Disneyland – The Singapore Government Bond Market
To be read with a pinch of salt and huge dose of compassion.
Days when the yield curve did not stretch past 10 years and interest rate swaps were in their days of early evolution. Who was to know that SOR was not an appropriate benchmark ? (when the purpose of SOR then was to prevent cost of funds arbitrage ?)
Bond swap spreads were the newfangled, almost far fetched concepts then, that bond risk could be hedged or rather, should be hedged and took off to a disastrous start that humbled some big market names.
The market even dabbled with 5Y bond futures in the early days, perhaps too early, in my opinion.
Why Disneyland ?
Because Mickey Mouse will feature a lot in my piece today.
For some months, I have pondered on this Herculean task of possibly condensing about 16 years worth of market experience into a fruitful venture of sorts. To assist the next generation in their roadmap to the future by examining the problems of the past, some of which do still persist.
Traders have come and traders have gone. So have strategists and economists. Ask them what they thought of the Singapore market and the word “Mickey Mouse” comes first to their minds.
They do not say it with vengeance or any form of malice. Rather, it is with resigned exasperation after being worn down by the harsh reality of market immersion, day in and day out of mind numbing logic and many emotionally challenging moments of being lassoed by the local cowboys.
Now, lets get past the muscle brained traders of banks and hedge funds alike, and move on to the real market. The investors behind the scenes; the bank balance sheet managers, the portfolio managers of asset management companies, the insurance fund managers, the offshore central banks and private banks.
What is Wrong With Disneyland ?
1. Understanding SGD Foreign Exchange Policy
Does anyone know how it works ? It is hardly the most transparent in the region and a hideous black box to the un-scholarly me. That I survived trading this market for the past 16 years, could only be given to a rare alignment of every single star of good fortune or a jinx sent to plague me for some sin of a past life.
I tried, raved and ranted and I am still trying really hard to understand the machinery behind the policy and how I can make myself believe that it is an effective way to police inflation and balance growth. Yet all I have accumulated is an unhealthy level skepticism, bordering on cynical, these days.
The first step to trading bonds is the concept of inflation. There is good and bad inflation to manage. In school, the rule of thumb ingrained in our brains is that interest rates should go up to contain inflation. But in Singapore, the reverse is to be implied.
That is because Singapore manages inflation by letting its currency strengthen and when it happens over here, interest rates fall. Inflows will pour in and liquidity brings interest rates down in an uncovered interest rate parity model. It is a mental challenge to even visualize, let alone trade particularly in the ZIRP environment of the past 5 years.
Yet we have an army of these so called expert strategists to help us which they would by complicating explanations, lining their pockets well in the process and commanding salaries many would only dream about.
And it is really necessary to forecast anything when it is just a one way path of appreciation ?
2. Over Regulation and Non Internationalisation
Brought up in the Singapore regime of education, it is rule based. There are rules and rules and more rules.
Investors not from town often express incredulity at the number of rules that MAS imposes on primary dealers, for example.
Primary dealers ARE OBLIGED to make prices for EVERY SINGLE BOND ON THE CURVE to each other during trading hours within SPECIFIED bid offer spreads. Even if they do not feel like trading, they have to.
Not only do they have to make markets to each other, they are each beholden to underwriting at least 10% of each government bond auction to ensure the auction’s success.
This underwriting commitment has now become the industry norm, extending to corporate bond issues, forcing banks to absorb unsold portions of debt issuances.
The outcome is sometimes over or under trading of SGS and interest rates, sometimes at the expense of corporate bonds which government bonds are supposed to complement in the entire scheme of the capital market picture.
As children, you need rules. At school, you need rules. In society, we have rules. But when the child outgrows the rules, rules become a hindrance to growth and development. This has led to the next problem with the bond market, under development in certain areas.
An offshoot of the controls would be the non internationalisation of the SGD policy. Non residents (institutions included) are not allowed to borrow more than SGD 5 million at any one time, unless it is to fund a specific onshore asset purchase. Thereby leading to initial investment apprehension for the newbie investor.
Seasoned players would realise that the SGD 5 million rule does not really apply much these days and SGD funding can be obtained via forward start trades, to create certain synthetic borrowings. But suffice to say, it is definitely not a marketing point.
3. Under Development
One glaring undeveloped aspect of the marketplace is the repo market. The authorities could never enforce repos to take off.
Well, they did try and even introduced bond futures which also failed to gather sufficient interest.
For repos, there is a rule that primary dealers have to make repo prices to each other for generic repos i.e. on unspecified collateral.
Well, they could not enforce banks to make repo prices that could be traded upon. Repo rates follow money market rates and it could be as wide as anyone wanted it to be unless MAS wanted to regulate interbank borrowing and lending too which sort of goes against the constitutional right of a bank.
