued to adjust policies to address rising vulnerabilities from rapid credit growth. In late 2016 they tightened monetary conditions. But the market turbulence that followed illustrates the risks that remain in China’s increasingly large, opaque, and interconnected financial system,” said the IMF.

Fitch analysts in April identified China’s increasing reliance on global markets as a potential trigger for a financial crisis, although they noted that this remained unlikely.

“High reliance on foreign capital to support economic growth risks policymakers ceding some control over funding stability,” said Fitch.

“Ultimately, if foreign investors are to discriminate in terms of credit quality and pricing, they could exert greater influence over the stability of system wide liquidity or profitability.”

Appetite for offshore Chinese credit could dip if a stronger renminbi reverses recent outflows, or if defaults continue to rise. In that case, Chinese banks could be most affected, as the country’s big four need to issue hundreds of billions of dollars of capital to meet total loss-absorption capacity requirements for global systemically important banks.

The framework for loss-absorbing senior bonds is not yet in place, but it is unlikely that mainland institutions alone will be able to support the estimated US$500bn–US$1trn of additional issuance required.

S&P noted in April that Chinese non-bank financial institutions, including distressed asset management companies, have emerged among the biggest bidders in the US dollar offshore bond market, driving up the prices of high-yield bonds in particular.

“We believe this is a liquidity-driven trend that is divorced from credit fundamentals. Spreads have tightened as credit fundamentals have remained weak or worsened,” said S&P credit analyst Christopher Lee.

The boom in international bond issuance has not been matched in Asia’s local markets. Across all Asian currencies, local issuance fell 42% year on year to US$146bn in the first quarter, mainly due to a plunge in volumes in China.

Rising domestic yields, default warnings and a fraud scandal involving Rmb16.5bn of bonds issued under a fake company seal have all contributed to a marked slowdown in China’s onshore renminbi market.

Capital flows

In the global arena, bankers say they no longer need to market dollar bonds from Asia in New York or London, as demand within the region is so strong.

For Asia bulls, that is a signal that the region is maturing and becoming self-sufficient. The old risks of currency mismatches and global volatility, however, have not gone away.

“Along with better US economic prospects, higher interest rates and consequently a strong US dollar may tilt global investor sentiment such that capital flows out of Asian markets, exerting downward pressure on asset prices in emerging Asia,” said ADB economists in the bank’s latest Asian Development Outlook report.

China’s overseas investments have contributed to net outflows from Asia since the second quarter of 2014, according to ADB data, and are expected to continue into 2018 as rising US interest rates pull more investment into US dollars. As well as adding to the burden of foreign currency liabilities, continued outflows raise the risk that Asian central banks will need to raise rates to stem the tide.

“Because many emerging Asian economies have accumulated substantial foreign and local currency debt in the low-interest-rate environment prevailing since the global financial crisis, the possible tightening of monetary policy could undermine their financial stability,” the ADB said.

For now, however, the ADB does not see any immediate threat.

“The risks from capital flows and household debt appear to be manageable in the short term, and continued vigilance by policy makers promises to further strengthen financial stability and resilience.”

(Additional reporting by Thomas Blott and Wakako Sato.)