Treasury Today Country Profiles in association with Citi

Formosa bonds

Early morning at memorial hall in Taiwan

Taiwan’s Formosa bond market has become a favourite location for multinationals looking to raise debt. But might a rule change reduce the popularity of the market?

It was reported late last month that Apple is to issue bonds in Taiwan. The US$1bn sale is the technology giant’s second foray into the Formosa bond market following its successful US$1.38bn issue in June 2016.

Apple is not the only US blue chip to be tapping the market, with Verizon, Intel and Anheuser-Busch InBev all recently seen raising funds in the market.

Taiwan has long been a favourite market for large multinationals, offering issuers favourable terms and access to a pool of cash-rich investors in search of yield.

But the recent flurry of issuance is also being driven by Taiwan’s Financial Supervisory Commission’s rule change which will prohibit insurance companies in the country – the largest buyers of debt – from buying bonds with call options earlier than five years.

Comparing yields: Formosa bonds versus US Treasury zero-coupon bonds and US credit

Security Yield
30-year zero coupon US Treasury rate 2.65%
Generic investment grade corporate spread 1.80%
Callable option value 1.00%
30-year non-call 5 callable zero 5.40%
Formosa bond yields ~4.50%
Value difference (between 30-year nc 5 callable zero Formosa bond yields) ~0.90%

Source: Bloomberg, based on PIMCO calculations as of 31st October 2016

An attractive market

The rise of Taiwan’s bond market has been fast. As little as three years ago, the country’s largest insurers primarily bought sovereign bonds, due to a regulatory cap that restricted the holding of foreign corporate debt for insurers.

A regulatory change in 2014, however, enabled insurance firms to view foreign currency bonds denominated in foreign currency as domestic investments.

The move had its desired effect and global corporates soon began to issue in the market, led by Verizon communications. Issuers were buoyed by the ease of issuing and the tight concentration of the market.

Damaging changes?

The amendments coming to the bond market, pushing out the call date, look set to change the landscape somewhat, especially for investors.

Indeed, Rick Chan, Portfolio Manager, Interest Rate Derivatives at investment management company PIMCO outlines that investor interest has already cooled somewhat due to lower yield and the coming change may mean that the effective investment return and reinvestment rates on Formosa bonds will be lower still. “Even at today’s yields, investors may not be adequately compensated for the call risk in the bonds,” he says.

US issuers are therefore in a rush to take advantage of the short-dated call options before the rule change comes into effect, which is expected to be later this month.

Yet, despite these trends, Chan doesn’t believe that there will be a significant decline in issuance or take up of bonds as a result of the rule change or falling yields.

“The regulators want these bonds to become longer-term investments to better match the portfolio of insurance companies,” he says. “But we don’t believe that this will have a huge impact on issuers as typically for every bond they called they generally issued a new one to replace it.”

Chan goes on to add that: “We think issuance will continue as long as these bonds don’t count as foreign content limit and have favourable accounting treatment.”

That being said, Chan notes that the introduction of IFRS 9 in 2018 may change this somewhat. “The introduction of IFRS 9 could complicate investing in Formosa bonds because bonds with call options would not meet the ‘solely payments of principal and interest’ test and would, therefore, be classified as fair value investments,” he concludes.

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