Process flow of issuing a bond - what to look out for and key risk areas

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Below is a simple presentation of what to do and what to focus on at the various stages of the bond issuance process. Full details on the various stages can be found in previous postings such as:

The Flow of a Bond Issuance - Part 1 - Pre-issuance stage

The Flow of a Bond Issuance - Part 2 - Primary Level

The Flow of a Bond Issuance - Part 2 - Primary Level (continuation)

The Flow of a Bond Issuance - Part 2 - Primary Level - Users of FAST

The Flow of a Bond Issuance - Part 2 - Primary Level - Primary Trading Process and Procedures

The Flow of a Bond Issuance - Part 3 - Secondary Level - Trading process and market conventions

 

Process Flow of the Bond Issuance Process

Bond Defaults - Rights of Bondholders

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In theory:

•Unsecured bondholders:

–Ranked parri-passu with all other unsecured creditors

•Secured bondholders:

–Rights to the assets secured to the bondholders

•Subordinated bondholders:

–Ranked lower than the unsecured creditors

In Practice: There are a few loop holes that bondholders can exploit. This is especially so with bonds that was issued when then the market initially boomed. As time progresses, lessons learned from previous defaults have been incorporated into the latest legal documents so as not to provide the legal means to do something that goes again the original understanding.

Bond Type: Exchangeable Bonds

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This kind of bonds is a relatively new concept whereby issuers will exchange the bonds with shares from another company. An example is the Berjaya Holdings which issued exchangeable bonds to be exchanged for Berjaya Sports Toto shares.

The motivation behind issuing such a facility is to piggy-back on the share price performance of the other company. If planned correctly, issuer need not pay back the bonds as bond holders will see better value in exchanging it into shares than redeeming it at nominal or face value.

The risks to both issuers as well as the bond holders are as follows:

1.For the issuer, it must have the shares in the target company before issuing such a bond.

 

2.Issuer may dilute its holdings in the target company is bond holders exercise their rights to exchange. 

 

3.As the reference asset is not the issuer, the issuer may not have control over the whole life of the bonds.

 

4.Due to the convertibility factor, an overestimation of the company’s share price performance may caused the investors to overpay for the bonds.

 

5.The volatility of the equity markets can caused similar volatility in the shares of the bonds.

Bond Type: Convertible Bonds

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Issuers which listed shares can issue convertible bonds. The motivation behind issuing such a facility is to piggy-back on the share price performance of the issuer. If planned correctly, issuer need not pay back the bonds as bond holders will see better value in converting it into shares than redeeming it at nominal or face value.

The risks to both issuers as well as the bond holders are as follows:

1.For the issuer, there is a very strong possibility of share dilution. There is an opportunity for new shareholders to enter the company.

 

2.Due to the convertibility factor, an overestimation of the company’s share price performance may caused the investors to overpay for the bonds.

 

3.The volatility of the equity markets can caused similar volatility in the shares of the bonds. Generally, the volatility of bond market is less than the equity market (hence the lower returns).

Bond Type: Subordinated Bonds

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Issuers can issue bonds with varying degree of subordination. Unlike the junior/senior bond structure which is a split from a bond programme, subordinated bonds are stand-alone programme.

In the Malaysian context, banks are the most prolific issuers of subordinated bonds. This is because due to the Basel capital requirements for banks, subordinated bonds can be recognised as quasi-capital.

Because the subordination can be done at anytime, it is possible for issuers to have multiple bond issues with varying degrees of subordinations i.e. The most subordinated will take the first loss for the rest, the second most subordinated will take the next loss for next set of subordinated bond above it etc.   

In reality, investors are not keen to participant in bonds issued by such issuers as their priority may just change with a new issuance.

Bond Type: Commercial Paper versus Medium Term Notes

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Commercial Papers (CP) and Medium Term Notes (MTN) are bond that is different in terms of tenure. Generally, CPs are short-term bonds that have maturity of less than 1 year whereas MTNs are long-term bonds that have maturity of 1 year of more.

