Commentary

The unfolding scandal in Tokyo involving pension investment management firm AIJ Investment Advisors Co. is depressingly predictable.

BKPM (Indonesia Investment Coordination Board) expects foreign investments to grow to USD 19,2 billion in 2012 from USD 18,7 billion.

The banking community of the Asia Pacific region continues to impress with its commitment to the branch.

Every time a new way of paying for something has arrived – credit and debit cards, internet payments, contactless cards, mobile phone payments – the imminent death of cash has been announced. It sounds a reasonable prediction to make given the convenience of these new methods.

With the dark clouds of a recession looming on the horizon, conservation measures will be the default procedure by Asian companies for the next 12 months.

As Asia emerges as the world’s largest wealth region, the one question foremost on the minds of all private bankers should be this: what does a typical Asian client look like?

Not too many people enjoy seeing volatile investment markets. It seems to set a mood of doom and gloom. As red numbers continue to be displayed on investment market information screens or headlined in the media, some people just get downright depressed. But it is not necessarily all doom and gloom.

Beyond the noise generated by the European sovereign debt crisis and the seemingly unending debate about reducing the U.S. federal fiscal deficit, we believe macroeconomic fundamentals are evolving just as they might be expected to in the wake of the financial crisis of 2008-2009.

It is easy to see how individual investors can be confused and anxious recently because of the Euro-zone crisis – and many will be wondering what to do next. In a buoyant market confidence runs high and most people feel they can take higher risks and expect higher than average returns. But when, like now, the markets are volatile, investors tend to take the other extreme position and stay in cash or bonds. But the greatest advice at times like these is to adhere to your investment strategy (as long as it is a sound one) even if it makes you feel uncomfortable. But, in times of market turbulence this advice is rarely adhered to and we see investors making the same common mistakes time and time again. Here are the top three: 1. We tend to ‘follow the herd’ and seek safety in numbers. This type of investor behavior means we are easily affected by all media noise which blinds us against making rational investment decisions. 2. The pain we feel when we take a financial loss is twice as large as the joy we feel from a financial win. We are programmed so that a short term loss means more emotionally to us than the ability to appreciate the medium or long-term wins, which directly impacts our investing behavior. 3. We confuse price for value. If the markets are at a discount, shouldn’t that be a good time to be buying quality stocks? Hence, if you recognize that we succumb to the above pitfalls - then you know we need to be smarter in order to catch the market edge – we need to look beyond the doom and gloom of market volatility. When the going is good, most people are not averse to engaging in risk concentrated activities such as emerging markets or commodities. But it makes sense to have your portfolio founded on a well diversified investment strategy – no matter what is going on in the markets. You can reduce the impact of market movements by diversifying your portfolio and by doing this you reduce your risk. There are a number of ways to diversify within your portfolio, for example you can diversify across the four different asset classes: shares, cash, property and bonds. You can diversify within the asset classes themselves, for example purchasing shares in companies that operate in different industries such as mining and banking retail etc. You can also diversify across countries which will reduce your exposure to a single country and currency. Managed funds are a good way to help provide you with an easy route to diversification. To survive in volatile times (and even profit from them), it is important that your portfolio has a strong framework and you have the discipline to save and invest in both good and bad times. We know it is tough to keep a balanced view of things around money in turbulent times and a financial guide with a compatible philosophy can help to keep you grounded, even when the markets are not.  

