One of the many tests 2012 will administer is the resilience of Asian countries to capital outflows. There’s no question Asian countries are in better shape to deal with capital flight now than they were in the Asian financial crisis, or even 2008; but they might need to be a whole lot better.

Asia’s economies represent strong and sustainable GDP growth, low levels of sovereign debt, high foreign currency reserves and in many cases stout budget surpluses. That’s all well and good, but the fact remains that capital continues to flee these markets when things get bad in the US and Europe. With every passing period of global uncertainty, the rallying cry goes up that it’s different this time, and that Asia is decoupled; it’s never, remotely, different this time, and it won’t be next time either.

Asian stock market investors see this as a crushing injustice, but there it is. Across the problem nations in 2011 the Dow gained 5.6%, the S&P 500 was flat, the FTSE 100 lost 5.6% and Germany’s DAX lost 14.7%. Yet emerging markets were down 20%, as was Hong Kong’s Hang Seng index; of the mighty Asian BRICs, the supposed engines of global growth, China lost 18.2% in US dollar terms – worse in RMB – and India a dreadful 37.1%.

So long as Asian markets remain risk-on bets to global portfolio managers, this is going to keep happening, both in equities and debt, and it’s more important than ever for the Asian nations with free market access to be ready for it. That’s because foreigners have built up unprecedented positions in Asian government debt in particular: by August, foreigners accounted for 36% of all Indonesian government debt in rupiah, for example, and there are very high levels of foreign engagement in other markets such as Malaysia and Thailand. The fear has long been: what if it all goes away again? And, if the European situation turns for the worse, there’s every chance that will happen.

The question then is how sturdy Asian nations are to deal with it. We had something of a test case in September, when a period of dollar strength related to fears about Greece led to a decline in most Asian currencies and a correction in bond yields. Capital started to leave. In Indonesia, the most closely watched, the foreign ownership level fell from 36% to under 30% in a matter of weeks – but then it stopped, and has since stabilised at around 31%. The long-dated money in particular stayed put. There are similar patterns in other markets too.

One of the big differences is the financial strength of the countries themselves. In 2011 Indonesia topped US$100 billion in foreign exchange reserves for the first time; that hardly holds comparison with China’s multi-trillion dollar backing, but it’s more than enough to deal with a bit of volatility. Indonesia spent about $10 billion of its reserves to defend its currency, and brought to bear an elaborate set of initiatives to keep support in government bonds; not only did it succeed in stabilising the markets, it also sent an important message that it was going to back its assets. The absence of such a message in 1997-8 saw a sevenfold collapse of the currency in a matter of weeks; those days, it appears, are gone.

Elsewhere, Malaysia’s central bank argues that the biggest difference between the Asian crisis and today is the maturity of the financial system, from the banks and asset managers to the local capital markets themselves. This means the system is much more able to intermediate flows, whether in or out, without broader damage to the marketplace or a sense of panic. Similar arguments are made, with varying degrees of plausibility, in Thailand and the Philippines.

But as with everywhere else in the world, it’s all a question of degree. Asian nations today can handle volatility; they can handle shocks, even distant crises. But something as systemically vast as the collapse of the euro? Nobody’s safe from that, no matter how big their population, how vast their stocks of coal, and how muscular their forex reserves.

Asia is widely accepted as the most enticing market for asset management growth in the coming decade and beyond. It’s little surprise, then, that the region also hosts a vibrant market for M&A transactions.

This can take a number of forms. One is international businesses seeking to acquire local enterprises, or – where regulation requires – to form joint ventures with them, as is most commonly the case in China. Alternatively, local businesses often acquire one another, or conduct mergers of equals, in order to achieve scale – something that is prominent among the Australian industry funds landscape, for example. Drivers of M&A can include regulatory change and the framework of the institutional investment industry that these fund managers seek to support.

China and Australia dominate M&A in asset management, and China generates by far the most attention.

There are several reasons for this. Firstly, China is obviously the region’s main prize, not so much for the market it represents today but what it is likely to turn into tomorrow. Even after considerable slippage since 2007, the public mutual fund industry in China had RMB2.027 trillion under management at the end of the third quarter, and in brighter economic circumstances is likely to soar. It’s still very clearly an important industry to have a foothold in. Retail mutual funds represent only about 3% of retail investor portfolios, according to research group Z-Ben.

Plenty, though, have already done more than secure footholds. When Essence FMC was established in November, it became the 69^th fund management company active in China. For anyone new seeking to get involved, they must wait for a new licence, and, although six have been established this year (only one of them a JV), it is very hard to know how many more will be licensed and at what pace. A rule of thumb is to wait three years for a new business to be licensed and launched. For foreigners, it can make more sense to find an existing joint venture (there are 36 active) with a foreign partner who wants to exit.

On top of that, regulatory change has driven M&A activity. No domestic fund management company can be 100% owned by one company (although a local company can hold more than 49% in a Sino-foreign JV, in some cases going as high as 80%). Instead, no shareholder can own more than 49% of a domestic fund manager. Consequently many of the bigger local groups have had to sell stakes – either domestically or internationally – and in some cases have opted to change their structure to a JV.

These three trends (potential scale, need to enter an established industry, and regulatory change) are what has made China such fertile ground for M&A.

Perhaps the most striking in 2011 involved China AMC, the biggest local asset manager with almost 10% of all industry assets under management, owned by CITIC Securities. Being the biggest made the China AMC stake difficult to sell, and for some time CITIC found itself in violation of local law because of the size of its shareholding. Eventually, China AMC was banned from new launches until it redressed the problem.

So in 2011, it created five tranches for auction. First, 10% went to Shandong Rural Economy Development and Investment Company, for RMB1.6 billion, and then an 11% stake to South Industry Asset Management Company for RMB1.76 billion. But the most significant sale was the third, in August, since it went to Power Corp, a Canadian financial services firm, for CAD276 million (which at the time was RMB1.78 billion) for a 10% stake. This sale to a foreign house has turned China AMC into another joint venture.

While China AMC, as the biggest, is the most striking example of Chinese M&A, there have been many others besides. Bohai International Trust bought an 18% stake in Orient FMC in 2010, while ICBC announced that Cosco – a shareholder in the ICBC Credit Suisse joint venture – would sell its 20% stake to the bank, with Credit Suisse selling 5 of its 25% stake. The 20% piece cost RMB258.2 million. Southwest Securities, based in Chongqing, bought a 20% stake in Yinhua, another fund management company. Analysts expect other bank-backed JVs, such as CCB Principal, Bank of Communications Schroders and ABC-CA, to see the banks try to up their holdings in future.

The following charts look at the composition of the joint venture businesses in Chinese asset management today.

[Contact Cerulli to see version with charts]

In Australia, one of the main drivers is the pension fund (or superannuation) industry, and in particular industry funds. In an open and highly competitive market for funds, there is a clear need for scale. In early 2011, five separate industry fund mergers were underway simultaneously: First State Super with Health Super, AustralianSuper with Westscheme, LGSuper with City Super, Equip Super with Vision Super, and Non-Government Schools Superannuation Fund with Cue Super. There have been others besides.

While the quest for scale is understandable, it may not always be in the best interests of members. Russell Investments launched a paper in August saying that the cost efficiencies and economies of scale from mergers are not necessarily serving the members of the fund. Issues raised by the paper include ensuring member equity in addressing differing exposure to liquid and illiquid assets between merging funds. Handling varying member balances and managing transparency and accountability principles also raise difficulties. Members are often not given a detailed analysis of expected costs, so can’t then hold their trustees accountable.

Outside these two markets, M&A volumes are lower, but there are several interesting trends underway. India deserves close scrutiny, partly because its own asset management industry has similar demographic potential to China. Here, acquirers of stakes in local businesses, or creators of new joint ventures, have been a widespread group in recent years, from homegrown ambitious businesses like Religare to international heavyweights like Robeco, Nomura, T Rowe Price and most recently Goldman Sachs.

The chart below demonstrates how many of the leaders in international asset management are well represented in ventures of various forms in India today. As with China, a number of different approaches are possible. Some entities carry the name joint venture but are in fact 100% foreign owned, such as those established by Morgan Stanley, Franklin Templeton, ING, HSBC, BNP Paribas, Fidelity and JP Morgan, though the last of those was set up in 2006. Since then, full foreign ownership has also been possible, but they are now termed private sector entities: this approach describes the ventures owned by AIG, Mirae, Daiwa and Goldman Sachs, among others. Still others are true JVs in which the foreign partner ties up with a local, sometimes in a majority stake, sometimes a minority; this is the approach for BlackRock (tied with former Merrill Lynch partner DSP), Sun Life (with Birla), Standard Life (with HDFC), Prudential (with ICICI), and Nomura. Finally groups like T Rowe Price – which holds 26% of a venture called UTI Asset Management – and Robeco and Pioneer (with stakes alongside Canara and Bank of Baroda respectively) have taken a model termed bank-sponsored.

As with China, movements in stakes in these businesses can often be driven by events outside of India. So, for example, Daiwa Asset Management is there not because Daiwa bought in but because it acquired fellow Korean Shinsei Asset Management in 2010. Others change hands because of mergers elsewhere; just as BNP found itself with stakes in three Chinese JVs and was obliged to sell out of two of them following its various financial crisis-era mergers and acquisitions, in India it ended up with two and had to sell its stake in Sundaram BNP Paribas in October 2010.

There is not scope in this article to go into Taiwan and Korea in detail, but both are also important markets for M&A, as the charts below demonstrate.

That’s the backdrop. But should a foreign party acquire a business, or a stake in one, rather than building organically?

There are clear arguments on both sides. It can be extremely hard to launch a greenfield business in many emerging markets. The process of licensing can be opaque and time-consuming, and, once achieved, it is very difficult to start from scratch in an intensely competitive field – none more so than China, but also in established markets like Korea and Taiwan. That’s a clear argument for buying into a business or JV: access to existing client base, infrastructure, and local knowledge, with the opportunity to revamp or improve an existing product range, rather than having to launch and market a whole new one.

On the negative side, it can be frustrating to be the minority partner in a joint venture – and in several markets, China among them, that’s as good as it’s going to get in the near term. There is no opportunity to exercise leadership and to drive the direction of a business. That’s not so much of a problem if the local partner has the right strategy. But no venture ever takes place without some internal friction. Additionally, in competitive markets like China, the costs of acquisition are getting steadily higher, as the China AMC sales show; in a slowing market, no matter how much potential it has, that’s a difficult situation in which to thrive.

Confidence is running high that Asia’s rapid growth will protect the region from the worst of the turmoil in Europe. Yet global bank exposure to Asia, at US$2.3trn at the end of June, means the threat of capital flight is ever-present. Is Asia guilty of complacency?

The theme of Asian decoupling is as old as the hills. For years, economists and analysts have argued over whether or not Asia is a sufficiently powerful and independent economic bloc to be able to come through the macro shocks relatively unscathed. It is always hoped for, but never quite achieved. With Europe in crisis and the US flirting with recession and unresolved debt, the question is being asked again.

The simple truth is that, no matter how much more robust Asian economies look than those in the west, regardless of how much better their fiscal positions and demographics, capital continues to fly from these places whenever there are global (or western) worries. Illogical though it may be, Asian capital markets remain a risk-on bet. “We saw trickles in September, but the risk is we may start to see serious net capital outflows from Asia, which can be very destabilising,” said Rob Subbaraman, Nomura’s chief Asia economist.

