After a slump in international issuance in 2020, fresh thinking may be needed to restore the appeal of the Japanese yen as a global funding currency. Japanese banks should also make another effort to get local investors to fund lower-rated issuers.
The grand buildings of the Bank of Japan and Tokyo Station stand as testament to Japan’s embrace of modern ideas at the end of the 19th century. The mastermind behind both structures, Japanese architect Kingo Tatsuno, spent four years studying architectural design at the Royal Academy of Arts in London and is credited as being the first to introduce European-style brick masonry to Japan.
The change in architectural style was mirrored in wider society. The turn of the 20th century marked a period of rapid economic development for Japan, when the abolition of many old-fashioned restrictions helped unlock the country’s full potential.
After a miserable year in 2020, it is the architecture of Japan’s capital markets that is now in need of a similar, transformational approach.
The yen has largely retained its value throughout the Covid-19 pandemic, along with its status as a safe haven G3 currency, but it has lost its appeal as a global funding currency.
Indeed, cross-border yen issuance plummeted 65% in 2020 to its lowest in 36 years. International issuance in yen totalled just ¥1.164trn (US$11.26bn), according to Refinitiv data, compared with ¥3.309trn in 2019, for the worst year since 1984.
Bankers in Tokyo said foreign issuers and Japanese investors were equally affected by the breakout of Covid-19 and the subsequent response from the world’s central banks, which scrambled to provide ample liquidity to help battered economies deal with the effects of the pandemic.
On the supply side, easy money elsewhere led to a decline in issuance from French banks, which have been the main issuers in the cross-border yen market in recent years, while other global banks simply looked elsewhere. And with central banks in many emerging economies having adopted bond purchase programmes regular sovereign Samurai issuers from emerging economies also skipped.
On the buyside, uncertainty around Covid-19 and the pandemic’s effects on credit quality of foreign issuers led Japanese investors to shift their focus to a domestic market that was easier to get a handle on.
Even after market conditions improved, pension funds remained largely on the sidelines.
"They shifted focus out of the cross-border yen market to the domestic market as they chose to make money steadily by doing the 'BoJ trade'," said Akihiro Igarashi, head of debt syndicate at Nomura, referring to the practice of buying domestic bonds and then selling them to the central bank, which expanded its corporate bond purchases in 2020 to help the coronavirus-hit economy.
Subordinated hybrid bonds were also an attractive alternative. They had sold off badly when the market became volatile between March and May, but once things settled down, the products became very popular again. Even short-term investors started participating, motivated by the fact that subordinated bonds are more liquid in the secondary market than cross-border yen bonds and hence it is easier to sell whenever an investor wants to take profits.
After the global credit markets stabilised in the middle of the year, foreign issuers were well aware of the importance of diversifying their funding channels but chose to issue in their domestic currencies or in US dollars, with funding costs declining because of easing by central banks – the US Federal Reserve in particular.
"Issuers this year were in crisis mode, raising funds from wherever [cheap] funds were available," said Igarashi. "As a result, the yen market was left as an 'auxiliary' to the dollar and euro markets."
Some bankers expect foreign issuers to return to Japan in 2021 to expand their investor base, but others are sceptical, expecting cross-border yen volume to remain low as long as US and European central banks continue their ultra-accommodative policies.
Low risk-tolerance
But it wasn’t just gaikokujin who were avoiding yen deals. The yen market became less attractive to some Japanese issuers, too.
A record ¥1trn four-tranche deal from NTT Finance, a unit of Japanese telecoms giant Nippon Telephone and Telegraph, showcased the depth of liquidity the yen market can offer. However, Nissan Motor could only raise ¥70bn in the domestic market. Later in the year, the automaker tapped the US dollar and euro markets to raise more than ¥1trn-equivalent.
The contrast between the response to Nissan (rated Baa3/BBB–/A by Moody’s/S&P/R&I) and NTT (AAA from local rating agency JCR) clearly shows most Japanese investors still prefer bonds with very high ratings, and remain selective when it comes to Triple B issuers.
The Nissan deal has revived calls to improve market access for issuers with lower investment-grade ratings.
"We realised how small the domestic market is," said Haruhiro Ikezaki, head of debt capital markets at Mitsubishi UFJ Morgan Stanley.
Masanori Ogiwara, Morgan Stanley MUFG’s head of fixed income capital markets, also noted there is a big gap between the Japanese and overseas markets in the depth of liquidity for Triple B issuers, although he said Nissan’s domestic and foreign deals should not be compared given the deals priced at different times and in very different conditions.
Many Triple B issuers depend heavily on bank lending, and would be in big trouble if banks were unable to lend. In early April, when the government was about to declare a state of emergency, banks backed off lending even short-term money, sending the commercial paper market into panic mode, with some issuers having to pay an unheard of 1%.
Such issuers “may be faced with limited choices if they cannot rely on banks," Ikezaki said. "It is an urgent task for us to increase investors’ risk tolerance.” He also said his firm should go one step further and help develop the high-yield bond market.
Unlocking potential
Japanese bankers say that modernising the yen market will increase its attractiveness for foreign issuers, but also help domestic names in need of funds. To do so, they have tried or are planning to introduce western-style practices.
In contrast to the US dollar and euro markets where most new issues are announced and priced within a matter of hours, it takes days or sometimes weeks to price a bond in Japan. Even NTT Finance needed more than 10 days to price its bond – or even longer if the sounding process is included. The deal also needed two days after final guidance before it formally priced.
Foreign issuers in the cross-border yen market tend to be a little quicker than that. US life insurer Aflac, for example, did an exceptionally good job in March, when, with the coronavirus spreading rapidly around the world, it shortened the marketing period of its bond deal to one-and-a-half days to minimise its exposure to volatile markets.
Yen bankers stress that the Aflac trade is not a one-off. "We do tell potential issuers that we can do 1.5-day marketing," said Kazuma Muroi, executive director in Mitsubishi’s DCM division.
That said, not all Japanese investors can make investment decisions so quickly, and a shorter marketing period will likely result in a subdued response from investors.
"It is a matter of choosing size over speed or speed over size; it's up to the issuer," Muroi said.
SMBC Nikko is planning to introduce the same kind of price-discovery process that is standard in global markets, using more flexible initial price thoughts rather than fixed marketing ranges.
"We haven’t decided on which deal to use IPTs, but we do talk about it with some foreign issuers," said Hiroyuki Kinoshita, head of global fixed income capital markets at SMBC Nikko.
Some bankers are not convinced that Japanese corporate culture will accept such global practices. Regional investors are slow to make decisions because of their internal approval system, while some Japanese issuers remain convinced they are only able to communicate thoroughly with investors via long marketing periods.
However, the cross-border yen market has now fully adopted the pot system, and even the domestic market has started to drop its traditional dependence on the retention format, a sign that Japanese market participants can be convinced to abandon old-fashioned styles.
From January, the Japan Securities Dealers Association has introduced a new rule on domestic bond issues requiring bookrunners to share investor information with issuers.
To unlock the yen market’s full potential, Japanese bankers may find they have to design new ways to connect foreign issuers with Japanese investors and deepen the domestic market. As the architect Kingo Tatsuno discovered more than a century ago, new ideas can have a lasting impact.
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