Korea Capital Market Institute

Needs of Cross-border Bond Market in Asia Asian countries have developed and nurtured their bond markets by addressing the problems related to currency and maturity mismatches that were pointed out as the primary cause for the Asian financial crisis in 1997. At the same time, however, they accumulated huge foreign exchange reserves to brace for a future financial crisis, and invested the reserves in US treasuries which are highly liquid and safe assets. When the recent global financial crisis caused a dollar shortage in international financial markets, Asian countries had difficulty in securing liquidity. As part of their attempt to alleviate the problem, they signed into a currency swap agreement with the US Federal Reserve rather than turning to the regional safety net, CMI. This eventually increased Asia’s dependency on the US dollar. Despite regional financial collaboration, the creation of financial safety net, and the development of bond markets, the primary reasons why Asian countries face limitations of bond market development are the following. 1) Asian countries` high dependency on the US dollar, and 2) the premature cross-border financial intermediary function in the region. Therefore Asian countries now have incentives to reduce their dependency on the US dollar, and to use their own currency in international transactions such as settlements for trades and cross-border bond issuance. This is well reflected in China`s recent attempts to internationalize its currency, the yuan. To further develop bond market in the reigon by facilitating the cross-border transaction and bond issuance of Asian currencies,the first step toward an advanced cross-border bond market is to allow offshore currency transactions and cross-border bond issuance based on financing needs that can overcome the different rule and market practices in each nation. To make matters worse, since the Asian financial crisis, many Asian nations have banned or controlled offshore transactions of their currency and cross-border issuance of bonds denominated in their currency amidst growing concerns that those transactions might destabilize the currency value. Contrary to the concerns of the authorities, our empirical results demonstrate that cross-border transaction lowers exchange rate instability and that foreign exchange rates are not affected by overseas bond issuances. This shows that a large scale and liquid foreign exchange markets could contribute to stability of the currency by lowering the volatility due to the economies of scale. Therefore intentionally regulating the foreign exchange market might reduce the market efficiency and deter the financial market development. Developing Cross-border Bond Markets in Asia It is important to develop domestic bond markets however, what is more important and challenging is to develop the regional bond market which can circulate regional savings glut within the region. It is necessary making efforts to simultaneously develop regional bond markets as well as domestic bond markets in line with the global market trend. Also necessary is a concerted effort by each nation to integrateAsian markets so that each nation can go beyond the limits of its small domestic market and enjoy the benefits of the scale of economy and abundant liquidity. In an integrated market, participants can issue bonds based on a single standard and regulation. This will help expand investment opportunities and reduce costs from issuing and trading under multiple different regulations. Eventually, market integration is beneficial to every nation in the region. Unlike Europe, Asia has no integrated body to make political decisions. Forming an integrated market in Asia by harmonizing different regulations across nations is both politically and legally challenging. Rather than trying to harmonize each nation’s regulations, Asia needs to establish a single set of rules and a uniform standard. This will help Asia establish a flexible offshore market governed by market participants’ self-regulation, and thereby improve the efficiency of market. In order to address those challenges and to develop cross-border bond markets, ASEAN+3 governments established, in September 2010, the ASEAN+3 Bond Market Forum (ABMF), through which they can discuss ways to standardize cross-border bond market practices and regulations. In addition, Asia established the common bond market infrastructure, the Credit Guarantee and Investment Facility (CGIF). The establishment of regional bodies such as the Regional Settlement Intermediary (RSI) and the New International Credit Rating Agency (NICRA) are in discussion. With these regional financial cooperation and continuous efforts, Asian bond markets have gained more economic importance at the global level as well as the regional level. Policy Implications As demonstrated in the recent global financial crisis, Asia’s bond markets are still not developed enough to effectively channel the regional savings glut into investments in the region. There are many reasons behind this, but particularly, the absence of a cross-border bond market in the region such as US 144A market or Eurobond market is one of them. Therefore, in line with the efforts to develop each nation’s bond market, East Asian countries should establish a regional cross-border bond market that can play a stronger financial intermediary role within the region. To do so, not only the governments, but also the private sectors in the region should participate and cooperate. Recently, China attempted to internationalize its currency, and other smaller nations such as Hong Kong, Singapore, Australia, and New Zealand have already internationalized their currency or liberalized foreign currency transactions, implementing successfully their role as competitive financial centers in the global financial markets. Korea has been no exception to this trend. As part of its master plan to become a northeast financial hub, Korea is trying to internationalize its capital markets and the Korean won. However, the recent global financial crisis has put off, albeit temporarily, Korea`s plan. The time is right for Korea to consider the establishment of Asia’s cross-border bond market and allowing the Korean won to be flexibly traded in the regional cross-border market in order to develop Asia’s bond market and to improve the competitiveness of Korea’s financial industry.