A look at capital flows over the last five years is illuminating. According to Subbaraman, in the 10 quarters before the global financial crisis from the first quarter of 2006 to the second of 2008, Asia ex-Japan attracted US$265bn of net capital inflows – a broad measure, including net portfolio debt and equity, FDI, international bank lending and balance of payments. In the following two quarters, in the eye of the credit crisis, US$118bn departed. “A reasonable chunk left,” he said. “However, what’s interesting is that in the next 10 quarters, from the first quarter of 2009 to the second quarter of 2011, net capital inflows totalled US$684bn.”

That vast increase has been down to Asia’s better fundamentals relative to the rest of the world, the higher interest rates available, and the easing policies in advanced economies that pushed capital towards Asia. Still, should we expect, as happened last time, for half of it to leave again when things turn sour? “There is a lot of room for foreign capital to leave Asia if we start to move towards anything starting to resemble the global financial crisis,” Subbaraman said.

This is a more alarming prospect in some markets than others. Indonesia, in particular, has been watching closely for signs of capital flight, since, at its peak, foreigners accounted for 35% of all rupiah government bonds, with a similarly high representation in the stock market. “We have the capacity to withstand reversals,” said Rahmat Waluyanto, in the debt management office of Indonesia’s Ministry of Finance. “We have relatively large forex reserves, a widening domestic investor base, and a bond stabilisation framework.”

However, money is leaving. The rupiah, having gained more than 5% against the US dollar in the first eight months of 2011, has slid by more than 6% since the start of September as overseas investors sold stocks and bonds. Foreign ownership of government bonds fell 1.1% in a single week in late November. Indonesia is a market darling: a domestic consumption story, a model new democracy, a fiscally sound nation and one capable of borrowing US$1bn of seven-year money at just 4% in November at a time when Italy was paying almost 7% on its own debt. A move up to investment-grade status within the next six months is considered a formality. However, none of that is enough to stop foreign capital leaving when there are difficulties in Europe and the US.

“The Global Financial Crisis Part II is spreading to Asia a little faster than we had anticipated,” said John Woods, Citi Private Bank’s chief investment officer for Asia Pacific. Speaking on November 22, he noted that every currency and every equity market in Asia had declined month to date, with India, Australia, Korea and Taiwan hardest hit.

According to Woods, this is partly a function of weak levels of risk appetite, and partly capital outflows as continental European banks reduce their cross-border lending to shore up their capital positions at home. BIS data says that, of Asia’s US$2.3trn loan exposure to global banks, 21% of it is extended by eurozone financial institutions. “Fears are growing that as French, Italian and Spanish banks exit the region, a credit crunch could escalate in scale similar to the global financial crisis of 2008–09,” he says.

Lessons learned

Leaving aside capital flows, it is inevitable that growth will slow as a consequence of problems in the US and eurozone, but, from this economic viewpoint, concerns are not so high. “These are challenging times, but, in many emerging economies, such as Malaysia, we did our reforms and strengthened our economy and our financial system [after the Asian financial crisis] and there is a tremendous payoff now,” said Dr Zeti Akhtar Aziz, Governor of Bank Negara Malaysia. “These measures placed us with a greater degree of resilience in coping with not only the economic implications, but the surges and reversals of capital flows, which are better intermediated into our financial system.”

She added: “With all the developments in Europe, the impact is in volatile financial markets, which impacts our money and foreign exchange markets. However, aside from that, the domestic economy is particularly strong.”

Many of her Asian peers share similar views, as do some economists. “Asia ex-Japan is becoming more resilient to economic conditions in the major advanced economies,” said Subbaraman. “One big reason is China: not only do we have the world’s second biggest economy in our backyard, but nearly all its growth is domestic-led. And several indicators suggest that more and more of Asia’s exports to China are staying in China, rather than being assembled and shipped out.”

This is a crucial point in the decoupling argument: economists have argued for years that growing intra-Asian trade has bolstered Asia’s independence from macro shocks, while just as many have countered that most of that intra-Asian trade comes from goods to be assembled in China and then ultimately exported to the West, undermining that independence.

There is a “tipping point” though, for Subbaraman, at which point Asia does start to get hit by slowing growth or recessions in the West. “When exports are cooling moderately like they are now, firms just accept that. But if the downturn really starts to deepen, firms have to face more difficult decisions on cutting back on jobs, expansion plans and capex, which has multiplier effects on domestic demand.” Then, there’s the effect of negative wealth and falling asset prices from equity to property on confidence.

For central banks in Asia, there are considerable challenges. “It’s really tough to be an Asian central banker,” said Subbaraman. “I think they should get paid more. They’re stuck between a rock and a hard place at the moment.” There are obvious threats to growth, and already some central banks, with Australia and Indonesia at the forefront, are cutting rates, with many others expected to follow, such as Malaysia and Korea. “But, on the other hand, you can see a number of other reasons not to ease right now,” said Subbaraman. Although headline inflation is easing, core inflation is still quite high in most countries; loan growth in many Asian nations is still at double digits; and it’s still possible that capital flows could come back in very quickly. “It could prove to be a mistake if Asian central banks are aggressively pre-emptive right now. It might be better to wait.”

Woods notes that the market is pricing in interest rate cuts across the region, but notes that although inflation is peaking, “price pressures are proving surprisingly stubborn.” He added: “Sticky inflation complicates Asia’s growth-versus-inflation trade off.”

All eyes are on China, which more and more people (Woods included) think is ready to move towards easing monetary policy. “For all sorts of reasons, China rightly fears a global recession,” Woods said. “Still highly dependent on external demand, China has been attempting to transition towards higher private consumption, but reforming your economy in the teeth of slumping global demand is challenging to say the least.”

There’s just one question that investment bankers in Asia want to ask the region’s top headhunters. Just how bad is the next bonus round going to be?

“The next six month outlook is grim,” says one of the region’s leading banking headhunters. “Given the problems banks are going through, this bonus round is going to be very ugly. There will be cuts between now and the end of the year.”

A second opinion? “I suspect total comp will be cut in half for the good people, and for a lot of others there are going to be zero bonuses,” says another.

A third? “There is a big reduction in compensation,” says another of the region’s biggest movers and shakers. “But the bigger trend is that people have finally realised this wasn’t just a short term aberration in 08 and09. This is the new reality: it keeps coming down.”

Even the handful of top headhunters who are prepared to put their names to bearish quotes aren’t much more positive. “We are seeing higher bases, and I don’t know what’s going to happen on bonuses, but I can assure you they will not be going up,” says John Wright, founder of Global Sage. “More of it will be in stock and deferred. I think everyone needs to adjust their expectations because one thing is certain, compensation in the traditional banks needs to be on a long downward trend as the world works through this drawn out balance-sheet recession.” And Christian Brun, one of the founders of Wellesley Partners and in charge of its Asia operations, says this bonus round “could be comparable to the 2008 bonus round,” which is to say one of the worst in recent times.

Oddly, though, the drop in compensation is one of the few areas headhunters can agree on. Otherwise, the experience is very mixed. Some report a dreadful year, others a record; some say fixed income is the only area where anything is happening, others say that’s the quietest area of all. It’s an environment within which consultants play to their strengths and try to thrive as markets around them fail. “This is not going to be, for any of the headhunters, the best or second best year on record,” says Wright. “But for those who know quality, it’s been a good year.”

Different shops report varied areas of activity. At Wellesleys, it’s fixed income and the buy-side in particular. “Asset management has been interesting,” says Brun. “If you’re looking for a trend, that’s an important one.” There is a sense that where many foreign houses have previously existed with a small sales force, they are increasingly aware that they need to build a stable, sustainable, well-led team. Wright sees this too, at least within fixed income asset management. “The biggest area in fixed income is on the buy side,” he says. “Many asset management firms are hiring heads of fixed income for the region; on the equity side it’s more hedge-fund start ups. Most asset managers are about two things: hiring capital formation people, and having a sales force out here.” Several asset managers have been staffing up in the region, but BlackRock probably stands out.

Some find opportunity in other areas. “Hiring in investment banking has been very active in 2011,” says Wright. “Most of the major bulge bracket players will either have completed or begun changing about half of their executive committees – that means new product heads, new investment banking heads, new equity and fixed income heads, heads of legal and operations. It’s a lot of very senior changes, and there are more to come.” People at a vice-chairman level, for example, have been moving. Others expect focused cuts. “We anticipate that many of the shops that cannot provide local currency, local market access in fixed income, are going to cut back significantly,” says one recruiter.

The development of offshore RMB has created some activity both in asset management and around the dim sum bond market, particularly around high yield. And if not offshore, then China itself remains a mainstay. “Most of what we have done this year has been China, then Indonesia,” Brun says. “The focus on China will continue for everyone next year. That is not going to change.” Another headhunter adds: “China continues to be busy in investment banking. We just don’t see any end to the demand for good bankers with great relationships in China. China is the only bright spot on the compensation landscape this year: it’s the one place where there’s no downturn.” India, by contrast, has been relatively quiet as a hiring environment over the last 12 months; many of the leading practices report more interest in buoyant, domestic demand-driven Indonesia instead.

Other areas of growth include private equity. But one thing that’s been missing this year is a bank conducting a major, bull-headed new buildout. In recent years ANZ and, to a degree, Standard Chartered have kept things moving in the industry, not just because of their own big hires but because of the hires that the banks on the losing end have to make to replace the lost stars. There was also Barclays’ decision to build from their customary strength in debt and forex into a broader equities capability. And in most recent years there’s been an obvious headline departure: in 2010 it was probably Henry Cai, the China banker, from UBS to Deutsche. But there’s been much less in any of those themes in 2011. The one big move everyone talks about is Nomura’s poaching of a team from Deutsche Bank led by Daniel Mamadou, but in any other year that wouldn’t have stood out as that big. And while people highlight Macquarie’s attempts to build up in debt, it’s not as if it was that small a player in the first place. “Premiums are not a feature of life any longer,” says one headhunter. “It has not been a year of any great drama or excitement in recruitment. There are plenty of individual movements, but not any big strategic buildouts of moves into new business. There is a significant transition in the industry, away from an era of highly complex structured products and into a kinder and gentler world.”

Within the recruitment industry itself, there are a few interesting developments. One is a rumoured tie-up of Global Sage with another, global partner, though John Wright would not be drawn on it when asked. The other is the disintegration of Pagoda Partners, set up in Singapore by Nick Burnham and Andrew Britton, who now appear to be going their separate ways. Pagoda did not respond to written requests for comment. In general the bigger, listed firms such as Korn/Ferry and Heidrick & Struggles face shareholder pressure to cut costs (notwithstanding the fact that as an overall firm Heidrick is on course for a year-on-year increase in profitability, based on third quarter numbers) but are considered big enough to be able to deal with short term shocks; for the many boutiques in Asia, a single big team hire in this environment can make all the difference.

It’s not an environment that’s going to make anyone rich, whether headhunter or client. But it still has the potential to be interesting. As one recruiter points out, the dreadful performance of bank stocks means that many people’s long-term vesting stock options have become worthless – and hence they’re a lot more willing to move. For opportunistic hirers, 2012 could yet be a very lively time.

TENCENT

Chinese internet group Tencent Holdings completed a $600 million deal this week – the first internet company from anywhere outside the US, never mind China, to sell a dollar bond – in a transaction that was impressive for being completed in a difficult market, but baffling for its timing.