What is a Convertible Bond (CB)? CBs are hybrid instruments combining a corporate bond and a buy option on the underlying share. They thus offer the best of both worlds: their equity component allows investors to participate in market upswings, while their bond component offers a protective buffer. Their performance is dictated by credit spreads and the performance of the underlying share. These traits have made this asset class the object of increasing interest, as reflected by the major inflows into dedicated directional funds over the past three years. A special dynamism is evident in the Asian CBs market – the only market of any discernible size among the emerging regions, with USD 20 billion of new issues this year as of November 30th 2011 (48% of 2011 total number of issues / 28% of the total volume). Attraction of Asian CB market? Ø Play Growth While Europe’s future remains uncertain and growth in the US is only gradually recovering, the emerging nations, although not immune to the global slowdown, are still growing healthily. Traditionally regarded as export-oriented economies, the countries of the Asia-Pacific region are establishing themselves as major drivers of global growth by virtue of their size and the pace of progression in their consumption and GDP. Ø Look for asymmetry Against this backdrop, CBs are a smart way for investors to expose themselves to Asian growth, enabling them to benefit considerably from equity market rallies with a “parachute” effect in the event of a decline. They offer an attractive rate of return (superior to their European or US counterparts for the same credit rating) and inexpensive options: the average options of Asian CBs today look cheap. It is worth mentioning that equity sensitivity is quite low in the universe at present. Lower deltas mean the credit component is stronger. Furthermore, it reacts with more volatility for a higher beta region. Ø Dynamism and Diversification With capitalization totalling USD 78 billion (according to UBS), the Asian CB market consists of about 600 securities and constitutes a dynamic and diversified market in which all sectors and major economies of the region are represented. However, roughly half of the pool is issued by Chinese and Indian companies. Even if nowadays about 60% of the pool is listed in USD, we are seeing an increasing number of bonds issued in local currencies (HKD, SGD, AUD, KRW, CNY). Another characteristic of this market is that a large proportion of the bonds issued are not rated, even if the issuing companies are, themselves, subject to a rating (S&P, Moody’s, Fitch). The absence of a rating is not, however, an indication of poor quality. Indeed, a number of issuers are blue chip regional companies. Ø Cheapness CBs are currently attractively valued in technical terms. This is especially true for Asian CBs. The attached chart compares the price of CBs with their valuation based on a sum-of-the-parts analysis (sum of the valuation of the bond component and the option). In other words: Participate in the region’s potential without assuming all the risks CBs thus currently offer an attractive risk/return profile and serve as a useful tool for boosting the performance of diversified portfolios. By virtue of their asymmetric profile, they allow investors to take advantage of the huge potential offered by the region without being exposed to all of the risks. Source: BoA Merrill Lynch

The next generation of cross-border electronic trading is gaining strong traction over the past few years in the global financial markets. Ironically, in some Asian markets, it can take seconds to execute an equities order. For algorithmic traders who use sophisticated algorithms to trade thousands of shares in mere milliseconds, any slowdown in the transactions can mean loss instead of profit. The spilt second is where traders’ enormous opportunities lie.In other words, slow trading speedscan be seen asthe result of hidden transaction costs. Yet, if financial institutions can deliver high speed capabilities while keeping costs down, they can gain a valuable competitive edge while elevating their game. High Frequency Trading (HFT) involves the use of computerized algorithms to generate short-term trading signals with a very short risk-holding period.In 2010, HFT accounts for 70% of the turnover of equity markets and over 50% of U.S. equity trade volume. In Asia, HFT drives 40% of market trading activity in Tokyo and around 10% to 30% in Asia Pacific. So what has been holding Asia’s financial markets back over the past few years? State regulations, opposition from entrenched interests and the lack of critical IT infrastructure are some of the key reasons. The current IT infrastructure of many financial exchanges and financial service institutions in Asia is to be enhanced to meet the anticipated demands for micro-second transactions.Many Asian financial institutions are wising up to this fact – local and regional investors, hedge fund managers and investment banks are exploring all possible means to step up for the IT arms race. Now, IT infrastructure has been widely regarded as a necessity to capture this spilt second advantage and compete with its peers. For most algorithmic traders, HFT means the need for high performance for cross-border electronic transactions. How can financial institutions improve their connections to key Asian financial markets? This calls for a new generation of sophisticated Financial Data Centres that provides proximity advantages and ultra-low latency solution. Proximity advantages, as the name suggested, means proximity to the financial exchange. In Hong Kong, for instance, the first Financial Data Centre, to be completed in 2013, is built next to the Hong Kong Exchange’s next generation data centre in Tseung Kwan O.This physical proximity of the trading systems will significantly matter on the latency networks.

A momentous step forward has recently been taken by the Chinese government in its quest to apply a Value Added Tax (VAT) across both its goods and services sectors.

China’s informal and unregulated shadow banking system has grown rapidly in the past two years, and now accounts for over one-fifth of total credit in the economy. Among the reasons for this rapid growth are: (i) efforts by depositors to shift from standard bank accounts to higher yielding wealth management products; and (ii) incentives for lenders to circumvent tighter prudential regulations imposed on the formal banking system. The shadow banking system has played a useful function in the past, by channeling credit to profitable businesses, especially SMEs that might otherwise have been credit constrained.

Islamic Risk Management standards aim at enhancing and improving the current standards in the shariah compliant banking industry.