In terms of ratings, due to the peculiarity of the tenure classes, the way credit risk is assessed is different with different rating scales.  Generally, the purpose of the two types of structures are as follows:

1.CP: usually used for short-term cash flow management purposes.

2.MTN: usually used for mid- to long-term capital investments

Risks:

 

1.Issuers using CPs to finance mid- to long-term capital investments can face liquidity issues if no investors wants to rollover a CP programme upon maturity.

 

2.Moreover, the cost of a CP programme cannot be locked. Re-pricing will happen upon rollover.

Bond Type: Junior versus Senior Bonds

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•Purpose: to apportioned more credit risk to the junior piece

•Method: creating an internal credit enhancement

•Effect: reducing costs

By splitting a bond into two tranches, a junior bond with higher credit risk and a senior bonds with a lower credit risk, the issuer is able to offer the necessary risk reward payoffs to two sets of distinct investors. The first, which is risk adverse and the other who is risk preferring.  The design of such structuring is an internal credit enhancement and therefore offers the least costs to the issuer.

The risk reward payoff to the investors are as follows:

1.Junior bond holders usually get a higher coupon. However, in event of difficulties, they may not be paid even if the senior bond holders get paid i.e. they take first loss.

2.If the senior bond holders get paid but not the junior bond holders, generally it is do deemed as an event of default.

Collateralized Debt Obligations

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CDOs are a type of structured ABS whose value and payments are derived from a portfolio of fixed-income underlying assets. CDOs securities are split into different risk classes, or tranches, whereby "senior" tranches are considered the safest securities. Interest and principal payments are made in order of seniority, so that junior tranches offer higher coupon payments (and interest rates) or lower prices to compensate for additional default risk.

The first CDO was issued in 1987 by bankers at now-defunct Drexel Burnham Lambert Inc. for Imperial Savings Association, a savings institution that later became insolvent. A decade later, CDOs emerged as the fastest growing sector of the asset-backed synthetic securities market.

The issuer of the CDO, typically a bank, earns a commission at time of issue and earns management fees during the life of the CDO. The ability to earn substantial fees from originating and securitizing loans, coupled with the absence of any residual liability, skews the incentives of originators in favor of loan volume rather than loan quality.

CDO is a broad term that can refer to several different types of products. They can be categorized in several ways. The primary classifications are as follow:

Source of funds

•Cash flow versus Market Value CDOs

–Cash flow CDOs pay interest and principal to tranche holders using the cash flows produced by the CDO's assets. Cash flow CDOs focus primarily on managing the credit quality of the underlying portfolio.

–Market value CDOs attempt to enhance investor returns through the more frequent trading and profitable sale of collateral assets. The CDO asset manager seeks to realise capital gains on the assets in the CDO's portfolio. There is greater focus on the changes in market value of the CDO's assets. Market value CDOs are longer-established, but less common than cash flow CDOs.

Motivation

•Arbitrage versus Balance Sheet CDOs

–Arbitrage transactions (cash flow and market value) attempt to capture for equity investors the spread between the relatively high yielding assets and the lower yielding liabilities represented by the rated bonds. The majority, 86%, of CDOs are arbitrage-motivated.

–Balance sheet transactions, by contrast, are primarily motivated by the issuing institutions’ desire to remove loans and other assets from their balance sheets, to reduce their regulatory capital requirements and improve their return on risk capital. A bank may wish to offload the credit risk in order to reduce its balance sheet's credit risk.

Funding

•Cash versus synthetic CDOs

–Cash CDOs involve a portfolio of cash assets, such as loans, corporate bonds, asset-backed securities or mortgage-backed securities. The risk of loss on the assets is divided among tranches in reverse order of seniority.

–Synthetic CDOs do not own cash assets like bonds or loans. Instead, synthetic CDOs gain credit exposure to a portfolio of fixed income assets without owning those assets through the use of credit default swaps, a derivatives instrument. (Under such a swap, the credit protection seller, the CDO, receives periodic cash payments, called premiums, in exchange for agreeing to assume the risk of loss on a specific asset in the event that asset experiences a default or other credit event.) Like a cash CDO, the risk of loss on the CDO's portfolio is divided into tranches. Losses will first affect the equity tranche, next the mezzanine tranches, and finally the senior tranche. Each tranche receives a periodic payment (the swap premium), with the junior tranches offering higher premiums.

