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Opening markets through
a bond fund: The Asian
Bond Fund II
Guonan Ma
Bank for International Settlements
Representative Office for Asia and the Pacific
APEC Seminar
Developing Asian Bond Markets: from Investors‘ perspective
4-6 November 2005, Shanghai
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The issues at stake
I.
What is Asian Bond Fund II (ABF2)?
II.
Why was ABF2 launched?
III. How is ABF2 structured?
IV. What are the advantages of ABF2?
V.
How has ABF2 performed so far?
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I. What is ABF2?

ABF2 is the second stage of the Asian Bond Fund
(ABF) initiatives and invests in EMEAP local
currency bond markets.

ABF2 investment is initially funded by international
reserves pooled from the EMEAP central banks.

It complements other parallel regional initiatives to
promote bond market development in Asia.
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ABF and EMEAP
 First initiatives in which a regional
1.
Reserve Bank of Australia
organisation has contributed
financial resources to setting up
actual bond funds in Asia.
2.
The People’s Bank of China
3.
Hong Kong Monetary Authority
4.
Bank Indonesia
5.
Bank of Japan
6.
The Bank of Korea
7.
Bank Negara Malaysia
8.
Reserve Bank of New Zealand
9.
Bangko Sentral ng Pilipinas
 This organisation is a central
bank forum called EMEAP
(Executives’ Meeting of East Asia
and Pacific Central Banks) with
11 members:
10. Monetary Authority of Singapore
11. Bank of Thailand
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Two stages of ABF:
ABF1 and ABF2
 ABF1:
 launched in June 2003;
 US$1 billion pooled from the 11 EMEAP central banks only;
 investing in dollar bonds issued by 8 EMEAP sovereign and quasi
sovereign borrowers.
 ABF2:
 launched in Spring 2005;
 initial seed money of US$2 billion by the 11 EMEAP central banks;
 investing in local-currency bonds issued by 8 EMEAP sovereign and
quasi sovereign borrowers.
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The catalyst role of ABF
 ABF1 allowed EMEAP central banks to work together and
build trust.
 Importance of the size of the funds – not so big as to influence
markets but big enough to signal serious intent.
 The combined foreign reserves of the 11 EMEAP central banks
exceed US$2 trillion
 The aggregate outstanding domestic debt securities of the 8
EMEAP markets approach US$1.4 trillion
 RBA, BoJ and NZRB pure investors
 Process more important than size: Learning by doing an
important advantage.
 Aim of ABF2 is to reduce market impediments.
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Initiatives in Asian regional cooperation
 Various regional initiatives to promote Asian domestic
bond markets under three banners =>
1. The Asia Pacific Economic Cooperation (APEC)
2. The Association of South East Asian Nations Plus China,
Japan and Korea (ASEAN+3)
3. The Executives’ Meeting of East Asia and Pacific (EMEAP)
 They tend to supplement and complement each other.
 ABF was unique as the only initiative involving actual
bond funds
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The role of BIS in ABF
 BIS is a cooperative organisation of central banks.
 BIS has been working closely with the EMEAP group
as well as other regional central bank fora.
 Upon invitation, the BIS plays an important role in the
ABF exercises =>
• Fund manager for ABF1
• Administrator for ABF2
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II. Why ABF2?

Asian domestic bond markets have advanced but remain
underdeveloped.

Learning by doing: impediments are more appreciated in
the process of actually setting up bond funds.

Market reform as a public good: ABF2 accelerates bond
market development.

