1. 1 Regional Bond Markets: Rationale, Concerns and Roadmap S. Ghon Rhee K. J. Luke Distinguished Professor of Finance Executive Director Asia-Pacific Financial Markets Research Center University of Hawai ‘ i Presentation at US Central Intelligence Agency March 26, 2004 Asia-Pacific Financial Markets Research Center, University of Hawaii

2. 2 Two Questions 1.Are Asian bond market activities integrated with global market activities? 2.Why do we need a regional bond market? Asia-Pacific Financial Markets Research Center, University of Hawaii

3. 3 Reality Check of Regional Bond Market Activities (I) Fact 1: Active Participation of Asian Investors in Asian Bond Issues  71 bonds (US$41.2 billion) issued by Asian borrowers in April 1999-August 2002  44%-46% of these bonds were purchased by Asian investors Source: BIS Study (2002) Asia-Pacific Financial Markets Research Center, University of Hawaii

4. 4 Reality Check of Regional Bond Market Activities (II) Fact 2: Active Participation of Asian Borrowers and Investors in Singapore Bond Market  Bonds Issued (US$ Billion) 20022003 20022003 S$-bonds 10.42 11.11 (27% by Asian Issuers in 2002) (27% by Asian Issuers in 2002) Non-S$ bonds 11.06 22.75 (40% by Asian Issuers in 2002) (40% by Asian Issuers in 2002)  Who are the Buyers? Source: MAS Source: MAS Asia-Pacific Financial Markets Research Center, University of Hawaii

5. 5 Reality Check of Regional Bond Market Activities (III) Fact 3: Active Participation of Asian Investment Banks in International Bond Issues  Borrowers from 6 Asian countries raised US$53 billion, 1991-2001  1/3 of these issues: Asian investment banks Source: Park & Bae (2002) Asia-Pacific Financial Markets Research Center, University of Hawaii

6. 6 Reality Check of Regional Bond Market Activities (IV) Fact 4: Dragon Bonds Issued by Multilateral Financial Institutions  No Liquidity on the Secondary Market  Very Little Contribution to Bond Market Development Asia-Pacific Financial Markets Research Center, University of Hawaii

7. 7 Reality Check of Regional Bond Market Activities (V) Fact 5: Tokyo Market Fails to Serve Region ’ s Financing Needs  Foreign Currency-Denominated Bonds Virtually Non-Existent  Limited Role of the Yen-Denominated Bond Market during the East-Asian Financial Crisis Source: Rhee (2003) Asia-Pacific Financial Markets Research Center, University of Hawaii

8. 8 Gaisai Bond Market In Japan Unit: ¥ trillion Unit: ¥ trillion Japanese Number of Samurai Number of Shogun Japanese Number of Samurai Number of Shogun Fiscal Year Issues Bonds Issues Bonds Fiscal Year Issues Bonds Issues Bonds 1991 27 0.71 1 0.41 1991 27 0.71 1 0.41 1992 37 1.57 0 0 1992 37 1.57 0 0 1993 49 1.23 1 0.59 1993 49 1.23 1 0.59 1994 60 1.26 0 0 1994 60 1.26 0 0 1995 85 2.11 0 0 1995 85 2.11 0 0 1996 154 3.79 0 0 1996 154 3.79 0 0 1997 66 1.58 0 0 1997 66 1.58 0 0 1998 10 0.15 0 0 1998 10 0.15 0 0 1999 24 0.87 0 0 1999 24 0.87 0 0 2000 63 2.38 0 0 2000 63 2.38 0 0 2001 47 1.55 0 0 2001 47 1.55 0 0 2002 30 0.67 0 0 2002 30 0.67 0 0 2003 31 0.76 0 0 2003 31 0.76 0 0 Source: Japan Securities Dealers Association Source: Japan Securities Dealers Association Asia-Pacific Financial Markets Research Center, University of Hawaii

9. 9 Reality Check: Foreign Holdings of US Treasury Securities (VI) Asia-Pacific Financial Markets Research Center, University of Hawaii

10. 10 Asian Currency Figure 1 Regional Bond Market Asian Issuer Asian Investor Asia-Pacific Financial Markets Research Center, University of Hawaii

11. 11 Two Major Concerns: On- Going Initiatives for Creation of A Regional Bond Market 1.Strong Sense of Regionalism Bonds rated by Asian rating agencies Bonds issued by Asian borrowers and purchased by Asian investors Bonds traded, cleared, and settled in Asia 2.Strong Emphasis on the Public Sector ’ s Role Asia-Pacific Financial Markets Research Center, University of Hawaii

12. 12 As long as Asian borrowers issue bonds at the minimum cost and the majority of these bonds are purchased by Asian investors, does it matter? 1.Where these bonds are issued 2.Who rates these bonds 3.Who serves as lead managers 4.Where these bonds are traded 5.Where they are cleared and settled Extreme Regionalism can be costly and counterproductive Asia-Pacific Financial Markets Research Center, University of Hawaii

13. 13 Does It Make Sense? For the Public Sector to Spearhead: 1.Creation of a regional bond rating agency 2.Creation of a regional clearing and settlement system 3.Creation of a regional trading system How Do We Coordinate Roles of Public and Private Sectors? Asia-Pacific Financial Markets Research Center, University of Hawaii

