Basel III, deleveraging, could triple Asia's bond market
* New rules to curb corporate bank lending
* Companies likely to turn to bond markets
* Danger that investment reversal could hamper growth
By Christopher Langner
Dec 4 (IFR) - Asian bond issuance could triple over the next five years, according to a recent report by Standard Chartered, as deleveraging and more stringent regulatory requirements stifle bank lending and drive borrowers to alternative sources of funding.
"We estimate that these events [Basel III and European bank deleveraging] will lead to a tripling of the size of the AXJ [Asia ex-Japan] corporate bond market, to more than USD10trn by 2017 from just USD3.3trn today," said the report, first issued on November 9.
The report predicts that Basel III will cause a lending shortfall of about USD340bn over the next five years.
"We assume that this financing shortfall will be covered by increased issuance of corporate bonds. This increased issuance is expected to raise the share of bond markets to circa 40% of corporates' total funding mix by 2017, from around 25% currently," the report said. Other borrowing needs should make up the rest of the number.
If StanChart's analysts are right, it means that the record USD125bn of bonds that Asian credits have issued in dollars and euros so far this year could well be broken in 2013. The report said that much of the growth, however, would come from local currency markets.
In its quarterly Asian Bond Monitor report issued in November, the Asia Development Bank (ADB) had already flagged the strong growth of corporate issuance in local currencies. The report said there was USD2.16trn outstanding in corporate bonds in the local markets of Emerging East Asian countries, 21.7% higher than in 2011.
That figure is in line with the 21% annual growth that StanChart predicts. The numbers may be big, but the prediction may not be far-fetched. G3 issuance this year has almost doubled the USD76.2bn booked in 2011, which was itself a record year, so when local currency bonds are added, StanChart's speculation looks credible.
Yet, fixed-income investors in the region were alarmed, given the high numbers involved. One manager expressed concern that the massive supply would not find sufficient demand. One analyst, however, was more optimistic: "There should be enough money coming into the region to absorb all this supply."
So far, this year has backed the optimistic analyst's case. According to research firm EPFR, investors allocated USD35bn in new money to mutual funds focused on EM bonds in the year to November 28.
Add to that pension funds and other asset managers which have been opening shop in Asia but are not featured in EPFR's survey, and it is clear that there is plenty of money coming into the region.
Besides the foreign money, Asia also has plenty of savings itself. According to the World Bank, developing Asia has the highest level of savings as a percentage of GDP, at 43.5%. One analyst said that less than 20% of investments in Asia are allocated to fixed income.
That is significantly higher than the 10%-12% figure seen three years ago, but it is a long way from the 33%-35% allocations of European and US investors, meaning there is plenty of room to grow.
The problem, though, is if there is a sudden shift in that flow. With corporates relying mostly on the bond markets, if demand dwindles, funding costs could spike.
Demand is not the only concern. Companies in Asia will be competing with banks and governments, especially in the local markets. Government borrowing in Asia has been on the rise over the past five years as countries boost investment to maintain high growth rates.
According to the ADB, local currency government bonds outstanding in Emerging East Asia grew 10.1% to USD4.08trn in the third quarter of 2012 versus the same period in 2011. While the percentage growth was smaller, the additional USD377bn that sovereigns printed was almost equivalent to the USD385bn more that corporates issued.
Then there are the banks themselves. The same Basel III regulations that will curtail their lending to local companies will compel them to raise capital by issuing bonds in local and international markets.
Estimates put the amount of new capital that banks in the region will have to raise to meet Basel III's more stringent requirements at up to USD5trn.
While much of that will come via the equity markets or through withheld earnings, a good chunk will reach bond investors - at juicy premiums too.
Hence, if in the next five years money stops flowing to Asia, funding conditions could become quite challenging. Or, as the StanChart report put it: "If the expected growth in corporate bond markets does not materialise, economic growth in some countries in the region is likely to be compromised." (Reporting By Christopher Langner; Editing by Nachum Kaplan and Julian Baker)