Asian local currency bonds are becoming a more
important asset class in investors’ global portfolio.
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Domestic debt market development
Domestic debt securities outstanding in East Asia1
In billions of US dollars
Total
1,200
Private
1,000
800
600
400
200
0
1998
1999
2000
2001
2002
2003
2004
1
Includes the bond markets of the eight EMEAP members China, Hong Kong SAR, Indonesia, Korea,
Malaysia, the Philippines, Singapore and Thailand.
Source: BIS.
Graph 1
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Asian bond markets advance …
 Local currency bond markets in Asia has expanded
considerably since 1998:
 Total domestic debt securities of the 8 EMEAP markets have
almost tripled.
 Domestic private debts outstanding also more than doubled.
 Economic consequences of the Asian crisis
themselves added impetus to market development:
 It brought home the lessons of currency mismatch due to a weak
domestic debt market.
 Budget deficits widened amid economic contractions.
 Large-scale bank recapitalisation added to public financing needs.
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Domestic debt securities
(% of GDP, 2004)
100.0%
90.0%
80.0%
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
ID
HK
PH
CN
TH
SG
KR
MY
Sources: national authorities and BIS.
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… but remain underdeveloped
 Despite expansion, Asian local currency bond markets
are still well below their potential to intermediate.
 Capital flows show that much of financial intermediation
is being carried out abroad =>
 Asians investing in low-yielding foreign assets and foreigners in
higher-yielding Asian assets.
 To bring such intermediation home, Asian policymakers
perceive a need for deeper and more liquid local bond
markets.
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Share of non-intermediated debt
(% of total domestic debt, 2004)
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
CN
HK
TH
ID
PH
MY
SG
KR
Note: Domestic debt is the sum of domestic debt securities and domestic credit. Non-intermediated
debt is domestic debt securities.
Sources: BIS and IMF.
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Impediments to market development
 Cross-border impediments:
 Capital controls and FX regulations
 Excessive regulatory hurdles to non-resident issuers/investors
 Cross-border delivery and settlements
 Local market impediments:
 Taxes
 Regulatory fragmentations and inconsistency
 Insufficient market development
 Inadequate market infrastructure
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ABF2: Learning by doing
 Learning: impediments encountered and better
understood by policymakers in setting up of actual
bond funds.
• Direct participation as an investor offers fresh perspectives.
 Doing: overcoming these impediments directly by
policymakers benefits broader market development.
• Reducing regulatory impediments can be seen as providing
public services.
• Private-sector approach via circumventing or lobbying may not
be the most efficient.
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Asian bonds as an asset class
 From USD, yen and euro investors’ perspectives, low
correlations between an EMEAP basket and their home
currency bond returns make a strong case for
diversification.
 Even among components within the Asian basket, there is a
good case for diversification via capital flows across the region.
 For a dollar or yen investors’ perspective, the ABF2
basket offers higher risk-adjusted returns.
 Moreover, the Asian index has higher risk-adjusted returns than
most of its individual components.
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Annualised 3M USD returns of 5Y bonds
over the past five years
18
Source: Martin Hohensee, “An Introduction to ABF2”, June 2005. The EMEAP basket includes HK, MY, PH, KR & TH.
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Annualised 3M USD returns of 5Y bonds
over the past five years
Source: Martin Hohensee, “An Introduction to ABF2”, June 2005. The EMEAP basket includes HK, MY, PH, KR & TH.
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III. How is ABF2 structured?

ABF2 has nine funds in two phases:

Phase One: 11 EMEAP central banks invest $2bn in 8 EMEAP
markets via 9 separate private bond funds.

Phase Two: these 9 bond funds will be open up to all investors
via listing in exchanges.

All nine funds are index funds tracking benchmarks
provided by International Index Company (IIC).

