The headhunters who serve Asia’s banking community have mirrored their clients through the financial crisis. A severe plunge; an unexpected bounce; and a reshaping of the industry along the way.

“The business fell off a cliff for us in December and everything came to a grinding halt,” recalls John Wright at Global Sage in Hong Kong. “Everyone had to reorganize their businesses and shift people around; it took them a few months to figure out who was going to do what. But now we find ourselves massively busy – we had a record July.”

Other firms mirror that experience, and a few trends have arisen along the way. One is the seniority of hires and searches. In the good times, work tends to come in bolstering teams, or picking off star bankers in particular areas; over the last year, worldwide, so much of the change has been at the very top. “The biggest trend that’s happened is that very senior executive arrangements keep changing,” says Wright. And the institutions that have come through the crisis in the best shape are aggressive. “Firms who have got a good grasp on the future are prepared to consider and recruit the very best talent out there and take advantage of this time to bolster their business. As that restructuring happens, and as they get their liabilities under control, they are looking at how they are going to grow. Our clients are all looking at their growth plans and Asia has been the most robust region in the world.”

As the financial crisis unfolded, some interesting shifts took place. The most visible in Hong Kong’s corporate recruitment industry has been the bold growth of Heidrick & Struggles, which has hired some of the biggest names in the industry. Harry O’Neill, formerly of Whitney Group, came first, as head of Asia financial markets; next was the former head of Akamai in Asia, Daren Kemp; and finally, in probably the biggest surprise of all, Stephen McAlinden, a founder of Eban. Those who know the firm well point to the influence of Daniel Edwards, the mid-30s ultra-endurance athlete who heads the Tokyo office and is co-global practice managing partner for Heidrick’s financial services practice. “He’s the brains and the rock star behind the whole thing,” says one person who has dealt with him and the firm. “He’s going to be the next CEO of the company. His plan is to control 70% of the market so that H&S can dictate pricing.”

Asked what the relative strength of a global player like Heidrick is, Harry O’Neill says: “It’s reach, really, as much as anything else. The boutiques are very good at a local level, but the reality was that they had very good individual pieces of the business in the regions, rather than one good global business.” Additionally, for senior management or boards of major institutions, there is a certain safety in hiring a top five firm because they have the security of working with a high street brand and people are therefore less likely to be blamed for using them than if an experience with a boutique works out badly.

Wright at Global Sage also believes that scale has helped, particularly in an environment in which so many global firms are being overhauled, usually led out of the US or Europe. “I can’t stress to you enough how important having a global business has been to our survival,” he says. “Our ability to source all this information worldwide has given us an edge.” In the days before our conversation, JP Morgan, Morgan Stanley and UBS have all announced very senior hires globally – chief executives, investment banking heads – with ripples that will be felt worldwide.

Some feel that the big firms were better equipped than the boutiques to ride out the storm. Heidrick is one of the few listed headhunters so we know how that business did through the tough times: in the first quarter of 2009, ending March 31, it made a US$32.4 million operating loss, or $19 million excluding restructuring charges. The operating loss was US$11.6 million in the second quarter. This gives some illustration of the strain corporate recruitment firms felt in the first half of the year.

“It was an utter bloodbath. There was carnage in this industry in the first quarter and most of the first half,” says one headhunter. “Big firms can survive that but it’s much harder for a boutique.”

That said, while some boutiques have struggled and even fallen over the last 18 months, others appear to have flourished. The benchmark headhunters poll in Asiamoney magazine showed two lesser known groups climbing through the ranks, notably Matthew Hoyle Financial Markets, whose founder, Matthew Hoyle, was name the best executive overall in Asia. Similarly Wellesley Partners, set up only in 2005, has gained ground in a range of fields from investment banking to prime broking, fixed income and derivatives, with Christian Brun on the investment banking side an example of a rising star there, competing with established investment banking leaders like McAlinden, Wright and Executive Search’s Max Lummis. Of the boutiques that have suffered losses, Eban continues despite McAlinden’s departure, with Simon Waterson and Dionne Tai running the Hong Kong office; Whitney’s future was much darker after O’Neill left, with a major law suit between him, Whitney and Heidrick after his resignation. Whitney itself has since gone under (O’Neill took many of his Hong Kong team with him to Heidrick).

Asked what the selling point of a boutique is, banking specialist Christian Brun at Wellesley says: “Attention.”

“Our approach has been just working with a very small number of clients and doing as much as possible for them,” he says. Brun represents the opposite direction to McAlinden and O’Neill – he left the London office of Heidrick in order to set up a boutique. He’s known for being particularly closely connected to Credit Suisse, Morgan Stanley and Nomura, and the firm generally was very closely linked to Lehman Brothers, which had the consequence of making last year a much better year than it might have been as they moved people across to Nomura and replaced people who left afterwards. “Being a global firm doesn’t make any difference for a lot of the stuff we do,” he says. “At the end of the day it’s the relationships you have with the people at the top and the banking community generally.”

But some feel that the need for scale becomes more important as banks realise the need to make on-the-ground hires in mainland China and India, rather than just big-hitter bankers in Hong Kong and a couple of other hubs. “When you drill down into the key areas, China and India are the most significant,” says O’Neill. “In our previous lives, Stephen and I operated out of Hong Kong and Tokyo, Daren had a Singapore office, but none of us had anything in China, India or Australia. Now, we originate these searches here, and it’s Chinese consultants in China and Indian consultants in India who do the work with us.

“One of the features of this year has been that international firms are increasingly recruiting from domestic Chinese financial institutions – it’s one thing you really need to be on the ground to be able to do. Being able to approach candidates at a domestic level is very important.”

In terms of the money firms make, opinions differ on how much fee pressure there has been. At the top level, the point is not really the charge – typically varying between 25 and 33% – but the fee cap, which all firms agree to. “A head of investment banking in the region might be paid $7 million this year depending on what the firm is,” says one headhunter. “We wouldn’t get one third of that, we’d get whatever the cap is, perhaps half a million.” Others report that the money out there for senior hires varies, too: one says that Citigroup is offering multiple-year guarantees for some individuals, which is having a driving effect on the market.

“There’s an awful lot of hiring in China, natural resources and FIG – mainly senior strategic hires,” says Brun. “Next year’s going to be like 2007 again. We’re already seeing people being paid at levels I find amazing, right back up at 2007 levels.”

And, after all the turmoil, the retrenchment and the re-hiring, are there still good people out there?

“At a very senior level there are still good people out there – the very, very senior,” says Wright. And the process of rotation among that echelon may still have another round to go.

In September Hong Kong’s renminbi bond market took a major step forward. To that point, it had been a fascinating but fairly insubstantial new venture, attracting some interesting credits but lacking the scale or liquidity to have broader impact. But then China’s Ministry of Finance launched a RMB6 billion sale of government bonds to retail investors in Hong Kong – and by the time the offer closed on October 20 had attracted bids for three times that much.

The deal was significant on a number of grounds. The 13^th RMB bond issue in Hong Kong, it was the biggest, the first by a sovereign, the first to come in multiple maturities, and it increased the market’s curve from three to five years. Not only did it provide a government pricing benchmark to this new market, it also represented the first time the Chinese sovereign had issued an RMB bond anywhere outside the Chinese mainland. And, in so doing, it heightened the sense that what’s happening with this market in Hong Kong is a tentative but vital step towards convertibility of the Chinese currency.

“China obviously doesn’t need the money for fiscal purposes, so you have to ask why they are issuing,” says Tim Condon, chief economist for Asia at ING Financial Markets. “The answer is to prepare to give the renminbi a wider circulation outside of China – and so a small step towards internationalizing the renminbi. I see these small steps as being towards the end of full convertibility.”

Hong Kong’s RMB bond market started out with a RMB5 billion issue – still the second biggest to date – from China Development Bank in July 2007, and was followed by other Chinese state-linked agencies (Export-Import Bank of China in August that year) and major mainland banks (Bank of China in September 2007 and again a year later, and Bank of Communications and China Construction Bank in July and August 2008). The next milestone was allowing foreign banks with incorporation on the mainland to issue too through their Chinese subsidiaries: HSBC (China) was first, with a RMB1 billion institutional bond, the market’s first floating rate issue, in June 2009, followed by Bank of East Asia (China) with a RMB4 billion raising the following month. HSBC was back again in August with a RMB2 billion deal, this time chiefly for retail buyers.

With the Ministry of Finance deal, the total raised now stands at RMB38 billion from eight issuers, with tenors from two to five years and coupons between 2.45 and 3.4%.

