Malaysia ready for Retail bond market, why I don't think so, pricy stock transaction fees.

From the Edge Malaysia:

Malaysia is ready to open up the bond market to retailers towards providing another alternative investment option for the individual investors, said CIMB Group’s deputy chief executive officer (group treasury and investments) Lee Kok Kwan.

With the persisting low interest rate environment, the discussion about opening up the bond market to retail investors has been heating up, although not everyone is in agreement that it should be done.

Criticisms range from the affordability of bonds to the complexities involved in bond trading, which can arguably be beyond the grasp of the average retail investor.

Bonds, with their fixed return rates, are typically considered safer investing instruments than equities, although the relative ratings of the instruments must be taken into consideration.

Moreover, the fact that the United States subprime and the eventual global economic crises originated from structured investment products has also cast further scepticism on the viability of opening up the fixed income market to the general retailer.

Speaking to The Edge Financial Daily recently, Lee said the next major step forward for the local debt market would be to implement retail-side service. “The next big step is the retail bond market,” Lee said. “Typically, you don’t want to let retailers invest in credit ratings that are too far down the credit curve to protect them because they are not in the same position as a big unit trust or big fund manager to study the credit terms.

“You would want to have some minimum standards and credit rating they can buy into. Having said that, once you allow them access into the bond market, the yield is much higher than bank deposits.”

As with most other countries, interest rates in Malaysia have come off since the onset of the economic crisis. Presently, the 12-month rate for fixed deposits in almost all major banks has been set at 2.5%, 50 basis points higher than the benchmark overnight policy rate (OPR) set by Bank Negara Malaysia.

Although the stated return of Malaysian Government Securities (MGS) might not be that much higher than FD rates — the three-year benchmark MGS maturing on August 2012 has a coupon rate of 2.509% — investors could see greater returns through the trading of their bondholdings.

Moreover, there is an argument to be made that the papers of some corporates, or private debt securities (PDS), which are highly rated — AA or higher — are safer investment instruments than some of the equities available on Bursa Malaysia presently.

In addition to better returns, access to the bond market also allows retail investors to diversify their investment portfolio, which is presently limited to the equities market, unit trusts and banking products.

“In countries where savings rates are very high, there’s a need for it,” Lee said. “In the US, where the country’s savings rate is very low (about 6%), you don’t need it — you can route it all through the mutual funds. The individual deposits in the bank system here are about RM500 billion.”

There have been some criticism from certain quarters that retail investors simply cannot afford to invest in bonds, which are presently sold in RM5 million denominations. While the process of dividing up the denominations might be straightforward, Malaysian Rating Corporation Bhd (MARC) CEO Mohd Razlan Mohd said the cost might be prohibitively high.

“It’s a function of cost. At what cost do you want to open it up? In theory, we should let the bonds be traded in smaller denominations. But the cost might be prohibitively high to divide up the bonds and it would become costlier for bond issuer who has to pay Bank Negara Malaysia to maintain the system,” he said.

Razlan added that existing bond funds already provided the same kind of diversification and exposure to bonds, although he cautioned that the viability of those funds would depend on the bond manager.

Lee demurred. He said the bond market did not need to incur additional costs, but could use the same existing platform of the equities market.

“When you develop a retail bond market, you don’t want to create unnecessary costs. Just piggy-back on the stock exchange infrastructure and use the same platform. Instead of quoting equities, you list the bonds there. Instead of dividends, you have a coupon. Singapore to some degree has done this, which has worked quite well.”

Hong Kong and Singapore currently have a system that allows the purchase of bonds denominated in one thousand units of their local currency through automated teller machines (ATMs). The banks providing the service take a cut from the transaction, of a few basis points, as their service fees. Supporters of the move also say that the introduction of retail investors will lend greater depth to the bond market as it provides greater diversification in the investor base. This would then boost stability and allow for greater trading in the secondary market, which will also improve the pricing mechanism.

Currently, only high net-worth individuals with RM3 million or more can directly purchase bonds.

The fact that retail investors are interested in purchasing bonds is plainly evident from the overwhelming response to the RM2.5 billion three-year Sukuk Simpanan Rakyat issued by Bank Negara Malaysia in January, which was fully taken up within two days.

The bond market here should be traded in smaller denominations. But there are other absurdities at work in the market. For instance, the liquidity of bonds here is non-existent. What happens when an investor wants out of a bond fund?

The bond fund uses its existing supply of cash or tries to find other investors to take the spot of the one that just left. I'm not an expert, but when a person leaves, does he get cash worth the Net Asset Value of the bond fund? Because if the fund were to actually take his portion and sell it on the market, the fund might not get the NAV price as desired. So who loses out? the one that left or the remaining investors of the bond fund? I say the losses are subsidized between the remaining investors of the bond fund.

The big problem with bonds here is that the minimum cost of a corporate bond is RM250,000. The average household income in Malaysia is about RM3200 based on a 4% growth rate from 2004 data from the Department of Statistics compounded to 2008. Here, I assume 70% urban/30% non urban population distribution (from the CIA world fact book).

Assuming this average income, it's hard to see how an individual investor could ever hope to buy the cost of a bond. I doubt very much so that the average Malaysian household will get to RM250,000 based on salary alone. Even if they were to put away a portion of their income (20%), they would probably be able to save RM500,000 at the end of 30 years and buy only two bond issues. That's an absurd number. Forget about diversifying bonds on your own.

Theoretically, there are not a lot of reasons why they should trade in such large amount per unit. First of all, debt issues aren't huge compared to stock market listings. If investors can buy in smaller lots for stocks, why can't they do the same for bonds? The banks just have to write checks from the bond payouts to a larger pool of investors which shouldn't cost that much. It's more bond holders to handle, but financially, it does not cost that much more.

But alas, the market here in Malaysia is much more developed for stocks than for bonds. First of all, when I tried to sign in to the BPAM website, guess what? I couldn't even register properly. It wouldnt' even send my verification link to my email address. That's just horrible. There is very little information on bonds out there. Most of it is centered around stocks.

While i'm on this subject of criticism of capital markets in Malaysia, the transaction fees for purchasing and selling stocks are incredibly high. In order to buy and sell a single stock, the transaction fees are 1.4% (.7 to buy, .7 to sell). Effectively, this makes liquidity in the market horrible. In countries like the US where transaction fees are $10 per trade so (RM35 to buy, 35 to sell), with just a trade size of RM5000, the US will be on the same price as Malaysia. Over RM5000, it will be even cheaper!

They should have a cap on the transaction fees because this policy is making liquidity poorer by taxing large transactions. They will try anything and everything under the sun to increase liquidity, but capping the transaction fees. It's obvious the reason why, profits. All these stories about increasing liquidity by having the FTSE index the markets are merely cosmetic.