What a difference a year makes, or does it? Here we are at the beginning of a new year, ready to manage the challenges before us. It's also a good time to take stock of what has changed and not changed over the past year. Unfortunately, the global economic and regulatory pressures of the past years are still with us, which will have a meaningful impact on how we do business during the period ahead. While favourable trends are difficult to find these days, one of the shining stars is the offshore RMB market. RMB settlement volumes in Hong Kong more than doubled over the past year, RMB cash deposits soared to well over RMB 600 billion and the number of issuers tapping into this market continues to grow. There is also increasing interest in Reg S and Rule 144A securities issuance, and we're hearing about plans to issue the first CNY-denominated sukuk. The most active issuers of CNY-denominated paper are based in mainland China and Hong Kong. They are working through both syndicated and non-syndicated distribution channels, targeting both local and foreign investors. Issuers are mostly using one of two options to tap the “dim sum” bond market, either by issuing RMB-denominated securities through the Hong Kong Central Money Markets Unit (CMU) or the international central securities depositories (ICSDs), such as Euroclear Bank. Within the two options, the issuance process is very similar, except for inclusion of the “lodging agent” that only accompanies issuance through the CMU. International issuers are already familiar with the ICSD issuance process, which is the same as for Eurobonds. We find that issuers are becoming more sophisticated when selecting the place of RMB securities issuance, considering where they will be more likely to reach a local or international investor base. Moreover, if there are any special requirements, such as the need to collect tax certificates specific to the issuer’s jurisdiction, they are including this consideration in their choice of venue. Due to its strong position as an international financial centre and hub to mainland China, Hong Kong has clearly established itself as the natural offshore RMB centre. Singapore, New York and London are also positioning themselves as alternative offshore centres, and RMB-denominated bonds are now even listed in Luxembourg. Trades in some RMB bonds may be settled in a currency other than the RMB, which are known as synthetic bonds. The offshore RMB market is still a relatively short-term paper market. More than 96% of issues have a tenor of five years or less. In addition to RMB-denominated bonds, we are also seeing equities, investment funds and hybrid securities in RMB. Thus, the internationalisation of the offshore RMB-denominated securities market is a reality. And, with this favourable trend comes the responsibility for market participants to manage exposures arising from different types of transactions involving these securities, particularly on a cross-border basis. For example, the CME Group, the world’s largest futures exchange based in the US, will allow international investors to use the RMB as collateral for trading in all its futures products in January 2012. These are some of the reasons why Euroclear Bank is a strong supporter of collateral pooling, where assets held in a domestic market, either in the local CSD or with local banks, can be used to support collateral needs for cross-border transactions outside the home market. This also means that assets held in Euroclear Bank can be as easily moved to the domestic market or abroad for the same purpose. The range of securities that may be used as collateral is enormous, when considering that Euroclear Bank has more than €22 trillion of assets held in custody. The collateral management services to be offered by local entities, such as the local CSD, can be white labelled or offered as a Euroclear Bank service to their clients. Settlement of collateral movements occurs locally between local CSD accounts, and local CSDs retain full ownership of their contracts and relationships with their members. The service can also be extended to help local market participants manage their collateral needs for central counterparty margin management. And, the range of transactions are almost limitless, including repos, derivatives, securities loans, central bank monetary policy operations, access to central bank liquidity and more. The international capital market community has been seeking ways to ease access to China and promote best practices within this fast-changing market. For example, SWIFT and the Asian Securities Industry & Financial Markets Association (ASIFMA) have organised and led various working groups to tackle issues relating to reference rates, the distinction of trade versus non-trade settlement, the differences between onshore and offshore transactions, and the possible need for a new currency code (CNH) for offshore CNY, among others. There are also some exciting developments happening on a pan-Asian dimension. A task force comprising Asian central banks, CSDs and Euroclear Bank are looking to create a post-trade infrastructure for the clearing and settlement of Asian bond transactions. A pilot platform is being conceived for launch in the first months of 2012. The Hong Kong Monetary Authority, Bank Negara Malaysia and Euroclear Bank will streamline cross-border settlement of Asian bond trades, build a common securities database, manage relevant corporate actions, facilitate the primary issuance of new securities and perform the necessary collateral management functions to ease cross-border flows. The beauty of this common approach is that it tackles local market issues and needs using existing infrastructure, thereby limiting up-front investments and providing a quick time-to-market timeframe. Moreover, it enables each country to develop its local bond market at its own pace, offers issuers the opportunity to reach investors in multiple markets through a single platform and provides the foundation for future initiatives to harmonise market rules and practices across markets. We look forward to welcoming other Asian infrastructures to connect to this common platform and to consider the appropriate involvement of other business partners, such as SWIFT and global custodians. The world's capital markets have their sights on the APAC region. While Asia is not immune to the turmoil storming through the US and Europe, the growth prospects of many Asian and South American markets are expected to outperform the western world. The success of the offshore RMB market is clear and is evidenced by the confidence investors have shown in the stability and promise that the region can offer. The infrastructure service providers have an important role to play in furthering progress while keeping a very watchful eye on managing the risks associated with more global market participation in the region.

Everyone working within financial services agrees that the number and frequency of new regulations is increasing dramatically, resulting in a significant diversion of management attention and resources without improving operational effectiveness or firm performance.