Whatever China’s broader ambitions for the currency, the Hong Kong RMB bond market is underpinned by a pragmatic rationale: the steady accumulation of the Chinese currency outside of China. “Although as a percentage it’s small, it’s something that China has allowed and wanted to see,” says Anita Fung, treasurer and head of global markets for Asia Pacific at HSBC. “It started with the growth of renminbi deposits, and the RMB bond market in Hong Kong reflects the fact that it’s important to give investors a wider choice of investments than just those deposits.” Hong Kong resident retail investors can accumulate RMB20,000 a day, and by September 2009 RMB deposits in the city’s banks stood at RMB58.2 billion.

Aside from retail, selected specialist merchants can open RMB accounts with banks – those groups who naturally accumulate Chinese currency in the course of their business, such as international trading companies that accept RMB from their Chinese mainland counterparties. It’s a limited field: even these businesses must get approval from the Hong Kong Monetary Authority before being allowed to open an RMB deposit account with a Hong Kong commercial bank.

Between them, these two groups have created a modest institutional market too, made up of the banks in Hong Kong who offer the accounts that service those retail and merchant clients. “The RMB bond market in Hong Kong provides a means for the banks in Hong Kong to diversify their RMB assets from just placing them with the clearing bank,” says Fung. There is only one clearing bank licensed to handle RMB today – Bank of China (Hong Kong) – and it pays just under 1% interest, hopelessly unattractive for an institution. “If you have RMB deposits, you can invest them in RMB bonds at a more attractive yield without compromising the risk, if it’s a quality issuer.”

Consequently there is healthy appetite for any new issue. “Renmimbi retail deposits in Hong Kong receive a very low deposit rate, below 1%,” says John Sun, executive director of fixed income at Citic Securities International. “Anyone who has an RMB bank account in Hong Kong is going to receive that interest rate; compare that against 2.7% [the rate on the three-year tranche] for a bond from the Chinese government. That’s why the response is so good from retail.”

Between retail and the modest permitted institutional market described above, there’s already more demand than supply has yet been able to cater for. But if the net was broadened to a greater range of buyers, that demand would become truly insatiable. “When the MOF issued this bond I got a lot of calls to see if they could buy this bond – from Taiwan, the Middle East, Europe,” says Sun. “A three year bond offering 2.75% yield, and the potential appreciation of the renminibi – which on a two year trade is probably roughly 5% – means in US$ terms this bond offers more than 5% yield. It’s very attractive when US treasuries and yen offer so little. But unfortunately none of them can be involved in the deal.”

One consequence of this is a market that lacks liquidity. Deals fly out the door, but don’t then tend to trade. “Because of a lack of participants, the secondary market is not active,” says Sun. “Retail use these bonds as a replacement for their deposits, and so hold them. And commercial banks do the same thing – there’s no other way for them to invest their renminbi.”

More broadly, the market helps develop expertise, opportunity and familiarity. “By having an RMB bond market in Hong Kong it expands the range of RMB products and services outside China,” Fung says. “It’s part of integrating into international trade and financial markets, and it complements QFII, QDII and other initiatives to open up the financial sector.” QFII refers to qualified foreign institutional investors, a system whereby selected foreigners are permitted to invest in domestically-listed securities in China; QDII, or qualified domestic institutional investors, is the reverse process, where mainland asset managers can invest outside of China and launch mutual funds giving domestic investors exposure to world markets. Both have long been seen as early experiments in opening up China’s financial markets while improving the expertise of domestic participants.

In this context the Ministry of Finance bond was particularly important, since quite apart from soaking up available deposits in Hong Kong, it demonstrated the conviction in government towards this process of gradual openness. “It’s very significant,” says Fung. “It provides a sovereign bond curve, provides a wider range of investment tenors, and provides a pricing reference for future issuance. It also arguably provides a foundation for building an offshore interest rate swap market, or even a cross-currency swap market, as and when regulations permit.”

But she cautions against going too far. “People tend to mix up this market with the liberalization of the currency, saying it’s going to appreciate faster or means we have a faster timetable for capital account convertibility. I don’t think that’s the right way to look at it. It’s more a continuing process of gradual opening up of the financial market, becoming more internationalised, more market driven.”

From an issuer’s perspective, for the foreigners, RMB bonds in Hong Kong are not really about the money. “In terms of our funding needs we are well funded in RMB in China,” says Fung. “When we issued RMB in Hong Kong, it was not because we don’t have the RMB deposits to fulfil our local ratio of assets and liabilities. We issue because we think it very important to broaden the investor base and the types of investment products available in Hong Kong. We want to be the front runner in terms of the development of the RMB market for onshore and offshore.”

There are really only three major RMB deposit banks in Hong Kong: Bank of China (Hong Kong), HSBC and Standard Chartered. Bank of China (at the parent level) and HSBC have both tapped the market already, so all eyes are on Standard Chartered, which instead has more frequently been linked in the trade press with RMB issuance in China itself. Asked about Standard Chartered’s intentions, Sundeep Bandari, regional head of global markets, says: “As an active capital markets participant in Hong Kong, Standard Chartered is very keen to be involved in the development of the market.”

Whatever Stanchart decides, or is permitted to do, the trend appears to be towards a greater range of issuers. “We have seen good progress over the last two years,” says Bandari. “Initially only a few select Chinese banks were allowed to tap the market. Since this year, it has broadened to include the China subsidiaries of Hong Kong-based banks as well as the sovereign.” Bandari notes the China subsidiaries of Hong Kong’s banks, rather than the banks themselves, were permitted to launch RMB bonds in Hong Kong. “This is significant as it signals the Chinese regulators may be willing to consider non-Chinese issuers to tap the RMB market in Hong Kong, and may pave the way for possible future consideration of other foreign issuers.”

Fung’s perspective is also useful as an arranger, since HSBC has held a lead arranger role on nine of the 13 issues to date. “Issuing an RMB bond in many ways is no different to issuing a bond in other emerging currencies, but there’s a lot of work and coordination required in bringing these to market as it’s about transcending between the Hong Kong and mainland Chinese markets,” she says. “Coordination and setting the price discovery processes is critical to ensure it’s not a one off transaction, but benefits investors as well as setting a good benchmark for issuers, and this requires a lot of cross-border work, including with the regulators on both sides.” HSBC wasn’t a lead on the MOF deal, which instead was handled by Bank of China (Hong Kong) and Bank of Communications as bookrunners.

So what next? In launching the Ministry of Finance bond, vice finance minister Li Yong said that investor response to the issue would determine whether the Chinese sovereign issues more RMB sovereign debt in Hong Kong. Judging by the reception, they’ll be back.

China report – capital markets

China’s stock markets are back with a vengeance. The Shanghai Composite Index, the worst performing major market last year, has doubled since November, better than any comparable index worldwide. The initial public offering of China State Construction Engineering, which raised RMB50.2 billion in July, was the biggest in the world since March 2008. And new IPOs are in some cases trebling on debut. Which raises the question: boom or bubble?

The pace with which China’s markets have rebounded has been extraordinary, but in keeping with the behavior of one of the world’s most volatile markets. Despite the fact that China has weathered the global downturn surely better than any other major nation – many believe it is on track for 8% GDP growth in 2009 – its stock market dropped 65% in value in 2008 before this year’s rebound. By market capitalization China is now the second largest stock market in the world, overtaking Japan, but this scale has not given it stability, and the dominance of retail money has made it a particularly fiery place to be. That’s not going to change any time soon: in a single week in July, 566,937 new trading accounts were opened.

A bubble? If so, not yet, according to fund managers. Samantha Ho, investment director at Invesco and manager of many of its Greater China products, notes that the MSCI China index is trading on a price earnings multiple of about 17 times, about midway between historic lows of 10 and highs of 25 times; and that the A-share market (domestic shares which can generally be purchased only by people within China) is trading at 26 times, again in the middle of its recent range. “We’re definitely not cheap, but we’re not expensive either; we may be looking at fair valuation,” she says. “If you believe, as I do, there will be earnings growth this year, the market is not that expensive.”

There are several kinds of Chinese stocks. A-shares tend to have a higher valuation because local investors have very few investment vehicles to choose from given the capital controls that restrict most Chinese from investing outside China. That creates high demand for local stocks. Most international investors get exposure to China through H-shares, which are Chinese companies listed in Hong Kong, or red chips, which are domiciled outside China but get almost all of the revenues from China and are typically owned from the mainland.

Most of the stock market gain took place during a period in which domestic IPOs were suspended. They stayed that way for nine months until the end of June, creating pent up demand which has been reflected in some remarkable listing stories.

After two smaller issues, the first listing of note after the end of the ban was the IPO of Sichuan Expressway in Shanghai. On its first day of trading it tripled in value at one stage. Hong Kong is experiencing similar fervor for Chinese stocks (see box).

“The IPO pipeline has been building up for the better part of 18 months,” says Chris Keogh, senior advisor to the chairman at Gao Hua Securities, the Beijing partner of Goldman Sachs. Keogh says he is not concerned about the size or pipeline of the IPO market. “Yesterday [July 29] the market turned over US$60 billion – that’s more than all the other markets in the world combined,” he says. “The ability for these IPOs to come to market is certainly there. The only thing I really worry about is how much of this market is still dominated on a daily basis by retail investors. It’s about 80 to 85% and that leads to excessive intra-day volatility: as fast as the market has gone up, it can absolutely go down.”

