By G. Sharmila
In our last article, we looked at the underdeveloped retail bond market. Another area that is often overlooked is the repo situation in relation to bonds. Despite the size of the Malaysian bond market, the repo market for bonds is practically non-existent. So, what gives? KINIBIZ investigates.
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We have already established in previous articles that the Malaysian bond market is the third largest in Asia in relation to gross domestic product (GDP). As at end-2014, the domestic bond market was worth a little over RM1 trillion.
Ahead of Malaysia are Japan and South Korea, who occupy the number one and two spots. A key difference between the Malaysian bond market and that of South Korea and Japan, is that the domestic bond market does not have an active repurchase agreement (repo) component.
As one banker who declined to be named told KINIBIZ: “If you look at South Korea and Japan, the value of their respective repo markets is so much more than the cash market in relation to bonds. Our market, in contrast, is currently a ‘pump and dump market’, there is no shorting of bonds. Investors must have the ability to short bonds for a fully developed bond market.”
But first, let us look at what a repo market actually is and why it is so important in relation to bonds. According to the International Capital Market Association (ICMA), the term “repo” is a generic name for both repurchase agreements and sell or buy-backs.
The ICMA explained the repo transaction process in further detail: “In a repo, one party sells an asset (usually fixed-income securities) to another party at one price at the start of the transaction and commits to repurchase the fungible assets from the second party at a different price at a future date or (in the case of an open repo) on demand.”
“If the seller defaults during the life of the repo, the buyer (as the new owner) can sell the asset to a third party to offset his loss. The asset therefore acts as collateral and mitigates the credit risk that the buyer has on the seller,” it explained.
To the uninitiated, fungibility refers to a good or asset’s interchangeability with other individual goods or assets of the same type, according to Investopedia.com.
Therefore, assets possessing this property simplify the exchange or trade process, as interchangeability assumes that everyone values all goods of that class as the same, the website said.
According to the ICMA, although assets are sold outright at the start of a repo, the commitment of the seller to buy back the fungible assets in the future means that the buyer has only temporary use of those assets, while the seller has only temporary use of the cash proceeds of the sale.
“Thus, although repo is structured legally as a sale and repurchase of securities, it behaves economically like a collateralised loan or secured deposit (and the principal use of repo is in fact the borrowing and lending of cash),” the ICMA said.
Why is a repo market for bonds so important?
According to the ICMA, an active repo market allows a wider array of borrowers and lenders into the wholesale money market than just commercial banks. The resulting breadth and diversification create a deeper and more robust market, which facilitate liquidity management between financial intermediaries and reduces systemic risk.
Which brings to mind the question, what is the repo market situation for bonds really like in Malaysia?
Nik Ahmad Mukharriz Nik Muhammad
“There is a repo and reverse repo market in Malaysia. However, I suspect it is not as active as the cash market as I don’t have basic statistics on this. But I know that a number of banks offer repos to customers, both for short and longer tenor debt securities,” CIMB Group head of regional fixed-income research Nik Ahmad Mukharriz Nik Muhammad told KINIBIZ via email.
He added that for the government market, the drag on growth in repo is that liquidity is very ample and that the amount of securities outstanding is also pretty high.
“Usually, investors need not conduct a repo to get hold of government securities and incur a cost, because the market already offers easy access to bonds. For corporate bonds or credits, the common need or practice is for investors to hold to maturity; this means that there is little interest to conduct repo or reverse repos in Malaysia currently,” he explained.
AmBank Group’s strategist, FX and rates, markets, Wong Chee Seng, concurred. “Malaysia does not have active secondary bond trading, he said, adding that the absence of a repo market is one of many issues affecting secondary trading.
He also cited education and investor awareness as other considerations affecting secondary trading.
“With or without repos, given the current activity mostly centred around long-term investing by asset managers, pension funds, and insurance companies, it doesn’t help much as most of these kind of investors are long term in nature,” he told KINIBIZ via email.
These investors, he said, do not trade in an active manner and are very likely to hold to maturity.
“They buy these papers for yield. Another good example to share is inactive trading or investing retail interest in the maiden RM300 million sukuk of DanaInfra Nasional Bhd that is partially funding the Klang Valley’s Mass Rapid Transit (MRT),” he added.
Wong emphasised that an active repo markets will have strong complementary effect to a complete supply chain of the bond market in Malaysia. “It is an extension of the current trading system and would not be too difficult for the set-up to take place, provided there will be efforts for active trading needs,” he said.
How can an active repo market be created for bonds?
It has to be initiated by active demand-supply needs, Wong said. A “right” issuance of bonds, active portfolio management added with right policy efforts to promote secondary trading will be among the first things needed to kickstart a repo market, he added.
Critics say that the bond market regulators such as the Securities Commission and Bank Negara Malaysia should play a more active role in developing the repo market. (Note: Both parties declined comment for this series of articles).
For now, it would seem that both the regulators and investors themselves are not yet ready to create a thriving repo market for bonds. One hopes that the situation will change sooner rather than later to bring diversity and more dynamism to our bond market.
Yesterday: Developmental issues remain in bond market
Tomorrow: What’s next for the bond market?
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