Government Bond Secondary Market Liquidity:
Seven Basic Requirements
February 2012

Nicholas de Boursac
Chief Executive Officer
Asia Securities Industry & Financial Markets Association (ASIFMA)
Phone: +852-2537-1789
Email: ndeboursac@asifma.org
Website: www.asifma.org

Will You Buy It? Can You Sell It?
• Liquid bonds can be sold easily, in large amounts and with minimal
impact on the selling price.
• In extreme cases, illiquid bonds remain unsold for long periods ormust be sold at a discount.

2February 2012

Liquid Domestic Government Bond Secondary Markets•••••••

Establish “risk free” reference yield curves
Allow accurate derivatives pricing
Facilitate cost-effective risk management
Support the development of sound corporate debt capital markets
Support the development of sound money markets
Create “risk free” assets to meet regulatory liquidity requirements
Allow optimal bank liquidity management

3February 2012

Liquid Domestic Government Bond Secondary Markets(cont.)• Enable governments to borrow for longer terms• Promote the development of institutional savings sectors(e.g., pension funds, insurance companies, mutual funds)• Lower government funding costs• Promote overall financial stability• Act as shock absorbers in a crisis• Lower systemic risk
• Precede full capital account convertibility

4February 2012

Liquid Government Bond Secondary Markets:
Seven Basic Requirements
1.
2.
3.
4.
5.
6.
7.

Disciplined issuance and reissuance programs to support large benchmark
issuesLiquid “classic” term repo markets that allow easy short selling of government
bonds
Active, liquid government bond futures markets
A broad range of liquid OTC derivatives contracts and exchange-tradedderivatives contracts
High-quality, efficient and cost-effective electronic price discovery, trading,clearing and settlement platforms
A broad, active domestic and foreign investor base (e.g., pension funds)
Market friendly regulatory, accounting and tax regimes: no withholding taxes
and no transaction taxes
5February 2012

Bond Issuance Program• Disciplined and transparent, so market participants can anticipate
precisely and plan for new issues• Active retiring and reissuance (taps), to encourage the development
of benchmark issues• Broad product range availability in the market, including long-datedbonds, inflation-indexed bonds, zero-coupon bonds and strips

6February 2012

Why Classic Term Repos Are Important• Support primary markets• Allow Primary Dealers to hedge• Improve secondary market liquidity by fostering:• Price discovery, two-way pricing• Market making, trading vs. broking• Counterparty participation for shorting which provides:
 Multiple trading strategies
 Hedging tools

7February 2012

More Reasons Why Classic TermRepos Are Important••••

Provide the prerequisite for a bond futures market
Facilitate development of OTC derivatives markets
Broaden funding markets (because secured)
Link money markets, bond markets, futures markets and OTCderivatives markets

8February 2012

Active Government Bond Futures Markets• Are critical to the rapid hedging of large-value transactions (e.g., forunderwriters, Primary Dealers)• Facilitate the development of OTC derivatives• Enhance bond (cash) and OTC market liquidity• Reduce systemic risk
• Lower credit risk

9February 2012

Active OTC Derivatives Markets••••••

Support primary markets
Allow Primary Dealers and corporate bond underwriters to hedge
Enhance liquidity of bond (cash) and futures markets
Allow banks and corporates to hedge
Sustain project finance and other long-term ventures
Promote interest rate OTC markets, which are key to other OTC
derivatives markets (e.g., FX, commodities, equities)

10February 2012

High-quality, Efficient and Cost-effective Electronic Price
Discovery, Trading, Clearing and Settlement Platforms• Inefficiencies and costs reduce trading volumes• Competition stimulates product development

11February 2012

Broad and Active Investor Base
• Domestic institutional savings sector:• Pension funds• Insurance companies• Mutual funds• Other institutions and corporations• Retail investors (generally more limited)• Foreign direct investment in domestic interbank government bondmarkets, repos and derivatives

12February 2012

Excessive Taxes Dampen Market Activity
Examples：• Withholding taxes (domestic and foreign)• Transaction taxes• Business taxes and value-added taxes• Capital gains taxes• Taxes on total assets or total liabilities• Unclear taxes• High cost of state owned monopoly service providers

13February 2012

Certain Laws and Regulations Impede
Market Development••••••••

Capital and FX controls
Excessive liquidity requirements
Encouragement of a hold-to-maturity culture
Weakened or unclear creditor’s rights (e.g., close-out netting and cherry
picking in bankruptcy)
Restrictions on and barriers to market participation
Unclear regulation or accounting treatment
Slow response to requests for rulings on regulations, taxes or accounting
treatment
Changes in regulations without a suitable phase-in process
14February 2012

Characteristics of Classic Repo•••••••

Title transferSingle contract for both legsStandard documentation (GMRA)
Overnight, term and open
General collateral (equivalent bonds) and special (specific bonds)
Initial margin and margin calls
Hold-in-custody, delivery or tripartite repo

15February 2012

Characteristics of Classic Repo (cont.)• Seller remains beneficial owner:• Risks and returns• Taxes• Manufactured coupon• Unfettered right of substitution• Buyer becomes legal owner:• Receipt of coupons but payment of “manufactured” coupons• Right to re-use: sell, repo, pledge!
• Collateral can be sold “immediately” in the event of default• Taxes
16February 2012