While domestic stock markets capture the headlines, the development of the local bond market is just as significant – and is growing fast.  “You’ve seen tremendous growth in all segments of the RMB bond market in China: enterprise bonds, CP [commercial paper] and MTN [medium-term note],” says Patrick Tsang, head of cross border debt capital markets at Deutsche Bank. “A couple of years back there was much growth on the equity market side, but in the last two to three years you’ve seen similar momentum in the debt markets.”

In absolute terms, bond issuance may be a lower total for 2009 than 2008, but this misses the more interesting fact, argues John Sun, executive director, fixed income for Citic Securities International. “The reason the overall number in 2009 is because there have been less treasury securities as the central bank doesn’t want to withdraw liquidity from the market,” he says. “But if you look at corporate bonds, in 2008 only about RMB85 billion was issued; in 2009 we expect it’s going to reach 500 billion, six or seven times higher.”

2008 saw the launch of a whole new type of bond, the medium term note (sometimes referred to locally as a mid-term note). The significance of this market rests with the regulators who oversee it. China’s bond markets are overseen by a labyrinthine range of regulators. The National Development and Reform Commission regulates the corporate bond market for unlisted companies; the China Securities Regulatory Commission regulates the corporate bond market for listed companies and oversees the underwriters. The People’s Bank of China regulates the structure of the industry, banks, and interest rates. The Ministry of Finance has an involvement, such as for supranational issues. And then the new MTN market is regulated by a different group altogether – a self-regulatory body, the National Association of Financial Markets Institutional Investors (NAFMII).

“My view is this new entity [MTN market] will become a much more popular method of issuing bonds in future,” says Sun. “The regulator is an association, and the application procedure is much simpler compared with other routes.” Also, Sun says, it doesn’t have the short-term limitations that the term MTN infers in international markets: issues can go as long as 10 years in tenor, although so far they have tended to stop at five.

There is, though, a sense of whether the domestic bond market could be more than it is. “On the demand side, institutional investors in China are absolutely dying for longer duration, higher yielding debt investments, which suggests seven to 10 year maturity and corporate credit,” says Keogh. Insurers, for example, are obvious buyers: they have lots of excess RMB capital to invest, and they need long-dated instruments to match the length of their policies. “But this demand is unsatiated even with the increase in issuance, because the increase has been in CP or the new MTN market – the shorter end of the curve.”

An interesting question is whether a panda bond market could be developed in China. This term refers to non-Chinese issues launching bonds in renminbi, onshore in China. This has two obvious attractions: it provides another source of funding to foreign issuers at a time when credit markets remain shut or at least difficult for many of them; and it provides a home for the vast liquidity in China’s domestic markets.

The idea of the panda bond market was first attempted in 2005 when two multilaterals, International Finance Corporation and the Asian Development Bank, issued them, on the strict understanding that the proceeds remained in China for development purposes. Much has been discussed since then but the idea didn’t really progress until July 2008 when China published a draft revision expanding the scope of panda bonds from development institutions to foreign banks and corporations with operations in China.

Standard Chartered is likely to be the first such issuer, although even then it will be through an entity that is incorporated in China, so one could argue it is not strictly speaking a panda bond. Other groups, notably HSBC and Bank of East Asia, plan to tap a different market again – issuing RMB denominated bonds in Hong Kong, a method which sources the significant retail deposits held in Hong Kong.

There’s no shortage of willing borrowers. “You would find issuers from General Motors to Walmart to any of a number of multinationals with liabilities or sourcing requirements in renminbi, who would want to issue tranches in renminbi as they already do in yen or euros,” says Keogh.

For sovereigns, too, there is potential, and this could benefit China itself. “We now have over US$2 trillion in foreign reserves, and about 70% of it is US bonds or assets,” says Yifan Hu, chief economist at Citic Securities International. This creates a clear exposure risk, particularly if one fears for the future performance of the US dollar. “The panda bond could be a short term solution. The US has to issue government bonds to support its economy; it could issue panda bonds to raise RMB, then buy US dollars from the central bank. In this way China continues to increase the US debt, and avoids the exchange risk.” In her view, “The Chinese will be more interested than the Americans, because the US would have more risk than China.”

Whatever form it takes, the debt markets have a big future in China, and one can already see international investment banks trying to take part in underwriting them – first Goldman Sachs and UBS through their pioneer ventures (see banking article), and more recently with the licenses granted to local joint ventures involving Credit Suisse and Deutsche. “It makes sense that China should have a vibrant RMB domestic debt market, and the government has taken the right steps in developing that market,” says Tsang at Deutsche. “I believe this will be an area of focus for us and other investment banks.”

THE ROLE OF HONG KONG

In recent years there has been a trend for China to encourage its companies to list on the A-share markets of Shanghai and Shenzhen, rather than just following the pattern of previous years and trekking to Hong Kong.

This raised doubts about Hong Kong’s continuing viability as a listing venue for Chinese companies. But recent weeks suggest there’s not much to worry about yet. At the end of April, China Zhongwang raised US$1.27billion in a Hong Kong IPO, in what remains the second largest IPO globally in 2009 at the time of writing; when Beijing-based building materials manufacturer BBMG came to the markets in July, raising US$884 million, its retail tranche was oversubscribed 800 times and its institutional side 200 times. “That’s something we haven’t seen since 2007,” says Kester Ng, head of equity capital and derivatives markets at JP Morgan.

While China’s stock markets may threaten Hong Kong in the long run, for the moment they are very different. “China is a closed market,” says Ng. “Unlike New York or London where money flows in and out and an investor in Hong Kong can buy shares in New York or vice versa, in China you cannot buy Chinese shares from overseas unless you have a quota.”

 “I don’t currently think about a Hong Kong versus Shanghai discussion,” says Ng. “They cater for very different investors. Until that investor base converges, it’s not Hong Kong versus Shanghai.”

Asian real estate has followed up an epic plunge with an equally dramatic rebound. Extraordinarily, deep in a global financial slowdown, there is even talk of a bubble in the residential property markets of China, Hong Kong and Singapore.

It’s quite a difference compared to the mess of 2008 and early 2009. According to CB Richard Ellis, the real estate services group, Asian property investment sales fell 83% to US$3.1 billion in the first quarter of 2009 compared to the same period a year earlier, with Japan, Singapore and Hong Kong suffering the biggest falls; investment turnover for industrial and office property fell 95% and 89% respectively. Many listed property stocks halved in value last year: indeed, the average real estate investment trust (REIT) in Singapore fell 54% in 2008.

While few property stocks have recovered all their losses, they have bounced impressively from their lows, to the point that analysts are already starting to wonder if there is any value left. “Asia Pacific listed property is relatively expensive,” says Matt Nacard at Macquarie Research, who says the sector is now at just a 3% discount to net asset value (NAV), compared to 8% outside Asia, and is now trading at 19 times 2009 earnings. The MSCI Asia Real Estate Index rose 47% in the second quarter alone.

So how has this happened? It depends on the market, but there are some common themes. “This revival in property prices has been mainly driven by the abundance of liquidity in countries such as China and Hong Kong,” says Keith Chan, an analyst at HSBC Global Research. China is probably the clearest example. As our special report on banking in China on page xx explains, the RMB4 trillion government stimulus package there has triggered a vast increase in lending by Chinese banks, with most of the bigger banks showing year on year loan growth of around 30%. Lending like this naturally helps the property market, as well as generating earnings revisions. Says Nacard: “In the absence of cooling measures from the authorities, this leads to a powerful positive combination.”

China also has some unique characteristics. “In China investment alternatives are very limited: it’s either the residential property market or the listed market,” says Kenneth Tsang, head of Asia Pacific research and strategy at LaSalle Investment Management. “And the underlying fundamentals: demand has always been very strong in China because of the growth in income, GDP and productivity. They are long term drivers for the China market.”

Consequently, just months after a period in which the real estate market seemed to be dragging down China’s economy, it is booming again, at least on the residential side. According to data from the National Bureau of Statistics of China, national residential sales were up 54% in volume and 82% in value in June year on year. Eastern seaboard cities, particularly Beijing, led the growth. According to Morgan Stanley, listed property developers in China have achieved an average of 63% of their full year sales targets in the first half of the year, “setting the stage for a potential upward revision of their target during the interim result announcements”. Also, despite the bounce back, Morgan Stanley believes affordability in China “remains at a healthy level, with property prices at six to eight times annual income, or monthly mortgage payments at 40-50% of monthly household income.” This suggests support for further growth. Correspondingly, developers are now actively bidding for new land in China, trying to get prime sites cheaply before the market recovers.

