1 Asian Bond Market Development: Risk Management Dimension Alfred Wong Hong Kong Monetary Authority

2 Risk management dimension Developing the bond market –Not about increasing sales or purchases of traditional issues –But about helping buyers and sellers meet  Filling a liquidity gap  Filling a credit gap Managing credit risks –Credit guarantee –Securitisation –Credit derivatives

3 Securitisation Making products that people can buy (and sell) –home loans (mortgage) –car loans –consumer loans –credit card receivables Making products that people would buy (and sell) –over-collateralisation –collateralised debt obligations (CDOs)

4 A typical securitised transaction

5 Credit derivatives Credit default swap (CDS): a contract that the buyer pays a periodic fee in return for a contingent payment by the seller upon a credit event happening Total return swap (TRS): a contract between two parties whereby they swap periodic payments Credit-linked note (CLN): a CDS except that the contingent payment is in the form of a note. CDS swaption: a CDS option

6 Putting the cart before the horse? Source: BIS

7 Securitisation in Asia Asset-backed securities (ABSs) –ABSs are mostly triple-A: over 90% –Dominated by Japan, Australia and Korea: over 65% –Followed by Hong Kong, Malaysia and Thailand –ABSs are mostly MBSs, especially Australia and Malaysia –Diversifying into all sorts of credits, including non-performing assets! C ollateralised debt obligations (CDOs) –Demand: highest quality of credits –Supply: lower quality credits and/or less diversified credits –Credit enhancement requirement tends to be high –Structural issues, e.g., tax, regulatory, legal or corporate governance

8 Securitisation in Asia

9 Credit guarantee in Asia Before the Asian financial crisis –Overpricing by US monoline insurers –Mandatory for bond issuers in Korea –Asian Securitisation and Infrastructure Assurance (ASIA) First multilateral guarantee agency in Asia Effects of the Asian financial crisis –Failure of major guarantee agencies in Korea –Heavy losses on Indonesian and Korean exposures by ASIA –Credit downgrade of ASIA

10 Source: BIS By counterparty By maturity By reference entity

11 Source: BIS By counterparty By maturity By sector By rating

12 Credit derivatives in Asia Size of the CDS market: about US$1.37 billion by end-2005 Activities mainly taking place in Korea, Hong Kong and Singapore

13 Regional cooperation and initiatives APEC Initiative on Development of Securitisation and Credit Guarantee Markets –Spearheaded by Korea, Thailand and Hong Kong –Objective was to promote the understanding of these markets –Channel was to provide advice through panel visits APEC economies: Sponsored by Australia, China, Hong Kong, Korea, Thailand, and US, and World Bank Two visits each to China, Mexico and Thailand Recommendation son changes in tax, regulatory and legal structures Establishment of interdepartmental taskforces in Thailand and China Two policy dialogues: Korea and Hong Kong

14 Regional cooperation and initiatives Asian Bond Market Initiative (ABMI) under ASEAN+3 –Developing credit guarantee facilities –Led by Korea East Asia-Regional Financial Sector Flagship Study by the World Bank –Securitisation –Asset management –Regulatory regimes

15 East Asian Financial Markets: the Next Frontier June 22-23, 2006, Hong Kong The World Bank Regional initiatives to promote financial integration and the broadening and deepening of the financial sector; The contractual savings industry and the asset management industry and their role in developing capital markets; Developing securitization and derivatives markets for risk management and risk sharing; Developing the securities markets Attendance will be limited to about 120 participants drawn from central banks, financial market regulatory authorities, high ranking officers finance ministries, investment banks, rating agencies, money managers, institutional investors and academic institutions.