One of these nine bonds funds directly covers the eight
EMEAP markets.
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Nine bond index funds under ABF2
 ABF2 comprises nine separate bond funds:
• 1 Pan-Asia Index Bond Fund (PAIF);
• 8 single-market bond index funds.
 All 9 ABF2 funds are bond index funds:
• Passively managed against (tracking) benchmark indices;
• International Index Company is the third-party benchmark
index provider.
 So far, the PAIF, Hong Kong Fund and Malaysia
Fund have already been listed.
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Structure of ABF2
USD 1 billion
USD 1 billion
EMEAP’s investment in
ABF21
Pan-Asian Bond Index
Fund (PAIF)
Eight single-market funds
Local currency
bond markets
China
fund
Hong
Kong
fund
Indonesia
fund
Korea
fund
Malaysia
fund
Philippines
fund
Singapore
fund
Thailand
fund
China
markets
Hong
Kong
market
Jakarta
market
Seoul
market
Kuala
Lumpur
market
Manila
market
Singapore
market
Bangkok
market
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Two phases of ABF2
 Phase 1: investments of some $2 billion in the nine
ABF2 funds are confined to EMEAP central banks
(already fully operational).
 Phase 2: the nine ABF2 funds are to be gradually
opened up to other institutional and retail investors, both
within and outside the EMEAP region (so far, four funds
have been listed on exchanges).
 A staged approach: each fund could proceed at its own
pace and timing to accommodate differences.
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More on the PAIF
 A single-index fund covering all eight EMEAP markets.
 Domiciled in Singapore and initially listed in the Hong Kong
Stock Exchange.
 Quoted in USD on an unhedged basis and tracking the total
returns of the Pan-Asia Index.
 Starting with an initial equal weight, the market weights of the
“iBoxx Pan Asia Index” are determined by four factors:
1.
Bond market size (20%)
2.
Turnover (20%)
3.
Sovereign rating (20%)
4.
Market openness (40%)
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Market weights for the PAIF
China
Korea
China
Korea
Others
HK
Hong Kong
(HK)
Others
Singapore
(SG)
SG
Based on market
capitalisation alone
Based on four factors
Note: Others comprise the remaining four EMEAP markets of Indonesia, Malaysia, the Philippines and Thailand.
Sources: International Index Company (2005b, right-hand panel); BIS calculations (left-hand panel).
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A new family of indices by IIC (iBoxx)
 A family of Asian bond indices, known as iBoxx ABF, serve as
the benchmarks for the ABF2 funds.
 These indices include sovereign and quasi-sovereign local
currency debts, with the latter subject to credit rating criteria.
 Bond prices for index constituents are provided daily by
leading international investment banks and local institutions.
 A useful addition to market infrastructure.
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Two ways to trade the PAIF
Investors
Buying and selling
Buying and selling
Stock exchange
Participating dealers
Subscription
and redemption
Liquidity
Arbitrage
PAIF trustee
Market-makers
Primary market
Secondary market
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IV. What are the advantages of ABF2?

Market impediments were encountered in the setting up of
ABF2 …

… but peer encouragement “fast-tracks” market reforms

and promotes central bank cooperation and public-private
sector cooperation.

Mechanisms have been built to offer incentives to further
reduce impediments.

