(Bloomberg) -- Asian companies are turning to the dollar bond market like never before, selling record amounts of securities that leveraged investors desperate for yield are scooping up. But there’s a flip side to all that growth: it’s getting easier for funds to sell them short.
With unprecedented numbers of first-time borrowers and concerns about the financial transparency of some issuers, the market is increasingly vulnerable to higher volatility. Traders are already reeling from high-profile meltdowns this year after prices collapsed on bonds from Noble Group Ltd. and Reliance Communications Ltd.
“You will see movements that you won’t have seen before," even as short selling can help improve market efficiency, said Owen Gallimore, head of credit strategy at Australia & New Zealand Banking Group Ltd.
Booming issuance and more buying by banks is increasing the supply of securities available for lending -- and therefore shorting. Sales of dollar bonds in Asia excluding Japan have soared to $310 billion this year.
“We have found it easier and less expensive to short bonds,” said Darryl Flint, chief investment officer at Double Haven Capital (Hong Kong) Ltd. “There is more liquidity in the repo market.”
Repos, or repurchases, are agreements by a bondholder to lend out the security, retaking possession after a set time. Funds on the other side of the trade can sell the borrowed bond in hope of profiting from a slide in its price during the repo period.
Greater Leverage
Because the deals occur off organized exchanges, volume numbers are hard to estimate. But market participants say a rising stockpile of Asian dollar bonds at banks, along with the increased use of leverage to buy such securities, has fueled repos.
Banks took 30 percent of new note issuance this year, up from 17 percent in 2014, JPMorgan Chase & Co (NYSE:JPM). estimated in a note this month. That bump has come at the expense of institutions including pension funds.
“As you have more Chinese banks and securities firms buying Asia dollar bonds in large amounts, such investors are more able to lend out bonds for repo, which improves liquidity,” said Richard Cohen, head of credit for Asia-Pacific at BNP Paribas (PA:BNPP) SA.
That all threatens to shake up what’s been a notably stable market, aside from some company meltdowns like Noble. In some cases Asian dollar bonds have shown less volatility than U.S. counterparts during times of stress.
Investors in Asia have up to now also had less opportunity to bet against dollar bonds in the region due to a relative lack of credit-default swaps, which have been slow to catch on compared with developed markets.
“The market is more able to fulfill demand from investors to short Asia dollar bonds now because there are more bonds being lent out on repo by counterparties that are new to the market and taking a bit more leverage,” said Edward Gildar, Asia regional head for global finance products at Citigroup Inc (NYSE:C).