14. 14 Regional Bond Markets Are Justified for Two Reasons Two Major Factors 1.Asian Common Currency 2.Credit Enhancements for Region ’ s Borrowers Asia-Pacific Financial Markets Research Center, University of Hawaii

15. 15 Asian Common Currency Lessons from EU: Major Benefit of the Euro for Europe ’ s Bond Markets Lessons from EU: Major Benefit of the Euro for Europe ’ s Bond Markets i.Elimination of Exchange Risk ii.Harmonization of Market Practices iii.Re-denomination of European Government Bonds in Euro …. A bigger, deeper, more liquid, and more homogeneous European bond market Full or Partial Currency Unification in the Region :Coordinated Monetary and Fiscal Policies? Full or Partial Currency Unification in the Region :Coordinated Monetary and Fiscal Policies? Regional Efforts are Missing! Asia-Pacific Financial Markets Research Center, University of Hawaii

16. 16 Credit Enhancements (I) Taniguchi Proposal (2003): ADB and JBIC serve as credit enhancing organizations? Asian Bond Fund (ABF) by EMEAP (2003) Useful only for Demand Side of Equation but Too Small ASEAN+3 Proposal (2003): Asian Basket Currency (ABC) Bonds Good Idea for Supply Side but Operational Framework Missing Asia-Pacific Financial Markets Research Center, University of Hawaii

17. 17 Credit Enhancements (II): Creation of Asian Bond Bank Modeled After the Municipal Bond Banks in Canada and the United States Successful Examples: a.Bond Bank of Alaska b.Municipal Finance Authority of British Columbia Source: Rhee and Stone (2003) Asia-Pacific Financial Markets Research Center, University of Hawaii

18. 18 Asian Bond Bank (I) Major Benefits of ABB 1.Economies of Scale in borrowing cost 2.Greater liquidity with larger size bond issues 3. “ Credit rating arbitrage ” : ABB re- lends funds raised at its higher credit rating to participating Asian borrowers through structured debt issuance Asia-Pacific Financial Markets Research Center, University of Hawaii

19. 19 Asian Bond Bank May Implement One or More Credit Enhancing Programs (II) A.Internal Enhancements a.Cash Reserves b.Structured Bond Issue: Collateralized Bond Obligations c.Sinking Funds Asia-Pacific Financial Markets Research Center, University of Hawaii

20. 20 Asian Bond Bank (III) B.External Enhancement i. Third-party Guarantees: Multilateral Financial Institutions ii.Letters of Credit: Commercial Banks iii. Bond Insurance: Monoline Bond Insurers C.Let ABB Bear Foreign Exchange Risk Asia-Pacific Financial Markets Research Center, University of Hawaii

21. 21 US Economic Leadership is Missing in Asia Asia-Pacific Financial Markets Research Center, University of Hawaii US is Absent from Various Asian Bond Market Initiatives 1.Lost Business Opportunities 2.Image of Uninterested Economic Partner

22. 22 APEC Regional Bond Market Initiative Component 1 Component 1 A comprehensive approach to development of regional bond markets Led by:MOF (Thailand), ADB, World Bank Component 2 Component 2 Development of securitization and credit guarantee markets Led by:Hong Kong, Korea, and Thailand Component 3 Component 3 Development of new products Asia-Pacific Financial Markets Research Center, University of Hawaii

23. 23 ASEAN + 3 Initiative (I): Five Working Groups 1. New Securitized Debt Instruments (Thailand) 2. Credit Guarantee Mechanisms (Korea) 3. Foreign Exchange Transactions and Settlement System (Malaysia) 4. Issuance of Bonds Denominated in Local Currencies by MDBs, Government Agencies and Asian MNCs (China) 5. Local and Regional Rating Agencies (Singapore and Japan) Asia-Pacific Financial Markets Research Center, University of Hawaii

24. 24 EMEAP Initiative: Asian Bond Fund Executives ’ Meeting of East Asia and Pacific Central Banks ( 11 Members (Australia, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, New Zealand, Philippines, Singapore, and Thailand) Executives ’ Meeting of East Asia and Pacific Central Banks (EMEAP): 11 Members (Australia, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, New Zealand, Philippines, Singapore, and Thailand) a.ABF with an initial size of US$1 billion b.Invest in US dollar-denominated bonds issued by Asian sovereign and quasi-sovereign issuers c.BIS: Manager Asia-Pacific Financial Markets Research Center, University of Hawaii

25. 25 Pacific Economic Cooperation Council Finance Forum Tripartite Organization : Tripartite Organization : Government, Business, and Academia Inaugural Meeting Inaugural Meeting July 2002: Honolulu, Hawaii 2 nd Annual Meeting 2 nd Annual Meeting July 2003:Hua Hin, Thailand 3 rd Annual Meeting 3 rd Annual Meeting June 2004: Santiago, Chile Asian Bond Bank proposed Asian Bond Bank proposed Asia-Pacific Financial Markets Research Center, University of Hawaii

26. Thank You! For Further References, Please visit http://www2.hawaii.edu/~rheesg Asia-Pacific Financial Markets Research Center, University of Hawaii