Regional Credit Guarantee and Investment Mechanisms

1. Regional Credit Guarantee and Investment Mechanisms Masato Miyachi Senior Advisor Office of Regional Economic Integration, ADB 5 November 2005, Shanghai Asia-Pacific Finance and Development Center

2. Topics • Why Developing Asian Bond Markets? • Various Efforts in the Region • ASEAN+3 Asian Bond Markets Initiative • ABMI Working Groups • Regional Guarantee Mechanism Study • Case Examples • Preliminary Conclusions of the Study

3. Why Developing Asian Bond Market? Prevention of Crisis ASIAN CRISIS in 1997/1998 Double Mismatch Problem (Maturity + Currency) Increased Risk of Financial Crisis Bank- dependent financial structure Foreign borrowing without hedge

4. Why Developing Asian Bond Market? Recent Pattern of Capital Flows in Asia • Huge current account surplus  from capital importer to exporter • Rapid increase in foreign reserves ($1.2 trillion) • Import safe assets and export risky assets  ASIA’S SAVINGS ARE NOT BEING RECYCLED BACK INTO ASIA

5. Benefits of RecyclingAsian Savings into Asia • Economic development • Crisis prevention • Diversification • More choices • Better return/risk

6. Asian Bond Market - Growing Deepening of Asian Bond Market • Total local currency bonds outstanding in major EMERGING East Asia (EEA) tripled from $356 billion in 1997 to $1.2 trillion in 2003. • The share of local currency bonds in EEA’s capital market is rising, from 13% in 1997 to 19% in 2003.

7. Asian Bond Market – Growing, but… Market Size and Liquidity • Despite encouraging growth, local currency bond markets in EEA remain small, about 3% of total local currency bonds worldwide ($40 trillion) and only 44% of EEA GDP. • Market liquidity, measured by trading volume and turnover ratios, has increased significantly in recent years, but remains low in comparison to developed country markets.

8. Main Problems – Asian Bond Markets Lack of: • Attractive Bond Issuers • Bond Market Infrastructure • Long-term Funds for Bond Investment

9. Various Efforts in the Region Various Efforts  to Enhance Regional Financial Cooperation after Asian Financial Crisis in 1997-1998 • AMF Proposal (1997) • Manila Framework (1997) • New Miyazawa Initiative (1998) • Chang Mai Initiative (2000) • Asian Bond Markets Initiative (2002)

10. Progress in Various Fora EMEAP APEC ASEAN + 3 Use of Foreign Reserves Discussed by Central Banks ABF I & II Initiative on Securitization & Guarantee Holding Government Bond Seminar Comprehensive initiatives

11. ASEAN+3 Asian Bond Markets Initiative (ABMI) • Endorsed by ASEAN+3 Finance Ministers in August 2003. • Six (6) Working Groups were Voluntarily Established

12. ASEAN+3 Asian Bond Markets Initiative (ABMI) Background and Issues • High savings rate in many Asian countries • Short-term bank loans were the dominant • Underdeveloped bond markets in the region • Savings deposited in local banks  funneled to international financial centers  back to the region • Raise and invest local currency bonds as a long-term capital without maturity and currency risks.

13. Objectives of the ABMI 3 Key Objectives: • Facilitate recycling of Asian savings within the region • Develop local bond markets • Develop regional bond market

14. ABMI Working Groups At the Inception of ABMI • Creating New Securitized Debt Instruments • Credit Guarantee Mechanisms • Foreign Exchange Transactions and Settlement Systems • Issuance of Bonds Denominated in Local Currency by MDBs, Government Agencies and Asian Multinational Corporations • Local and Regional Rating Agencies • Technical Assistance Coordination Group

15. ABMI Working Groups Currently • Creating New Securitized Debt Instruments • Credit Guarantee & Investment Mechanisms (the “Mechanism”) • Foreign Exchange Transactions and Settlement Systems • Local and Regional Rating Agencies + Plus, Ad-hoc Support Team

16. ADB’s Involvement on Regional Guarantee Mechanism (RGM) Providing Technical Assistance (TA) to Working Groups  ASEAN+3 Regional Guarantee Mechanism • Mechanism Works? • Targeted Countries and Sectors? • Demand Estimates • Organizational Option and Choices • Hurdles • Market Consultation and Survey

