Spurring prudent development of domestic corporate bond market

Donald Lambert - Principal private sector development specialist Asian Development Bank

The Asian Development Bank (ADB) forecasts that Vietnam will register economic growth of 1.8 per cent in 2020 and 6.3 per cent in 2021. Although lower than recent years, these prospects are remarkable given that many economies are mired in pandemic-induced recessions.

Banking regulation is also supportive. The State Bank of Vietnam has capped bank loan growth since 2014. In 2019, 18 of the country’s largest banks implemented Basel II, which reduced their capital available for lending. These measures, coupled with restrictions on using short-term borrowings to fund long-term loans, make bonds an increasingly attractive alternative. But this growth carries risks, particularly because few issuers have a public credit rating. While investors should never base their decisions solely on a credit rating, they are an important reference that can foster market discipline by discouraging investors from “chasing yields” and issuers from placing “covenant lite” bonds. Moreover, credit ratings can help issuers to secure more favourable terms including longer tenors and lower credit spread. This lowers borrowers’ cost of capital and spurs economic growth.

Ratings are sparse because Vietnam lacks a dominant domestic credit rating agency. Two agencies have been licensed, but both are nascent. By contrast, Phil Ratings was established in the Philippines in 1985, Rating Agency Malaysia in 1990, and Pefindo in Indonesia in 1993.

Credit ratings in Vietnam are overdue. Their acceptance will require credibility, and around Asia, domestic credit rating agencies have partnered with global rating agencies to gain that credibility. Vietnam should follow suit. Global agencies are also interested in these partnerships, which can provide expertise and access to new and growing markets.

Global rating agencies are likely to prioritise three factors. The first is analytical independence, which Vietnam offers. Market stakeholders understand how important this independence is to a credit rating agency’s credibility.

Second is stakeholder support and again, they will not be disappointed. In 2014, the Vietnamese government issued Decree No.88/2014/ND-CP on credit rating services, which has provided a legal basis for credit rating agencies to be licensed. The government has also supported events to educate the market on the value of ratings. The Vietnam Bond Market Association, the leading industry association, has also been supportive.

The final ingredient is demand, which is a challenge. A recently published ADB working paper, funded by the Australian Department of Foreign Affairs and Trade, estimated that approximately a third of bond issuances would need to be rated to generate sufficient revenue to sustain a single domestic rating agency. It is unlikely that this demand for ratings will develop organically, so the Vietnamese government should consider five coordinated initiatives to push the market’s growth.

The first is market education. Vietnam will move away from unrated issuances if issuers better understand the benefits ratings can provide in terms of larger issuances, lower pricing, and longer tenors, and if investors grasp the potential gains from greater transparency, benchmarking, and secondary market trading.

The second factor regards state-owned enterprises (SOEs). To change the credit culture, the market needs examples of companies that have benefited from securing a credit rating. SOEs should lead this push. This would align with government initiatives for SOEs to raise more debt against the strength of their own balance sheets, diversify SOEs’ funding away from banks, and facilitate benchmark issuances to build a credit curve and culture.

Third is Vietnamese Social Security (VSS). In many countries, pension funds are among the largest buyers of corporate bonds. However, VSS, the state-sponsored pension fund, can only buy corporate bonds issued by banks. VSS should expand into nonbank corporates to bolster its financial returns and diversify its portfolio. If VSS required its corporate bonds to be rated, it would drive demand for ratings and help VSS to manage the risk of these assets.

The next factor is mandatory ratings. Vietnam passed a new security law in 2019 that would require ratings for some public issuances, but a draft decree published for comment in June 2020 suggests that many bonds may be exempted. Vietnam should make ratings mandatory for all public placements, following the example of other economies in the region, as these are a component of the overall cost of a bond issuance and in many cases pay for themselves. They build a credit culture and are regulatory tools for monitoring market soundness.

Finally, the last factor to be considered are public placements. In 2018 and 2019 private placements were an unusually high 94 per cent of issuances. To avoid compounding this anomaly, any move to mandatory ratings for public offerings must encompass a streamlining of public offerings and requirements for private placements.

A credible local rating agency is a key missing ingredient in Vietnam’s otherwise flourishing corporate bond market. Partnerships with global rating agencies would unlock the market’s potential, but these agencies want certainty that the demand for ratings is real.

The government can lay the groundwork through reforms that drive the demand for credit ratings and spur the prudent development of the corporate bond market.