In FY 2016, Japan’s net external assets rose to ¥349tr ($3.12tr). That did not quite match the record of ¥363tr set in 2014. But it was well ahead of China’s ¥210tr, according to the Ministry of Finance’s data, meaning that for the 26th consecutive year, Japan was the world’s largest creditor — a position it looks likely to retain for some time yet.
While much of Japan’s excess liquidity, especially from the megabanks, has been channelled into US Treasuries in the past three years, little appears to have found its way into the sovereign, supranational and agency bond market in recent months. This is especially true of euros, which have played a bigger role in the overall funding programmes of a number of top quality borrowers this year. “We’ve seen very little take-up from Japan this year in euros, which has been very frustrating,” says one London-based SSA head.
SSA bankers say there are three reasons Japanese demand for even the top-quality credits in euros has been muted over the past year or so. The first was concerns over European politics in general, and the prospects for far-right parties at the Dutch and French elections in particular. “In the early part of the year there were indications that Japanese investors were selling French bonds in advance of the elections in France,” says one banker. “More generally, political risk made them cautious on euros in the first few months of 2017, although the selling stopped after the French elections.”
A second dampener of demand from Asia in general and Japan in particular has been the lengthening of maturities in the euro SSA market, which has seen substantial supply at the very long end of the curve, where borrowers such as EFSF have generated strong demand from yield-starved European institutional accounts.
“It’s true that there are a number of Japanese insurers looking for duration,” says one London-based syndicate head. “But by duration they generally mean maturities of seven to 10 years, where they have historically been large buyers in euros.”
The third and most obvious deterrent for Japanese investors in the SSA market for euros, say bankers, has been absolute yield levels. “We rarely see Japanese demand for euros or sterling, because the headline yields are low and on an after-swap basis they are even less attractive to Japanese investors,” says David Hague, managing director, DCM origination at Nomura in London.
A caveat about Japanese demand for euros, say bankers, is that their participation in the primary market is not necessarily the most accurate barometer of their appetite. “Japanese investors tend to be more active in the secondary market, where they can be more selective about timing to ensure the cross-currency swap is aligned with their return targets,” says one DCM head. “So the fact that there is not always a big allocation to Japanese investors in new issues does not necessarily mean they are not buying euro paper.”
Certainly, misgivings about the credit quality of eurozone issuers seem to have dissipated in recent years. “We visit Japan every year, but we have not yet specifically targeted the Japanese investor base,” says Rodrigo Robledo, head of capital markets at Spain’s Instituto de Crédito Oficial (Ico) in Madrid. “This is because up to now our issuance has been focused at the short end of the curve, between two and four years, whereas Japanese institutional demand is at the medium and long end of the curve.
“Later this year, when we are able to start printing in five and six year maturities, I’m sure we’ll be able to do something in Japan. All in all, Japanese investors are very constructive about Spain, and we expect to see rising demand for Spanish credit from Japan, especially if the ratings agencies upgrade the government to A-. This will be a game changer for Japanese demand for Spain.”
Intermittent demand
for SSAs in dollars
Japanese demand for SSAs in the under-supplied dollar market has also been little more than intermittent in 2017. “One of the reasons there has been low issuance in 10 year dollars is that there has been so little Japanese interest,” says one London-based banker. “In order for us to justify recommending 10 year trades to issuers, we’re conscious that Japanese demand is key.”
The same banker adds that on the rare instances when SSA borrowers have provided supply at the 10 year point on the dollar curve, Asian demand has remained robust. The most striking illustration of this came at the end of June, when the Inter-American Development Bank (IADB) generated demand of $3.5bn for its largest ever dollar benchmark. More than 30% of this $2.3bn issue was placed in Asia, with one London banker saying that healthy Japanese take-up was driven by elusive favourable relative value dynamics with JGBs. Be that as it may, Japanese demand was by no means the driver of the issuer’s choice of maturity, accounting for a modest 6% of total placement, according to IADB’s head of funding, Laura Fan.
This year has seen the usual name-specific demand in dollars for Japanese public sector banks, which are always guaranteed a warm welcome by Japanese institutions. Comfortably the biggest Japanese issuer in the international bond market remains Japan Bank for International Co-Operation (JBIC), which has twice issued multi-tranche $5bn benchmarks this year, including 10 year portions in both cases. JBIC generated demand of $14bn for its trade in May and $16bn for its July issue.
