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Bond market development: Bond market development: The case of Hong KongThe case of Hong Kong

Alfred WongHong Kong Monetary Authority

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OutlineOutline

I. Motivation to develop bond market

II. Authorities’ efforts

III. Lessons and impediments

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Part IPart I

What motivates the authorities What motivates the authorities to develop the local currency to develop the local currency

bond market?bond market?

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An overview of the financial systemAn overview of the financial systemFinancial Markets

Money marketBond market

Equity market

Banks and other financial institutionsInsurance companies and pension funds

Other financial intermediaries

LendersHouseholds

FirmsCentral bank

BorrowersHouseholds

FirmsGovernment

Financial Intermediaries

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Financing structure in Asia – 1996Financing structure in Asia – 1996

0

50

100

150

200

250

300

350

Chi

na

H

ong

Kon

g

In

dia

In

done

sia

K

orea

M

alay

sia

P

hilip

pine

s

S

inga

pore

T

aiw

an

T

haila

nd

Stock

Bond

Loan

% of GDP

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Motivation of the authoritiesMotivation of the authorities

• Lessons from the Asia financial crisis

– Currency and maturity mismatches

– Prone to sudden capital flow reversal

• To foster financial stability

– As back-up facilities

– Diversity in financial intermediation

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The role of the StateThe role of the State

• A multifaceted role:– Investor protection– Innovation– Provision of market infrastructure

• Positive non-interventionism– Facilitating, not forcing!

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Part IIPart II

What have the authorities done to What have the authorities done to develop the local currency bond develop the local currency bond

market?market?

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Major initiatives taken since the Major initiatives taken since the Asian financial crisisAsian financial crisis

1. Product development

2. Market infrastructure

3. Tax and regulation

4. Regional cooperation

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1. Product development1. Product development

• Government issues

• Securitised debts

• Bond funds

• Retail bonds

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Government issuesGovernment issues• Exchange Fund Bills and Notes (EFBNs)

– HK$ debt instruments issued by the HKMA– Benchmark yield curve – Good liquidity in the secondary market

– Banks collectively hold about 85% of the outstanding EFBNs for favourable risk weighting and can be used as collateral to borrow from the HKMA

Government bonds– The Government successfully launched its first global bond offering

in July 2004– Total HK$20 billion of which US$1.25 (around 50%) in a 10-year

US$ denominated bond

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Securitised debtsSecuritised debts• The Hong Kong Mortgage Corporation

– Established by the Hong Kong SAR Government in March 1997

– To promote development of a secondary mortgage market

mortgage purchasedebt issuancesecuritisation of mortgage loansmortgage insurance

• In May 2004, the Government sold HK$6 billion (US$770 million) of securitisation bonds, backed by toll revenues from 5 tunnels and 1 bridge to finance infrastructure projects

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Bond fundsBond funds

• An EMEAP initiative ABF1 (2003)– Closed-end: Confined to investment of the central

banks only

– USD-denominated sovereign and quasi-sovereign bonds in the region

• ABF2 (2005)– Open to any interested investors

– Domestic currency-denominated bonds in the region

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Retail bondsRetail bonds

• The Hong Kong Mortgage Corporation first offered bonds to retail investors in October 2001

• The HKMA operated a pilot scheme to stimulate retail investment in Exchange Fund Notes in 2003– The programme was refined in 2005 under

which the fee structure was simplified and retail distributors were appointed

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2. Market infrastructure2. Market infrastructure

• Benchmark yield curve

• Hong Kong bond settlement system

• On-line access to market information for retail investors

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Benchmark yield curveBenchmark yield curve• A domestic yield curve gradually took

shape when the HKMA began issuing Exchange Fund papers in 1990s

• Considerable effort has been directed at maintaining a smooth and continuous yield curve in designing the EFBN issuance programme

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Hong Kong dollar bond settlement Hong Kong dollar bond settlement systemsystem

• Central Moneymarkets Unit (CMU)– Established in 1990 to provide computerised

clearing and settlement facilities to debt securities

– Linked with other major international securities settlement systems

• To foster cross-border bond trading and investment

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Clearing and settlement systemClearing and settlement system

