Regulator mulls options for Formosa market

A regulatory clampdown on Formosa bonds with short-dated call options has hit issuance volume, but market participants are hopeful new products will satisfy ongoing demand for higher yielding investments than are currently on offer in Taiwan’s local currency bond market.

Taiwan’s Financial Supervisory Commission (FSC) banned Formosa bonds with call options of less than five years in late May. The decision had an immediate impact on international issuers since they had largely been attracted to the market in the first place due to the cost savings such bonds offered.

However, demand for higher-yielding instruments has not gone away, but only intensified, as Fubon Life’s first-quarter results demonstrated. The Taiwanese insurance group’s returns were hit after a large number of bonds were called away ahead of the deadline. Fubon said this was the main reason why its pre-hedged recurring yield decline by 64 basis points quarter-on-quarter to 3.01% from 3.65% during the period.

It needs new instruments to invest in to boost it back up again.

Moody’s vice president Frank Yuen believes international issuers will return to the Formosa bond market, but says local insurers will probably have to cede a few more basis points to lure them back.

“When you’re competing against a large global liquidity pool, then you need to incentivise issuers to come,” he said. “Now that issuers can’t monetise the short-dated call option any longer, they may want to shave a few basis points off the initial yield instead.”

The Taiwanese government has a number of options, including loosening its 45% foreign investment cap, although it is already more generous than Korea’s at 30% and China’s at 15%.

The trio have a cap, because all three share a history of capital controls. These controls have been progressively loosened since 1990’s, but vestiges still remain and in other developed markets, life insurers are not bound by the same international investment restrictions.

Annemarie Ganatra, head of Global Medium Term Notes at Standard Chartered, believes 30-year non-call five issues will become the new normal for Taiwanese life insurers to invest in and issuers will adjust.

Their Korean counterparts have a wider range of options in the Reg S market. Ganatra said they tend to invest in a mix of range accruals, fixed callables, and callable zero bonds, often with one-year call options, which are now outlawed in the Formosa market.

“The two investor bases have different preferences in terms of credit exposure," she said. “Korean insurers tend to buy higher-rated paper from a narrower group of issuers.”

“They also entertain structures where the accretion is linear rather than compounding,” she continued. "This makes the internal rate of return look optically higher. However, the end pay-out at maturity is the same.”

Market participants said the FSC is also considering a number of proposals to widen the Formosa bond market’s investment options.

Formosa bonds go green

One new type of deal seen earlier this month was executed by Credit Agricole, which launched the first green bond by an international issuer. Acting through Credit Agricole Corporate & Investment Bank (CACIB), the A1-rated credit raised $120 million from a five-year deal with a 2.64% yield. 

Bankers said local investors are petitioning the government for tax incentives to buy green bonds, although so far the government has not indicated it is willing to listen.

Back in Europe, Credit Agricole has also pioneered another type of new structure, which is now under consideration in Taiwan: non-preferred senior debt. Last December, the French bank launched the world’s first senior unsecured bond, which becomes loss absorbing in the event of the bank’s resolution.

Such bonds would appeal to Taiwanese life insurers because they tend to price about 30bp above straight senior debt. However, bankers said Taiwan’s FSC is unlikely to release guidance until Europe has smoothed out a number of kinks, not least whether the structure should be classified as senior or subordinated debt in global bond indices.

Taiwan’s FSC is also considering allowing sukuk issuance, according to market participants, who expect guidance before the end of the year. Bankers are also hopeful the regulator will allow insurance companies to join banks in being able to issue tier-2 debt.

They are also waiting for it to expand the eligibility list for offshore bank branch issuance. Banks are only allowed to issue Formosa bonds if their common equity is listed on certain designated exchanges. But these do not include some major markets including Brazil and India.

Dual listings

Another increasingly common feature may be dual listings. So far this year, Standard Chartered has executed two deals for Korean banks with dual listings in Singapore and Taiwan; one for a European bank in Amsterdam and Taiwan and one for a Latin American bank in Luxembourg and Taiwan.

Ganatra says the two jurisdictions complement each other well.

For example, the Taiwanese investment community normally gives accurate demand indications, enabling banks to build firm order books of anywhere up to $250 million to $300 million.

“If issuers want to raise more than this then it makes sense to add an offshore Reg S component as well,” Ganatra said. “The Taiwanese investors anchor the deal and provide a good base for international investors, who typically wait to see how momentum is building before they come in.”

The strategy enabled both Kexim and Kookmin to build $1 billion-plus order books in the past few months.

Kookmin’s A1/A+/A rated deal priced at 95bp over three-month Libor in late May and is now trading at around 87bp over. Its $400 million deal had a split between 56% onshore/44% offshore.

Ganatra said Taiwanese investors have a sweet spot for single A or high BBB rated names priced between 80bp to 100bp over Libor.

But Moody’s Yuen noted that more life insurers are moving further down the BBB scale to pick up yield at a time when investment grade spreads have compressed to historically tight levels. However, they have not ventured far into the high yield space. 

Portfolio configuration

Life insurers are also re-tuning their investment portfolios by boosting the equity component. Back in 2015, equities typically comprised about 8% to 9% of the overall portfolio. In the first quarter, Fubon reported a 15.6% allocation.

They are also making room for more foreign currency exposure by selling more US dollar-denominated insurance products. Yuen expressed surprise at how popular the latter have proven with the Taiwanese public, given the New Taiwan dollar appreciated by 6% against the US dollar during the first quarter, but attributes it to enhanced marketing and promotions.

The US dollar partially recovered in June, only to resume its downward slide again in July. This means insurers are unlikely to have been able to shave much off the 1% to 1.5% they typically paid for short-term FX hedging during the first quarter.

But they might yet benefit from moves in the government rates market. Analysts expect US Treasury yields to rise, but Taiwanese rates to decline or stay flat. This should finally help an industry, which has learnt its lesson and today only offers guaranteed products with payout rates no higher than 2%. 

Source: Dealogic