17. Regional Guarantee & Investment Mechanism Progress to Date 2003 Commenced the study with original scope of examine the guarantee mechanism March 2004 Expanded scope of the study: - Consider additional business lines of loan and equity investments in addition to bond guarantee March 2005 Preliminary report presented June 2005 Market consultation held in Hong Kong September 2005 Final (draft) report to be presented

18. Rationale of the Mechanism • Nurturing Bond Issuers • Private sector to participate in & benefit from the market development • Broadening Long-term Investor Base • Catalyzing Private Sector investment • Ensuring Smooth Functioning of Regional Bond Markets • Building Market Infrastructure

19. Rationale of the Mechanism Offers Advantages • Focused mandate • Systematic long term approach • High credit rating • Lower costs and better diversification from economies of scale Based on principles of additionality & partnership

20. Business Lines & Products (preliminary) • Bond Guarantees • ABS, MBS, SME securitizations • Project & Infrastructure bonds • Corporate bonds • Municipal bonds • Loans • Bridging loans, e.g. during construction • Warehouse loans for securitizations whilst volumes assembled • “Governance building” loans • Equity Investments • “Governance” • Infrastructure – improve debt:equity ratio to support bond issue • Support bond market infrastructure development

21. Are Existing Mechanisms Sufficient? MDI Guarantees: • Some MDI such as ADB, IFC and World Bank: • Provide Credit Guarantees in the Region • Scope of Services  Limited • Not purely focused on bond markets Guarantees by Bilateral Institutions: • Quite active  trade financing & cross-border investment • Generally not very active  promoting regional bond markets • Collaborate with partners on a case-by-case basis No private guarantee companies offer: • Credit guarantees on bonds in local currencies, or • Investments to support development of bond market infrastructure

22. Business Philosophy (plan) • Development of local currency bond markets in ASEAN+3 countries • Private sector focus • Focus developmental but based on commercial principles – no subsidies • Principle of additionality and partnership • Well diversified business portfolio • Accordance with OECD standards of corporate governance

23. Characteristics of the Mechanism (Preliminary Idea) • Active use of securitization and credit guarantee to mitigate credit quality gap • In Asia, credit and currency risks are the most important factors impeding smooth recycling of savings • Securitization coupled with credit enhancement is a good solution to address this problem • Can issue higher-credit securities than collateralized assets enough to be accepted by investors

24. Organizational Choices Options • Establishing a new MDI as a subsidiary of ADB • Expanding the existing facilities of ADB • Consolidating bilateral efforts • Establishing a new independent MDI • Private & Public Partnership (PPP) or Private Entity  Lesson Learned

25. Lesson Learned Private Sector Examples Failed examples Public-Private Partnerships • ASIA Ltd. • AFIC

26. Lesson Learned Private Sector Examples • What went wrong? • Design and Refinement of Mission • Strategy • Business Modality • Lines of Products and Services • Capital Adequacy • High Credit Rating Maintenance • Risk Monitoring and Mitigation • Concentration of risk in low rated countries & transactions • Corporate Governance • Operational Management

27. Case Example: Potential Infrastructure Bonds • Shanghai, PRC - Bus System • Zhejiang, PRC – Wind Farm • Thailand - Government Building • Korea - Build Transfer Lease Projects • Mekong Delta - Various Infrastructure projects

28. Regional Mechanism Guarantee Mortgage Finance Co Institutional Investors Mortgages Securitization MBS Vehicles Equity & High Yield Investors Mortgages Case Example: Residential Mortgage-Backed Securitization Building on Existing Programs • Malaysia Cagamas • Korea Housing Finance Corporation • Hong Kong Mortgage Corporation • Singapore CMBS and Residential Pre-sales • China Construction Bank pilot MBS - authorized.

29. Preliminary Conclusions of the Study • Sufficient business for the Mechanism • Market gap to be filled • The Mechanism needs to invest in financial infrastructure + Technical Assistance. • The success will depend on strong management team + focus & clear objectives. • A mix of business products is advisable in the initial stages. • It is essential to have a high investment grade rating. (ideally, AAA)

30. Preliminary Conclusions of the Study • The Mechanism may not meet all the demand in the region. • A number of organizational choices are available for consideration. • There are regulatory improvements that can be introduced by the member countries.

31. For More Information Masato Miyachi, Senior Advisor Office of Regional Economic Integration (OREI) Asian Development Bank mmiyachi@adb.org +63-2-632-6832 Asian Bonds Online Website: http://asianbondsonline.adb.org ADB website: http://www.adb.org

32. Thank You! Question & Answer