Liberalisation won’t help all bond issuers

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KUALA LUMPUR: The plan to liberalise the Malaysian bond market come 2017, touting cost-efficacy, may in fact prove more detrimental to small and medium bond issuers.

“The move will help the development of the bond market to a certain extent but not for the small- and medium-sized companies or issuers. Actually, in terms of cost it is quite the reverse,” Charanjeev Singh, managing director of New Paradigm Capital Markets Sdn Bhd, told The Edge Financial Daily.

At Invest Malaysia 2014 held last week, Prime Minister Datuk Seri Najib Razak announced that effective Jan 1, 2017, the mandatory requirement for credit ratings will be removed in the hope of broadening the corporate bond market.

“Ultimately, the liberalisation will enable the Malaysian bond market to become a more cost-effective and attractive long-term financing platform,” said the premier.

But according to Charanjeev, while the actual cost of issuing bonds would be reduced as a result, the overall cost for small and medium companies could actually be higher.

“The cost of issuing a bond is one thing. But the credit rating gives transparency and it helps the issuers price their bonds — to get a feel of where they are,” he said.

“If you don’t have a rating, any investor with a profit motive will price the bond [yield] as high as possible. The reasoning is that when a bond is unrated, it is illiquid, thus it [its yield] will be priced higher resulting in it costing more to the issuer. So having a rating actually saves money,” said Charanjeev.

Charanjeev believes the issue comes down to liquidity. The big players, usually institutional funds, are generally unwilling to participate in an issuance if there is low liquidity. But again, these funds are subject to their own set of investment mandates.

“Our bond market is largely catered to institutional investors who by their own investment mandate have to buy high-quality, investment-grade bonds,” said a local bond expert.

“The bond market in Malaysia is well-established, but because of this it is skewed toward higher rated paper and very little lower investment-grade paper. It is not an all-encompassing financing environment.”

With a limited variety of bonds in the market, there are few offerings for retail investors, who make up a small portion of the bond market. “So until we get more retail investors involved in the market, then it wouldn’t really mature because it is quite niche in its offerings,” said the bond expert.

Another problem for retail investors in a not yet mature market is assessing and valuing the bonds.

“If the market is not mature enough by 2017, there may not be sufficient take-up because investors are wary of not having a credit rating attached to the bonds. That could stifle the market.”

This creates something of a paradox for small and medium firms that are now able to enter the liberalised market because without the stamp of approval a credit rating provides, investors may not have the confidence to take up the bonds.

“The risk is if it is not a well-known issuer, without a credit rating and transparency, investors will not be able to make a solid assessment and it really won’t be picked up. This is a kind of safeguard in itself.”

These risks are mostly isolated to newcomers and the smaller issuers as opposed to the well-established ones who already have a stable reputation.

“So it could be a riskier environment for investors if we are unable to reach a level of maturity where investors are capable of making decisions on their own. It is entirely possible that issuers may revert back to credit ratings if that is the only way their bonds will be picked up,” said the expert.

At the end of the day, it could in fact depend on investor sentiment how relevant credit ratings become beyond 2017.

“The removal of mandatory credit ratings is not going to help because as long as the big boys are not going to buy unrated bonds, there won’t be a real market for them,” he said. It is not likely that these institutions will alter their own investment guidelines to include unrated bonds.

“It is not a familiar market to retail investors. We need to build confidence first and for that we need the institutional market,” Charanjeev said. This article first appeared in The Edge Financial Daily, on June 16, 2014.