Asia’s equity-linked market is undoubtedly going through a difficult period.
The asset class, which broadly includes convertible bonds, exchangeable bonds and other structured products, is struggling from both demand and supply side.
With dedicated funds and new issuance both on the decline, Asia’s equity-linked market is gradually drying out.
With the exception of Japan (which is often seen as a standalone market), there were about $3.9 billion worth of equity-linked securities redeemed or converted since the beginning of the year, compared to $5.8 billion for last year, according to Daiwa Capital Markets.
The nearly one-third decline in redemptions implies a similar drop in demand for new paper, as most equity-linked funds typically reinvest their redeemed money back into new deals.
From the supply side, the decline is even more vivid. Total new issuance amounted to $3.1 billion in the first nine months, half the $6.2 billion in the full year of 2016.
Nearly one-third of the volume came from a single deal – Shanghai International Port’s $1 billion exchangeable bond into Postal Savings Bank of China.
As a result of the decline in both redemption and new issue, the Asia ex-Japan market is shrinking rapidly – there were only $21.8 billion worth of outstanding equity-linked securities as of early August, dropping nearly a third from $30 billion at the end of 2014.
And there are other clues that show the market is struggling.
Shutting desks
Contrary to a few years ago, there are now only a handful of bulge-bracket investment banks with dedicated equity-linked origination and sales desks.
Some banks have incorporated the equity-linked business into bigger departments like equity financing or leveraged finance, while others are running equity-linked deals with junior staff in the absence of a senior banker.
“It is a very opportunistic business,” said one head of equity-linked at a bulge-bracket bank. “You can put together a deal within weeks, but you can also struggle to find a single deal in a year, or maybe more.”
With the number of deals falling and a lack of visible pipeline, many banks have not found it cost-effective to maintain a team of equity-linked bankers.
However, due to the fact the business involves a complex structuring and pricing process, the lack of experienced rainmakers mean it is more difficult for banks to give proper advice to prospective issuers, thus creating a vicious cycle for the entire market.
Complicated structuring process
By nature, equity-linked deals are harder to originate and execute because of the need to take into consideration both the equity and debt side of the business. Typically, convertible and exchangeable bonds act as a low cost funding alternative against debt financing, while providing hedging opportunities for bondholders against the underlying equities.
As such, more preparation is needed from a structuring perspective. The issuer has to pre-arrange a stock borrow facility for bondholders to conduct equity hedging – buying equity-linked bonds and short-selling the underlying equity in the open market.
Sometimes, the issuer needs to provide an asset swap – an instrument that allows bondholders to offload the credit portion and keep the equity option only. At the same time, issuers may have to secure a credit rating (although this is not mandatory) before selling equity-linked bonds, which makes it a slower process compared to straight equity financing.
All these suggest structuring an equity-linked deal is time-consuming, which bankers attribute as part of the reasons that the asset class is not as popular as other straight-forward fundraising methods.
One equity-linked banker said it is often difficult to pitch a new deal to a company CFO because he may not be familiar with the asset class. That also explains why Asia’s equity market is often dominated by repeated issuers such as CapitaLand and Ctrip.
From an issuer’s perspective, the current low interest rate environment also reduces the attractiveness of an equity-linked product because it is easy to find cheaper funding alternatives elsewhere.
In face of the deal drought, bankers are dropping standard formats and changing the way deals are structured, bringing in new elements that cater to the needs of both issuers and investors.
In a forthcoming article, FinanceAsia will look at some of the uniquely-structured deals that found successes over the last two years.