–Hybrid CDOs are an intermediate instrument between cash CDOs and synthetic CDOs. The portfolio of a hybrid CDO includes both cash assets as well as swaps that give the CDO credit exposure to additional assets. A portion of the proceeds from the funded tranches is invested in cash assets and the remainder is held in reserve to cover payments that may be required under the credit default swaps. The CDO receives payments from three sources: the return from the cash assets, the reserve account investments, and the CDS premiums.

Key Concepts in Securitisation & its Benefits

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True Sale Criteria:

•Any transfer of assets by the originator to an SPV must comply with the true sale criteria

•The underlying assets must be isolated form the originator – even in receivership or bankruptcy situations

•The originator must transfer all rights and obligations in the underlying assets to the SPV

•The originator must not hold any equity stake, directly or indirectly, in an SPV

•The SPV must not have any recourse to the originator for losses arising from the assets apart for any credit enhancement provided by the originator at the start of the securitisation transaction

Special Purpose Vehicle:

•An SPV must have independent directors or trustees

•It must be bankruptcy remote

•It is responsible to ensure that its assets are managed properly and in the best interest of the bond holders

•The SPV and the bonds issued must not carry the same name as the originator or be similarly identified with the same

•It must maintain proper accounts and records to enable complete and accurate view of its balance sheets as well as its income statements

•It must comply with all regulatory reporting requirements

Benefits of ABS

Originator

•Additional source of cheaper funding 

•Reduce asset/liability mismatch 

•Monetised illiquid assets 

•Locking in profits 

•Transfer risks 

•Off-balance sheet  

Investor

•Portfolio diversification

•High quality asset

•Not exposed to the credit risk of the originators

•Potential higher rate of returns

Introduction to Securitisation

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Securitisation is a financial technique of pooling various categories of assets and creating securities in order to represent an aggregated and pooled assets.

These assets are usually homogeneous with relatively same characteristics.

The assets are legally isolated from the source so that the securities will not affected by the financial performance of the originator. 

The value of the securities comes for the pool of assets and its related income stream.

As it is legally a stand-alone structure, investors rights are only to the pooled asset.

Key definitions:

Asset backed securities (ABS):

Bonds that are issues pursuant to a securitisation transaction. Such bonds shall exclude bonds that are capable of being converted into equity. Examples of such excluded bonds include exchangeable bonds and bonds with attached warrants.

  

Securitisation transaction:

An arrangement that involves the transfer of assets or risks to a third party where such transfer is funded by an issuance of bonds. Payments to investors are derived directly or indirectly form the cash flows of the assets.

The Flow of a Bond Issuance - Part 3 - Secondary Level - Trading process and market conventions

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Once issued at the primary level, investors are free to sell it down at the secondary market level. Here is where the bond market trading (as we know it) happens.

Government securities and other scripless debt instruments, including sukuks, are traded in the secondary or "over-the-counter" (“OTC”) market - either via a money broker, direct dealing through telephone or via the Electronic Broking System (“EBS”). Principal Dealers are committed to continuously providing 2-way prices for MGS. Every morning, Principal Dealers will submit and advertise their indicative bids and offers on all benchmark securities in the BIDS system. Financial institutions that are Non-Principal Dealers may also choose to become market makers by quoting 2-way prices in the BIDS system. All trading done via the OTC market must be captured by the BIDS system, where the sellers of securities will key in the deal and the buyers will confirm the same within a stipulated 10-minute cut-off time from trade execution.

Normal business hours for a regular Government securities trade is for standard settlement or value spot, i.e. 2 business days (T+2) settlement, from 9.00 am to 4.30 pm Mondays to Fridays, excluding holidays. Government securities can also be traded based on value today, value tomorrow or value forward.