The issue of five-year bonds priced at 375 basis points over Treasuries, the tight end of 375-387.5 guidance, but widened significantly after launch.

Tencent is an interesting and exciting company. While the sense of ‘China’s Google’ has proven an appealing draw in the equity markets, Tencent is actually a more diversified group, earning roughly half of its revenue from online gaming and being particularly well known for an online instant messenger product, QQ, with over 700 million subscribers – not far short of Facebook’s subscriber base. A search engine is a large part of the company’s potential, but advertising represents only 7% of Tencent’s revenue compared to over 20% for Google. “There is a huge captive audience already, and the company will look forward to better synergies between product lines,” said someone familiar with the company.

None of that is in doubt, but few in the market could understand quite why a cash-rich internet company, a debut borrower, in an uncharted sector, would pick this of all markets in which to launch a bid for non-essential funding. “It was never clear to me why an internet company needs that much money,” said one banker, not on the deal. “They wanted $750 million [believed to be the initial target] for what exactly? General corporate purposes was the stated use of proceeds, but I don’t get that.”

Those close to the deal agreed the need for funding was not obvious, but said it makes sense in the context of global peers. “These companies are typically incredible cash rich,” said one. “Microsoft did its debut bond in 2009”, whenit had $25.3 billion in cash and short-term investments. “Bill Gates was asked why he was issuing, and he said as a tech company you prefer to have loads of cash on the balance sheet.” Google, similarly cash-rich, has also issued. “It’s the same reason Tencent is doing this: there is a rates environment that offers them the opportunity to lock in funding at a compelling coupon.” This banker also noted that Tencent has operations offshore – it has bought businesses in Thailand, for example, and has operations in India – and the movement of cash offshore from China is not straightforward. “The bond gives the ability to fund mature operations offshore, and also repays some offshore loans and short term debt. Beyond that, there are potential acquisitions as well. It’s a mixed bag.”

But why now? “With $2 billion available [its net cash position is $2.4 billion], this is not a company that needed the money,” agreed one banker close to the deal. But, since the completion of a global roadshow several weeks ago, the company had been watching the markets closely. “In Europe you see windows open and close with maybe one day a week that’s superb for issuance, and the rest pretty negative. They were looking towards next year and saying: what’s the chance that January is going to be any better? There are a lot of big redemption spikes coming for sovereigns in Europe.

“Could they have waited six months and had another window? Potentially, but a trade was on the table at a price that was OK for them, and they managed to achieve $600 million. For a debut borrower, that’s a big-size transaction.”

The deal certainly stood out from the other deals that have thrived in difficult markets in recent weeks, chiefly top-drawer Koreans and other big names such as ICBC or the Indonesian sovereign, all of which have long track records in the dollar markets and loyal followers in the investment community. “This is an interesting time of year to be bringing a new sector and debut borrower,” said one banker. “For China overall, it was incredibly front-loaded in the first half of the year. Then you had the problems in May around Sino-Forest, and so on. China had an interesting ride this year, with corporate governance being the focal point; fair play to management in overcoming that difficulty and being the first Chinese corporate to issue [in dollars] since May.” And the internet sector is not even well-trodden by European issuers, let alone Chinese. “It was an entirely new sector for emerging market investors as well, who obviously haven’t bought the likes of Google and Microsoft.”

In the circumstances, although the $750 million-$1 billion levels mooted during the roadshow were not achieved, joint global coordinators Goldman Sachs and Deutsche Bank (with joint bookrunners Credit Suisse and HSBC) did well to get the deal away at all; pricing, with no obvious comparables, took in mind a range of reference points from US internet players to Chinese SOEs and major shareholder Naspers (a South African company with 35% of the company). The deal eventually sold 45% to the US, 45% to Asia and 10% to Europe. “This is an emerging market buyer base: you’re looking at the big macro EM funds,” said one banker.

But once out of the blocks, things quickly turned south. After pricing at 375 basis points it went as wide as 392 basis points after pricing, and yesterday [Thursday] was being bid at around 388. Partly, this is mitigated by deteriorating conditions as the deal was being concluded. “We priced this at 4.30 in the morning on Tuesday Asia time; S&P had come out with a negative outlook on the 15 European sovereigns at 2.30, so at the back end of the process there was negative sentiment in the market,” says one banker close to the deal. “The follow-through after that wasn’t too bad, but the initial reaction was pretty negative.” That said, the bonds widened further than the broader market after launch, before improving yesterday morning. “It’s slightly wide of re-offer, but at this time of year when liquidity is pretty think, that amplifies problems,” said one banker. “This is a different type of credit, and banks have significantly downsized credit trading in Asia.”

The transaction was also interesting for highlighting variable interest entities, or VIEs – fairly commonplace in Chinese deals but increasingly in the spotlight given the governance issues at many Chinese companies this year. In offshore listed companies like Tencent, which is listed in Hong Kong, VIEs hold the licences necessary to conduct business. There is some concern about what happens if there are regulatory changes in this area, and in particular if foreign owners could find their assets (notably intellectual property assets or licences) moving from one structure into another without their control. To mitigate this concern, Tencent included a change of control clause for any change of law around VIEs.

These issues have become increasingly important in China this year. “For any deal, ultimately the closer you are to the asset and the more transparent the ownership structure, the better,” said Bryan Collins, portfolio manager for fixed income at Fidelity. “If you do not get that level of comfort, then you need to be sure you are getting adequately compensated, and if not then you should question whether to participate.”

Others had different concerns. “I didn’t participate in Tencent,” said one investor. “The risk of this bond was not in the issuer’s business fundamentals, which are in fact quite strong, but with the likelihood of a follow-on acquisition and the potential for more debt issuance. That is what turned us away because at this time it is not possible to gauge the size of these material risks.”

The bond had a coupon of 4.625%, reoffered at 99.74 to yield 4.684%. The change of control clause involves a put at 101 if any party, Naspers aside, builds a stake of more than 35% of the company.

HANA

The appetite for top Korean financials was illustrated once again on Thursday morning, Asia time, as Hana Bank’s books were almost nine times covered on a $500 million, 5.5-year trade.

The Reg S/Rule 144a senior notes tightened heavily from guidance of 370 basis points over five-year treasuries to price at 345bp. The notes carried a coupon of 4.25% and priced at 99.458 to yield 4.362%. Like many recent deals, this one was completed quickly. “This was perceived to be a one-day execution, with almost no rolling off into the next day; that’s consistent with almost everything we’ve seen this year,” said one person close to the deal. “The issuer had a preference to do something this side of Christmas, and possibly to take advantage of a let-up in supply.” It also benefited from reasonably benign sentiment towards Europe, and also from a Standard & Poor’s upgrade for Hana Bank on the morning of the deal.

Initial guidance was, one banker said, “a fairly generous starting point,” which after allowing for about 15 basis points to cover the difference between a 5-year benchmark and a 5.5 year deal, equated to a new issue concession of about 40 basis points. Final pricing was more like a 15 basis point concession. “Starting as we did [with generous terms, then tightening guidance] is in line with how you’re seeing deals getting done,” said one banker. “Hyundai Motors last week had to do a similar thing to get books up to a decent size.”

The books in the end were more than decent. Like Hyundai Motors, this was capped at US$500 million; aided by the scarcity value, the books eventually closed at $4.4 billion from 259 accounts, although not all of that book represented investors who stayed in at lower pricing. By region, 67% went to Asia, 18% the US and 15% Europe; by investor type, 62% went to funds, 14% banks, insurance 9%, central banks and public institutions 7%, private banks 4%, and others 4%.

Barclays Capital, Bank of America Merrill Lynch, Citi and HSBC were joint bookrunners on the deal. In aftermarket pricing yesterday it was being quoted at 344 bp, marginally inside its launch price.

FUTURE

So, is that it for the year? Issuers and investors do not expect many more significant trades before Christmas, although some may squeeze through.

Of well-flagged deals, the only outstanding one from Asia is an expected deal from Reliance Industries, covered in previous editions of Euroweek. The Indian issuer has appointed Bank of America Merrill Lynch, Citigroup and UBS on a deal widely expected to be a 10-year bond raising around US$1 billion, but those close to it were coy about its likely timing yesterday.

And time is running out for anything to be launched quickly. “Hana was definitely one of the last on our calendar,” said one banker. “There are always things on the backlog, but the reality of getting something priced next week becomes more difficult.” Anything that does price next week will have a settlement date in the week of the 19^th, when many people are leaving the office and shutting down books.

Investors are not expecting much more issuance. “I expect the primary markets to be generally quiet as we move further into December,” said Scott Bennett, head of Asian credit at Aberdeen Asset Management. “There will likely be another few deals from existing issuers that offer a good new issue concession, but I wouldn’t expect an inaugural issuer.”

Another investor added: “Any new issues between now and the end of the year are likely to be opportunistic in nature.”

That said, a piece of good news from Europe would open a window for a fleet-footed borrower. Friday’s EU Summit will again be crucial for market sentiment. “Tonight will be the start of what promises to be a volatile yet fascinating journey for the single currency,” said Stan Shamu at IG Markets [speaking yesterday, ahead of the ECB’s rates decision]. “There are many highlighting that the next few days are pivotal, not just for the fortunes of sovereigns, but the entire banking system.”

Elsewhere, there is a sense that there is still room for one or two more dim sum borrowers to access the market before the year-end, even though the supply-demand dynamics have shifted markedly in that market during the course of the year. Dim sum issues have frequently managed to get away despite bad news from the eurozone.

Asian real estate represents a series of different stories, each with their own dynamics. There are bubble worries in China, inflation pressures and stalled growth in India, softening markets in Singapore and Hong Kong, and questions about the robustness of REITs across the region. But one question that unites them all is how they will respond to a global downturn or recession.

“Major external shocks from Europe or North America would make it very difficult for Asia to be totally immune,” says Peter Mitchell, CEO of the Asia Pacific Real Estate Association (APREA). “I don’t think Asia is necessarily decoupled from the full effects of what’s going on.”

Paul Guest, a real estate specialist at fund manager LaSalle Investment Management, notes that “the medium term growth story for this region hasn’t changed,” but says the region is unavoidably affected by global malaise: it hits exports, it reduces the hiring of multinational corporations, and most importantly reduces market confidence. The impact, though, varies. “We bucket property markets into several categories,” he says. “At one end, the most affected are the small, open, volatile economies like Hong Kong and Singapore, prone to short sentiment-driven cycles. There is a group where the impact is mainly macro, where a significant share of GDP is driven by exports to more advanced economies: Korea is the biggest example. And the third category is strong internal growth dynamics, including China, India and Australia.” Here, domestic demand shields economies and housing markets from global shocks.

Worries about market declines are reasonably new; until recently, there was a lot of concern about bubbles forming in Asian real estate. “I don’t think there are bubbles in the region except perhaps China,” says Mitchell. Even there, there’s progress. “The government measures to cool the real estate market in the last year or two seem to be paying off and creating a softening; if there as a bubble there, hopefully that means a soft landing.”

‘Soft’ is open to interpretation, though, and some analysts do expect significant declines in China. Patrick Ho, head of equity and credit research at UBS Wealth Management estimates a 10-15% decline in property prices in tier one cities, with lesser declines elsewhere. It’s a question of balancing the influences. “We think there are strong demand factors such as urbanization, demand for an upgrade in living quality, income growth, and strong household balance sheets,” says Ho. “However, affordability is stretched, especially in tier one cities.” With liquidity tight, developers may lower prices to boost sales and generate cashflow, while tightening measures from the state have also depressed demand and land prices have started to fall. “These reasons might contribute to a decline in property prices, but we do not expect a crash,” Ho says.