Similarly, in Hong Kong too, liquidity is driving residential prices up, despite the fact that rents are falling. Partly it has to do with government stimulus in Hong Kong itself, but also China is having a big influence. “We are seeing increased inflows from China into Hong Kong,” says Chan. “In the past, buyers from mainland China accounted for less than 5% of the property purchases in Hong Kong. Nowadays 20 to 30% is the norm.” So, when China receives a huge boost to liquidity, it is felt in Hong Kong property too. “I won’t be surprised to see property prices continue on this up trend in Hong Kong,” Chan adds.

Singapore, too, is suddenly filled with talk of price bubbles, which seems remarkable in a recession-hit country that expects its economy to shrink by between four and six per cent this year. Residential rents have halved, and yet the purchase price of the properties themselves is soaring to the point that the government is openly discussing overheating. National Development Minister Mah Bow Tan was quoted in state media in July as saying: “I wouldn’t say there’s excessive speculation at the moment, but there is some element of speculation involved. I think some of the practices that you saw in the last property boom are starting to come back. So I think we’ll have to be careful.” He also said: “I would say that there is more than sufficient supply over the next couple of years and it’s a bit too early to say whether there is a speculative bubble or property bubble building up.”

But analysts seem less enthused about the prospects in Singapore’s real estate markets than Greater China’s. Macquarie expects a 20% fall in residential prices this year.  Morgan Stanley analyst Melissa Bon calls the valuations of Singapore’s listed property developers “fundamentally unjustifiable” and has an underweight recommendation on big developers like CapitaLand, Keppel Land and City Developments.

The office market in Singapore has been particularly badly hit: CB Richard Ellis said it hosted the worst office rental contraction in Asia in the first quarter, down 34% on the previous year, and Macquarie expects a 38% fall in office rents in total this year. Indeed, across the region the office market has not enjoyed anything like the ardor that residential has. “Office is a different picture,” says Chan. “In top tier cities in China office values have dropped 15 to 20% from the peak of last year.” In Hong Kong the office market suffered in the first quarter – the 25% drop in office rents compared to the previous quarter was the worst Macquarie had seen since it started keeping records in the 1980s – but Chan says the limited supply in places like Central (Hong Kong’s CBD) help to maintain stability.

Tsang agrees. “Supply for commercial real estate in Hong Kong is not an issue: not much is coming and we are not anticipating very high vacancies.” This is in contrast to Singapore where a lot more supply is still due to come on to the market, “which may delay the recovery process.”

Nevertheless, things have clearly improved, but analysts and fund managers are mindful of how quickly things can change. Morgan Stanley’s Derek Kwong, in a recent report on Hong Kong, notes: “While we are upbeat about the benefit of escalating asset prices on the back of ample liquidity, there is always the risk of its exit.” He adds: “We are certainly mindful that the bull case is not dissimilar to a bubble situation.” In China, where momentum and mood have such an impact, there are a number of things that could reverse sentiment: the authorities may seek to rein in lending or implement a round of tightening by raising rates and reducing the attraction of debt; or a round of corporate earnings downgrades could also reduce confidence.

The global financial crisis put a serious dent in the REIT market, which had otherwise been flourishing up to 2007. Asian REITs suffered their deepest ever fall in the second half of 2008, with their market capitalization falling by almost one third to US$48 billion, according to CB Richard Ellis. Only one new REIT has been launched in Asia in the last 12 months – Centra Hotels & Resorts Leasehold Property Fund, in Thailand in October – and many existing ones struggled to raise funds to meet short term debt obligations. New City Residence, listed in Tokyo, was the first to be wiped out, filing for bankruptcy in October 2008 (see Japan box). In other cases REITs were offloaded in order to help shareholders improve their own positions: Allco Finance Group sold its stake in AllcoCommercial REIT to Frasers Centrepoint; Malaysia’s YTL bought a 26% stake in Macquarie Prime REIT from Macquarie, and renamed it Starhill Global REIT.

At its worst, there was real concern about the very viability of the REIT model, although that moment appears to have passed. “The model was under a lot of pressure when yields were 8, 9, 10%,” says Arjun Khullar, managing director and head of equity capital markets for south and southeast Asia at JP Morgan. “It’s difficult to make an accretive acquisition then. Now some are at 5, 6%, it is much easier to do.” Many of the bigger REITs that needed to recapitalize were able to do so, notably Ascendas REIT, Singapore’s biggest industrial property trust, which raised S$300 million in January in the first successful recapitalization, and CapitaMall Trust, part of the CapitaLand family, which managed to raise S$1.23 billion in a rights issue in February. “S-REITs have not disappointed in terms of refinancing their debt,” says Bon. “Indeed, they recapitalized ahead of our expectations.”

Singapore is ex-Japan Asia’s biggest market for REITs, with 21; Hong Kong, which started trying to attract REITs later, has only seven. Other, smaller markets exist in South Korea, Taiwan, Thailand and Malaysia. The Philippines and China have both spoken about launching REIT markets, with legislation already underway in Manila. Since the Philippines boasts three of the region’s blue chip developers in Ayala Land, SM Prime and Megaworld, it is a natural home for REIT structures.

While it’s clearly going to be some time before any new REITs are launched, existing ones may return to the markets. “We’re likely to see more REITs raising money again,” says Khullar. “A-REIT and CMT [Ascendas and CapitaMall], earlier this year, were defensive plays: they were raising money so that if the world did end, they would still be able to stay standing. Now valuations have come down, I think REITs will look to raise money for more aggressive reasons: for acquisition.”

BOX: Japan

Japan’s property markets have slumped with the rest of that economy. According to Mizuho Trust and Banking, real estate transactions more than halved in value and volume in 2008, particularly because J-REITs, Japanese real estate investment trusts, have not been buying. “The J-REIT market is still stagnant in terms of property acquisitions, given that most of the J-REITs’ balance sheets are geared up to their respective self-imposed maximum levels, and concerns about financing and potential bankruptcies had brought down most JREIT share prices substantially below their book values, essentially closing the door for equity raising,” says Macquarie in a recent report.

Japan was where REITs first started to come unstuck, with New City Residence being the first in the region to go under in October 2008. Things have picked up in the second quarter, though. The government has brought in measures to try to temper concerns about bankruptcies, including the provision of loans through the Development Bank of Japan, and eased tax transparency requirements around M&A (making it easier for one J-REIT to acquire another at a discount to its NAV). Also, new sponsors are being found for those J-REITs whose existing sponsors have already applied for bankruptcy. Most recently Daiwa Securities announced in June it would become the new sponsor of DA Office; other JREITs including Nippon Residential, Nippon Commercial and Joint REIT, were expected to appoint new sponsors at the time of writing.

Despite the trials of the markets, Tokyo is not officially the most expensive place in the world for office space, according to CB Richard Ellis: US$183.62 per square foot per annum, edging out London’s West End and Moscow. Despite that, vacancy rates have continued to rise in Tokyo; Macquarie expects a 9% peak within the next two to three quarters.

BOX: Asia’s blue chips

Asia’s blue chip companies are emerging from financial crisis, sometimes scarred but generally intact, and ready to take on opportunities as they arise.

The Dow Jones Country Titans indices, which measure the performance of the biggest and best known companies in each country, tell the story. Its China 88 index is up 92.5% year to date, while Singapore’s is up 48.4%, Hong Kong’s 43.7% and South Korea’s 41.1%. Compare this to the world’s old guard: the UK’s blue chips have gained just 5.4%, Germany’s 6.4% and France’s 8%.

Partly, this is because Asian markets fell irrationally far in the first place, particularly given that their banking systems were largely immune from the problems that blighted those in the US and Europe. The fall was a consequence of capital behavior: as times turned difficult for US and European fund managers, they tended to bring money home in the belief that it was safer to do so. This exit of foreign institutional capital more than anything else hit Asian markets so hard.

Now, though, some common sense is returning. Economically Asia has the best prospects, given the scale of its population steadily growing in wealth, bringing with it demand for goods and services that can’t be matched elsewhere in the world. As it is, GDP numbers in many Asian markets remain highly impressive despite their decline – China may well log 8% GDP growth this year. Generally, Asia’s populations are characterized by high savings, and those in weaker Anglo countries by higher debt. On top of that, Asian banks and companies, have learned lessons the hard way from the Asian financial crisis in 1997-8, have tended not to be highly leveraged; the banks in particular have been run with greater conservatism than many US houses in particular, and it could also be argued they were protected by a lack of sophistication from owning things like collateralized debt obligations which caused such trouble elsewhere.

Those fundamentals are coming back into focus for analysts and investors. “Expect Asian markets to outperform in the next five to 10 years,” says Shane Oliver, chief economist and head of investment strategy at AMP Capital Investors. And the biggest companies, since they have the easiest access to capital when bond and stock markets regain their liquidity, are also in the best position to acquire other businesses.