All trades are settled on a DvP basis, although free-of-payment (“FoP”) settlement is also available where necessary. As the securities are scripless, ownership and transfer of Government securities are reflected as book entries in the ADIs’ custody accounts with BNM in RENTAS. Non-RENTAS members, such as institutional investors and other financial institutions, can transact scripless securities via their ADIs. Cash payments of coupons and redemption proceeds will be passed to the investors via their respective ADIs.

Payment Settlement

Investors can purchase debt securities in the primary market by submitting bids to Principal Dealers, which are all members of FAST. In 2005, FAST was upgraded to a web-based application, thus allowing better dissemination of information and transparency vis-à-vis primary-market activities.

 Meanwhile, the settlement of primary and secondary market transactions for Government securities and unlisted PDS - including sukuks - take place through the Scripless Securities Trading System (“SSTS”), which is part of RENTAS. Established in 1999 by BNM, the payment system comprises the Inter-bank Funds-Transfer System ( or IFTS), which deals with large-value fund transfers, and the SSTS, which allows the book-entry settlement and record-keeping of holdings of scripless debt securities. A sale or purchase of securities from one party to another involves a book entry and intra-day settlement of funds in the cash-settlement account maintained with BNM. The RENTAS system, which has straight-through-processing (or STP) capability, will process, transfer and settle inter-bank funds and scripless transactions simultaneously, in real time. The RENTAS system is a DvP system, i.e. securities and funds are settled throughout the day.

For custody, the securities issued are in the form of Master Certificates and lodged by the issuer directly with BNM, as the authorised depository for custody. BNM will hold the Master Certificate on behalf of all the holders and their scripless securities accounts, for the purpose of trading and transfers. For non-RENTAS members, the function of recording the holdings and transactions is undertaken by ADIs, which maintain aggregate cash and securities holdings accounts with BNM. The ADIs maintain a separate account for every holder that is their customer.

Market Convention

Long-dated Government securities are traded on a “clean price” basis, but settled on a “dirty price” basis that includes accrued interest or dividends. Treasury bills are traded on a “discount yield” basis and quoted in maturity bands of 1 to 10, depending on the number of days to maturity. Treasury bills that fall under the same maturity bands are equally acceptable for delivery for any band-based quotations. Prices and discount yields are typically quoted up to 2 decimal places for all transactions. The standard settlement period is T+2, although trades can also be settled on the same day or the next day, or forward settlement of usually not more than T+5. The standard market lot per transaction between market participants is RM5 million. Odd-lot amounts of less than RM5 million are also traded, but not as frequently and at potentially wider bid-offer spreads under normal market conditions.

Coupons on individual Government securities are usually paid semi-annually, and the day count is actual/actual. At present, there is no standard coupon-payment date. Coupons are paid at semi-annual intervals, determined backwards from the maturity date of the issue. MGS and GIIs are typically issued in a precise number of years, with the maturity date being the exact date of the issue’s anniversary. As such, there is naturally no odd-first or odd-last coupon period, with only a few exceptions. A business day is defined as any working day from Monday to Friday in the Federal Territory of Kuala Lumpur, excluding any day which is a public holiday or bank holiday.

The Flow of a Bond Issuance - Part 2 - Primary Level - Primary Trading Process and Procedures

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Once all the documentation have been perfected, the bonds will be ready to be sold for the first time. This is similar to the IPO stage in the equities market.

However, there are three methods to which the bonds can be sold. Depending on the needs of the issuer, these three methods have their own peculiar advantage and disadvantages. As shown in the diagram below, the three options are tender, bought deal and book building.

Tender Method (Option 1)

•There are 3 ways through which a new bond or sukuk issue can be distributed to the market. The first is the tender method, which is usually used for Government securities. Highly rated corporates sometimes utilise this option. The tendering process is open to all Principal Dealers. In the case of GIIs, all Islamic banks are also allowed to participate in the auction. Principal Dealers are obliged to tender competitively for a minimum of 10% of the issue amount. Bids submitted during the auction may be based on either price or yield. The tender announcement detailing the size and exact date of the issue is announced at least 5 business days before the issue date, via FAST. The “when issued” (“WI”) trading will commence on the tender-announcement date, after stock creation through FAST. WI trading begins upon formal announcement of an issue. WI trading is done on a yield basis, regardless of whether it is a new or reopened issue; it will continue until the tender results are announced. The value date for settlement of WI trades must be on or after this date; the standard value date is 2 business days (value spot). Trading on a WI basis is aimed at facilitating the price-discovery process. 