It’s important to notice how clear a distinction there is in China from one property market to another. “We don’t see a nationwide property bubble in China,” says Raymond Ngai at Bank of America Merrill Lynch. “We see a bubble in certain cities, particularly tier one such as Beijing, Shanghai and Hangzhou. Similarly, property affordability is at a reasonable level nationally: it takes six years of annual income to buy an ordinary-sized apartment in China. But in Beijing or Shanghai, the figure is 10 to 13 times, about the same as Hong Kong.” And while the government has been heavily interventionist, it’s hard to quantify exactly what it wants to see. “The central government’s objective is to see property prices come down to a more reasonable level – but Premier Wen Jiabao didn’t say what is a reasonable level,” says Ngai. “Is it 10, 15, 20% down?”

China’s view on how much moderation is enough – at which point it will presumably stop intervening in the market – will be crucial. In future in China, “we might see some measures not being as rigorously implemented,” says Christopher Gee at JP Morgan. “But at the end of the day, policymakers are unlikely to retract too far from their current stance on the sector: it’s too politically sensitive for them to be making a rapid reversal of policy so soon.”

There are, though, some broader changes on their way to Chinese real estate. Ho says there could be a consolidation of property developers. “Given the current funding constraints, the small developers will be acquired or run out of funding.” That’s better news for bigger, stronger developers who have better access to credit and lower funding costs. For example, as of late November, state-owned developers’ bonds were yielding around 5%, while some smaller developers were over 20%. This clearly has implications for the banks too, though Ho argues that even if property prices decline by 30%, banks will remain profitable.

It’s also worth remembering that China’s whole property market will evolve from its residential dominance. “The development of commercial real estate in China is still in its infancy, and we think there will be a greater flow of funds away from basic home building, from a build and sell business model to a real build and own business model,” says Gee. He notes that home builders account for about $120 billion of enterprise value in China, compared to $40-50 billion in the USA.

While they wait, though, investors have been voting with their feet. “International investors have already been reducing exposure and taking out active short positions in this space,” Gee says. “A number of high profile hedge fund managers have taken that view.”

China grabs the most attention, but property is also a mainstay of local conversation (and international investor interest) in the established hubs of Singapore and Hong Kong. Both have enjoyed considerable increases in property prices, particularly in residential; both are experiencing softening now. In Singapore’s case, so far it’s more a slowing of growth rather than a decline – growth momentum has slowed for eight consecutive quarters in private residential property, according to the URA price index – but there is a growing feeling that a decline is on the way. “Our forecast is that we could see 5-15% declines in Singapore private residential real estate prices over the next 12 months,” says Tan Chin Keong, Singapore equity analyst at UBS Wealth Management.

There’s more to Singapore than housing: it has sophisticated listed sectors, including REITs, in office, retail and logistics besides residential. Office is especially vulnerable, and Tan says he sees “potential cyclical weakness” since office space demand is particularly sensitive to the economy and macro uncertainties. That said, it won’t fall 60% as it did in 2008-9, largely because it has never regained that ground; today rentals are still 40% below the previous peak in 2007 and the supply of new office space on its way is expected to be below average in the next few years, Tan says. Industrial, on the other hand, is generally more resilient. “While Singapore industrial production activity is slowing, we could potentially see some office tenants downgrading to business park and hi-tech space in order to save on rental costs,” Tan says. Retail, too, holds up well in downturns, especially retail property rentals that cater for consumer staples.

“We see a plateauing of real estate values in Singapore, particularly residential, but there is unlikely to be a collapse,” says Gee. “There is still significant demand in the mass market space, the result of pent-up demand that built up when Singapore had a significant pro-immigration policy.”

Hong Kong is slightly different, in particular because Hong Kong has much less control over its own currency (which is pegged to the US dollar) and therefore monetary policy. “I think that the cause of overheating in the real estate market in the early 1990s, and in the last two years, was that our currency was linked to the US dollar but our economy is tied more to the Chinese economy,” says Ngai. “Unlike Singapore we don’t have any opportunity for currency revaluation, which makes the situation more difficult.”

Gee agrees. “In Singapore the strain is taken by the currency; in Hong Kong it obviously has not adjusted because of the peg,” he says. “Hot money flows from China and elsewhere have been a hugely powerful driver of the real estate market in Hong Kong.”

This is one reason the Hong Kong market tends to turn very sharply, and at the moment most people think the likely direction is downwards – indeed, in residential, it’s already falling. “We expect the Hong Kong housing market to continue to correct, for two main reasons,” says Ngai. “First, we are starting to see more land supply coming onstream.” The Hong Kong government has pledged to supply land upon which 20,000 units of housing can be built, each year, compared to a recent average rate of about 15,000 in terms of annual takeup. Additionally, new clauses in land sale documents require developers to build more small-size units, which will likely lead to an oversupply within three or four years. “The other is demand. Next year we expect the economy in Hong Kong to slow down, unemployment to move up, and the mortgage rate to rise. When you add these supply and demand effects, we are looking for a 10 to 20% drop in housing prices.” In the fund management community, Guest at LaSalle says he has seen predictions everywhere from no change to a 30% decline. While he is not that bearish, he notes: “When Hong Kong declines, it’s never single digits.”

As Gee puts it: “It’s a hugely volatile space: as soon as people think the next move in prices is down, it compounds on itself, and the inflexion point is very sharp. You go from extreme optimism to extreme pessimism in a heartbeat.”

The other national market worth taking a close look at is India. Again, the outlook depends on the sector. “We are more bullish on the commercial side than the residential side,” says Jyoti Jaipuria, [TITLE BEING CHECKED] at Bank of America Merrill Lynch in Mumbai.  “In commercial, the demand is still fairly decent and supply overhand will ease off.” That’s in contrast to residential (retail, in India, being a small and niche market so far). “On residential in general, we are quite negative. We think there will be a lot more supply coming up, and demand has been fairly weak.”

India has spent recent years battling inflation pressures, a key priority of the Reserve Bank of India. “When the boom was taking place, the Reserve Bank did caution banks against lending to real estate companies,” notes Jaipuria. “For example they don’t allow lending for land, just for real estate. That semi-cautious stance may not change in a hurry, because the central bank thinks this is a relatively risky segment.”

Investors are positioning themselves for a decline, at which point opportunity might arise. “The crux is we are seeing a slowdown in demand, but nobody is cutting prices,” Jaipuria says. “From a strategy perspective, the decision the developers have to make is: do they roll back their plans, not develop and not reduce prices; or do they go ahead with new projects and reduce prices? Then you have a chance of volumes coming back, but the margins may be lower. The builders have to decide what to do.”

From a regional perspective, one market to watch closely is real estate investment trusts (REITs). These are supposed to be stable, steady generators of yield, yet in the global financial crisis the REIT market in Singapore – the biggest in Asia outside Japan – underperformed the broader market, exactly what it’s not meant to do. However, many feel that it is in far better shape today. “Going into the heart of the GFC at the end of 2007 there were a number of REITs that had levered up on the expectation that cheap credit was here to stay forever,” says Gee. Others had committed to large acquisitions that needed to be funded, had bullet repayment loans due, and a concentrated debt maturity profile at a time when the debt capital markets closed. “Today the situation is rather different. The number of outstanding and unfunded acquisitions was far fewer, REITs have recapitalised post financial crisis, and in general they are in a far healthier state than in the previous cycle.”

Any market downturn will hit REITs, and they generally do need access to capital markets to sustain them, since they need distribute their taxable income and need new capital to expand. “But Asia’s banking system has proven to be quite resilient, having reformed itself as a result of the Asian crisis, so access to debt didn’t totally dry up here like it did in the US in 2008-9,” Mitchell says.

“The Asian REIT market has been impressively resilient,” he adds. “It has some positive features post-crisis that are not shared in North America and Europe.” For a start, its market cap today is higher than before the crisis, and it has sustained capital raisings, including new IPOs. Mitchell adds that regulators in Singapore, Japan and Malaysia in particular have been supportive of REIT markets and intervened swiftly where necessary; they also insist on openness. “There are a lot of REIT regulations here which make them very transparent,” Mitchell says.

“People used to say they were boring products before the crisis: they are restricted as to what they can invest in, the gearing is limited and there are other investor protection rules that don’t apply to operating companies. That has held them in good stead.”

Private wealth clients in Asia are facing intense market volatility and uncertainty for the second time in three years. The bad news is that almost all investment classes – equities both global and local, debt, property and commodities, everywhere from the US to Europe, Japan to China – face a deeply unclear and likely negative outlook. The good news is that compared to the global financial crisis of 2008, clients are much better prepared this time.

“There is a very marked contrast between what we’re seeing this time and what we went through in 2008 with private clients,” says Arjuna Mahendran, managing director and head of investment strategy at HSBC. “At the retail end of the market, they are going through the same experience as 2008: huge redemptions, forced selling, and a general state of panic. But high net worth clients are different. Because a lot of them used derivative instruments in 2008 and got burned, they learned their lessons and have deleveraged.” That leaves them less exposed this time, with more liquid investments and lower risk.”Most of them are looking at this as a guarded opportunity to pick things up fairly cheaply.”

Alongside the ructions of today’s market, there are other, longer-term trends at work in Asia private banking. Many of them stem from a key theme in Asia: the first generation who have built wealth approaching the end of their working lives and pondering how, or if, to pass the management of that wealth to the next generation. There are numerous knock-on effects of this trend, discussed in more detail in this report. Among them are an increasing professionalism in the way people manage wealth: corporate structures, family offices, more diversified portfolios, and a greater use of financial advice.

To see the report as it ran in the magazine, click here: Forbes Wealth Management v2

Another is an increased interest in estate planning, from straightforward wills and probate to training younger generations about wealth management – even including children. And a third is a more hands-on approach to philanthropy, often among newly wealthy individuals who have first-hand experience, and a clear memory, of genuine poverty.

One thing’s for sure: Asia is increasingly the engine of wealth generation, and correspondingly an important focus for wealth management. In October, Merrill Lynch Global Wealth Management and Cap Gemini released their closely-watched Asia Pacific Wealth Report, which found that Asia had overtaken Europe as the world’s second biggest market of high net worth individuals, measured either by population or combined wealth; on either measure, it’s only a matter of time before it overtakes North America for the top spot. One week later, the Credit Suisse Research Institute released its Global Wealth Report, finding that Asia Pacific accounts for 36% of all global wealth creation since 2000, and 54% since January 2010.

In this changing environment, there is a need for tailored, individual wealth management advice that does more than push a product. “The first question should not be: do you need life insurance, or a trust structure,” says Hugues Delcourt, CEO for private banking for Asia at ABN Amro. “It should be: what are your goals, your objectives, your constraints? What do you want to achieve? Then we can start talking about solutions.”

PART 1: INVESTMENT

Older and wiser, Asian private banking clients are approaching today’s market volatility with caution. But bankers say there is still a willingness to engage in markets and take a long-term view.

“Those with a strong opinion on a company or sector are seeing an opportunity to enter, in a gradual fashion,” says Arjuna Mahendran at HSBC. “But they don’t throw all their eggs in one basket.”

