Most Asia-Pacific investors see several challenges to investing in Basel III-compliant capital instruments, according to a new Fitch Ratings regional cross-sector investor survey.
This is not a surprise as the issuance of such instruments is at a nascent stage across the region, and there are growing – though varying, country-specific – reasons for raising fresh capital.
The main issue identified by survey participants was the uncertainty over loss-absorption trigger points at the point of non-viability (PONV); 65% of investors highlighted this issue. Another important concern was the appropriate balance of risk/reward, with 52% viewing risk as inadequately priced, and a further 45% highlighting the issue of secondary market liquidity. Of less concern was the issue of investment mandate restrictions hindering purchases of these instruments, and whether such instruments were riskier than their legacy counterparts.
Investor uncertainty around PONV, as it relates to Tier 2 instruments, has arisen as APAC regulators have followed global trends by not defining what event would trigger this. Industrial and Commercial Bank of China (Asia)’s proposed subordinated US dollar bond amplifies the uncertainty as it includes two triggers: one at the discretion of the Chinese authorities on the parent bank Industrial and Commercial Bank of China, and one for the Hong Kong regulators on the issuing subsidiary.
Coordination between the authorities seems likely in such cases, while we generally expect regulators will assess each potentially problematic financial institution on its own merits before calling PONV. Therefore, precise trigger points are bound to vary across the region’s issuers and markets.
Fitch will address this issue by notching from the Viability Rating (VR), which best represents how close an issuer would be to the point of failure or PONV. In certain specific cases, Fitch will continue to notch off the IDR where we believe the authorities will intervene before deeming a bank to have hit the PONV – this is mostly where there is a particularly strong linkage between the sovereign and the bank. Fitch considers this to be the case for the ICBC Asia transaction, and therefore used ICBC’s and ICBC Asia’s support-driven IDRs as the anchor ratings.
Investor concerns about risk pricing, and secondary-market liquidity, reflects several factors. One is the uncertainty about the stance which could be taken by regulatory authorities in various jurisdictions. Another is the potentially wide rating differentials between credit rating agencies stemming from differing methodologies.
Moreover, the influence of private or retail investors who have been attracted to these securities in the low-interest environment has also been a factor. Finally, as Basel III is still at an early stage of implementation across the region, there are simply not that many compliant-instruments in active use.
Survey respondents were quite optimistic on the APAC financial sector in general. Views on fundamentals were more positive on financials than on all other sectors except developed market sovereigns. The outlook for new issuance activity was also similarly constructive. The main risks to APAC banks’ credit quality are seen from a weakening in asset quality due to property market exposure (by 82% of respondents), rampant credit growth in China (76%), and high or rising leverage (67%).
Fitch conducted the survey between 20 August and 30 September. It represents the views of 72 senior investors in the APAC region, including asset management companies, sovereign wealth funds, insurance companies, pension funds, wealth managers, banks and hedge funds. We will publish the full survey results in mid-October.