 

•Non-Principal Dealers or other inter-bank institutions can also submit their bids via a Principal Dealer, with a maximum allotment limit of 30% per bidder. If bids are successful, RENTAS will allot the securities to the bidder by lodging these securities with their appointed Authorised Depository Institutions (“ADIs”). Settlement will then take place automatically in RENTAS, on a Delivery-versus-Payment (“DvP”) basis.

 

 

Bought-Deal Basis (Option 2)

 

• This is the most typical issuance process for corporate bonds or sukuks. This method overcomes some of the major risks associated with the tender method, one of which is the risk of under-subscription. Demand for sukuks is a function of credit appetite as well as the economic environment at the point of issuance. As such, the likelihood of under-subscription is there. Although such risk can be mitigated by having an underwriter  (or underwriters), the upfront costs and additional administrative processes (e.g. documentation), not to mention having another external party involved in the issuance process, may not appeal to some corporate investors. 

 

• The tendered yields could  also be substantially above what had been originally expected. Due to the time required from structuring up to the point of offering the sukuks during the tender period, the risk-reward appetite of potential investors may have moved against the issuer. In this case, the original cost projections for the sukuk may become inadequate. Similar to the under-subscription situation discussed earlier, an underwriter (or underwriters) may be employed to provide a floor price (i.e. a ceiling yield) for the paper. 

 

Book-Building Basis (Option 3)
 

•This is somewhat similar to the tender method, except  that it is done on an informal basis. Via private arrangements with a number of identified potential investors, a list of final investors will be built based on the individual one-to-one negotiations. After a given period for tender, the Facility Agent or Lead Arranger will announce the allocation based on the bidding results.

The Flow of a Bond Issuance - Part 2 - Primary Level - Users of FAST

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Some of the key players at the Primary level that would use the FAST system are listed below.
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Users of FAST and their roles:

•Issuer. This is the eligible entity approved by the regulators to raise funds through the issuance of sukuks. The issuer will determine the mode of issue (tender or private placement) for the facility. 

•Facility Agent or Lead Arranger. For Government and BNM papers, the Facility Agent or Lead Arranger is BNM. For Cagamas debt securities and Khazanah bonds (guaranteed by the Government), the Facility Agent or Lead Arranger can be Cagamas Berhad and Khazanah Nasional Berhad, respectively. For sukuks, only licensed investment banks, commercial banks and universal brokers that are FAST and RENTAS members are allowed to be lead managers. The Facility Agent or Lead Arranger will be responsible for the overall coordination of the facility. They are required to advise the issuer on all matters relating to sukuks. 

•Principal Dealers – Direct Bidders. Principal Dealers are licensed financial institutions appointed by BNM to carry on the business of dealing in specific securities as principals and/or agents. They have the exclusive right and obligation to, among others, participate in the primary tender of securities, either on their own account or on behalf of clients.

•Tender Panel Members (“TPMs”) – Direct Bidders. TPMs are eligible investors approved by BNM  to bid for PDS issues.  

•Indirect Bidders (FAST members). Indirect Bidders must be fully aware that their bids placed with the Principal Dealers may not be the final bids received by the system, as Principal Dealers have the right to amend the bids - as provided for in the agreement between the Principal Dealers and Indirect Bidders. Indirect Bidders must consult their respective Principal Dealers on which instruments are qualified for amendment, as specified by BNM.

•Underwriters. Underwriters  are obligated to subscribe for underwritten issues that are undersubscribed, i.e. when the total amount tendered for by bidders is less than the issue amount. When TPMs bid higher than the underwritten yield price, the underwriters are also obligated to take up the unsubscribed quantity or the amount of the TPMs’ bids where the rate is higher than the underwritten yield.