It’s largely a safety first environment. “With falling macro momentum and an expectation of choppy markets, UBS has recommended clients to position more defensively for quite some time,” says Alexander Kobler, Head of Investment Products & Services, Asia Pacific, UBS Wealth Management. “High dividend and high yield stocks are an ideal way to gain defensive equity exposure, with the security of a stable income stream in demand from investors right now.” He favours rebalancing cyclical exposure towards defensive sectors such as telecoms, healthcare and consumer staples, and focusing on companies with stable earnings, solid balance sheets and high dividends. “In addition, hedge funds can benefit in this environment,” he adds. “Given the current market volatility as well as the speed and magnitude of directional changes, we prefer trading strategies within the hedge funds space.” It is not a universal view: some are tired of hedge funds failing to deliver.

One particular challenge in this environment is working out where the safe havens are for investment. In some ways, the answer is simple. “The best safe haven is to be properly diversified,” says Hugues Delcourt at ABN Amro. “Yes, have a little bit of your wealth in gold, or treasury notes, but putting everything there? That would not be very wise. In these difficult times we ought to come back to the real fundamentals: risk profile, investment horizons and diversification.”

But it’s also arguable that safe havens have never been harder to find. “Safety is very costly nowadays, be it in terms of close to zero returns or high costs of protection strategies,” notes Kobler.

Throughout this year, the answer has typically been gold, but even that fell dramatically in October, albeit from all time highs. “Our advice is that gold was bound to have a bit of a correction, because it was becoming exponential in terms of price appreciation in the last few months,” says Mahendran. “But our basic advice is to start accumulating below US$1500 for another burst upwards. Gold remains in demand as central banks are debasing their currencies and facing inflation.”

Some felt gold had simply become too highly valued to be a sensible investment anyway. Speaking just before the major price decline, Lee Boon Keng of Julius Baer said gold was “somewhat overplayed” as a safe haven. “Gold and other precious metals are no longer safe havens but speculated commodities. Would I put gold as an important part of my portfolio right now? At these prices [$1800 at the time of the interview] probably not.”

But it does have good fundamentals. “Right now, strategic investors are still encouraged to build up exposure to gold as a means of diversification and portfolio insurance,” Kobler says. “Compared to the Swiss franc and Japanese yen, gold does not have a central bank that tries to prevent further appreciation. Thus, the metal can be viewed as the purest-play hedge against prevailing sovereign and currency risks.” Corrections in the gold price simply provide good opportunities to enter, he says.

In terms of currencies, two in Asia stand out: the Singapore dollar and the Chinese RMB. The Singapore dollar is expected to benefit from the fact that the Swiss franc, the traditional safe haven currency, has now been capped against the euro. “We are telling our clients that amidst all these uncertainties, we need to focus on the things that are the least uncertain,” says Lee. “One is that after the SNB fixed the Swiss franc, we will see the establishment of a replacement as a safe haven currency, and that is likely to be the Singapore dollar. The make-up of the economy is fairly similar, both have the rule of law, they are key financial centres and have similarly high governance standards. That is going to make the Singapore dollar a very attractive currency to have over the course of the next couple of years.” What to do with the Singapore dollars is a different question: Lee advises clients to look at high yielding Singapore stocks, including real estate investment trusts (REITs).

The RMB is a different story. While still not fully convertible, it is becoming an increasingly internationalised currency, with the so-called dim sum bond market thriving (with a few dips and glitches) in Hong Kong, and RMB bank accounts appearing both there and increasingly in Singapore. “Our clients have been building positions in RMB,” says Mahendran. Lee at Julius Baer argues that problems in Europe and the US will prompt China to increase the speed of the internationalization of the currency, which ought to mean it will appreciate steadily; over time, as investment products for offshore RMB develop, they are likely to prove extremely popular with overseas clients. Julius Baer itself is launching a China equity fund, and has combined with Singapore’s DBS to create a product investing in dim sum bonds. And a host of mutual funds for offshore RMB have sprung up in the last 18 months, including big asset management names such as HSBC, UBS, Schroders, Barclays Capital, Singapore’s Fullerton Asset Management, and – soon – BlackRock.

One problem with assessing a client’s risk tolerance is that it’s one thing to explain a possible decline, another to experience it. “Risk tolerance is not a discussion that takes 20 minutes and then you fill out the forms,” says Delcourt. “It’s very different to say to a client: ‘can you take a 20% decrease in your portfolio?’ and then the decrease actually happening. Nobody likes losing money, but when you are confronted with the reality of losing 20% of your portfolio, you may realise there were a few things you were hoping to do and can’t do anymore.”A proper understanding of a client’s true risk appetite is key.

That said, the dangers for private wealth clients do not seem so acute this time. “2008 basically pointed out the perils of leverage and derivatives: those were considered the two most toxic elements,” says Mahendran. “So everything else is considered relatively safe.” Within that, clearly emerging markets appear to have the better economic prospects, so advisers tend to suggest allocations to Asia on both the debt and equity side. While Asian equities tend to be hit with those in the developed world – unfair as that might seem – Asian debt has remained more resilient. “Asian debt in general is managing this volatility quite well,” says Mahendran. “Spreads haven’t widened as much as in 2008.”

Hedge funds, he says, are out of favour since they have not performed well; long-only funds are fine, but clients have a greater need to understand exactly how they operate. “The client wants to understand intrinsically what a long only fund is investing in, rather than plunging in.”

But no matter how bad the markets, investors have to do something. “You can’t remain uninvested when Asia is running at historically high levels of inflation,” says Mahendran. “In Singapore inflation is running at 9.5%. Clients realise they can’t just keep their money in cash; they’ve got to make their assets work for them to keep pace with inflation so they don’t lose the value of their wealth in real terms.”

And as Kobler says: “The time will come over the next months where the higher risks will also be rewarded with higher returns.” Timing is everything.

PART 2: FAMILY OFFICE/ESTATE PLANNING SECTION

In recent years many banks, such as UBS, Credit Suisse and Citi, have launched dedicated family office business units; others, whether or not they have separate units, report an increase in the amount of business in this segment. It’s no surprise: family wealth drives Asia.

In October Credit Suisse launched a comprehensive study of family-owned companies (not family office wealth management, but the corporate growth at a family level that drives the trend). Everyone knows the heavyweights – the Mittals, the Tatas, the Samsungs, the members of Li Ka-Shing’s family – but in fact across Asia’s 10 major markets there are more than 3,500 family-owned companies with a market capitalization of more than $50 million. 1,279 of them have a market cap of greater than $500 million. All told, family businesses account for 34% of Asian nominal GDP, and 32% of market capitalization, but in some markets the figure is far higher: 83.2% of the Philippines market cap, for example, with Singapore and South Korea both over 50% too.

“An interesting difference to Europe is that these are businesses that are relatively young,” says Nanette Hechler-Fayd’herbe, head of global financial markets research for private banking at Credit Suisse. “38% of them were listed after 2000. Many of them are first-generation led, whereas in Europe there have usually been several generations. They are at the early stage of their life cycle compared to their peers in Europe.” That in turn means more family office investment structures. “As family businesses grow and create wealth for the family, there is a movement towards a more professional investment approach as well. It goes hand in hand.”

Naturally, this is all linked to the succession theme too. “Succession from one generation to the next will accelerate over the next decade,” says Agnes Au-yeung, Head of Family Wealth Advisory, HSBC Private Bank. “The new generation of family offices will have to adapt to the needs and values of the baby-boomer entrepreneurs, who cherish new ideas and values, and who are concerned about continuity and leaving a legacy.”

Amy Lo, Head of Ultra High Net Worth for Asia Pacific at UBS Wealth Management, agrees. “One of the main reasons for this change [growing interest in family offices] is generational transition,” she says. “While we see many family businesses being successfully handed over to the younger generation, some families decide to divest and continue the legacy in the form of investments of philanthropic activities, transforming from a business family into a wealth management family, while staying entrepreneurial and continuing to look for new opportunities.”

But it’s not an area where many people appear satisfied with what they’ve done. A recent UBS Family Advisory study surveyed 120 ultra high net worth families globally, finding that 76% were concerned about protecting their wealth, but only 25% considered the way they approached the issue to be sufficient. “32% said that lack of know-how was the biggest show-stopper in putting a structured approach to family wealth protection in place,” says Lo. Good estate planning, she says, should involve not just the senior generation but junior ones too, “in a dialogue about the core values of the family and what the family wants to achieve in the long run. Many families make the mistake of limiting their efforts to the legal structuring, while missing the point of the true reason of such a structure. Successful legacy building involves a clear long term family strategy and thought through governance system,” which might include the drafting of a family constitution or the creation of a family council, she says.

A big part of family office advice is structural. “For those that want to get started, we help them with the structure and definition of governance,” says Marcel Kreis, head of private banking for Asia Pacific at Credit Suisse. “That is crucial to the success of the operation. We discuss issues of legacy and asset protection, help them with the formulation of investment policy if that’s required, and provide any financial services they need.” Kreis’s colleague Hans-Ulrich Meister, CEO for private banking globally, adds: “All over the world, with family offices, you have to push them on succession. If succession is not timely you can lose everything you built up in the last 30 to 40 years. It is such an important part, especially in companies who might need years preparing for a successful transition.”

But investment advice is naturally crucial too. Banks report that with more formal structures, risk management becomes more sophisticated and time horizons for investment tend to grow – perhaps allowing people to invest in illiquid asset classes like infrastructure, which improve diversification. That said, many family offices did lose a lot in the financial crisis from illiquid alternative investments. “Form these lessons many families have started to define risk buckets,” says Au-Yeung. “They may set aside a bucket as a nest-egg, or the start-over-again fund, while managing another bucket with a higher risk level or a thematic focus so that that combined buckets meet the aggregate needs of the family.”

For banks, this is growing business, as more and more institutions broaden from a traditional focus on investment management to a far more rounded sense of partnership with family wealth. “I look at the relationship manager as being a conductor, being able to play with a number of musicians,” says Hugues Delcourt at ABN Amro. “An orchestra without a conductor plays a cacophony. A conductor without musicians doesn’t entertain his audience. I believe in a private bank that is a partner to our clients: not only to advise on whether an investment should or should not be made, but to structure wealth in a way to achieve their objectives.

“The private banking model of the recent past in Asia was much more transaction-oriented,” he adds. “It still is, to a large extent. We ought to move to a more client service approach, and wealth structuring is fundamental part of that advisory scope we need to provide.”

Family office structures can take a variety of forms, “ranging from a trusted assistant to a virtual family office managed by an ex-senior banker, and in more mature cases to an entity with an independent legal status and staffed by well-qualified professionals,” says Au-Yeung. Such professionals can be in high demand: Credit Suisse’s most significant private banking hire this year was Bernard Fung, who formerly managed the wealth of the UK’s Sainsbury family.

Lo at UBS distinguishes three separate groups. There are ultra high-net worth families in Hong Kong and Singapore, who are sophisticated and have reached a natural point where it makes sense to separate business interests from financial assets; they use investment specialists who coordinate sourcing and screening of investment opportunities. Then there are clients in China and India. “They are quickly picking up in terms of professionalizing their wealth management and are very active in enhancing their knowledge as well as seeking ways of adapting the western family office concept to their business driven, high growth environment,” she says. “One of the main challenges for UHNW families in these countries is the fact that most of the family wealth is tied to a family business. In such a situation, the first critical step in creating a family office usually lies in diversifying this concentration risk and adopting an asset allocation approach to managing their wealth for the long term.” And the third group is European family offices establishing a presence in Asia in order to be in a better position to gain suitable exposure to the Asian growth story, typically through a Hong Kong or Singapore hub.