From the investor perspective, much of the easy gains may already have passed: Oliver, speaking to Institutional Investor in July, points out that most Asian markets are already trading around their long-term price/earnings ratio averages despite the fact that most of the world is still technically in recession. Nevertheless, he thinks that five to 10 year projected equity returns are higher in ex-Japan Asia (11.6% per year, 3.6% of it coming in dividend yields) than anywhere else in the world – he projects just 6.4% for Europe, for example. Besides, very few stocks have recovered so far as to be higher today than they were 12 months ago: while a handful have done so, such as China Life, Posco, CNOOC and Sun Hung Kai Properties [NOTE to EDITOR: this is based on August 6 closing prices], even some of the most resilient portfolio stalwarts are still under water over the last 12 months, among them PetroChina, Hutchison Whampoa, Taiwan Semiconductor Manufacturing, Industrial & Commercial Bank of China, China Mobile and Shinhan Financial. This suggests there is still value available.

For many years now, Chinese companies have been seeking a home away from home. Investors can access Chinese companies listed in Hong Kong, Singapore and the United States, making these companies open to investors the world over.

Doing so has a number of advantages for Chinese companies. Most obviously, it provides an additional source of capital, increasing dramatically the potential investor base. But in addition, the fact that these markets are known for their long and respected track record and their regulatory stringency gives a sense of legitimacy to Chinese companies in the eyes of international investors.

Hong Kong is the most obvious and natural home for these companies. They come in two main forms. H-shares are mainland companies who are listed on the Hong Kong Stock Exchange. Red chips are those that are Hong Kong companies but with majority ownership by shareholders within China. According to Hong Kong Stock Exchange, by the end of March there were 150 H shares and 96 red chips. A further category, non-H share mainland private enterprises, constitute a further 224 stocks typically smaller than those in the other categories; between the three groups they represented 37% of the 1266 companies listed on the exchange.

In fact, China’s dominance of the Hong Kong market is bigger still than that, since many H-shares are extremely large, such as China Mobile. In fact, they account for 60% of Hong Kong’s total market cap, and they’re also the most actively traded stocks: 70% of total equity turnover value as of March.

The march to Hong Kong can be clearly seen by comparing the picture to five years earlier. There were 264 mainland companies listed then, accounting for 25% of listed companies and 30% of market cap.

Singapore has built its own niche in attracting Chinese companies, in particular private sector enterprises that are typically smaller than the big state-owned behemoths that have traditionally gravitated to Hong Kong. Some of these private companies feel they would be lost among the state-owned giants in Hong Kong, and consequently hope they can get more investor attention in Singapore. There are over 100 of these S-chips listed on Singapore Exchange.

Still more have opted to launch American depositary receipt listings on the New York Stock Exchange, or to list on Nasdaq or the American Stock Exchange. The Halter USX China Index, which only tracks Chinese companies with a market capitalisation of more than US$50 million with listings on NYSE or Nasdaq, and even then only subject to selection committee approval, tracks 100 stocks on its own. Bigger examples include CNOOC, China Telecom, China Unicom and Sinopec.

How big a leap is it for Chinese companies to meet the disclosure and corporate governance requirements of big exchanges like Hong Kong? “It varies,” says HKEx in detailed written responses to questions from Euromoney. “It is probably easier for a larger mainland enterprise that has senior management and advisers with a lot of Hong Kong market experience to meet the listing requirements than it is for a small Hong Kong-based company with less experienced staff and advisers. Generally, it has probably become easier for mainland enterprises to meet the Hong Kong listing requirements than it was 15 years ago since there are more people with Hong Kong market experience working at mainland enterprises and advising them now than there were in 1994.”

This is almost certainly true: after all, the laws that Chinese enterprises operate under have changed dramatically in that timeframe, as described in an earlier chapter. HKEx notes this too. “Mainland authorities have made great efforts to align mainland law and regulation with international standards,” it says, citing the Basic Standard for Enterprise Internal Control, released in June 2008 and effective from July 1 this year, as an example. (See the earlier chapter for more on this.)

For some companies this means that international compliance is not such a big stretch. Ping An, for example, is listed in Hong Kong, has a level one ADR issue in New York (so not a full listing but a method of reaching institutional investors), and a POWL listing in Japan, requiring it to be compliant with all three sets of regulations. “We believe the regulatory environment is quite similar,” says Jin Shaoliang, head of the group board of directors office at Ping An in Shenzhen. “Of course there are differences between the Hong Kong and Shanghai stock exchanges, but for our company we have clear rules and we follow the most stringent ones no matter what the differences between the exchanges.”

As the world’s private banks struggle to come to terms with their vastly changed status after 12 months of market turmoil, so too are they adapting to changing needs and expectations from their clients. The market for private banking services in Asia, and the models of those banks who seek to provide them, are in a great state of flux.

It starts at the very top. Consider the field of the world’s leading private banking groups. UBS remains intact, but with confidence in the bank and its model shattered and $4.4 billion of write-downs in the third quarter alone; it has committed to paying back $8.3 billion of auction-rate securities held by its private clients, securities it clearly now believes should not have been sold to them in the first place. Credit Suisse wrote down SFr2.4 billion in the same quarter. Merrill Lynch lost so much that it has been taken over by Bank of America. Citi’s losses were so big, in terms of money and confidence, that it had to be bailed out by the US government. Of the bigger names, JP Morgan and HSBC have come out looking best – and one would hardly call them unscathed.

None of these losses of capital and credibility have come from private banking divisions, but the perilous state of the parent organisations cannot help but have had a negative effect on private banking clients’ perceptions. And, though private clients are generally well diversified and long-term in their thinking, the losses from almost every asset class since the end of 2007 won’t have helped. So private banks face a double challenge: not only do they have to find ways to help their clients make, or at least preserve, money in one of the worst financial environments in a century, but they also have to rebuild the level of trust those clients have in the organisations as a whole. Private banking is the ultimate people-business, and trust is never more important than in this field of banking: an institution that loses that trust has lost its business model.

There are several knock-on effects of this change. One is an apparent opportunity for those private banks that do nothing else but manage wealth – names like Julius Baer, Coutts, LGT, Clariden and Pictet. Another is that an even bigger opportunity has been created for those local names in the region with aspirations in private banking: regional players like Singapore’s DBS, or the clutch of Chinese banks who have spent the last few years building dedicated wealth management divisions to serve their local population. So far the perception of the credit crunch from Asia has been that is mainly an affliction of Western investment banks; with no Asian banks (yet) caught up to any great degree, there is a major branding opportunity for them to present themselves as safer institutions more in tune with local requirements.

In fact, the level of competition for private banks has never been higher. In addition to the specialists and the locals, there are also insurance companies, commercial banks and independent financial advisers all competing for market share among the high net worth segment. In some countries, notably Taiwan, wealth management is increasingly seen as the only profitable game in town for commercial banks, as other areas of business have suffered increasingly cramped margins or regulatory change; every bank of note is now active in this area. Elsewhere, China’s Ping An is an example of an insurer that now wants to be a financial services powerhouse, with wealth management a key part of the offering. (Globally, one could point to AIA, Skandia and Axa as part of the same trend.) And in the long run, IFAs may yet be the biggest threat, although their involvement in private client affairs is still fairly nascent in Asia.

There are also considerable changes taking place in product demand. One of the biggest is a rising mistrust of complex structured products. Many private clients around the world had money in collateralised debt obligations or credit-linked notes and have come to regret it. Currency-linked accumulators have also cause problems, and in many cases litigation. The fate of structured products has depended very much on the underlying, and on the mechanisms used to access or replicate it, but many of these products have been plagued by low or non-existent liquidity, meaningless capital protection or hopeless returns.

The banker is smiling but there’s an undercurrent of venom in his voice. “You won’t believe me, but our business has done exceptionally well recently,” he says. “Our revenue from Asia is well up year-on-year.” He lists four different areas of his bank’s franchise which have grown, not flagged, in the last 12 months. And then comes the inevitable postscript. “Of course, not that any of us are going to get paid for it…”

Every conversation with a banker in Asia these days seems to have that undertone. The subtext: we’ve done what we were supposed to do. We’ve worked hard. We’ve brought in business. But because of decisions somebody else made – and generally someone half a world away in New York or London – we’ll get no bonus this year, and we’ll very likely lose our jobs. Worse, we might lose our jobs in order to save the jobs of some of the fools in New York or London who put us in this mess in the first place.

