In the stricter regulatory environment, where the ability of lenders to absorb losses is continually being scrutinised, Taiwan is trying to corner a market for bank capital deals. When the island-state started allowing foreign banks to sell dollar-denominated tier two bonds domestically in January, the news was positively welcomed by banks as a much need fresh source of liquidity.
''It was a very good surprise when we learnt that the Taiwanese had released the new rules,’’ said Michael Tromp, head of capital issuance at ABN Amro, which became a pioneer in the market when it became the first issuer to take advantage of the new rules in March.
The move was also fillip for Taiwanese investors which are on the hunt for better returns. With Taiwan’s economy contracting and exports with its biggest trading partner China falling, the government cut its benchmark rate for a fourth consecutive quarter by 12.5bp to 1.375% in June. Meanwhile, Taiwan’s 10-year government bonds were yielding 0.69% in early September.
One of the key selling points of Formosa bonds is that as long as they are listed on the Taipei Exchange, they count as domestic investments for life insurers — the main buyers of bank capital bonds. This designation is important because Taiwan’s insurers are subject to a regulatory limit on the amount of foreign debt they can own. Formosa bonds were removed from this 45% overseas investment cap in 2014 which means insurers have more money to put to work in foreign credits.
“Local life insurance companies are well experienced and highly interested in investing in dollar denominated bonds,” said a senior official in the Treasury division of Yuanta Bank.
The low interest rate environment and relatively narrow domestic market is pushing these companies to seek higher yielding investments, he continued. This has provided an opening for bank capital trades which offer higher yields from strongly rated names. Taiwanese life insurers are reluctant to go too far down the credit curve for returns so will generally accept subordinated notes from an issuers rated A- or above.
Pricing tension
The advantages for issuers are also clear. ABN sold a $300m 15 year bullet with a coupon of 5.6% in March. Despite being the first of its kind, the deal priced with no new issue premium, close to the bank’s outstanding €1bn ($1.1bn) 2.875% 12 non call seven bond issued in January said Annemarie Ganatra, global head of MTN solutions at Standard Chartered, one of the arrangers on the deal. “ABN did get some pricing tension by issuing its tier two debt in Formosa format, by virtue of the fact that there’s good liquidity available to put into domestic issuance and a relatively limited supply of assets,’’ she said.
After ABN, two other banks sold bank capital deals in quick succession. Société Générale priced a $500m 20 year bullet for a coupon of 5.1% on June 6, followed ten days later after by BNP Paribas with a $200m 4.2% 12 year bond.
As well as the pricing advantages, the relative ease of selling these products from an issuer’s point of view is another encouraging factor.
“It's definitely a market that we would return to,’’ says William Huang, head of Greater China sales at SocGen “It's an important funding source for high grade issuers, including Société Générale, and we've built good relationships with buyers.”
And as ABN’s Tromp points out, Taiwan’s bond market offers a greater certainty of execution even in periods of volatility.
“It’s a market where you can issue a decent size and the investors are quite transparent, meaning they stick to earlier indications,’’ he said.
Holdco conundrum
But for all the benefits, issuance from the three banks only amounts to $1bn of bank capital debt sold into Taiwan. One of the major factors holding back sales of tier twos is eligibility. Regulations stipulate that borrowers need to have first sold senior Formosa bonds out of the same issuing entity and the size of any tier two bond is limited to the outstanding amount of senior notes.
This can be problem because quite often, financial institutions have a holding company (holdco) and an operating company (opco) structure, whereby senior debt is generally issued out of their operating company due to the higher rating, allowing the borrower to achieve tighter pricing. Meanwhile tier twos are usually sold from the holding company.
“If they issue senior debt at the holdco level, there can be concerns regarding a widening impact on the spreads that can subsequently be achieved at the opco level,’’ said StanChart’s Ganatra. ”So, in deciding whether to issue senior Formosa bonds at the holdco level, pricing impact on the future opco issuance is one consideration and TLAC eligibility is the other.”
For ABN, however, the ruling about the same issuing entity was not a concern as the bank only issues equity from its holding company while all short and long-term liabilities are sold from its opco.
In addition, global systemically important banks, or G-SIBs, are required by the G20's Financial Stability Board to have a certain amount of instruments that can be written down or converted into equity, which together make up the bank’s total loss-absorbing capacity (TLAC).
Most G-SIBs that have an opco/holdco structure would only really consider senior issuance at the holdco level as long as it is TLAC eligible. As a result, the Formosa market could be one that G-SIBs look to for their TLAC needs as once a bank has established its senior benchmark, a follow on tier two transaction would then possible.
European banks, in particular, are expected to be the key issuers of dollar subordinated bonds domestically in Taiwan as many have substantial TLAC needs that have to be met by 2019 and they have already been fairly active Formosa bonds. European G-SIB that have issued Formosa bonds in addition to BNP Paribas and SocGen include Barclays, BPCE, Credit Suisse, Deutsche Bank and HSBC. Aside from the prohibitory point about selling from the same entity, restrictions on the type of borrower and the bond structure are also preventing the market from really taking off.
“Only banks can issue subordinated Formosa debt currently; not insurers or corporates,” said Sean McNelis, HSBC’s Hong Kong-based head of financing solutions group for Asia Pacific. “That list of banks is further limited to those listed on certain recognised stock exchanges. Also, those banks can issue only vanilla tier twos; AT1s are not currently permitted in Formosa format.’’
Mainland Chinese banks are also not allowed to issue dollar Formosa tier two bonds.
Dealers and issuers are said to be lobbying for a relaxation of the rules, particularly regarding the requirement to sell senior and subordinated notes from the same entity. As yet there has been no word from the authorities on any changes but the official from Yuanta Bank is convinced it is just a matter of time as regulators want to attract more issuers.
Dollar-denominated Formosa debt has grown by leaps and bounds since it was first introduced in 2014. Already this year, some $30bn of Formosa debt has been sold, more than the total for the whole of last year. In a market where investors are looking for yield and issuers have regulatory drivers, the Formosa dollar market definitely has the potential to flourish in both senior and tier two.
“Compared to other markets, Taiwan has the advantage of strong investor demand, as well as a simpler listing process,'” said a senior official at the Treasury division of E.Sun Bank. ”We believe Taiwan could be one of the major funding centres of the world.”