It can be a tricky market to service. “In our experience, single-family office clients require a much higher level of service and attention,” says Au-Yeung; HSBC services them through its HSBC Private Wealth Solutions business, which manages over US$100 billion of these assets worldwide. “Family members can be quite hands-on, especially with investment decisions.” There is perhaps a suspicion that needs to be addressed too. “Our advisers need to continually validate our objectivity to client families. To assure their independence, our advisers are not incentivised by product sales, nor measured by asset gathering.” And advice has to be customised – it’s not a one-size-fits-all sort of market. Lo says: “Due to the highly personal nature of the work, we have found that most families prefer to set up their own, bespoke, family office with a combination of their own trusted employees (often having served the family business for many years) and external experts with specialist skills,” including lawyers, accountants and tax advisors as well as investment professionals.

That said, it’s still an industry in its infancy. “The family office is a relatively new concept, with many still studying, comparing, developing and evolving their models,” says Au-yeung, who adds that family offices in Asia typically follow a US and European-style pattern. She says more and more families are using this approach, but says it is unclear how widespread they will become. “The definition is vague, and family offices tend to be very private,” she says. “We expect families to lean towards single-family offices as they prefer their affairs to be managed internally and separately from other wealthy families.”

Another theme that often comes from family wealth management is the impact on the family itself. “As an administrative centre supporting the family’s governance structure, the family office provides a unique platform to improve and promote communication and harmony among family members.” Perhaps this is one reason that multi-family office structures are relatively rare in Asia. But they do have some merit. “Rising costs, a difficult investment climate, and a desire for a breadth of services tend to drive families to partner with larger multi-family offices,” says Au-Yeung. Lo says multi-family offices serve the needs of, at most, six or seven families; this sort of model is more common than third party-owned commercial service providers branded as family offices (multi client family offices, as Lo calls them), which can serve as many as 50 families – a model that is common in the United States.

Above all, though, Asia is characterised by a stronger sense of possibility, and of momentum in new wealth generation. Delcourt summarizes it like this. “Europe has a tendency to look at tomorrow as a zone of risk. Asia has a tendency to look at tomorrow as a zone of opportunity.”

PART 3: PHILANTHROPY

Like family office structures, philanthropy is professionalising in Asia. “There are increased expectations of transparency and accountability and evidence of social impact,” says Cynthia D’anjou-Brown, senior philanthropy and governance advisor, HSBC Private Bank, which manages more than US$1 billion in assets and handled US$50 million of donations on behalf of clients in 2010. She says the definition of what constitutes philanthropy is broadening, from informal charity to structured grant-making, to investments with social value. The young generation is having an impact here. “There appears to be a high engagement of donors at a younger age and a trend towards working with family members,” she says.

Philanthropy in Asia differs from the rest of the world in some crucial ways. One is the dominance of education in giving programs. A recent study by UBS and INSEAD found that education is likely to account for 35% of giving in Asia in 2011; the next biggest cause – poverty alleviation – accounts for just 12%. “These are strong cultural roots that support education, tied to Confucian, Hindu and other Asian traditions,” says Jenny Santi at UBS Philanthropy Services. And many who have risen from poverty recall either their lack of education or the gift of being the first in their family to receive it. “One of the most deep seated reflections they have is that they were deprived of a high quality education, so want to give back in that sector; or they recall that the only reason they were successful was because somebody gave them a handout and made a difference in their lives,” she says.

Other banks confirm this: D’anjou-Brown says nearly half of the donations HSBC administered on behalf of charitable trusts and foundations in Hong Kong over the period from July 2010 to June 2011 were allocated to educational projects, compared to one fifth for social services and one tenth to health and medical services. Few philanthropists in Asia donate to environment or conservation themes, animal protection or culture.

One can argue that the Asian cultural emphasis on family is also relevant to the way people give, and distinguishes it from more individualist approaches in North America. “In Asia the older dominant religions, the social structure of the clan, and collectivism breed a culture of caring for the large extended family and community,” says D’anjou-Brown.

The UBS study found that giving was chiefly domestic, although D’anjou-Brown says there is a trend towards giving internationally – particularly what she calls “diaspora giving”. In particular she sees a growth in donations to mainland China.

As with estate planning, much of the important advice given around philanthropy is structural: choosing the legal entity for giving and ensuring it is properly set up in terms of succession, flexibility, tax advantages, liability, privacy and compliance. “A charitable trust or foundation managed by a professional or corporation trustee is an excellent choice because it provides better succession arrangement and need not rely solely on individual directors as in the case of a company,” says D’anjou-Brown. It is vital to be clear on what a donor wants to achieve, and how to measure it. Measurable results are a renewed focus in Asian giving.

The rise of governance also has an impact on philanthropy. CSR Asia says that 87% of family businesses participate in CSR activities, though only 53% have a policy and 39% have clear CSR goals and targets.

Many banks report an increasing insistence on direct involvement in charitable initiatives. “Rather than ‘I donate so much to such and such an organization’, people want to be able to help advise on a  philanthropic project, and to get involved,” says Delcourt. “It’s not just about a financial return, but for people to get their own return – to see that what they do has a positive influence, and a multiplying factor. We continue to support a number of institutions which are applying the private equity way of thinking to philanthropy.”

KOREAN AIR

Korean Air closed a US$300 million asset-backed deal this week to enliven what has been a quiet period for securitizations from Asia.

Standard Chartered was lead manager and sole arranger on the issue of secured floating rate notes, the first dollar securitization of passenger ticket sales by the airline. Most of the receivables are from KAL’s North America routes. KDB was credit facility provider and swap provider on the deal, a move that clearly helped in this volatile environment, giving investors comfort that they were effectively taking KDB risk.

The transaction matures in October 2014 and offers a floating rate coupon of one month dollar libor plus 200 basis points. Standard Chartered’s global head of structured financing solutions, Warren Lee, called it “very competitive pricing despite the continuing market turmoil.” The receivables have a weighted average life of 1.5 years, and the notes were rated A1(sf) by Moody’s. The notes are listed on the Irish Stock Exchange.

KAL is a reasonably familiar name in the asset-backed markets despite never having issued in dollars before; the transaction is its sixth cross-border ABS deal, and follows five previous deals in yen. Moon Kwon Oh, general manager and head of the financing team at KAL, said it was “meaningful for the company that this transaction is backed by USD denominated assets for the first time.” The deal is understood to have had considerable overlap with the investor base of KDB’s own $1 billion 5.5-year global bond in October.

Observers found two points of significance in the deal. One was that a dollar securitization was taking place at all in such difficult markets, although it was not clear that there was a pipeline of similar deals looking to follow. The other was curiosity about the approach of KDB, whose role as credit facility provider on this deal follows a guarantee on a $350 million bond for Doosan Heavy Infrastructure last week. It will be interesting to see if KDB offers further guarantees and facilities as a means of raising additional fee revenue in the months ahead.

DIM SUM

Issues from Orix, Baosteel and Shougang Corp this week showed that there is still appetite for dim sum bonds, even as world capital markets turn increasingly nasty.

Yesterday Baosteel, the Chinese state-owned steelmaker, raised xxx in a three-tranche issue lead managed by Deutsche Bank and HSBC as joint global coordinators and bookrunners, with China Merchants Securities, DBS, ICBC and Standard Chartered as joint bookrunners.

The deal was significant because it was the first mainland company to issue an offshore RMB bond. Numerous mainland entities have issued offshore, but until now always through an offshore vehicle. A recent change of regulation permitted onshore borrowers to raise funds in this way, and bankers expect to see many more issues from mainland enterprises in this market.

Its success was hearting to investors, with a total book size of xxx. “It was enormously well received,” said someone close to the deal. “There was standing room only at the roadshow lunch in Singapore, 130-odd people in Hong Kong. Baosteel is huge, one of the pre-eminent producers in China, and being owned by SASAC it’s seen as a strategic company.”

The deal was made of three benchmarks. A two-year deal was offered at a range of 3.125% to 3.375%, and priced at x; a three-year bond came with guidance of 3.5% to 3.75% and priced at x; and a five-year tranche was offered at 4.375%-4.625%. Yesterday morning there was talk of a deal as big as RMB6.5 billion, since the company had been given approval to raise up to that amount, but those close to the deal said a more realistic target had been about RMB4 billion.

The bonds, expected to be rated A3/A/A- by Moody’s, S&P and Fitch in line with the borrower rating, carry a change of control clause with a put at 101% if state ownership (through SASAC) falls to 50% or below.

Also yesterday, another steelmaker, Shougang Corp, priced an offshore Reg S reniminbi bond in Hong Kong, raising RMB1 billion in a two-year transaction. This deal priced at 4.875%, in line with guidance, and was lead managed by Bank of China International, Citic Bank International, DBS, ICBC Asia, JP Morgan and Wing Lung Bank. The deal was unrated.

The Baosteel deal followed a RMB500 million three-year issue from Japanese Orix Corp earlier in the week. This was Orix’s second issue in the market, and being a repeat issuer clearly helped the deal get away smoothly, but attracted inevitable comparisons with its outstanding paper: Orix priced at 4%, while outstanding bonds due March 2014 were paying 3.35% – having been launched at just 2%. Joint bookrunners on this deal were ANZ, BNP Paribas, Credit Agricole, Daiwa, Mizuho and Standard Chartered. “Orix were cognisant of the new issue premium payable and it was not a problematic trade of any sort,” said one person close to the deal. “A well known name, repeat issuer; a nice easy one to get away.”

52% of the paper went to Hong Kong, 39% to China/Taiwan and 9% to Singapore. Insurers were the largest group by investor type, taking 49%, followed by private banks (24%), funds (19%) and banks (8%).

HYBRIDS

Australia’s regulator yesterday warned consumers about dangers in hybrid securities, in a move that seemed timed to coincide with the delay of a hybrid issue from Origin Energy.

On Tuesday, Origin began a bookbuild process for a A$500 million hybrid notes issue through ANZ, Commonwealth Bank of Australia, National Australia Bank, Macquarie Bank and UBS. The offer was due to open for retail investors the following day, but instead Origin announced that ASIC had extended the exposure period for the prospectus by seven days – that is, increased the length of time for study of the prospectus before the formal opening of the deal. Origin said: “The extension will allow ASIC to consider further the terms in the prospectus, including aspects relating to the mandatory deferral of interest payments.”Origin said it had received “very strong investor demand” for the notes, and said it and its advisors were “in discussions with ASIC with a view to resolving this matter as soon as practicable.”

Then, just before 6pm Sydney time, yesterday, ASIC put out a statement asking consumers to make sure they understand the conditions and risks of hybrid securities and unsecured notes before investing. “With considerable volatility in equity markets, many investors are looking for alternative investments, including debt and fixed interest securities,” said ASIC. “However, some of these alternatives need close scrutiny before the decision to invest is made.”

The announcement quoted ASIC chairman Greg Medcraft as saying: “In some cases investors are taking on equity-like risks but only receiving bond-like returns. Investors need to understand the conditions of these offers, such as terms and conditions that allow the issuer to exit the deal or suspend interest payments, and long term maturity dates of several decades.” The Origin notes have a 60-year maturity but are callable from 2016, with a 100 basis point step up if they have not been redeemed after 25 years.