MAS countered the repo problem with their daily securities lending facility, available to only the primary dealers that allows the primary dealer to borrow a specific security on a collateral swap. Well, the market outgrew that because the daily limit was SGD 50 million per security in a market where deals can amount to the hundreds of millions these days.
SGD 50 million ? Too small or too big ? against trillions of dollars ?
In other words, it is impossible to short bonds in a meaningful way.
4. Phony Borrowing Needs
Again a back to school question. Why borrow when you do not need the money ?
Governments running budget deficits issue bonds to fund them.
Singapore usually runs a budget surplus. Bonds exist here to boost the growth of the country’s status as a capital markets centre and to provide liquid assets for banks’ balance sheets.
This should give investors comfort in knowing that the market will only grow as much as the central bank wants it to. Bonds will be issued to meet needs of investors and the investors interests will be protected in that there will not be excessive supply.
That does not ring right. It sounds like a pretty artificial and controlled environment which cannot be called a free market (mickey mouse ?).
And how do you trade this ? What goes up CANNOT COME DOWN ?
You basically just buy then scream for first aid when the prices drop ? That happened in 2003 where they stepped in to buy back bonds to save the market or rather, local banks who are the biggest holders.
5. Inflexibility of Issuance
The inflexibility of the government bond issuance calendar which is announced 1 year in advance, with all good intentions to manage expectations, but has, in fact, created a loophole for exploitation in market appetite.
Gauging the market supply at the time of the bond size announcement and knowing in advance the pipeline of corporate bonds coming gives the parties with privy information a free hand in controlling prices by either sweeping up bonds or sitting out the issue, leaving the rest of the market chasing losses.
6. Critical Mass
Singapore’s bond market has grown in size spectacularly in the past decade not considering the little dip in 2003-2006 transitionary period when policy adjustments were made to formalise for example, the monetary policy announcements dates, bond market incentives and such.
There is only so much bonds the government can muster as the total GDP of the country caps the market size. And the truth is, Singapore is a small country. It will never be the South Korea in terms of total GDP and thus the government bond market cannot grow much more for the critical mass that will allow Singapore government bonds to attain anymore global attention. As it is, the Debt/GDP ratio is possibly the 2nd highest after Japan in Asia at >100% which is closer to Greece than Australia (27%).
The push for market development has resulted in a certain market monopoly where the game is controlled by, again, just a few players with the muscle power to profit from the other problems listed above.
Scenario for Illustration
A certain global bond fund wants to allocate 5% of their portfolio to Singapore. Say it works out to be 750 million.
Fund calls bank up. 750 million of bonds.
Bank does not have enough stock and risk appetite to make the price. Gets hit for 250 million.
No repo market.
Other banks find out. Short squeeze starts because banks are obliged to make prices at any time and so that bond will be the favoured issue and come under heavy attack.
No other party with any interest to short sell the bonds for the reason that there is no repo market and a lack of incentive to challenge the risk appetite of superior entity.
Market rallies. Fund watches bond price soar. Decides to allocate to Malaysia. Out they go. Market tanks in the same pattern as it rallies.
7. Market Inbreeding
I am aware that this section will not go down well with many of my associates out there but I deem this necessary to mention as a cursory note.
Singaporeans are generally a peace loving bunch with a lovely central bank who is accomodative to the cause of market development to almost a flaw.
The servitude of the central bank to market players – investors and traders comes with it the price of ensuring market stability (and control). Over the years, this has been reduced to the analogy of the same old generals advising the aging emperor. A market protectionism has developed unbeknownst to market participants. All old caution and no fresh blood.
For the old generals do not favour change and the new generations are plainly apathetic and soon leave for greener pastures. Whilst all looks rosy and good, the rulebooks need a coat of fresh paint for the future.
I have said enough.
Most traders out there would say they do not like SGD, it is boring and not like the exciting world of Asian rates. The crisis has led to the inclusion of SGD into the radars of the big players as the global pool of AAA assets shrink and does not look like it would grow anytime soon, making it all the more imperative for the SGD market to graduate to into the global stage.
There is something toy town and openly artificial about the market that is created not out of a need but out of a desire. And thus, perfect it must be on the superficial front. The fact is that the market is pretty stable with no big shocks and very well managed by the central bank.
Call this a rant, ravings of a lunatic trader, lamentations of a blinkered donkey, a demented loonie taking a stab at establishment, a short sighted individual aspiring for scholarly heights of the privileged class, I do not care. Simple.
I have been there. Done that and I am still no expert. I am just a battle hardened veteran who is just a little tired these days and waiting for my tour of duty to end.
Postscript : This was written 10 months ago. I held back publishing it while considering what I would possibly achieve in telling the truth from the angle of my own little fishbowl. Probably nothing but some entertainment value.