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.

The various stages of issuing bonds in Malaysia

In the last posting, I have given a summary of all the key infrastructure in the Malaysian bond market. In today's lesson, we shall go in detail to the various stages that a bond will have to go through before it could be sold in the market. There are three stages. These are:

(i) Pre-issuance 

•The idea of tapping the bond or sukuk markets is cultivated at this stage. Companies with various forms of capital requirements should obtain advice from financial advisers on the feasibility of this move. Whether refinancing existing obligations or funding new ventures or expansion, the bond and sukuk markets are much more likely and able to fulfil the needs of the potential issuer, compared to directly approaching lenders. The Malaysian bond market is competitive, characterised by many investors with varying degrees of risk appetite. It is therefore relatively easy to find natural partners throughout the risk-reward spectrum.

•There are several stakeholders in the pre-issuance phase. Apart from the potential issuer, professional service providers such as credit-rating agencies, legal and accounting firms, Shariah advisers, trustee companies and the banking fraternity will be actively involved at this stage. This is where private advisory outfits aggressively compete against established financial institutions vis-à-vis providing financial advice to potential issuers.

• The structuring of bonds and sukuks is also done at this level. Financial advisers will design a bond or sukuk structure that will maximise the potential issuer’s attractiveness. During this process, external support from guarantors and underwriters may be required. For sukuks, Shariah advisers will provide the necessary input to ensure that the structure conforms to Shariah principles. Regulatory approval will also need to be obtained at this stage.

(ii) Primary Market  

•With the structure of the bond or sukuk in place, the process of getting investors for the instrument begins at this stage. The arrangers will execute the transaction via the Fully Automated System for Tendering (“FAST”) managed by BNM, either with Tender Panel Members or Principal Dealers. Money from such transactions will go through the Real-Time Electronic Transfer of Funds and Securities (“RENTAS”) system, also managed by BNM. Trading information, which had previously been tracked by the Bond Information and Dissemination System (“BIDS”) - managed by BNM – was taken over by Bursa Malaysia on 10 March 2008.

•There are a number of new stakeholders in this phase. Tender Panel Members, Principal Dealers, trustees and BNM are represented at this stage. BNM plays a major role at this point as it provides the market infrastructure for deal reporting as well as facilitating the transaction, including transfers of money and security deposits.

•For the issuer, this is the most critical period; expectations vis-à-vis the pricing of the instrument will now be tested. If successful, proceeds from the issuance of the security will either be as expected or more, depending on the economic environment at the point of issuance. If unsuccessful, issuers may have to fall back on underwriters (if any) to take up the shortfall.

(iii) Secondary Market  

•At this stage, the securities can be actively traded among investors in the market. RENTAS, BIDS and trustees continue to play their roles of facilitating the transaction. Since only a small portion of the available bonds and sukuks are traded, daily prices generated by bond-pricing agencies are available for referencing by investors and other market participants.

•New Additional stakeholders at this stage are the money brokers and Non-Principal Dealers. The next section of this chapter will provide more detailed information on each of the stakeholders.

The Malaysian Bond Market Market Infrastructure

The Malaysian bond market can be segmented into 3 clusters:

(i) the pre-issuance stage;
(ii) the primary market; and
(iii) the secondary market.

These 3 segments represent the key phases in the life cycle of a bond or sukuk issue. The transition between phases is absolute, irreversible and definite; a bond or sukuk cannot “jump” phases. An issue will start at the pre-issuance stage before moving to the primary market, finally progressing to the secondary market. The life cycle of a bond or sukuk issue will end upon either the maturity of the instrument or its default.

Evolution of the Malaysian Bond Market - Key Milestones

Before we proceed further, it would be best to appreciate the various market infrastructure available to market players. Below is a diagram of the time-line for the bond market industry in Malaysia.

(You can click on the image to enlarge)

RAM - Rating Agency Malaysia Berhad
MARC - Malaysian Rating Corporation Berhad
SC - Securities Commission
PDS - Private Debt Securities
BPAM - Bond Pricing Agency Malaysia Sdn Bhd
BNM - Bank Negara Malaysia

Policy reaction to the 1997-98 Asian Financial Crisis for the Malaysian Bond Market

After 13 years, it is interesting to look back in history to under how the authorities faced the crisis and the strategies used to improve the situation. Below is a short write-up on the history behind the policy reaction to the Asian Financial Crisis for the Malaysian Bond Market.
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•The National Economic Action Council (“NEAC”) was established on 7 January 1998 - at the height of the Asian financial crisis - to make recommendations to the Government vis-à-vis arresting the deteriorating economic conditions and revitalising the domestic economy. To this end, the NEAC launched the National Economic Recovery Plan (“NERP”) on 23 July 1998.

•The NERP’s objectives had included the short-term focus of stabilising the ringgit, restoring market confidence, and maintaining financial stability. These had been complemented by the objectives of structural reform via strengthening economic fundamentals, maintaining the country’s socio-economic agenda, and rejuvenating adversely affected sectors. It had also contained 40 courses of action and more than 580 detailed recommendations. Furthermore, the NERP had recommended the easing of the country’s fiscal and monetary policies.

•All these measures had exerted a direct, positive effect on the local bond market. Given the floundering equities market and an overly conservative banking sector, the post-crisis environment had been more conducive for the bond market, which offered lower interest rates and an abundance of surplus liquidity. Moreover, the enhanced regulatory framework and market infrastructure had cultivated a broader investor base that sought better returns.