Approach by Euroweek, an ASIC spokesman said: “We have no comment about the Origin deal specifically.” But market participants said it was telling that the ASIC warning specifically highlighted deferral of interest payments – saying it “could leave investors temporarily out of pocket” and “the security’s market price may also be damaged by the decision to hold back interest payments” – when that was also explicitly stated as the reason the Origin issue was delayed by the regulator for further study.

ASIC also warned about market price volatility, the subordinated ranking of hybrid securities, early termination rates that apply to the issuer but not the investor, and the increased risk of extremely long timeframes.

The Origin deal was originally intended to close on December 12 for the shareholder and general offers and December 19 for the broker firm offer, with issuance on December 20.

DOLLAR DEALS

The market is watching two Asian issuers to see if they are prepared to brave the treacherous dollar markets next week. Chinese internet company tencent has completed a roadshow in the US, while Reliance Industries is pondering a benchmark deal of its own.

Of the two, tencent is closest to issuing. A roadshow that began in November 15 in Hong Kong before moving to Singapore and London concluded in the US on Wednesday ahead of the Thanksgiving holidays. If market conditions oblige, a Reg S/144a dollar deal should follow next week, although it appears a crushingly difficult market in which to raise a debut bond from a Baa1/BBB+ rated internet services provider with no obvious comparable to price against. Goldman Sachs and Deutsche bank are joint global co-ordinators on the sale, alongside Credit Suisse and HSBC as joint lead managers and bookrunners; those close to the deal describe the mood around the roadshow as “positive”.

Reliance Industries is somewhat further away. Market talk is of a two tranche deal with 10 and 30 year tranches in dollars, but at the time of writing the issuer had still not confirmed the lead managers, nor given the green light to a deal going ahead at all. Mandates were proving characteristically competitive. As one banker put it: “We are standing very close to it, and shouting that we should be on it, and others are doing the same, while the company is playing one off against the other. There are more players being told the deal is theirs to lose than there are seats at the table.”

Another spoke of the issuer “getting commitments from bookrunners on terms that aren’t exactly commercial.” And yesterday afternoon one banker said “it looks like it’s not going anytime soon.”

INDONESIA

Indonesia dominated the Asian dollar capital markets this week, with a well-received $1 billion sovereign sukuk rapidly (some would say alarmingly so) followed by another $1 billion benchmark from state electricity company Perusahaan Listrik Negara (PLN).

The seven-year sukuk was priced on Tuesday morning Asia time and gave a clear demonstration of how positively Indonesia is now seen in world markets. It priced at 4% (strictly speaking this is a profit rate rather than a yield, since this is an Islamic security), the tight end of 4-4.125% guidance. It was widely agreed that the tight pricing reflected an assumption that Indonesia, rated Ba1/BB+/BB+, with a positive outlook in Fitch and S&P’s cases, will be upgraded one more notch to investment grade. It formed a sharp contrast with the 6.29% Italy paid for a Eu3 billion five-year bond on Monday – Italy is rated A2 by Moody’s.

“The good news is in the price with regards to the rating,” said one banker. “Indonesia certainly trades like an investment grade sovereign. People feel very positive about how the future looks down there. But an upgrade is not going to result in a dramatic tightening of yields again; ratings need to catch up with reality.”

Those close to the deal say it attracted a $6.5 billion order book. “4% was an excellent outcome for them considering their last deal was 8.8% in 2009,” said one. “Seven years is a respectable maturity profile. Everybody is pretty happy with that.” The choice of maturity reflects the fact that Middle East investors, who were key to the transaction, prefer shorter-dated bonds, ideally five years; since the issuer wanted funding of up to 10 years, seven was seen as a sensible compromise. Middle East investors accounted for 30% of the deal, and had been a clear target, with a roadshow that visited Riyadh, Doha, Dubai and Abu Dhabi. Indonesian investors took 12%, the rest of Asia 32%, the US8% and Europe 18%. Funds took 59% of the deal. Citi, HSBC and Standard Chartered were lead managers.

It is harder to demonstrate that the deal’s success was down to a growing conventional investor appetite for sukuk, though some believe that it was a contributory factor. “There was a strong bedrock of interest from Middle East and Asian sukuk-specific funds, but conventional players also recognised the quality of the issuer,” said one person close to the deal, who estimated that 40% of the book were conventional investors but stressed there was some guesswork in that number.

The PLN deal was a $1 billion 10-year offer which priced on Wednesday morning Asia time, led by Barclays Capital and Citi as joint bookrunners. It priced at a yield of 5.625%, the tight end of 5.625%-5.75% guidance (a coupon of 5.5% with notes reoffered at 99.054). Some in the market considered this cheap, particularly in light of the sovereign sukuk; but S&P rates it one notch below the sovereign at BB (unlike Moody’s and Fitch, who have it at Ba1 and BB+ respectively), suggesting a slightly weaker credit than the sovereign, in addition to which the PLN deal carried a longer tenor. It is the lowest coupon PLN has ever paid for a dollar bond and represents a 150 basis point spread over comparable-tenor conventional sovereign debt.

Despite its proximity to the sovereign deal – something another banker in the market described as “breathtaking arrogance in timing” – it attracted considerable interest, with $5.5 billion of orders from more than 200 accounts. Those close to the deal say it was not simply a method of mopping up excess demand from the sukuk, since the two were marketed in very different ways as reflected in PLN’s final distribution: European investors took 21% and US investors 35%, far higher than in the sukuk, while the Middle East was not a significant source of demand for PLN. Fund managers accounted for 64%, insurers and pension funds 19%, banks 7%, private banks 6%, and central banks and others 4%.

Those close to the deal say the timing was partly coincidence; a necessary revision to the documentation had only come through late on Monday New York time, and the bond was issued swiftly thereafter to take advantage of a brief window. It did, though, probably have an impact on the aftermarket performance of the sukuk, which started out trading up and dropped below par in the wake of the PLN issue (which traded up).

Structurally, the deal was interesting because it did not use a special purpose vehicle, as most Indonesian companies do and as PLN previously has. The SPV structure avoids a withholding tax charge, but PLN’s government ownership rendered that somewhat irrelevant. Ditching the SPV opened it up to a greater range of investors, according to people close to the deal.

IILM

The International Islamic Liquidity Management Corporation, a body designed to issue short term Shariah-compliant instruments to foster better liquidity management among Islamic banks, will issue its first bonds within “the first six months” of 2012, according to Dr Zeti Akhtar Aziz, Governor of Bank Negara Malaysia.

Dr Zeti was interviewed on Tuesday in Kuala Lumpur, one day before a crucial IILM board meeting that was expected to move the body closer to its first issuance. She said the meeting should approve the parameters for issuance, including allocation of assets against which the issuance will take place, and the appointment of primary dealers who will make the market. “We are very close,” she said.

In the wake of the financial crisis, many Islamic finance leaders – Zeti prominent among them – conducted a study of the industry to establish what risks it faced and what to do about them. The lack of liquidity was one of the main findings and led to the formation of the IILM in late 2010. “We saw during this crisis that liquidity became an important issue,” she said. “With the internationalization of Islamic finance, cross-border flows require short term instruments to effectively manage, not only in stressful conditions but in normal times.”

Zeti said there will be a program of issues like to be around $2 billion to $3 billion apiece, with regular issues through the year. A first issue will be smaller, “to test the system”. Issues can come in a number of currencies but are initially expected to be in dollars; the first, pilot issue, is certainly expected to be in the US currency. “They will be high quality short-term liquid instruments and will be in demand by other funds managing portfolios – even conventional,” she said.

Issuance will be from IILM itself, which is a corporation established and backed by 12 central banks (Indonesia, Iran, Kuwait, Luxembourg, Malaysia, Mauritius, Nigeria, Qatar, Saudi Arabia, Sudan, Turkey and the UAE) and two multilaterals (the Islamic Development Bank and the Islamic Corporation for the Development of the Private Sector) as shareholders. It is understood that a formal rating will soon be announced for IILM, a vital precursor to issuance and something Zeti described as “a long process”.

The need for IILM is likely to become particularly acute if world capital markets lock up in the wake of problems in Europe. “Almost the entire world uses Treasury bills: they are highly traded and can be used to manage the liquidity of any portfolio or any financial business,” she said. “For Islamic finance, there is no sovereign that issues short term paper of that nature, and therefore IILM was established. It took us two years of work.”

Other founders agree the start line is near but that there is more to be done. “We are still crossing the Ts and dotting the Is,” said Malam Sanusi Lamido Sanusi, Governor of the Central Bank of Nigeria. “There are still issues in terms of the rulings of the Shariah Council on what we can and can’t do and how it will be structured. We’re still going through the process of structuring IILM to get the kind of rating we would like to have. It will take a little time for us to be out there.”

NIGERIA

Nigeria is set to become a fixture in the Asian debt capital markets with plans for a Malaysia-domiciled benchmark sukuk and possibly a dim sum bond next year.

In an interview in Kuala Lumpur, Malam Sanusi Lamido Sanusi, Governor of the Central Bank of Nigeria, said the country had been receiving advice from HSBC and CIMB on a sukuk, although the banks had not been formally appointed onto a deal. “We would like to see if we can issue a sukuk next year,” he said, probably in the second half. “We think that anything from five to seven years should be good for an initial offering, with the amount $700 million to a billion. That gives the kind of liquidity you want, and it also fits the tenor for most of the Arab funds who are not interested in 10-year instruments” – a consideration which also affected the choice of tenor in this week’s Indonesian sukuk (see separate story).

“The European funds tend to go for longer tenors, the Arabs for shorter, but given where Europe is, it makes a lot of sense to structure something to the areas that have a lot of liquidity,” he said.

But although Middle East investors would be targeted, Sanusi said the sukuk would “most likely” be issued out of Malaysia. “The central bank of Nigeria has had a very strong relationship with Bank Negara since I became governor,” he said, partly because Nigeria had recovered from a domestic banking crisis by studying Asian responses to the financial crisis there and had decided Malaysia was the best role model. “The Malaysian Islamic finance market is obviously the most advanced at the moment in terms of product, size and innovation, and the natural place to be.”

As with many sovereign sukuks, the hope in Nigeria is that it would prompt corporate issuers to follow. “Capital markets generally work better if you have a sovereign benchmark, that’s my view.” He also said that sukuk markets appeared to show better pricing than conventional finance. “Italy is paying 7%, so if Indonesia can raise at 4.125%, that’s a reflection of the liquidity in the sukuk markets. There is increasing interest: once conventional fund managers accept sukuk it is almost a no-brainer, as a sukuk targets both conventional and Islamic investors so you’ll probably have tighter pricing.”

He said the likely projects that would underpin the sukuk would be infrastructure, and could include aviation assets.

Sanusi also said that Nigeria’s recent decision to put 5-10% of its reserves into RMB could pave the way to a dim sum bond. The shift in reserves, he said, “is a strategic decision and recognizes the fact that China has become a major trading partner for us. It recognizes the possibility of Chinese investments in infrastructure coming in to Nigeria, and opens up for me, from a central bank perspective, the possibility of coming to the RMB market for dim sum borrowing.”

He said there was a natural argument for RMB funding. “Think of it theoretically. If we agree to accept RMB in payment for oil sales to China, you immediately generate RMB cash flows. If you have long term contracts to supply crude oil to China, you could securitize those, and raise dim sum bonds; that pays for what infrastructure investments you require from China.

