Building Pricing Mechanism for Asian Corporate Bond Markets The Challenges and the Road Ahead Presentation by Nitin Jaiswal Bloomberg LP
Presentation Overview Overview of Asian Corporate Bond Market Challenges facing Asian Corporate Bond Market Importance of Pricing Mechanism for Asian Markets What makes a successful pricing mechanism? Developing Pricing mechanism for Asian Markets Challenges Options Selecting the right option Asian market Initiative Bloomberg Experiences and Contribution Building pricing mechanism for Asia your thoughts, your ideas and your questions.
Overview of Asian Corp. Bond Market Govt. issued bonds dominate the Asian bond market Corporation prefers conventional method of bank loan instead of bond issuance to raise funds. Majority of bonds issued are via private placement basis to select few investors Low appetite & issuance of lower rated credit papers There are 19,000 plus outstanding corporate bonds in Asia ex-japan and only less then 2% of them get traded every day Low foreign participation in local bond market No good reference pricing for primary & secondary
Challenges before the Asian Corporate bond markets: Market Structure Transparency Liquidity Lack of coordinated Initiatives A good reference pricing model can resolve many problems related to corporate bond market.
Importance of pricing mechanism For Asian Corporate Bond Markets Increase the depth of Primary Market: Reference pricing for structured and lower rated bonds will make it easy for similar issuers to price their new issuance Improve liquidity in secondary markets: Asian Corp. Market Bond Markets lack liquidity. Transparency attract investment. A well developed pricing mechanism is an important first step towards transparency Help in the development of structured products: Asian market lack hedging opportunities and good
Importance of pricing mechanism For Asian Corporate Bond Markets Better Risk Management: Reference pricing helps in correct marked-to-market of portfolio resulting in better risk management Asian Bond Initiative: A well develop pricing mechanism for illiquid bonds will be an important step in this direction.
Asian markets lack liquidity Indian Markets Malaysian Markets
What makes a successful pricing mechanism? Easy availability of bond data and structures. A robust and successful pricing mechanism should be: Easy to understand, implement and use Generate credit and sector curves A mechanism which has participation from the markets Able to capture the dynamics and changes in the markets Endorsed and Accepted by all market participants Easy and wider availability of pricing data
Developing Pricing Mechanism for Asian Markets Challenges Options Selection
Regulatory Commitment and regional direction Developing pricing mechanism : Challenges Availability of Information: Difficult to obtain offer documents Offer documents not clear on the yield calculation Nature of the corporate bond market Each bond trade at different spreads because of characteristics: structure, calculator, rating grade, industry, amount outstanding Very illiquid markets No good initial input data to derive the prices for illiquid bonds
Developing Pricing Mechanism: Options: I. Yield Matrix II. Modeled pricings III.Contributed bond pricing IV.Hybrid model
Pricing Mechanism : Options I. Deriving prices through Yield Matrix The consensus yields for different rating classes for generic maturity points Yield Matrix Modeled pricings Contributed bond pricing Hybrid model How it works: Spreads are polled for each rating classes for each maturity points. Spreads are then added to the underlying government curve to derive the matrix How are prices calculated? Bonds are linked to their respective rating curves and then via the process of simple interpolation the yields and prices are derived.
Developing Pricing Mechanism : Options Deriving prices through Yield Matrix Advantages: Easy to understand and use Easy to make adjustments to the model Disadvantages: Way to simple and treat all bonds with on just one parameter, the ratings and ignore all other variables.
Developing Pricing Mechanism : Options II. Deriving prices through Financial Models The financial heath, credit quality and probability of default of a company is determined through different financial models. Some of the popular financial models used are: Jarrow Turnbull Heath-Jarrow Jarrow-Morton Model Altman Z score
Developing Pricing Mechanism : Options Deriving prices through Financial Models How it works: 1. Jarrow Turnbull Model: Jarrow and Turnbull created this model in the attempt to identify y a pattern between interest rate fluctuations and the probability of o default over a specified time period. The significance of this model m is its usage in pricing credit-based vehicles. 2. Heath-Jarrow Jarrow-Morton Model: A model that applies forward rates to an existing term structure of interest rates to determine appropriate prices for securities that are sensitive to changes in interest rates. 3. Altman Z-Score Z This model combines five different financial ratios to determine the likelihood of bankruptcy amongst companies.
Developing Pricing Mechanism : Options Deriving prices through Financial Modeling Advantages: Theoretically derived pricing scientific logic for pricing illiquid bonds Better consistency in terms of out put No manual intervention Atman Z score is a relatively accurate model -- real world application of the Z-Score Z successfully predicted 72% of corporate bankruptcies two years prior to these companies filing for Chapter 7. Disadvantages: Difficult to understand Uses the black box approach Human behavior can't be reduced to a mathematical equation.
Developing Pricing Mechanism : Options Deriving prices through contributed pricing Banks, security houses, brokers or fund managers provide prices either for all the outstanding or the bonds they hold. An average of all the contributed prices are taken to derive the final valuation price. Advantages: It represent the views of the markets. No brainier easy to understand and use Disadvantages: Difficult to implement and maintain on daily basis. Works only when it is made mandatory
Examples of consensus pricing approach Japan Indonesia
Pricing Mechanism : Options Deriving prices through Hybrid Model: It is a combination of contributed pricing from market and using of models to derive the pricing: Yield Matrix is a basic version of this approach. Instead of generic yields, under this approach, the prices for the liquid bonds are collected and are used for constructing the sector/rating fair market curve. Example AAA Banka, AA Utilities. The final prices are derived for all the illiquid bonds via interpolation from the fair market curve. Advantages: Best of both the worlds market views and financial modeling being used successfully in US and European markets. Disadvantages: Works well only for liquid markets.
Example of hybrid model US BBB rated sector curve Rating R and sector curves
Country Korea Malaysia Philippines Thailand Japan Indonesia India Pakistan Hong Kong China Asian Bond Markets approach towards Bond valuations: Pricing Mechanism Option Pricing Agency Modeled pricing Pricing Agency Modeled pricing Yield Matrix Hybrid Models Contributed prices average Contributed prices average Discretion Yield Matrix No model No model No model Content page 1
Selecting the right approach for Asian Markets: My Thoughts Market participation and views are very important, select the model which incorporate it. Market participants should be able to understand the pricing mechanism easily, should not be a complete black box. Asian regulators and market participants should come together and come up with a standard valuation mechanism. The prices generated should be available globally and should not cater to domestic markets. Keep it simple : corporate bonds are spread over the treasury, work on those line.
Bloomberg Experience and Contribution Work Closely with regulators, Market Association and Market Participants in building government and corporate bond curves and valuation pricing. Global presences and expertise. Well accepted, Robust models which have evolved over 20 years of time. Starting of a new business Bloomberg evaluated pricing. A radically different approach towards providing valuation pricing to the market.
Building a Robust Asian Bond Markets Your Thoughts Your Ideas Your Questions