•Rating Agencies. They are responsible for regular and timely updates on the credit ratings of bond and sukuk issues.  

The Flow of a Bond Issuance - Part 2 - Primary Level (continuation)

Another important infrastructure that I forgot to add in the last posting is the BIDS system. As the Malaysian bond market is an Over-the-Counter (OTC) market, the authorities decided to create a reporting system for the market.

Bond Information and Dissemination System (“BIDS”)


•This is the system under BNM that captures all trading data on the Malaysian bond market. The BIDS system was established in 1997, to enhance the transparency of secondary-market information. It is a computerised and centralised database on ringgit-denominated debt securities, providing information on the terms of issues, prices of trades, details of trades done, including transactions on repo activities, and relevant news on the various debt and sukuk papers issued by both the Government and the corporate sector. 

• Under the Rules on BIDS (effective October 2001), all the members of FAST and RENTAS are required to provide all the relevant trade information after a transaction has been executed, whether the parties are from the buy or sell side. They are obliged to report via BIDS the details of the trade done, within 10 minutes of execution. Rating agencies, on the other hand, are required to update the issuers' ratings. Selected information from BIDS is shared on an almost real-time basis with major newswire services like Reuters and Bloomberg. Members of BIDS must be guided by the principle of integrity, to ensure proper input of information as well as accuracy and timeliness. The Rules on BIDS are very explicit, in that responsibility lies solely with the members. BNM is not liable for any inaccuracies. 

•Since March 2008, the responsibility has been handed over to Bursa Malaysia.

The Flow of a Bond Issuance - Part 2 - Primary Level

With the bond or sukuk issue having obtained the necessary approvals from the relevant authorities, the stage is set for the papers to be issued. The key infrastructure at this stage is the FAST and RENTAS systems, both of which are under the purview of BNM.

Fully Automated System for Tendering (“FAST”)  

•FAST was launched by BNM in September 1996, to automate the tendering procedure for MGS and other BNM papers, which are issued through the Principal Dealers network. By July 1997, the FAST system was able to handle private debt securities (“PDS”). Today, FAST still serves as an entry point for primary activities vis-à-vis securities issuance, money-market tenders and repo tenders. 

• FAST is constantly evolving along with the development of technology and the needs of market participants, following international best practices on market transparency. The system’s centralised news and information are accessible by the general public, without requiring them to become members of FAST. This enables market players to improve their processes when handling instruments and also in the issuance processes, regardless of the mode of offer, while enhancing the overall transparency of Malaysia’s financial system.

• The Rules on FAST had been issued pursuant to Section 126 of the Banking and Financial Institutions Act 1989, to provide a set of procedures and practices that govern the issuance and tendering of all instruments captured under this system. There is now a one-stop aggregator that captures all issuance of instruments, regardless of the mode of issue. This facilitates the facility agent or lead arranger’s management of the debt issue throughout its tenure. Under the FAST Rules, each facility can only be maintained by one facility agent or lead arranger. For tendered instruments, FAST provides a standardised tendering process in terms of bid submission, tender processing and announcement of results. For non-tendered instruments, FAST enables the creation of a facility and stock that can be uniquely identified by certain codes of reference.

Real-Time Electronic Transfer of Funds and Securities (“RENTAS”)


•Under the RENTAS System, scripless securities had been created to facilitate the change from physical certificates to a fully scripless setting. The RENTAS Rules, published by BNM, are applicable to the issuance, allotment, reopening, payment, redemption and settlement of scripless instruments traded under the RENTAS system.

• All sukuks issued through RENTAS must comply with the terms and conditions set out in the Information Memorandum, Depository and Paying Agency Agreement (“DPAA”), Trust Deed and other relevant legal documents binding the issues. Each issue will be represented by a Global Certificate, which must be lodged with the Central Depository for safe custody. The Central Depository will keep the Global Certificate until maturity, and must not make any amendment or cancellation to the Global Certificate. The Facility Agent or Lead Arranger must submit the Global Certificate to the Central Depository at least 1 business day before the issue date. However, the Facility Agent or Lead Arranger is allowed to amend the Global Certificate after the issue date, but only under specific circumstances. In this regard, the amended Global Certificate must be submitted to the Central Depository – at the latest - 2 business days after the issue date.
 