More product innovations and broader investor base.
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Peer encouragement to fast-track
market reforms
 Working as a group, EMEAP central banks
benefited from peer encouragement =>
 Better appreciating more their divergent regulatory
frameworks.
 Seeing that neighbouring countries have already instituted
market reforms helps in “fast-tracking” your own initiatives.
 Central bank officials worked with their counterparts at the
MoF or securities regulator to deal with impediments.
 Building confidence and rapport for central bank cooperation.
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Some impediments are already removed….
 Relaxing capital controls:
 Malaysia announced significant measures to liberalise FX
controls on the eve of launching ABF2.
 ABF2 is the first foreign institutional investor gaining direct access
into China’s inter-bank bond market.
 Withholding taxes and other taxes:
 Thailand and Malaysia have already granted non-resident
investors withholding tax exemption;
 So far, five of the eight EMEAP member markets have offered
some sort of exemptions;
 In the Philippines, the documentary stamp duty will be removed.
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An example of public-private cooperation
 Seed money: EMEAP central banks.
 Initial mandates: EMEAP central banks.
 PAIF fund manager and custodian: SSgA and HSBC.
 Single market funds: prominent local fund managers.
 Index provider: IIC.
 Investors: ABF2 will eventually be open to retail or
institutional investors, both within and outside the EMEAP.
 Administrator of EMEAP investments: BIS.
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ABF2 broadens both investment
menu and investor base
 ABF2 brings new investment vehicles to local bond markets.
 Five of the eight single-market funds are expected to be exchangelisted, and another may join their ranks soon.
 PAIF is relatively low-cost, low-denomination and
transparent, appealing to a broad spectrum of retail and
institutional investors.
 PAIF is passively managed – leaving open the possibility of active
management for other asset managers.
 PAIF allows for diversification both into and across Asia in a simple
and cost-efficient manner.
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Dynamic incentives for further reforms
 Market weights determining ABF portfolio allocations will be
reviewed annually.
 Market openness is the single most important adjustment
factor in market weights.
 Portfolio allocation for a particular market may adjust upward
upon further deregulation.
 Incentives to continue reforms are thus built into the
mechanism of ABF2 annual portfolio weighting reviews.
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V. How has ABF2 performed so far?
 ABF2 was first launched in March 2005.
 So far, four of the nine-fund family have been listed.
 Sizable investment from outside the EMEAP.
 Liquidity varies across markets and over time.
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The launch of ABF2
 ABF2 was fully launched by June 2005:
• EMEAP seed money was invested in the nine funds.
 Four of the ABF2 family have been listed as ETF:
• The Hong Kong Index Fund (Hong Kong, 21 June)
• The Pan Asia Index Fund (Hong Kong, 7 July, LoF)
• The Malaysia Index Fund (Kuala Lumpur, 18 July)
• The Singapore Index Fund (Singapore, 31 August)
 Work under way to list two other funds as ETF.
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Outside investment into ABF2
 The four listed funds are open to non-EMEAP investors.
 Interest shown by both institutional and retail investors.
 All four listed funds registered growth (as of Sept 2005):
• The PAIF: 13%
• The HK Index Fund: 44%
• The MY Index Fund: 26%
• The SG Index Fund: 36%
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ABF2 trading
 Liquidity in the secondary markets for the four listed
funds was good initially …
 … but trading decline somewhat lately.
 Trading activities vary across markets.
 One way to measure market liquidity is the tightness of
bid-ask spreads.
 The PAIF and HK Index Funds appear to be deeper and
more liquid by this score.
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Bid-ask spread of listed ABF2 funds
(% of bid-ask average)
3.0%
HK Fund
PAIF
2.5%
MY Fund
SG Fund
2.0%
1.5%
1.0%
0.5%
0.0%
21.06.05
21.07.05
Source: Bloomberg
21.08.05
21.09.05
21.10.05
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Progress in ABF2
 Net asset value declined by 2% since launch …
 … mostly due to changing interest rate and currency
cycles:
• Higher local interest rates (ID, HK, KR and TH)
• Weaker regional currencies (ID, KR, PH and TH)
• The July renminbi move was initially a boost to the PAIF
• US interest rate cycle and dollar strength
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PAIF Closing NAV/unit (US$)
101
100
99
98
97
96
06.07.05
20.07.05
03.08.05
17.08.05
31.08.05
14.09.05
Source: State Street Global Asset Management.
28.09.05
12.10.05
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PAIF weighted average yield vs.
yield on comparable US Treasury
5.0%
Weighted Average Yield
Yield, Similar Duration US Treasury
4.5%
4.0%
3.5%
07.07.05
21.07.05
04.08.05
18.08.05
Sources: Bloomberg; SSgA.
01.09.05
15.09.05
29.09.05
13.10.05
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Summary
 ABF2 is a learning-by-doing exercise by EMEAP central
banks through actually setting up bond funds investing in
local-currency bond markets.
 ABF2 initially invests $2bn international reserves pooled from
11 EMEAP central banks in 8 EMEAP markets and eventually
will be open to all other investors.
 ABF2 has helped already reduce market impediments and
built a mechanism for further market reforms.
 The four listed funds of the ABF2 family so far have grown in
size, with liquidity varying across markets.
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If later you have questions or
comments, please email
guonan.ma@bis.org
Thank you!
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