Bonds – from carbon credits to Chinese central bankers

A fierce debate is under way among bond market specialists in Asia. Some believe the reg­ion’s markets are at last coming of age, but others fear the current boom will turn out to be shortlived and that there will be a return to their normal role of poor relations to the likes of New York and London.

Bond issuance in the region soared in the past year to reached record levels in international dollar-denominated debt by early May. Fewer local borrowers are registering to market their deals in the US, which implies they are more confident about their ability to raise money locally. That suggests that Asia is generating deeper pools of capital from sources with a better understanding of local needs and regional norms.

Arguably, more important for those backing a “this-time-is-different” view is the level of innovation apparent in bond transactions across the Asia-Pacific region. Lawyers are proving instrumental in devising and enabling these breakthroughs.

Examples of innovative deals in the past year include: “forest bonds”, in which interest is paid in carbon credits; China’s first “covered” deal, where the funds borrowed are backed by a ringfenced pool of collateral; and the first renminbi-denominated special drawing rights bonds, before the Chinese currency had even joined the International Monetary Fund’s SDR basket.

As well as that, borrowers’ legal advisers produced innovative ways to work across borders and in vastly differing legal systems in order to develop forms of financing in which internat­ional investors feel comfortable taking the risk of investing onshore in China and elsewhere.

Along the way, some of them have battled with bureaucracy and persuaded government institutions to accept new financing structures. A few have even trekked for days through rainforests to research their projects.

Conservation projects have proved a popular field for bond market innovation everywhere. In Asia, it includes the world’s first “forest bonds”, sold by the International Finance Corporation, an arm of the World Bank, which raised $152m to finance forest conservation. The five-year bonds offered interest of 1.55 per cent in either cash or in carbon credits sold by the Kenyan forest scheme the deal will support.

“It is hard to get professional funds flowing into conservation,” says Martijn Wilder, the Sydney-based head of Baker McKenzie’s climate change and finance team, which structured the deal. “One way of doing that was to use a traditional financing tool to raise money, which could be directed into forest conservation.”

Critical to the deal was a $12m commitment by miner BHP, which will pay the interest if the investors — which include funds such as TIAA, and Calstrs, the California teachers’ pension scheme — opt for cash instead of carbon.

“The truth is that many investors don’t know much about carbon credits. The point is to expose them to that,” says Mr Wilder. “[The investors] have to elect each year whether to take credits or cash. If they are really savvy, they should be able to sell the credit for a higher price than the cash interest.”

Another regional first was a renminbi-denominated deal backed by the IMF’s basket of currencies, known as special drawing rights. While SDR products — essentially backed by a basket of dollars, euros, yen, sterling and renminbi — are commonly used as reserve assets by central banks, the aim was to highlight China’s impending inclusion as a reserve currency, which took place in October.

The World Bank raised 500m in SDRs — about $700m — through the deal, which was more than two times oversubscribed.

Although rare, SDR bonds are not themselves new: the innovation lay in making this particular deal possible. One challenge was that the China Foreign Exchange Trade System (CFETS), run by the People’s Bank of China, did not publish reference rates for all SDR currencies at the same times each day.

It is hard to get professional funds flowing into conservation

“The PBoC’s system captured the points but they weren’t publishing them — so it had to revise its system,” says Christine Chen, a partner at King & Wood Mallesons, who praises the efforts of Chinese central bankers to make the innovation work. “They don’t always have much flexibility. But they really want to take the market structure forward and they want to attract international issuers and the very best international investors.”

Other innovations in the region dealt with challenges that are more familiar to lawyers: structuring complex deals to very tight time­tables.

A 27-strong team from Hogan Lovells, for example, was needed to structure a $70m investment by Goldman Sachs’ private equity arm into Red Planet Hotels.

This fast-developing budget chain has am­bitions to expand across the region but still lacked the scale to appeal to many banks. The time­table facing Hogan Lovells was just two months. Structuring the loan involved taking onshore security over the chain’s assets in countries that are often considered risky in legal terms, including Thailand, Indonesia and the Philippines.

Allan Wardrop, the partner who led the deal, concedes that innovation in such transactions can be hard to replicate in the next deal because of the differing complexities that are involved in each one. But he nevertheless predicts a growing market for similar private equity-based funding.

“There aren’t so many debt funds yet, but I think they will increasingly be looking at this type of deal — particularly in Asia where you’ve got high-growth businesses who can’t yet tap the mainstream markets,” he says.