“You hedge the currency risk, you get finance, and come to a very liquid market where the yields are lower and the spreads tighter than you would get in Europe at this point in time.”

A wish to avoid risk-averse European investors as a source of funding appears to be driving these moves towards Asian markets. “It is extremely important for the country to look to Asia as one likely source of borrowing,” he added. “That’s why the sukuk market in Malaysia and dim sum market in Hong Kong are markets we believe Finance [the Ministry of Finance] should be looking at.”

BEA

The Bank of East Asia’s China subsidiary has issued RMB3 billion of financial bonds in China’s interbank bond market – the second tranche in a RMB5 billion program, following a RMB2 billion launch in March.

The interest rate was set at 4.81% for the two-year bonds, which provides a reflection of how market sentiment has changed through the year; the first tranche, with the same tenor, priced at 4.39%, albeit for a larger volume.

The joint lead managers on the deal were ICBC, CICC, UBS Securities and Bank of Communications, with CICC as bookrunner. They sold the bonds only to institutional investors.

KOFC

The week’s most significant deal from Asia was a $750 million 10-year bond issue from new Korean policy bank Korea Finance Corporation (KoFC), which proved that windows for issuance do still exist provided they are exploited swiftly.

Unusually among the recent run of benchmark dollar issues in Asia, this bond was supported chiefly by the USA, which accounted for 51% of the deal, compared to 36% for Asia (which had been the anchor to most of the recent benchmark deals) and 13% to Europe. The deal priced in the middle of the New York trading day on Tuesday, by which time a strong book worth $2.4 billion had been put together. It priced at 265 basis points over 10-year Treasuries, the tight tend of 265-275bp guidance. They pay a 4.625% coupon and were re-offered at 99.699 to yield 4.663%.

There were a host of challenges for this deal, most obviously the volatile market conditions and changing mood around Europe. “Investor sentiment was boosted by the resignation of Berlusconi, but there was still a lot of uncertainty in the market,” Bong Sik Choi at KoFC told Euroweek. “We did not care too much about pricing. We listened to our lead managers and took their advice.”

The lead managers were telling them that the deal’s success would be all about timing. “The key is to identify market windows, because the market is extraordinarily unpredictable,” says someone close to the deal. “Two weeks ago, the market was buying into the big European plan, allowing some big deals. Well, that market rally lasted 36 hours. The market is in such an unpredictable state that when you do see signs of stability overnight, and do not expect as much volatility through your execution day, you have to proceed quickly.” The deal priced as vital budgetary negotiations were taking place in the Italian parliament, which could potentially have damaged the deal but did not. “With hindsight, it was the only day of the week KoFC could have done a dollar deal. The next day turned out to be appalling.”

Pricing also raised an interesting discussion, firstly because most Korean financial issuers populate the five-year space – an obvious comparable in 10-years was an outstanding bond from Kexim, which was trading at around 240bp over at the time of pricing – and partly because of an inversion in the treasury spread curve, making 10-year funding cost-effective. There was little rival backchat about pricing; the deal tightened modestly after launch before widening with the rest of the market. “We are very satisfied with how the bond is performing in the secondary market,” said Bong. US appetite was key to the final pricing, in contrast to KoFC’s previous deal, a five-year dollar raising earlier this year, which had attracted very little US demand.

Another issue was name recognition. KoFC is not exactly new – it was established in October 2009 to take over the policy banking role of the Korea Development Bank – and is not a first-time borrower, but for investors in the US in particular there was a need to remind investors just how it fits in among the host of Korean financial sector borrowers. KoFC had met investors on a roadshow earlier in the year, which helped. “We mandated the deal in May, but we had a large amount of liquidity so we let other state-owned banks go first,” said Bong. “Commercial banks find it more difficult to tap the market.” But a lead manager adds: “The market doesn’t know KoFC that well. Among the wider public, a lot of them didn’t know the initial deal. It wasn’t like a new name, but there was a need for a fairly intensive marketing exercise. Investors got the message.” KoFC is strongly supported by the Korean government and is the major shareholder in KDB Financial Group, whose holdings include KDB itself and Daewoo Securities.

Bong said the 10-year funding was an important step. “This is our second bond issue and it was important for us to create a yield curve,” he said. “We could sell even longer-dated deals in future, but the average tenor of our assets is between three and five years, so this is already a good maturity for us.”

Bank of America Merrill Lynch, Credit Suisse, HSBC, Royal Bank of Scotland and Daewoo Securities were joint bookrunners and lead managers on the A1/A/A+ rated deal (Moody’s, S&P, Fitch).

It remains to be seen if there is scope for more new issues in these increasingly volatile conditions. ICBC was on the road in Europe in the early part of this week, having visited Hong Kong and Singapore last week, ahead of a planned Regulation S dollar deal; at the time of writing there was no sign of it coming, and it appeared the Chinese bank was not attracted by the pricing guidance being quoted to it by its lead managers.

The mood changes from day to day. “I was doing the rounds with borrowers yesterday morning telling them markets are fantastic,” says one DCM banker. “I’ve changed my mind now.” On one hand Italy’s problems represent an extremely serious problem, potentially far worse than Greece. “It’s a very real threat that every borrower has to acknowledge and there’s not much we can do about it,” says one banker. But on the other hand, bankers say that many funds investing in Asia – particularly hedge funds – have very large cash positions, having set money aside in fear of redemptions that have not, so far, happened. “The appetite for those investors to commit to new issues is strong: stronger than it was pre-summer,” says one banker. “So there are opposing forces at work. Where does that leave you? In a state where you avoid the days when the markets are focused only on Europe. When that volatility diminishes, new issues from the right names, with the right groundwork, the right maturity and the right pricing, are going to be very successful. New issues are the only game in town.”

Another banker urged issuers to be realistic about funding costs, in an apparent reference to ICBC. “Borrowers don’t necessarily understand just how dark a cloud there is over the market,” he said. “In 2007 the market shut down for five or six months and it was very difficult to raise money. We’re in much better condition than then, but even so, I don’t think I would want to be a CFO who turned down a billion dollars of funding over five basis points.”

LAFARGE

A RMB1.5 billion dim sum bond from Sino-French joint venture Lafarge Shui On Cement on Wednesday evening proved there is still life in offshore RMB – if the issuer is prepared to pay up.

The three-year deal came with a coupon of 9%, a far cry from the exceptionally low yields that were commonplace a year ago. LSOC itself is unrated, but its guarantor, and the 55% majority holder in the joint venture, is France’s Lafarge, which is rated Ba1/BB+ (Shui On Construction & Materials, or SOCAM, holds 45%). Indeed, those close to the deal claimed that 9% was an impressively low number in this environment: the most obvious comparable, Shan Shui Cement, which is rated BB-, was trading at a bid of 10.42% at the time the Lafarge deal priced, having been priced at 6.5% back in June. “If Shan Shui wanted to come to markets today, it probably wouldn’t have access,” argued one banker. “Or if it did, it would be paying well into the double digits.”

At this price, investors were keen; books totalled more than RMB5 billion from more than 100 accounts. The French connection accounted for a relatively high European distribution of 12%, alongside 16% into Singapore, with the rest (72%) sold in Hong Kong. Private banks were the largest constituent, accounting for 56% of the deal, followed by funds at 35%.

“It’s been an unbelievable 12 months for this market, going from practically no bonds available in the market – with investors chasing every deal coming out regardless of its credit rating and structure – to a very different environment today,” reflected someone close to the deal. “CNH appreciation has hit a few speed bumps; the idea that it will always strengthen and so make up for any credit quality concerns, folks have realised that’s not a robust approach.” While recent issues for CNPC and ICBC (in subordinated debt) have shown that the right mainland names can still attract a loyal following, this deal was testing appetite for something different: a high yield issue from a joint venture with a guarantee from a western corporate parent. Indeed, it can be argued the deal established a new asset class in CNH.

Citigroup, HSBC, Mitsubishi UFJ Securities and Standard Chartered were joint bookrunners on the deal. The issuer is the largest cement producer in southwest China with 2010 production capacity of around 30.5 million tonnes of cement from 20 plants, and three million cubic metres of concrete from six mixing plants. It had HK$7.9 billion of revenues in 2010, with a 4.6 times net debt/EBITDA ratio.

Banks report full pipelines ready to come to market in CNH, but say that these pipelines have become so widely known in the market that they are affecting investor expectations. “The markets are aware there is a decent amount of supply coming,” says one banker. “A number of Chinese names have gotten approval to issue here and the markets know there is a fair amount coming through. That awareness of the pipeline is driving the market down: investors are aware they have a lot of choices.” This has been reflected in higher levels of secondary market activity than used to be the case, as some investors have sold bonds in order to make room for new deals. “It’s more of a buyer’s market,” says one banker.

RMB COVENANTS

As reported in Euroweek this week, investors in offshore RMB bonds are increasingly demanding tight covenant packages before buying new issues – in stark contrast to the situation a year ago.

Bankers almost universally see a change in investor expectation here. The initial supply-demand imbalance in the market meant that, then, the norm was “an inefficient market, with longer tenor, looser covenants, and rates below which one could borrow in onshore RMB,” says one banker. “In the last few months, the market inefficiencies have narrowed as there has been pushback from investors and the forward curve for RMB appreciation has come down. There is stronger price and covenant discipline among institutional buyers in particular.”

He adds: “Covenants always move in cycles related to the strength of the market.”

But what exactly do these covenant packages entail? Lawyers tell Euroweek that a high yield covenant package on an offshore RMB bond today typically include restricted payment, debt incurrence, negative pledge, asset sales, transactions with affiliates and change of control. As investor sentiment has become more picky towards these deals, investors are sometimes calling for still more in covenant packages, including restrictions on M&A, dividend payments, and issuance of capital stock by restricted subsidiaries.

As the market has evolved, so too the nature of specific covenants have changed. Asia Aluminum, for example, was a relatively early issuer, and had a covenant saying that it was only allowed to incur working capital debt onshore. Lawyers considered that impractical for most operating companies, so later deals, such as from Fosun International, focused on the ratio of offshore liquid assets to offshore debt, rather than the overall quantum of debt. Another feature of market evolution has been that some issuers require far more covenants than others. The strongest domestic issuers, such as CNPC, have been able to get issues away as recently as last month with relatively light covenant packages compared to more high yield names such as Lafarge Shui On Cement.

One thing covenant packages can’t do a whole lot about is an intrinsic challenge with offshore debt securities: upstream guarantees. “In some high yield issues from PRC issuers, investors want the issuer to provide security over assets in China,” notes one lawyer in Hong Kong. “Unfortunately, under Chinese foreign exchange regulation, that is not possible. To the extent that investors need security – and very often we see deals are not secured – they will have to settle for offshore security.” Offshore security just means security over the assets of the offshore holding companies, which rarely equates to hard assets.

This problem is not distinct to RMB issues: it applies equally to dollar issues from mainland issuers. “But with RMB bond issuance there is an extra layer of regulatory issues separate from the security issues, and the biggest of them is the repatriation of proceeds,” says a lawyer.

Even if covenant packages do attempt to address this, they may not have a lot of success in practice. “It’s all very well for cash to be generated onshore by an operating company, but if there is a big cash trap in China whereby you can’t get the cash out, that’s not going to help foreign creditors who are typically holding debts incurred by the offshore holding companies,” says a lawyer.