The Flow of a Bond Issuance - Part 1 - Pre-issuance stage

Now that we know about the key infrastructure in the Malaysian bond market, let us go straight to the process of issuance. As highlighted in the previous posting, there are three stages to a bond issuance. Today, we will cover the first part, the pre-issuance stage.

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•This is the most taxing process. The success of any bond or sukuk issue depends on the ability of the issuer (through counselling by the various advisers) to structure a deal that fulfils investors’ risk appetite at that particular point. It is therefore critical that the issuer has an intimate understanding of the risk appetite of their targeted investors. Misreading the market could cost the issuer dearly in terms of expenses as well as under-subscription of the bond or sukuk issue. The latter may, however, be mitigated by having underwriters.

• The key success factor in this process is the ability of the various parties to play their parts in maximising the issuer’s utility. To ensure that this goal can be easily achieved, a good project-management team is an important ingredient. The project-management team, typically the financial adviser, must be savvy vis-à-vis the necessary steps that can minimise time to market and also the issuer’s overall costs.

• The entire structure will then go through final certification by the relevant regulators. The SC is the main regulator when it comes to bond and sukuk issuance. Approval from the other regulators, such as BNM and Suruhanjaya Syarikat Malaysia (or SSM), is also needed - depending on the issuer as well as the type of instrument being offered for sale.

•Bond and sukuk markets can only function efficiently if there is transparency. The information presented to regulators and potential investors must be as comprehensive as possible. Should there be queries, the regulators have the right to request for clarification; this process could unnecessarily delay the entire issuance process. Moreover, it also entails some form of financial “penalty” in the form of administrative fees each time the SC sends out queries and reviews the answers from the prospective issuers.

 

 (Double click on image to enlarge)

Market Participants in the Malaysian Bond Market

Yesterday, you were introduced to the key infrastructure in the Malaysian bond market. Today, let us focus on the various players in the market. Below are the key players:
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1.  Principal Dealers

• Bank Negara Malaysia (BNM) introduced this system in 1989. Principal Dealers are the intermediaries between BNM and investors in the Government bond and Government sukuk markets. They are required to participate in both the primary and secondary  markets. They are also required to take part in money-market auctions.

• Principal Dealers are authorised depository institutions for investors. To qualify for this status, which is renewable annually, they must bid for at least 10% of the securities made available during the primary auction. They are also required to bid for Malaysian Government Securities (“MGS”) on behalf of clients at the primary level. Principal Dealers must provide acceptable 2-way price quotations, to create liquidity in the secondary market. They must also maintain a minimum 5%-share of the secondary market’s traded volume.

2.  Non-Principal Dealers

•Commercial banks, investment banks and Cagamas Berhad (the national mortgage corporation) are the other approved inter-bank institutions that are allowed to deal in the inter-bank market. Although they are not obliged to continuously quote 2-way prices, they are encouraged to participate actively in both primary auctions and secondary trading. Investors can appoint Non-Principal Dealers to act as agents, to buy and sell securities in the inter-bank market. Non-Principal Dealers are also authorised depository institutions for investors.

3.  Bond-Pricing Agencies

•Bond-pricing agencies provide daily independent and objective fair values for all ringgit-denominated bonds. With this service, bond investors are able to conduct daily mark-to-market valuations for their portfolios. Currently, there is only one bond-pricing agency registered in Malaysia – Bond Pricing Agency Malaysia Sdn Bhd.

4.  Shariah Advisers

•Prominent Shariah scholars, jurists or market practitioners are certified by the Securities Commission (“SC”) to provide Shariah advisory services. These advisers must provide follow Shariah principles that have been approved by the Shariah Advisory Council (“SAC’). Established in 1996 by the SC, the SAC is the ultimate body responsible for advising the SC on matters relating to the Islamic capital market, and to provide Shariah guidance on Islamic capital-market transactions and activities.