Bankers are disappointed, worn down – and angry. And it just keeps getting worse, often on the whims of people who wouldn’t know an investment bank if it bit them (which, in a manner of speaking, it probably has). Asia-based employees of American banks looked on in horror as the House of Representatives voted down the first bailout package in September, precipitating a market plunge and a further erosion of bankers’ already hopelessly out-of-the-money options. They have swallowed hard as US congressmen have lobbied for banks to be made an example of, something that would lead to redundancies for bankers with families to support not just in New York or Connecticut but in Hong Kong, Singapore, Seoul, Mumbai. And they have shaken their heads as Hank Paulson has redrafted the bailout that did eventually get through the House, going back on the promise to purchase toxic assets – assets mainly bought in the first place by people in Europe and the States, not Asia. Employees here, powerless to do anything about it, and without any kind of voice or leverage over American politics, can only watch.

There’s even the injustice of the markets’ behaviour. As of November 21, Asian markets, at 61% off last year’s highs, have done notably worse than those in the US at 52%, despite the US being at the root of the problems. What happened to decoupling? Remember that magical idea that intra-Asian trade would be sufficiently strong to protect Asia from falls in other markets? And as Asian markets have been hit by the repatriation of foreign capital back to Europe and the US in a supposed flight to quality – is the UK or US growing at 8% a year like China? – the cycle has been getting depressingly worse. Grown men can be found swearing at their screens at the irrationality of credit default swap pricing, or the stubborn refusal of emerging market stocks to bounce.

The reshaping of the world financial services industry is also creating some friction, and perhaps the most potent example of this can be found at Nomura following the acquisition of the Lehman Brothers franchise in Asia.

This was fabulous news for Lehman employees and at the time people were genuinely pleased to hear that the 5,500 European and Asian employees affected would no longer be out of work. One minute they were not only out of a job but not at all sure if they’d even be paid for their last month’s work; the next, they were back in their original positions, on their existing deals.

And there’s the rub. The problem is, being an American investment bank, those existing deals were in many cases considerably better than those the existing Nomura staff were on. Nomura says it’s been shifting its remuneration policy to better represent the meritocratic eat-what-you-kill approaches of the Americans, but it’s a work in progress and, as one banker puts it, “there are plenty of people at Nomura who’ve been bringing in millions of dollars of business and are taking home US$100,000 a year.” The arrival of the Lehman people, earning more than they are, was always going to create friction.

It’s tough to imagine a worse environment for an IPO than the one that faced Sociedade de Jogos de Macau, the casino business owned by Asia’s most legendary gambling tycoon Stanley Ho, when it listed on July 16.

There’s the hellish global market conditions, for a start: the Dow hit its lowest level for two years the night before SJM started trading in Hong Kong, and the Hang Seng has been hovering around similar lows. Very few issuers have braved these markets with an IPO and those who have attempted it have looked either brazen or desperate, and usually both.

But SJM faced a host of localised problems too. On the day of launch, Macau announced a series of restrictions on mainland visitors to Macau, the latest in a number of measures designed to cool the growth of Macau’s gaming industry and, in particular, curb the enthusiasm of mainlanders in helping it grow. The maximum length of time Chinese can stay in Macau en route to other places, and the frequency of their visits, have been cut by China.

The Chinese are the lifeblood of Macau. It’s hoped that the enclave will attract gamers from all over the world – hence the increasing appearance of the Las Vegas model of casinos, combining entertainment and retailing with the gambling tables – but the truth is Chinese patrons are the main prize, and they can gamble nowhere else in their own country. These measures have slammed gaming stocks (an extreme example, Dore Holdings, which specialises in catering for high rollers, has fallen from HK$3.50 to HK$0.22 in a year).

And then there’s Winnie. She’s the sister of Stanley, and the two are not close – in fact, she has filed more than 30 law suits against him and his companies, on a variety of grounds such as the structure of the companies and the nature of the IPO. The most recent of these was a call for judicial review on the eve of the listing, causing a one week delay to the float, after the books on the issue had been closed.

While the courts took a look, SJM and its lead underwriter, Deutsche Bank, elected to allow retail investors to retract their commitments for a full refund – and more than half of them did, even though a court ruling in the meantime held that the IPO was legitimate and could go ahead.

Although retail only accounted for 15% of the deal, this still meant more than 7% of the deal’s total book walking out the door. (Institutions, having made their decisions based on a more thorough analysis of the company story than the more flip-happy retail investors who dominate Hong Kong, generally stayed in.) Since the books were closed and there was no way to go back and reallocate – and the retail book had barely been covered in the first place – Deutsche had to cover the shortfall, although it did so by means of a series of total return swaps to other investors, meaning that today Deutsche has no effective exposure to the underlying stock.

The deal itself, when it finally came, raised half the figure that was being mooted early in the year, settling for $494 million. It has declined in trading since launch.

Some, though, think it a miracle such a deal ever got done at all. “It’s taken three years, 37 court cases, two attempts at getting a judicial review, two prospectuses plus a supplemental, in the shittiest market the world has seen since the 30s, in the casino business,” says one person close to the deal. “It’s had to get through legal and compliance, at least two regulators, and the Hong Kong exchange. That is a Herculean task, an unbelievable banking challenge.”

The other way of looking at it is to wonder what sort of masochistic zeal possessed the issuer to go ahead with such vast challenges in the first place. Ho needed the money: his eldest casinos, like the  alluringly hideous Lisboa, are hopelessly dated against the new wave of Las Vegas Sands-styled resorts, and need to be upgraded. Ho, who had Macau’s gaming industry to himself for decades, now faces five competing licensees (one of them, Melco, run by his son) and by some estimates now has a gaming market share only in the high teens in percentage terms. To stay in the game, so to speak, he clearly has to spend.

The other underlying reason appears to have been a realisation that to have any kind of clarity as a business, it needed to get all the potential law suits and judicial reviews out of the way. It surprised nobody connected with the deal when the call for judicial review came in at the last possible moment before listing; it had always been a question of when, not if. But now, there is a listed entity with its legitimacy confirmed by some of Hong Kong’s highest courts, and that gives it a much more investor-friendly base to build on.

Still, the sight of Greater China’s more colourful tycoons reaching the public markets has always been profoundly entertaining. One has to enjoy a prospectus with a risk section covering not only building delays, labour shortages and business rivalry, but money laundering, cheating, illegal mainland casinos and the risk that people win too much. It even includes this delightful clause: “STDM [the parent] and Dr Ho have the ability to exercise substantial influence or control over us, which allows them to influence or control our business in ways that might not be in the interests of other shareholders.” Ho is in his late 80s now but his kind will be missed when they’re gone.

 http://www.euromoney.com/Article/1990170/Hong-Kong-equities-Ho-gets-SJM-to-the-table.html

It’s all turning to custard in Asia. Stock markets have plunged this year: China down 46.5%, India 35.5%, Hong Kong 23.6%, Singapore 16.9% – all of it much worse than the USA (the S&P 500 is down 13.7%) despite the fact the current problems stem chiefly from the US economy and American investment banks.

There may still be worse to come. But when the dust settles, there’s no question there are going to be some bargains to buy in Asia. “Asia has absolutely not been immune” to the problems in global markets, says Peter Sartori, founder of Treasury Asia Asset Management in Sydney. “But the positive spin is that a stack of stocks across the region really look dirt cheap.”

There are many fund managers who offer Asia managed funds in Australia: apart from Treasury Asia, others include products from Challenger, BT, Platinum, Aberdeen, Invesco, Fidelity, Perennial and Schroders, among others.

Smart Money asked several portfolio managers to identify stocks they think look well positioned for the long run, even if (or because) they’ve taken a hammering recently. We also looked at other portfolios to build up a list of five stocks that Asia specialists are holding in hope.

CHINA CONSTRUCTION BANK

Country: China

Listing: Hong Kong

Price/earnings ratio: 12 times 2008 earnings

This is the pick of Matthew Ingram, equity analyst with Perennial Investment Partners. Even assuming you’re only looking at Chinese stocks that are listed in Hong Kong (known as H-shares), there are still a number of Chinese banks to choose from; why CCB?

Partly because it’s in a safe area. CCB is the largest mortgage lender in China, and is also an active corporate lender. “GDP growth in China of 8 to 9% is expected to continue to drive strong lending growth in both the retail and corporate sectors,” says Ingram. “Despite rising interest rates, the quality of CCB’s loan book has improved markedly in recent years due to strong risk management and limited exposure to the more risky lending segments.” CCB is enjoying strong fee growth, driven by cross-selling mutual funds and other products to its mortgage customer base, and this is likely to increase as demand grows for capital protected products.

It’s true that CCB had some sub-prime exposure, but it wrote off the bulk of this exposure in 2007. “CCB has the fastest growing earnings of any of the Hong Kong-listed government-owned Chinese banks,” says Ingram. “Earnings per share growth is expected to be over 40% this year.”

SAMSUNG ELECTRONICS

Country: Korea

Listing: Korea, USA (ADR issue)

Price/earnings ratio: Approx 12 times 2008 earnings

Samsung Electronics is arguably the staple of Asian portfolios. If we’d written this article five years ago, Samsung would have been in it; if we write it in another five, it will probably still be there. It is, for example, the largest holding of Aberdeen Asset Management in its Asia fund; and when last disclosed on March 31, it was a top three holding in Asia products from BT and Platinum.