Pledge Repos
••
•••
•
•

No title transfer
No re-use possible (cannot short)
No new trading strategy
Buyer gives up cash and liquidity
Tax and accounting (usually unaffected)
No support of overall market liquidity
No positive impact on the development of the bond futures market

17
February 2012

Why Market Participants Use Classic Repos
Sellers•••••
Buyers••••Bond portfolio finance (general collateral)
Cheaper because secured
Stable/reliable source of funds (because secured)
Leverage
Additional income/yield possible
Low credit risk lending
Efficient deployment of funds (lower capital charges)
Shorting a specific issue
Trading strategy

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February 2012

Why Market Participants Use Repos in General• Some trading strategies possible with repos/shorting:• Drop in value• Relative value trading – arbitrage:• Divergence or convergence• Spread trading• Slope trading• Carry trade19
February 2012

Requirements for Term Repos
Infrastructure• Confidential reporting of short positions to the central bank:• Monitor abuse with clear rules (e.g., intentional fails, squeezes)• Sanction for abuse• Monitor systemic risk
• Aggregate for delayed public reporting of shorts• No restrictions on naked short selling• No pre-borrowing of bonds requirements• A tolerance for fails (i.e., no event of default trigger for repos):• Convention for compensation• Operational errors, system failures, power failures, hectic
markets, interconnectivity, chain of transactions
20February 2012

Requirements for Term Repos (cont.)• Ability for central banks to issue phantom or synthetic or new bonds:• Alleviate or discourage squeezes• Anonymous• High cost
• Convention on general collateral• Ability to find specials (help from interdealer brokers or CDC?)• Accurate valuations of outstanding bonds• Anonymous trading (especially for shorts); need brokers?

21February 2012

Requirements for Term Repos (cont.)• Standard documentation (GMRA 2011)• Master, bilateral and single agreement, includes settlement and close-out netting
provisions• Clear and suitable accounting and tax treatment• Creditor’s rights:• Close-out netting• Set off
• Disposal of collateral• Finality of payment• Settlement netting• Efficient, dependable, sophisticated, competitive and low cost depository:• Central Counter Party?
22February 2012

Requirements for Term Repos (cont.)
Market participants must have
• Collateral management capability including:• Netting• Initial margin and margin adjustments• General collateral and specials• Suitable back-office and operational capabilities• Efficient post-trade and pre-settlement confirmation• Good links with CDC

23February 2012

Requirements for Term Repos (cont.)• Suitable credit lines in place• Good risk management systems providing:• High-quality credit risk assessment of borrowers and collateral• The possibility of daily portfolio evaluation (market risk)• The ability to evaluate bond liquidity• Quick identification of fails• The ability to evaluate legal risk
• A process that allows location and delivery of specific bonds• Incentive to participate in the repo market

24February 2012

Size and Composition ofAsia Ex-Japan LCY Bond Markets as % of GDP - Q1 2011*7060% OF GDP

504030Government
Corporate20100China

Hong Kong

India

Indonesia

Korea

Malaysia Philippines Singapore

Thailand

VietnamCOUNTRY*Source: ADB "Asia Capital Markets Monitor" August 2011, p.52
(http://www.asianbondsonline.adb.org/publications/adb/2011/acmm_2011.pdf?src=spotlight).

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February 2012

ASIFMA’s Mission

ASIFMA promotes the development of liquid, efficient andtransparent capital markets in Asia and facilitates theirorderly integration into the global financial system.

26
February 2012

ASIFMA Membership list
Members
Allen & Overy
ANZBank of America Merrill Lynch
Bank of China
Bank of New York Mellon
Barclays Capital
Bloomberg
BNP Paribas
Citibank
Clearstream/Deutsche Borse Group
Clifford ChanceCrédit Agricole
Credit Suisse
Davis Polk & Wardwell LLP
DBS Bank
Deutsche BankDTCCEuroclear
Fitch Ratings
Goldman Sachs
HSBC
ICAPICRA
ING Bank
J.P. MorganLinklaters
Mallesons Stephen JaquesMarkit Asia
Mizuho Securities Asia Limited
Moody'sMorgan Stanley

Royal Bank of Scotland
Skadden, Arps, Slate, Meagher & Flom
Société Générale
Standard & Poor’sStandard Chartered Bank
State Street Global Advisors
S.W.I.F.T.
Thomson Reuters
UBS
Westpac Banking Corporation
Associate Members
Gre Tai Securities Market
The World Bank

Nomura27February 2012

How We Work - ASIFMA••••••

Presents the collective views of ASIFMA members to central bankers, regulators,
legislators and other government officials, and representatives of trade bodies,
domestic industry associations and other relevant non-governmental organizations
on issues of importance to ASIFMA members
Responds to requests for information and viewpoints from central bankers,
regulators and other government officials based on the collective input frommembers and data gathered from other industry sources
Organizes industry-sponsored events, seminars, conferences, training forums,
surveys and research of interest to market participants and other relevant parties
Promotes the development and implementation of industry best practices, including
the use of standardized documentation wherever practicalFacilitates communication among market participants to promote the development
and exchange of ideas and information related to enhancing capital markets in Asia
Monitors and informs members, regulators and other market participants, asappropriate, about significant developments in regional capital markets, including
future trends
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February 2012