USDRTGS(2000)

DvP

CMU HKDRTGS(1996)

Clearstream

AustraClear- Australia

AustraClear- New Zealand EURO

RTGS(2003)

DvP

KSD- South Korea

PvP

PvP

PvP

DvP

Euroclear

2003

2002

1997

1998

1999

1994

1994

CDC- China

2004

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On-line access to bond pricesOn-line access to bond prices

• CMU Bond Price Bulletin website– Launched in 2006– Provides convenient access to indicative bond

prices quoted by major banks in Hong Kong

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CMU Bond Price BulletinCMU Bond Price Bulletin

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3. Tax and regulation3. Tax and regulation• Demand side:

– tax concessions to bond buyersTrading profits from bonds with a maturity period of 7 years

or more (issued after 5 March 2003) were exempted totally from profits tax (previously 50% tax concession)

Minimum maturity requirement for the 50% tax concession was relaxed from 5 to 3 years

• Supply side:– simplified issuance process for fund raisers

The Government and the Securities and Futures Commission have together streamlined regulations and procedures for issuing and listing debt securities

Enabled issuers to market their offers with greater flexibility and effectiveness to the public

Lowered issuance costs

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4. Regional cooperation4. Regional cooperation

• APEC Initiative on the Development of Securitisation and Credit Guarantee Markets

Asian Bond Market Initiative (ABMI) Asian Bond Fund (ABF)

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After all these…After all these…

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Hong Kong dollar bond marketHong Kong dollar bond market

• Steadily growth over the past decade– Outstanding Hong Kong dollar bond

reached US$85 billion at end-2005

– Almost 50% of GDP

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0

10

20

30

40

50

60

70

80

90

1997 1999 2001 2003 2005

0

10

20

30

40

50

60Others (lhs)

Public sector (lhs)

Total outstanding asa % of GDP (rhs)

Local currency bond outstandingLocal currency bond outstanding

Sources: HKMA and HK Census and Statistics Department.

US$ billion % of GDP

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Market growth by issuerMarket growth by issuerUS$, bn US$, bn

0

10

20

30

40

50

60

70

80

90

1997 1998 1999 2000 2001 2002 2003 2004 2005

0

10

20

30

40

50

60

70

80

90

AuthorizedInstitutions Non-MDB

overseas

MDBs

Exchange Fund

Local Corporates

Government &Statutory bodies

Source: HKMA.

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Financing structure in 2005*Financing structure in 2005*

100 80 60 40 20 0% of GDP

1996

0 20 40 60 80 100

Average

Indonesia

Hong Kong

Mainland

Philippines

India

Thailand

Singapore

Taiwan

Korea

Malaysia

Public

Private

2005*

% of GDP

*As at end-September 2005

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Part IIIPart III

Lessons and impediments: any Lessons and impediments: any more we can do?more we can do?

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More work to do?More work to do?

• Macroeconomic policies

• Government bonds

• Banking sector soundness

• Corporate governance

• Regulatory framework

• Tax treatment / incentives

• Investor base

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Impediments to the Hong Kong Impediments to the Hong Kong dollar bond marketdollar bond market

• Supply– Issuance of Exchange Fund papers is limited

– Government issuance is politically sensitive

– Lack of corporate issuersBusiness sizeCredit bureaux

• Demand– Mutual funds invest mainly in equities

– Currency board system

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Retail demand for bondsRetail demand for bonds

• Transaction cost is high for individuals

• Increased competition between banks made deposits fiercely competitive

• Attraction is mainly on medium term papers

• There is more interest in holding bonds via other investment vehicles (e.g. mutual funds)

• Any more room for ABF2-typed initiatives?

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Looking aheadLooking ahead

• Market making system– League table

– Tender arrangements

– Uniform-price auction

• Length of the yield curve

• Number of EFN issues

• EFN futures market

• Electronic trading platform

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ConclusionConclusion

• The Hong Kong bond market has grown steadily since crisis

• Structure of financing still tilted towards loans and equities

• Scope for improvements