Japan’s bond investors shake things up

Gone are the days when global central banks acted in concert.

More than two years after Bank of Japan introduced its negative interest rate policy, juicy returns still remain largely elusive in the country’s domestic debt market. But the US Federal Reserve is going in the opposite direction. As rates rise in the US, and remain suppressed in Japan, what are yen-based investors supposed to be?

The answer is as familiar as it is simple: they need to rely on the laws of supply and demand. Razor-thin margins in the Japanese yen bond market have made a raft of international borrowers wake up and take notice. They see cheap funding opportunities in the yen market, even if they have to pay well above what Japanese credits are paying. That is not just good news for issuers, but also for yield-starved Japanese investors.

Most international borrowers are also taking advantage of a favourable cross-currency swap rate between yen and dollars. Swap conditions have improved dramatically in the past year between yen-dollar and yen-euro, say DCM bankers based in Tokyo, pushing numerous global borrowers to sell yen-denominated notes, either in Japan through the Samurai or Pro-Bond markets, or internationally in the global yen or euroyen formats.

Economics start to work in yen

“For five year bonds, the swap rate is more than 50bp,” Tokyo-based Kazuma Muroi, an executive director in Mitsubishi UFJ Morgan Stanley Securities Co’s debt capital markets division, tells GlobalCapital at the end of March “Compared to one year ago, when it was at around 70bp, we are seeing a 20bp improvement for international issuers swapping into dollars from yen.

“Until recently, the dollar market was really strong, so there was no way we could compete,” he adds. “After we started seeing some market volatility triggered by recent interest rate movements globally, spreads on dollar bonds started to widen quickly. At the same time, the yen market remained stable. So for some issuers, including some AA rated names, the economics started to work in yen.”

As a result, the rising opportunities for funding arbirtrage is not just good news for issuers and investors, but also for local bankers, who are pitching a raft of credits to come to the onshore market. This will give a much-needed boost to issuance. In the fiscal year ending March 31, 2018, a total of 77 yen-denominated deals were sold by foreign issuers, worth the equivalent of $18.5bn between them, according to Dealogic. During the same period the previous year, 96 trades were priced worth around $22bn. For the year to March 2016, 121 deals worth about $26bn were recorded.

Akihiro Igarashi, head of international debt syndicate at Nomura, says international yen bond volumes were slightly down last year because cross-currency swap rates were still expensive for international issuers. That turned off some of the more reliable sources of yen issuance, including banks in Australia and the Nordic countries.

But as the dollar market gets more expensive, the scales appear to be tipping once again in favour of more yen issuance.

“The elevated credit spreads in dollars and elevated new issue premiums would make the Japanese market workable from the pricing perspective,” says Kaneyoshi Muramatsu, director, head of international JPY debt syndicate at Mizuho Securities Co. “Up until February, we thought the international yen market volume would be similar or may be less than last year, but with the recent volatility we’re feeling that the total volume could be slightly larger than last year.”

That is good news for bankers. But as more global borrowers seek out Japanese yen, is there enough investor demand to go around?

Bigger buy-side

There are plenty of different avenues through which firms can sell yen-denominated bonds. Samurai bonds and Pro-Bonds promise access to the domestic investor, although the latter market is barred from retail investors. The euroyen and global yen markets allow a wider distribution to global yen accounts, as a result often leading to a speedier execution.

The Samurai market has become the obvious yen funding source for high-grade or well-known issuers. The Republic of Indonesia raised ¥100bn ($935m) last May, French banking group BPCE bagged ¥58.1bn from a social Samurai — the first for Japan — and the Turkish sovereign sold a ¥60bn issuance. More are deals in the offing, too, with the Philippines and Mexico understood to be considering Samurais.

In the global yen market, deals have come from the likes of US multinational technology company Corning and retail behemoth Walmart, to name just a few.

Bankers point out that last year marked a turning point for yen bonds, with the gradual implementation of the pot method when selling notes. The pot method effectively means issuers and lead managers are able to see which investors are placing orders into the book and at what price in real time.

This is a change from the typical retention system used during bookbuilding, where each underwriter builds its own book of investor orders without sharing the details with others in the syndicate. The underwriter then takes charge of its own allocation and delivers the bonds to clients.

The pot system has improved transparency. Perhaps surprisingly, investors are embracing the change. Bankers say the trend of using the pot system started with some of the global yen or euroyen transactions issued by US corporations. But then the technique moved into the Samurai market too. South Korea’s Shinhan Bank paved the way when it used the pot system for its ¥26.3bn Samurai issuance in October 2017.

“Since then all Samurai or international yen transactions have been under the pot method,” says Mizuho’s Muramatsu. “It’s a big development in Japan. We still need time for the pure domestic market to convert into pot or complete conversion may not happen, but at least on the international yen side, the pot method is the new norm.”

Right timing

He adds that in other markets, the pot method is already common. And due to the increase in Japanese investors’ participation in dollar or euro trades, they have become more comfortable with the system. “That laid the groundwork,” he says.