While the SSA market has sometimes struggled to provide the sort of yields Japanese investors need, at least some of the slack has been taken up by financial institutions, principally in US and Australian dollars. Nomura’s Hague says that Japanese demand for MREL and TLAC-eligible debt in US dollars has been especially encouraging.
“Historically, Japanese demand has been focused on US dollar senior unsecured and RMBS,” he says. “But as compression in spreads in those products has made returns increasingly hard to find, they have become more involved in MREL and TLAC issuance. We’ve seen some price sensitivity from Japanese investors when prices have tightened for some of the best bid FIG issuers in dollars. But they are comfortable with how the product works in stress scenarios and with where it sits in the creditor hierarchy, so the investment decision is generally based on relative value on a currency adjusted basis.”
The magic trinity
Japanese investors, says Hague, also remain a key part of the investor base for financial institutions in Australian dollars. Robust demand in the seven to 10 year part of the Australian dollar curve, he says, has been fuelled by the magic trinity of strong issuer credit quality, a shortage of alternatives in yen and appealing absolute coupons.
The Japanese investor base in Aussie dollars has also traditionally been an especially important source of diversification for SSA borrowers such as Rentenbank. Stefan Goebel, managing director and treasurer at the German public sector bank’s Frankfurt headquarters, says that demand for Aussie dollars in the five to seven year range is still strong among asset managers in Japan.
But it is Japanese insurance companies that have been the principal engines of demand for Aussie dollar issuance at the longer end of the curve, which has underpinned a recent uptick in supply in the 15 year maturity. The World Bank printed the first 15 year benchmark in Aussie dollars last November, while this year the IADB and Asian Development Bank (ADB) have both followed suit.
James Holian, head of Asian syndicate and MTNs at Daiwa Securities Capital Markets, says that while Japanese lifers have underpinned activity in longer-dated SSA issuance in Aussie dollars, FX buyers have also been a significant source of demand. “When the Aussie dollar-yen rate headed towards 82, we saw some of the 10 year issuance from SSAs bought in quite chunky size by Japanese funds with a view to crystallizing FX gains at some time in the future,” he says.
An important by-product of robust demand for SSAs at the longer end of the market for Aussie dollars as well as other currencies, adds Holian, is that by driving down funding costs it has created opportunities for other borrowers. “As SSA issuers have tightened their funding targets, we have seen quite a lot of diversification in the Aussie dollar market by Japanese institutions,” he says. “For example, the corporate market has traditionally been concentrated in three to seven years. Demand from Japanese lifers is creating opportunities for borrowers in the Kangaroo market at multiple points on the curve.”
Uridashi demand still strong
While Japanese institutional demand for SSAs in dollars and euros has been patchy, the retail market continues to be fertile territory for international borrowers. KfW, for example, reports that although the number of trades it has issued in the Uridashi market has declined in 2017, the average volume per tranche has increased “significantly”, meaning that it is on track to match the €1.4bn (equivalent) that it raised from the Japanese retail market in 2016.
Another borrower that has made extensive use of the Japanese retail market is Finland’s Munifin, which raised 30% of its total funding in the Uridashi and MTN sector in 2016. This year, the share is 18%, according to Munifin’s Helsinki-based head of funding, Joakim Holmström. “Competition for funding in the Uridashi market has become increasingly fierce, with more and more financial names accessing the market,” says Holmström. “But we are still committed to deriving a good share of our annual funding from the Uridashi and MTN markets which access the same investor base but with a different filing procedure.”
Highly competitive funding costs, says Holmström, are not the only reason the Uridashi market is so attractive for a borrower such as Munifin. “It is also a very loyal and reliable investor base,” he says. “Once investors are comfortable with your name they will stick with you.”
That is true across a range of structures and currencies. Munifin, for example, has been focusing principally on yen-denominated equity-linked structures. “Nikkei and double-index linked structures have been popular,” says Holmström. “So have notes linked to single Japanese stocks where volatility and potential yields are higher.”
Beyond yen structures, retail investors continue to explore Uridashi opportunities in a number of currencies. According to Nomura’s most recent survey of individual investors, the Brazilian real (along with the Chinese yuan) has fallen out of favour among retail investors. But Uridashi and MTN issuance suggest that they remain very open to currencies such as Turkish lire and Russian roubles. SEK, IFC and the African Development Bank (AfDB) are all examples of borrowers that have responded to reverse enquiry from Japan with Uridashi issuance in roubles.