5.  Money Brokers

•Money brokers help arrange deals between 2 or more approved inter-bank institutions. Money brokers may also arrange deals between banking institutions and foreign counterparties in the international money market. There are at present 8 money brokers in Malaysia.

6.  Underwriters:

•Underwriters provide guarantees to issuers that there will be a minimum level of subscription or price for bond or sukuk issues . Underwriting fees will vary, depending on the amount issued, the credit rating assigned and the security provided to the underwriter.

7.  Lead Arranger

•A lead arranger is appointed by the issuer to structure, arrange and manage their bond or sukuk issue. The lead arranger’s primary objective is to advise the issuer on the optimum financing structure. They help coordinate the underwriters, guarantors, trustees, lawyers, Shariah advisers and rating agencies. They also submit applications (to the regulators) vis-à-vis the bond or sukuk issuance. Upon obtaining the necessary approval from the regulators, the lead arranger will prepare the requisite information memorandum to potential investors, and execute the transaction.

8.  Facility Agent

•The facility agent manages the overall coordination of the debt issue. It is the intermediary between the issuer and the Tender Panel Members. Generally, the facility agent is also the lead arranger, but not always.

 

9.  Tender Panel Members 

•These are institutions that have been pre-approved to tender for the bond or sukuk issue at the primary level. The Tender Panel Members consist of eligible financial institutions, corporates, insurance companies, takaful operators, statutory bodies, pension funds and foreign corporations.

10.  Trustee

•Trustees are the guardians of bond and sukuk holders ; they safeguard and enforce the rights of the latter. Trustees also convene bond and sukuk holders ’ meetings and, based on compliance (or lack thereof) with the trust deeds, declare defaults on bond or sukuk issues  on the instruction of the bond and sukuk holders  .

11.  Rating Agencies

•Rating agencies conduct credit assessments on bond and sukuk issuers. They will maintain surveillance on the issuer throughout the life of the bond or sukuk. The assigned ratings provide an indication of the level of credit risk of the bond or sukuk. On their part, bond-pricing agencies use the rating information to accurately price bonds and sukuks. For investors, ratings can be used as a form of investment criteria to hold, buy or sell a particular bond or sukuk issue.

12.  BNM

•BNM is the agent for Government bonds, including sukuks. The Central Bank is also an active issuer and investor, as part of the management of the country’s monetary policies. BNM used to be the regulator of the Malaysian bond and sukuk markets. Nevertheless, it still has responsibility over FAST and RENTAS. 

13.  SC

•As the regulator of the Malaysian bond and sukuk markets, the SC is also the supervisor of some of the key market players, such as unit-trust management companies as well as rating and bond-pricing agencies.

14.  Commercial, Investment and Islamic Banks

•These institutions have been the cornerstone of the Malaysian bond and sukuk markets. They represent both the “buy” and “sell” sides of the transaction, and are also a major group of bond and sukuk issuers in the local market.

 

15.  Provident and Pension Funds

•These constitute the largest bond and sukuk investors in Malaysia. They play a pivotal role in the demand for long-term bonds and sukuks due to their long-dated liability profiles. Kumpulan Wang Simpanan Pekerja, more commonly known as the Employees Provident Fund or EPF, is the biggest investor in the Malaysian bond market.

16.  Insurance Companies and Takaful Operators

•These entities are another type of long-term investors in the Malaysian bond and sukuk markets. Their investment strategies strictly follow the requirements set out by the Insurance Act 1996 and Takaful Act 1984, as well as the supervisory guidelines issued by BNM.

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17.  Bursa Malaysia

•Responsible to maintain the bond and sukuk markets trading data since March 2008. It also provides an electronic trading platform for market participants to trade bonds and sukuks via an exchange.

18.  Other Investors

•Other participants in the Malaysian bond and sukuk market include large corporates such as Petroliam Nasional Berhad (or Petronas), asset-management companies and foreign organisations.