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Saturday May 12, 2012

ETB brings bond market excitement

By TEE LIN SAY
linsay@thestar.com.my


THE introduction of the Exchange Traded Bonds (ETB), which is aimed at providing issuers with access to a new segment of retail investors, has certainly garnered some excitement across the bond market.

While most bond players feel it will add to the vibrancy of the market, liquidity and depth will continue to be challenges that the regulators need to address.

In 2010, the Finance Minister announced in the 2011 budget that Bursa Malaysia would launch a sukuk and conventional bonds trading platform to meet retail investors' demand for debt securities.

Bursa Securities has been tasked with providing a platform to increase vibrancy and liquidity to allow the retail market to tap into the Malaysian bond market.

Certainly, the size of the ringgit bond market has increased considerably from RM385.2bil in May 2005 to over RM800bil by the end of last year.

The ringgit bond market is expected to grow further in view of the ample liquidity within the financial system. There will be a continuous need for investment in bonds given a nation that encourages savings.

A compelling reason for Bursa Securities to offer ETB is to provide efficient and transparent access to investment in fixed income market to non-sophisticated investors, mainly the retail investors.

Having an ETB framework allows investors an alternative other than which provides a higher return from their typical plain vanilla bank deposits.

Currently the over-the-counter trading market for fixed income securities is inaccessible to retail investors and the only exposure they get to bonds is through the bond funds which carry upfront fees and yearly management fees.

Previously, bonds were only available to high net worth individuals and corporations. With the ETB, public investors can now participate in this investment opportunity.

“Investments in sukuk and bonds have generally been regarded as lower risk instruments compared with equity securities. Thus, the availability of a new class of sukuk and bonds fulfil the appetite of retail investors for lower risk instruments. The introduction of sukuk and bonds to be invested by retail investors opens up a new world of fixed-income investment alternatives which is able to provide higher returns compared to the current vanilla bank deposit offerings,” says Bursa's consultation paper in relation to exchange traded bonds.

Once on an exchange platform, ETB may be accessed by not only retail but also institutions that may require transparency of bid ask quotes and a reliable clearing and settlement system.

“For the issuer, the benefit is that there is a new class of investor. The ability to structure a retail offering provides further flexibility to issuers in fund raising exercises, especially for high profile issuers and projects,” says Bursa.

For the investor, there is a new class of investments.

What is being proposed now is that a minimum rating is to be prescribed by the Securities Commission from time to time.

For the local bonds, perhaps a minimum local rating of AAA and AA. While for the international bonds, a minimum rating of BBB and above.

These bonds will include Malaysian government securities, private debt securities and medium term notes.

Feedback from bond players

Michael Chang, who oversees US$1bil as head of fixed income at MCIS Zurich Insurance Bhd says the ETB will be an avenue for retail participation in the growing bond market in Malaysia.

“It is a good or rather strategic initiative as it would allow retailers to invest in bonds and maybe participate in a meaningful manner as these new group of investors grow. It will suit investors who are interested in alternative to fixed deposits at the same time fetching a higher yield and relatively lower risk than investment in equities. A bond exchange that is opened to the retail market will also encourage competitive pricing to the issuers of those bonds,” he said.

CIMB senior analyst for fixed income Nik Ahmad Mukharriz feels the creation of the ETB platform will definitely provide a larger pool of investors for the bond market, although the amount of funds to be raised by them may be small.

He feels that it will take some time before investors familiarise themselves with the bond market.

“Generally in Malaysia, retail investors are not familiar with bonds. It will take a couple of years before the buying and selling of bonds is as smooth as it is with equities. The development of the retail bond market will also depend on the brokers. Are they fast learners and will they be able to market the bonds to their clients?” asks Nik Ahmad.

Nik Ahmad says that currently, some banks are already allowing investors to participate in bonds, with smaller than the standard amount required such as the denomination of the bonds. Typically, for a person to invest in bond, a minimum of RM5mil is required. Nik Ahmad says certain banks divide up the tranches of the bonds for their investors into much smaller sizes.

“However the problem comes when an investors wants to sell a bond. Say for example the investors wants to sell RM100,000 worth of bonds? Then the bank will have to look for buyer to take that up. That's quite difficult. So the ETB could help solve this bid and ask problem,” says Nik Ahmad.

Hwang Investment Management Bhd head of fixed income Esther Teo says retail participation is not significant enough to drive liquidity and depth in the market as bond is still an institutional game due to the large sum involved.

“Trades are done in hundreds of thousand ringgit per pop. Besides, there is not a ready market for ETB just yet as the fixed income asset class is relatively unknown in the retail space. However, we are optimistic that over time, when retail investors gain a better understanding of this asset class, warm up to the idea of investing in bonds and the demand starts to gather moss, then yes, the collective pool of trades from the retail investor in ETB can create depth and liquidity in the bond market” says Teo.

Chang adds that the ETB will add market depth as it will be able to reach a new investor group who is keen to invest but has no direct investable option unless via unit trust bond funds or private banking.

“However in terms of improving market liquidity, I am afraid not, as most retail investors will be looking at absolute yield terms for investment in bonds. In short, if it is a credit-worthy issuer, these investors are likely to invest by locking in the offered yield and to hold to maturity of the bond investments. It is unlikely that this retail participation would trade actively, unlike institutional investors who have different investment and duration rebalancing requirement across time,” says Chang.

Nik Ahmad adds that the main things the ETB platform will need to look into to ensure smooth trading will be liquidity and pricing. Hence the provision for market makers.

Under the proposals for the ETB, Bursa Malaysia is reviewing the rules for market makers

Bursa Securities is proposing to clarify the rules to specify that where appropriate, Bursa Securities could modify the application of the rules to market makers and impose terms and conditions in relation to the registration of a market maker.

Chang says there will be some challenges in setting up the ETB.

“In terms of pricing, what's traded in the ETB and OTC market for the same bond issuer should be about the same price; given that credit risk and interest rate volatility are the same. If there is a difference due to liquidity, which one of them should be the fair market price and is ETB likely to follow what's done in the OTC market given that its volume is expected to be more sizeable? Rightfully, it should trade relatively close to the OTC price if it is dealt on a standard lot as it is more reflective of what the market would pay for a given bond,” he explains.

Teo says that publicity and an education campaign is the first order of business ahead of opening the bond market to the retail investor.

“A lower entry level to make investing in bonds more accessible to the man-on-the-street will make the ETB more attractive. For institutional investors such as the local and foreign fund managers, a lower bid-offer spread, transparent pricing platform and more diverse issuers to supply corporate and government bonds will make the ETB more attractive. The European bond market will be a good model to emulate,” she says.

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