“When some of the US issuers came to the market with global yen deals, the pot was their choice and investors accepted it. There was some hesitation to adopt pot into the Samurai format, but when Shinhan did the trade — we were one of the leads — we felt the timing was right and that investors were ready. So we introduced pot for Samurai and didn’t feel any pushback from investors. And once [France’s] BPCE adopted pot, investors accepted it without any problems. That accelerated the implementation of pot method into the Samurai market.”

Kazuhide Tanaka, head of long term funding for Japan at Rabobank, says the reason for the delay and the reluctance of the Japanese market to employ the pot system was a widespread belief that the release of investor names was a breach of confidentiality.

“Of course, if you are a dealer and an underwriter, you don’t want to give your investor list to anyone else,” he adds. “But the pot system has been accepted very well, and it has become a very transparent and fair way to price bonds. And I think it’ll continue to be employed here.”

Diversified investments

Japanese investors’ acceptance of the pot method is not the only change that has been notable in the yen market. Their investment behaviour has also changed. Traditionally, both borrowers and investors have opted for the Samurai format over Pro-Bonds. The Samurai market is more liquid thanks to a wider investor base. As Pro-Bonds are only available to professional investors, the number of accounts that can buy the product are limited, as is aftermarket liquidity.

But owing to the low-yield environment and often expensive basis swap conditions, investors are slowly warming up to accepting a variety of different issuance formats.

“Some accounts used to buy only in the Samurai format, especially asset managers,” says Nomura’s Igarashi. “But because the supply of Samurai is getting lower and supply of non-Samurai deals is rising, they have changed their internal policy and are now able to buy in the Pro-Bond format. So we are seeing a slight change and an increase of the investor base for Pro-Bonds, despite limited liquidity.” 

He adds that the preference for Samurai bonds will continue, but as investors get more flexible, the expectation is for more issuers to access the yen market using other formats, including Pro-Bonds.

Mizuho’s Muramatsu says one of the biggest evolutions in the international yen bond market is pension fund managers — namely trust banks and asset managers — buying euroyen or global yen bonds. Up until the recent past, these investors strongly preferred the Samurai format, as the perceived liquidity in the bonds is higher and for index eligibility.

“But after they saw an increase in the number of trades in global or euro yen, and after they saw a good pick up against dollars or optical yen spreads which has been very attractive for them, they started to invest in global yen or euro yen formats,” he adds.

In addition, Japanese investors’ need for yield is forcing them to look at credits they wouldn’t have before — in terms of ratings and duration. Bankers point to the fact that last year the Indonesian sovereign, rated Baa3/BBB-/BBB-, raised ¥100bn from a Samurai. In March this year, the Hungarian sovereign (Baa3/BBB-/BBB-) returned to the yen market for the first time in 11 years, raising ¥30bn with a 2021 at a 0.37% coupon.

Turkey, with a Ba2/BB/BB+ rating, bagged a ¥60bn Samurai in December, while Taiwan’s Foxconn Far East sold a ¥50bn trade in September and Genting Singapore, a casino operator and integrated resort developer, raised ¥20bn in October.

“Maybe five years ago, we wouldn’t see an integrated resort developer or Turkey or a Taiwanese corporate coming to the yen market, but now the macro environment has urged Japanese investors to change their investment behavior, which is why we are seeing more variety,” reckons Nomura’s Igarashi.

Greater acceptance

For Rabobank’s Tanaka, the biggest change in the past 10 years has been the acceptance of various credit instruments rather than just plain vanilla senior notes. He cites Rabobank’s example, which was the first Samurai issuer to sell a subordinated tier two bond, paving the way for more to follow.

“We’ve also seen investors accept senior non preferred issuance,” he says. “So there are different categories from the senior unsecured notes that everyone has been used to, and these different instruments have become more popular and investors have become more accepting of those instruments.”

The change in their attitude was also evident when China Eastern Airlines broke new ground in March by selling a Pro-Bond backed by a standby letter of credit — the first use of SBLCs in the yen market.

It priced a triple-tranche transaction with three year tenors, comprising a ¥10bn 0.33% 2021 bond at 20bp over yen swap offer rate, and two ¥20bn 0.64% 2021s at 51bp over.

The first tranche was backed by a guarantee from Sumitomo Mitsui Financial Group, with the other two portions having SBLCs from Bank of China’s Tokyo branch and ICBC Shanghai, respectively.

“We didn’t expect to see such strong demand,” says Yoshihiro Inoue, executive director, international debt origination, debt capital market, Daiwa Securities. “But we saw huge numbers of Japanese accounts — both central and regional investors — participate. Regional interest was surprising. Traditionally Japanese investors try to avoid Chinese paper because they just don’t understand how the country runs. We still have investors that cannot buy Chinese names, but we are seeing a huge development.”

Inoue adds that be it Samurai or Pro-Bonds, there are still restrictions around the acceptance of accounting standards of other countries.

“Many countries are not allowed to issue Samurai or Pro-Bonds because of differences in accounting standards with Japan, like Thailand and India,” he says. “To see strong developments in the Japanese market, the authorities need to deregulate to accept those countries’ accounting standards.”