Rationing Plan to Revive Bond Market Liquidity Shows Taiwan Mire

  • Trading in 10-year government notes plunged 98% in past decade
  • Market hampered by buy-and-hold strategy of large investors

A plan to ration bond holdings in Taiwan shows just how desperate authorities are to revive activity in a market plagued by near-zero inflation.

Trading in the island’s 10-year sovereign notes has plummeted 98 percent over the past decade as loose monetary policy and bouts of deflation pushed the yield down to 1.18 percent, the least in Asia after Japan. Recent proposals to reverse the slump include limiting each organization’s purchases of corporate debt in the primary market and capping holdings of benchmark government bonds in the first six months of trading.

Fewer bonds are changing hands globally as new regulations make it more expensive for banks to trade and unprecedented monetary easing prompts investors to buy and hold. In Taiwan, liquidity issues are compounded by a high concentration of ownership and the proposed rule changes may not have much impact, according to Frances Cheung, a strategist at Societe Generale SA.

"If the large investors don’t change their strategy, if they can’t buy the bonds at first, they’ll buy them later," Hong Kong-based Cheung said in a Nov. 9 phone interview. "After a while, the liquidity will return to where it was again."

Monthly volume for 10-year government notes, with each unit equaling NT$50 million
Monthly volume for 10-year government notes, with each unit equaling NT$50 million

The monthly turnover of Taiwan’s 10-year government notes has averaged NT$162 billion ($4.96 billion) this year, a 43 percent drop from five years ago. In contrast, trading volumes of South Korea’s similar-maturity sovereign bonds and linkers averaged the equivalent of $62.6 billion each month this year, Koscom Corp. data show.

About 73 percent of the 10-year debt auctioned in Taiwan in March is now owned by the top three holders, according to the Taipei Exchange. The five-year yield rose the most since March the week after the single-buyer cap plan was announced on concern it would curb purchases by large investors such as state-backed Chunghwa Post Co., which holds NT$6.7 trillion of assets.

The attempts to boost trading are part of broader efforts to bring more business to the local financial industry, which has long been hampered by narrow lending margins and the outflow of funds to regional hubs such as Hong Kong.

The new proposals will ban any one investor from owning more than a third of a new five- or 10-year government bond in the first six months, and cap a single buyer’s purchases at 80 percent of corporate notes sold to professional investors in the primary market. The Taipei Exchange also plans to make it mandatory for market makers to submit quotes for foreign-currency securities maturing in seven years or less in order to spur trading in Formosa debt, which is denominated in yuan.

Economy, Rates

This comes after slow economic growth and inflation prompted the central bank to hold its benchmark policy rate at 1.875 percent for four years before a reduction in September. With ample supply of cash, financial firms, seeing little room for capital gains, prefer to hold, while turning to overseas assets for returns, according to Vince Lin, a fixed-income trader at Concord Securities Corp. in Taipei.

Another reason for the low liquidity is that limited foreign buying of local bonds under existing restrictions has made market strategies very one-sided, said Cheung at Societe Generale.

The low interest rates forced 89 of 90 domestic bond funds to either shut or shift their attention overseas in the past decade, with Prudential Financial Return Fund the sole survivor. Most Taiwan sovereign notes are held by insurers or deposit-taking financial institutions such as banks, which often prefer to hold rather than trade.

“More than half of the bond traders I know have left over the past decade," said Concord’s Lin. "With competition from foreign-currency investments, you’d expect trading in low-yielding Taiwan-dollar products to fall. The larger environment has changed, and you can’t reverse that simply with nominal policy changes.”

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