Australian Debt Markets Evolution Practitioners view

1
Australian Debt Markets EvolutionPractitioners
view

• Sharon Mitchell
• Regional Head of Fixed Income, UBS

2
Overview

• The fixed rate debt markets in Australia have
  shown zero growth over the last 4 years despite
  the compulsory savings environment
• Non-government debt issuance has focused on short
  maturities (3 to 5 years). Issuance has been
  dominated by AA/AAA rated entities in the
  financials sector why?
• Australian issuers have been large users of
  offshore debt markets for capital raising why
  are they more efficient?
• Asset allocations are being shifted to offshore
  markets does this matter?
• What has been the experience in other markets
  what do they do differently?

3
Domestic market evolution
Overall fixed rate market growth has been limited
Fixed rate debt market outstandings (A million)
Charts.xlsGraphs?Chart 8
Charts.xlsGraphs?Chart 8
Charts.xlsGraphs?Chart 8
Source UBS Composite Bond Index
4
Domestic market overview
Corporate debt market is short duration and
highly credit rated
Corporate market is highly rated
Charts.xlsGraphs?Chart 4
Charts.xlsGraphs?Chart 4
Market outstandings by current maturity (fixed
rate)
UBS Credit index by rating
Source UBS Bond Indices
5
Domestic market evolution
Offshore issuers have added volume and
diversification
Australian issuers have been large borrowers
offshore
ANU PresentationA.XLSDeals?Chart 1
ANU PresentationA.XLSDeals?Chart 1
ANU PresentationA.XLSDeals?Chart 1
Cumulative Kangaroo market issuance
Cumulative offshore issuance by Australian
borrowers
Source UBS
Source UBS, Bondware
6
Australian Investor drivers

• Consultants and trustees play central role in
  portfolio construction
• Funds are index performance driven
• Benchmarking has limitations
• Index duration targets rather than liability
  immunisation
• Low risk appetite performance versus rewards
• Funds under management
• Asymmetry of out/under-performance
• Offshore assets and markets increasingly
  attractive

7
Australian issuer drivers

• Increasing sophistication in liability and
  capital management
• Diversification from traditional bank financing
• General trend to lengthen liability duration to
  match assets
• Floating rate liability benchmark issuance is
  swapped back to BBSW and interest rate risk
  managed as overlay
• Issuance volume requirements can be large
• Efficient access to global markets credit is a
  global commodity
• Australia economic performance and issuer credit
  quality has built strong offshore demand

8
Issuers perspective

• Issuers have access to global debt markets and
  will choose the most efficient market
• In 1H2003 issuance by Australian borrowers in
  offshore markets rose by 116 to A18.9bill while
  issuance in the domestic market fell by 27 to
  A7.7bill
• Liquid swaps markets allows issuers to hedge
  their exposures back to A

9
Cross currency swap
Swap flows determine an equilibrium
5-year basis swap A/US
ANU PresentationD.XLSSheet1C?Chart 2
Source Bloomberg, UBS
10
Does the domestic market matter?

• Issuers have access to offshore funding
• Investors have access to international assets
• Interest rate and cross currency risk can be
  hedged
• BUT
• Hedging requires efficient derivative markets and
  can increase costs
• Not all investors and issuers have access or
  sophistication to access offshore markets
• Increased systemic risk and offshore dependence?

11
Offshore markets overview

• How does government approach to debt influence
  the non-government debt market?
• What are the trends between issuance in local
  currency markets and offshore markets?

Bond market sizes and issuance activity
Source UBS, Bondware, Hanhwa Securities
12
USA

• Government reduced debt issuance significantly in
  1995-2000 but has since been large issuer with
  return of fiscal deficits
• No compulsory saving environment, but corporates
  run defined benefit plans and individuals
  maintain 401(k) plans which have investment
  discretion
• Savings market dominated by
• Life insurance market is 95 invested in fixed
  income
• Mutual funds bond fund growth has been strong
• Investors are US focused and have access to
  broad suite of local and international credits
  across ratings spectrum
• Borrowers are US target funders and have access
  to deep domestic investment grade and high yield
  markets

13
UK

• Savings industry is dominated by pension funds
  (largely defined benefit but moving to defined
  contribution) and life companies
• The life company fixed income asset allocation
  has risen in recent years driven by
• Solvency Test
• Equity market and bond yield performance
• Fixed income assets of life companies are largely
  managed against a long dated Gilt benchmark
  (15yr) as
• This is the discount rate for the Solvency Test
• Match of asset and liabilities
• Government had negative net issuance of Gilts in
  FY99-02 but has increasing borrowing requirement
  in FY03-04. During the period of negative
  issuance, a long dated corporate market
  flourished
• Crowding in
• Sharply inverse yield curve driven by investor
  demand

14
Singapore

• Government issues debt despite budget surplus and
  invests proceeds through under the Government
  Securities Act. External investments include
  equity and offshore debt
• Central bank reserves managed across broad asset
  allocation
• Compulsory defined contribution scheme (Employer
  13 plus Employee 20) administered by Central
  Provident Fund. CPF large S bond investor but
  beneficiary have increasing choice and
  flexibility on investments
• Lower corporate borrowing requirements
• Government owned corporations, but
  corporatisation/privatisation occurring
• Family owned businesses
• Low leverage, underdeveloped capital management
• Government and funds are large buyers of non-S
  debt assets

15
Hong Kong

• Compulsory defined contribution scheme (Employer
  5 plus Employee 5) administered by Mandatory
  Provident Scheme. Beneficiary has flexibility on
  investment with approved funds including 70 up
  to offshore assets
• Currency peg provides greater certainty to
  non-HK investors
• Lower corporate borrowing requirements
• Government owned corporations, but
  corporatisation/privatisation occurring
• Family owned businesses
• Low leverage, underdeveloped capital management
• Government and funds are large buyers of non-HK
  debt assets

16
Korea

• Government and corporate bond market witnessed
  strong growth following the 1997 crisis
• Government to fund fiscal deficits
• corporate driven by investor demand for yield
• Investor market is dominated by banks and
  investment trust companies (ITCs) which are akin
  to a mutual fund product
• Domestic market issuance
• dominated by short maturities (60 of 2002
  issuance in 3-years)
• evenly spread across ratings categories (48 of
  2002 issuance BB/BBB)
• evenly spread between corporate and financial
  institutions
• Appetite for Korean paper outside Korea is
  limited by
• Sovereign rating (A - / aa3)
• Credit quality of issuers

17
Conclusions

• Australian compulsory savings environment
  provides for investment assets, however
• funds are invested with an index philosophy
  rather than an ALM philosophy
• this creates a demand problem rather than a
  supply problem the issuers are supplying
  offshore markets
• The government has (currently) committed to the
  bond market, but issuance is long dated
• does this crowd out the private sector?
• given the investment of debt raised is short
  dated (RBA deposit) is public sector financial
  risk increased?
• Failure of a deep developed domestic corporate
• assets are increasingly being invested in
  offshore markets
• issuers are increasingly accessing offshore
  markets