Life has come full circle for emerging market debt in Asia. It started with distressed debt investing, which came into its own following the Asian crisis and dotcom bust during the early to mid-2000s. There were a handful of specialized investors, distressed funds and proprietary trading desks that bought the bonds and loans at very distressed levels and had the patience to sit through repeated and often frustrating negotiations.
The positive turn in the economic cycle as the world emerged from recession in 2002-03 helped turned things around for these investors, who just happened to be in the right place at the right time. Since then, favorable demographics and high growth — driven primarily by India, China and Indonesia — have made Asia a “performing debt” story.
However for an asset class that has both transformed drastically and evolved dramatically over the last decade, naturally there are challenges that have to be addressed. The following are a few current characteristics/trends of fixed income in Asia.
Unwillingness of the Issuers to Repay Debt
Up until a few years ago, a default in Asia reflected the inability of the borrowers to repay their debt. These days a default, more often than not, indicates the borrowers’ unwillingness to repay. The reason is not hard to miss — the bankruptcy and creditor protection laws in Asia aren’t the strongest in the world and it can be a long drawn and expensive battle for creditors (especially overseas ones) to get their money back.
Borrowers have acknowledged to this fact and are using it to their advantage. The respective trustees and courts fail miserably to recognize this. Also, Asian bond and loan documentation often falter by not including the necessary safeguards to prevent nominees of borrowers from buying backing their debt and voting against broader creditor interests. As a result, defaulted borrowers can easily sabotage the restructuring process. This phenomenon is not limited to any one country and there have been cases of intentional debt defaults in each of China, Indonesia, Philippines and India.
Divided and Cautious Investors
In most cases, creditor groups in Asia aren’t on the same page when it comes to debt restructuring discussions. The companies quickly become aware of this and use a “divide and rule” tactic quite successfully against them. They favor and repay a few local entities, or the ones backed by a sovereign, while completely shutting out on the rest.
In other instances, there is infighting among the creditor groups because one of them manages to cut a better deal with the company than the other. So instead of creditor groups working together to constructively restructure the debt, it is “every man for himself” in Asian distressed debt.
Many times investors are fearful that being too aggressive will cause the borrowers to become litigious and drag out the process for years. Consequently, they sell back the debt to a vehicle controlled by the borrower at an abysmally low price, thereby completely wrecking the pricing and chances of recovery for other investors. Thanks to this constant infighting and competition between investors, there is always a state of low liquidity and even lower prices in the secondary market.
FUTURE OUTLOOK
Dimsum Bonds: The New Kid on the Block
Any discussion of Asian fixed income can never be complete without a word of this exponentially growing instrument. In fact, in all the investor conferences and investment seminars that I have attended over the last six months, there has been one topic that has been talked about with relentless enthusiasm by one and all – the offshore renminbi (RMB) bond market (also known as the dim sum bond market).
While the dim sum bond market holds tremendous potential, some key issues remain unaddressed. One of them is competition from the parallel developing synthetic offshore RMB bond market while the other is obtaining Chinese regulatory approval to repatriate offshore RMB. The latter is preventing many Chinese companies from tapping this market for fundraising.
High-Yield U.S. Dollar Denominated Bonds
There has been a frenzy of high-yield U.S. dollar-denominated bond issuances over the last few months due to the large interest rate differential between U.S. and Asian economies. This has prompted many weak and dishonest companies to opportunistically tap the U.S. dollar bond market and raise funds.
Consequently, I wouldn’t be surprised if as much as 25 percent of the high-yield bonds issued over the last few months default on their coupon payment or have corporate governance issues by mid-2012. When the same happens, the cat shall be set loose among the pigeons. Since overseas investors have little recourse in debt defaults in Asia, the panic-stricken fund managers shall offload these (at a huge loss, of course) and might end up throwing out the “baby with the bathwater” thereby creating attractive opportunities for funds that do their homework correctly. This phenomenon can potentially paralyze the world economy and mark the rebirth of distressed debt investing in Asia.
Tanuj Khosla is currently working as a Research Analyst at 3 Degrees Asset Management, a fund management firm in Singapore. He can be followed on Twitter @Tanuj_Khosla. Alternatively he can be reached at khosla.tanuj@gmail.com. Views expressed are personal.