Why? “There are many legs in the group,” explains Adrian Lim, portfolio manager at Aberdeen Asset Management in Singapore. “There’s simple things like white goods, the stuff you have in the kitchen like fridges and washing machines; on the other hand it has TFT-LCDs [a type of computer chip used in televisions, particularly the latest flat-screen models] and other chips.” It has demonstrated over the last 10 to 15 years that it can squeeze out market share quite gradually: they’ve done a very good job of building a brand, understanding the distribution channels locally and abroad, and steadily carving out a segment for itself.” Samsung is also unusual in Korean terms in being union free: important in a country which has arguably the strongest industrial unions in the world, and certainly among the most volatile.

Incidentally, the other mainstay of Asian portfolios, Taiwan Semiconductor Manufacturing Co (TMSC), is absent from this list, mainly because of the bleak outlook for the end of the electronics market it operates in. But many fund managers have held it for years and expect to do so for much longer, attracted by the quality of the management, the market-leading technological ability and – increasingly – a hope that Taiwan might lose its laggard status among Asian stock markets thanks to a change of government that has brought a more pro-China leader to the helm. Invesco, for example, increased the Taiwan weighting in its ex-Japan Asia fund in the first quarter. “It was generally believed that a KMT win [the new party] would be beneficial for both the Taiwan economy and equity market, as the KMT party pledged to boost the island’s economy by building closer ties with China,” said Invesco in its most recent quarterly report, explaining its decision. Strangely, though, Taiwan’s market did shoot up almost 20% after the election but has since lost it all again.

Hutchison Whampoa

Country: Hong Kong (active globally)

Listing: Hong Kong

Price/earnings: 11

There was a time when Hutch was a real market darling. One of the two companies (the other being Cheung Kong) of Li Ka-Shing – the billionaire’s billionaire, and arguably Asia’s most famous entrepreneurs – for years it seemed it could never put a foot wrong, whether in ports, property, retail, energy or telecoms. And then it got into 3G.

“That company has been a complete dog since Li Ka-Shing bought into 3G in Europe,” says Peter Sartori at Treasury Asia Asset Management. “It has underperformed significantly since then: 3G has been a disaster.” But Sartori has recently bought in, and he’s not alone: it is among the biggest holdings of the Platinum Asia Fund. Why? “Firstly, it’s well and truly in the price. It’s now at a big discount to net asset value. And finally, after all these years, there’s a little bit of light at the end of the tunnel [for 3G]; it will be cash flow positive in the next 12 months and the rest of the businesses are in pretty good shape.”

Not everyone agrees, though: Macquarie’s Gary Pinge is neutral on the stock. He believes many fund managers are looking at Hutchison as a defensive investment, but doesn’t think they should, particularly since 30% of Hutch’s net asset value is derived from Europe which is where the US-led slowdown may go next. He still sees challenges to the 3G business with regulatory and competitive risks.

China Travel

Country: China

Listing: Hong Kong

Price/earnings:  13 times 2008 earnings

While Sartori finds Hutch interesting, he is more excited about a much smaller stock, China Travel, which covers travel and tourism in China from tour operations to hotels and theme parks. It has been absolutely smashed in the markets – it was trading at HK$2.10 last week compared to a 52-week high of HK$6.38. But that makes it well worth a look, Sartori believes. “Because the share price has come down so far, the valuations look attractive for the first time in a long time.”

The stock is geared to macroeconomic trends like growing Chinese wealth and disposable income, a greater willingness to travel both domestically and overseas, and the increasing interest from foreigners in spending time in China. “The whole tourism story in Asia, and particularly in China, is a secular growth story,” says Sartori. “We think it could grow at a minimum 20% a year for the next five years plus.

“Sentiment towards the sector and industry is very poor at the moment , because of the earthquakes and with the Olympics now on the nose, so we think it’s an opportunity to buy into a long term secular story.”

OLAM INTERNATIONAL

Country: Singapore

Listing: Singapore

P/E Ratio: 30.7 times (current).

When Macquarie Research published its vast Asia Equity Guide in March, one of its very top recommendations for the whole region was Olam International, a Singapore-based company that has built itself into every area of the supply chain for agricultural products and food ingredients from the farm gate to the end consumer. In early July, with the share price at S$2.30, Macquarie continued to hold an outperform recommendation on the stock, with a price target of S$3.82.

It’s this ability to be in every bit of the process that tends to appeal to analysts and fund managers, because it removes exposure to things beyond the company’s own control. It is also, arguably, a beneficiary of rising food inflation – the subject on everyone’s mind in Asia at the moment along with oil. Despite the problems other companies have had with slowing earnings, Olam’s third quarter results in May boasted a net profit up 38% year on year, with broad-based growth and improved gearing ratios (net debt to equity at 2.7 times). Recent rights issues have added more than S$700 million to the balance sheet, increasing speculation that it will take advantage of low valuations to acquire.

In July, it announced a joint venture with another stock much beloved of Asian analysts at the moment – Wilmar, the palm oil group. The venture brings Olam into a new commodity, stevia, used in the creation of sweeteners.

In May, the Monetary Authority of Singapore made a low-key but significant announcement. Speaking to a room full of Islamic finance specialists at a conference in Amman, Jordan, MAS managing director Heng Swee Keat explained that Singapore would develop a program of sovereign-rated sukuk issues.

It might not sound much in the telling, but that’s a big deal. Sukuks are the Islamic equivalent of bonds, and they represent a growing global market, already over US$100 billion in size, with issuers from sovereigns down to corporates all over Malaysia and the Middle East. But despite lots of conjecture, they’ve never yet been issued by a non-Islamic sovereign. Singapore’s announcement is, one could argue, the tipping point where the conventional world’s capital markets not only acknowledge the importance of Islamic finance, but join in.

In fact, the non-Islamic world has been watching developments in Islamic finance closely for some time. For a start, numerous multinationals headquartered outside Malaysia or the Middle East have built big businesses in this area, most obviously banks like HSBC, Citi, UBS, Deutsche and BNP Paribas. But additionally, world centres of finance – both the established order and those aspiring to join it – have increasingly come to realise that Islamic finance is something they ought to accommodate and, if possible, become a hub for.

London has been an early mover in this area, streamlining tax practice and changing regulations to become a better environment for Islamic finance to take off. For years people have been talking about the UK issuing a sukuk in its own name, although today’s credit environment has delayed that venture for the time being.

In Asia, Islamic finance has become yet another field of battle between Hong Kong and Singapore. The Jordan conference, hosted by the Islamic Financial Services Board, featured senior delegations from both states. They took it seriously: Singapore’s team featured Heng himself; Vince Cook, chief executive of the Islamic Bank of Asia, the Singapore-based Islamic bank part owned by DBS; Lawrence Wong, who heads listings for Singapore Exchange; Gerard Lee, chief executive of Fullerton Fund Management, a manager which has greater significance for being a wholly-owned subsidiary of Temasek; and representatives of Singapore’s tourism agencies. Hong Kong pitched up with Eddie Yue, the deputy chief executive of the Hong Kong Monetary Authority; Martin Wheatley, head of the Securities and Futures Commission; Lawrence Fok, chief operating officer of Hong Kong Exchanges and Clearing; and James Lau, CEO of the Hong Kong Mortgage Corporation, among others. One imagines Jordan has rarely attracted such a gathering of the great and the good of Asian finance.

In many ways Singapore has made the most headway so far. Seeing the volume of trade with the Middle East – it has doubled, to US$37 billion, in the last four years – Singapore decided some time ago that it needed an Islamic finance industry to help cater for increasing demand for Shariah compliant financing. The idea is to leverage off Singapore’s strengths – wealth management, trade finance, capital markets – and make sure that Shariah products are among the suite being offered.

On the regulatory side, the MAS built Islamic finance into the existing regulatory and supervisory framework, and reviewed its regulations and tax positions to ensure a level playing field between conventional and Islamic approaches. For example in 2005 additional stamp duties incurred by qualifying Islamic financing arrangements for immovable property were remitted; and banks were permitted to offer Murabaha financing in Singapore. The following year income tax and GST treatments for Shariah compliant financing arrangements, and also for sukuks, were clarified so that those structures would not be disadvantaged compared to their conventional counterparts. Since then Murabaha investments have been permitted, and retail investors in them have been given the same regulatory protection under Singapore’s Banking Act as any conventional depositors. Most recently, in the February budget, a 5% concessionary tax rate was announced on income derived from qualifying Shariah compliant financial activities, including lending, fund management, insurance and reinsurance.

One of the biggest steps came with the formation of Islamic Bank of Asia in Singapore in June 2007. The bank focuses on Shariah-compliant commercial banking, corporate finance, capital market and private banking services and logged over half a billion dollars of deals, including 20 cross-border capital transactions, in its first year of business.

IB Asia is not an entirely Singaporean entity: DBS is and will remain its majority shareholder, but 22 different Middle Eastern investors from prominent families and industrial groups in the Gulf were represented in the company at its launch. Its chairman is Abdulla Hasan Said, who is also economics affairs advisor to the prime minister of Bahrain; the bank has since opened a representative office in the Bahrain Financial Harbour complex.

“A couple of years ago a combination of things came into being,” says Vince Cook, IB Asia’s CEO. (Cook previously ran capital markets and corporate banking for Qatar National Bank, and before that was Barclays Capital’s MD in the Gulf.) “One was an initiative from Bahrain looking to build a joint venture approach between what they saw as an increasing Middle Eastern influence in Asia, making it easier for entities to bring equities, capital and a degree of governance structure back into the Middle East. This happened to coincide with Singapore’s similar wish to build closer ties from the same people.” The Islamic Bank of Asia grew out of those discussions. “The idea is to be at the forefront of these new market-based ideas and introduce opportunities in Asia to our Middle East investors,” he says. “And at the same time we’ve had DBS realising that for them to continue to thrive as a regional bank, they needed to build experience and competence in the Middle East. It’s a very convenient coming together of minds.”

It’s against this backdrop that the new sukuk announcement comes. Sovereign sukuks are seen as both practically and symbolically important. They create a benchmark for other issues to price off, thus developing a curve for issuers and giving predictability and comfort to investors. But they also demonstrate loud and clear that the state itself believes in this style of issuance. For example, Indonesia’s relatively stagnant development of Islamic finance is sometimes attributed in part to its lack of a sovereign sukuk issue; the clarification of laws earlier this year to allow one to be launched, and the suggestion that one will follow this year, have revived interest in the sector in Indonesia dramatically.

Singapore’s approach is an interesting one. Unlike most sukuk programs, this one will work on reverse inquiry: the MAS will issue according to the needs of financial institutions in Singapore conducting Islamic finance. Also, initially, the securities will be priced against the liquid Singapore government securities market, to provide a transparent price discovery mechanism. The idea is that as the Singapore dollar sukuk market deepens, it will then develop its own pricing benchmarks.

Why reverse inquiry? “We decided on this approach after consultations with financial institutions in Singapore,” Heng tells Asiamoney. “The reverse inquiry approach allows us to be more responsive to the needs of institutions. It’s a more flexible arrangement that just issuing on a regular basis. It’s very much market driven. As the need for instruments grows, demand will increase and we can respond more readily to changes.”

Singapore is already home to a number some sukuks and other Islamic securities. In April 2007 MBB Sukuk Inc, a special purpose company established by Maybank, raised $300 million in a corporate bond with Aseambankers, HSBC and UBS as bookrunners. A year earlier, the exchange teamed up with the FTSE Group and Yasaar Research, a Shariah consultancy, to launch the FTSE SGX Asia Shariah 100 Index, made up of 100 compliant stocks from Japan, Singapore, Taiwan, Korea and Hong Kong. The idea was that this index could be used as a basis for exchange traded funds and over the counter trading instruments.

Lawrence Wong at Singapore Exchange tells Asiamoney more are likely to come. “Things like the business trusts [an investment vehicle similar to a REIT, but used for infrastructure or transportation assets] lend themselves to Islamic product,” he says. “We’re working on a Shariah-compliant product in China.” Heng says he will “be glad to see the first Shariah ETF launched in Singapore in the near future.” There are also several Shariah mutual funds offered in Singapore.

Outside of the big public institutions, though, does anyone care? Singapore does have a significant Muslim population in proportional terms (13.6% of its citizens and permanent residents are Malay), but it’s still less than one million people. If Islamic finance is to fly in Singapore, it will be by targeting Middle Eastern institutional flows. Lee at Fullerton admits “at this point of time Fullerton is not known as a provider of Islamic finance products,” although it has established a partnership with EFG Hermes, probably the most powerful local investment bank in the Middle East. “But we do forsee that there will be demand from this part of the world [the Middle East] to invest in Asian capital markets,” he says. “And to the extent that there is money emanating from the Islamic world there will definitely be demand for Islamic compliant products. It would be music to my ears to talk to you in a year or two about such deals.”

If Singapore, with only a slice of its population Muslim, seems an odd place to base an Islamic finance business, Hong Kong looks stranger still. Eddie Yue acknowledges the fact. “We are aware Hong Kong faces a lot of challenges in building Islamic finance,” he says. “The Islamic community in Hong Kong is not big. But we are confident that development of Shariah compliant financial markets can take off even in an environment in which the Islamic community is relatively small.”

In Yue’s view, Hong Kong’s practical and logistical assets will outweigh its apparent lack of relevance to Shariah financial services. “Hong Kong’s relatively small population has never been a factor in undermining performance in conventional capital markets,” he says. “We are not positioning ourselves as a market for supply and demand of Islamic products from a domestic angle. Instead, our objective is to make Hong Kong a platform for international intermediation activities for Islamic finance. What we can offer are location, a highly developed financial services industry, liquid capital market, robust and efficient financial infrastructure and a business friendly operating environment.”

Hong Kong has succeeded in attracting some interesting deals. Much the most significant came in March, courtesy of Khazanah Nasional, the investment arm of the Malaysian government. Using a vehicle called Paka Capital, Khazanah raised US$647 million through a US$550 million exchangeable sukuk and a US$97 million stock placement; the sukuk is exchangeable into ordinary shares of Parkson Retail Group, a Chinese property group listed in Hong Kong. The sukuk itself is also listed on the Stock Exchange of Hong Kong, as well as the Labuan International Financial Exchange.

The real significance of this deal, apart from Hong Kong hosting its listing, was that it ushered China into the realm of Islamic finance. It was marketed as giving Islamic investors exposure to China’s growth story through a sukuk for the first time.

China has long been talked about as a market for Islamic finance. People tend to bring up China’s large Muslim population, in provinces such as Xinjiang in the country’s far west, but perhaps the more important point is the wealth of Middle Eastern capital that wants to get exposure to China in a way they are sure complies with Shariah principles.

Another sign of this growing interest came in May when Dow Jones Indexes launched a new product, the Dow Jones Islamic Market China Offshore Hong Kong Index. This represents the performance of companies that have been screened for Shariah compliance, whose primary operations are in mainland China, but who trade in Hong Kong (so H-shares and red chips). Like Singapore’s index devised with FTSE two years earlier, it is designed to be a reference point for other investment products, such as mutual funds and ETFs. Incidentally, an Islamic China index doesn’t look that much different to a mainstream China index: since there’s nothing unIslamic about telecommunications or oil, the top five components are China Mobile, China Unicom, CITIC Pacific, CNOOC and PetroChina.

This continued engagement of China with the Islamic world is really Hong Kong’s ticket to launch an Islamic finance industry, and it knows it. “We have the versatility and talent to be a conduit to facilitate capital flows between the Middle East and China,” says Yue.

Hong Kong, though, hasn’t yet got as far as Singapore in streamlining the tax and regulation. “We are conscious greater effort has to be made to establish a level playing field in the conduct of Islamic businesses versus conventional,” Yue says. He says the Hong Kong government is conducting a review of tax laws to make sure Islamic finance is not disadvantaged. It’s also hitting the road trying to build relationships with the established centres of Islamic finance: Yue arrived in Jordan fresh from negotiating a memorandum of understanding with Dubai International Financial Centre Authority to foster co-operation between the two jurisdictions on Islamic finance. Wheatley says Hong Kong is “in the relatively early stages of trying to come to grips with all the elements of Islamic finance and the legislation that is necessary,” but adds: “I don’t think there is any change we would need to make in securities regulation. It’s complex tax issues rather than broader legislative issues.”

Markets like Hong Kong may also have a role to play bringing liquidity to the sukuk markets, which up to now have enjoyed very little secondary market trading. “I think Hong Kong definitely has a very advantageous position to provide genuine liquidity,” says Anita Fung, treasurer and head of global markets for Asia Pacific at HSBC. “We have the infrastructure, the payments and settlement system, active participants, investors, issuers, investors, intermediaries… if you make $200 million you just push a button and you can transfer it. It would provide liquidity to Islamic products.”

From the perspective of Islamic countries themselves, the participation of markets like Hong Kong and Singapore is welcome. “The most countries we bring into this, the better service we give to customers and the better competition we get,” says Professor Rifaat  Ahmed Abdel Karim, secretary-general of the IFSB. And he notes a shifting balance. “If we look at the members of the IFSB, I see we have 11 from Asia. Asia is becoming very forceful on this.” And if even its non-Muslim countries start becoming big issuers of Islamic product, it’s going to be more forceful still.