Westpac's Disposable Triple-A Sub
Was Westpac Derivatives Products a temporary fix for a
bad credit rating, or simply a bad idea?
By Simon Boughey
In the early 1990s, Australia's Westpac had its sights set quite high.
The goal was to extend its reach beyond the Asia-Pacific rim and become
an international capital markets powerhouse. The bank established Westpac
Derivatives Products (WDP)-a triple-A-rated derivatives products company-in
November 1993 to defend and capture valuable bond and related swap business
with highly rated counterparties, and to help pull itself into the top tier
of bonds and swap market-makers.
Last year, Westpac decided to wind down WDP, and the decision is symbolic
of the failure of the Australian bank's international ambitions. During
the past couple of years it has drastically curtailed its ambitions and
is now concentrating its efforts on the Australian and New Zealand markets.
When WDP was established, triple-A-rated credit subsidiaries were nothing
new. Merrill Lynch had led the way with Merrill Lynch Derivatives Products,
its separately capitalized derivatives products subsidiary, at the end of
1991. During the next several years a variety of poorly rated banks and
investment companies established similar vehicles to allow them to compete
in the international bond markets with the likes of JP Morgan and UBS.
But the company was nevertheless an ambitious step. Westpac DP was the
first Asian company, including Japanese firms, to set up a DPC. It was initially
capitalized by $200 million in the form of $100 million in cash and $100
million in surety bonds provided by Capital Markets Assurance Corp., a triple-A-rated
U.S. bond insurer.
At the time, the decision appeared puzzling to some; the firm had recorded
a $1.6 billion loss in 1992 and was already in the process of cutting its
Eurobond operations and swap group in London and had already exited North
As Westpac retreated across the oceans to its home base, the triple-A
sub seemed increasingly redundant. DPC's are expensive both in terms of
the capitalization necessary to keep them viable, and the constant legal
and accounting fees. As James Mather, who worked at Westpac in New York
until 1994 and now heads Bank of Boston's swap group, says, "They asked
themselves, 'Why do we need $300 million firewalled in a sub that we don't
do anything with?'" Douglas Lucas, cohead of Swapco, Salomon Brothers'
triple-A sub, explained that in the first nine months, Swapco's accounting
fees and associated professional services amounted to no less than $1.8
At the end, there were very few deals on Westpac DP's books. In August
1996, total notional principal amounted to only $2.8 billion, which, according
to Lucas, would represent a very poor month at Swapco. When it closed down
WDP, the bank moved all outstanding transactions onto Westpac's books.
Westpac claims that the demise of WDP was not related to the trimming
on its international ambitions but was entirely attributable to the recent
improvement in its credit standing. In February 1996, in fact, the bank
was upgraded to AA- by Standard & Poor's Corp. and to Aa3 by Moody's
Investors Service in the middle of the year.
Westpac's new credit standing was good enough to allow it to deal with
its local borrowers and end-users, such as Australian central borrowing
authorities and Japanese securities firms, upon whom it depends. America's
country manager, Jim Tate, says that WDP was designed to terminate as soon
as Westpac's credit standing improved. "We said, 'The first day we
get back to AA, it goes.' And we got rid of the bastard as soon as we could,"
he explains. He adds that the formation of WDP, with its considerable costs,
stirred debate within Westpac and that the DPC was not "a loved thing
in Westpac at all." Nonetheless, Tate maintains that WDP was fundamental
to the bank's strategy of defending its core market during the period of
credit weakness, and that it has paid for itself over the past three years.
Westpac now makes swaps markets in four currencies only-Australian, New
Zealand and U.S. dollars and yen-from its London and Sydney offices, and
trades all the associated option products. Australian and New Zealand dollars
take pride of place and it makes markets in U.S. dollars "as a means
of getting to Aussie and Kiwi dollars," says Tate. These days, Westpac
has only 45 employees in its New York office, which trades fixed-income
derivatives and foreign exchange instruments in its four key currencies
as well as ECU and Deutsche marks.
Westpac now has only a marginal presence in Europe and is set to diminish
still further. "We have scaled back to concentrate on the Australasian
market," admitted a company spokesman in Sydney. He adds wryly that
Westpac's slogan "Australia's world bank" has now been dropped.
Although Westpac denies that its decision to close WDP is not directly
related to its retreat from the world stage, it admits that it never made
as much use of the vehicle as it had once envisaged. Cynics have noted that
there are now probably too many DPCs for the market and that forming a DPC
is probably bad business for banks that have never been in the front rank
of the derivatives industry.
Westpac's experience may have inspired its Asian competitors to try more
efficient approaches. Japan's Dai-ichi Kangyo showed an innovative way forward
for Asian and Japanese swap counterparties last year when it established
an arrangement with Merrill Lynch whereby DKB pays a fee to "borrow"
MLDP's credit when it needs to do business with a highly rated client. According
to Richard Robb, head of swaps at DKB, there have been "lots"
of deals run through the new arrangement since it was formed in February.
"I would say that we have done more deals that we would have done had
we formed a DPC by a factor of 10," he adds.
Kick Starting Long-Term Swaps in Taiwan
The Asian Development Bank wants to push terms to out to
seven years and beyond.
By Simon Boughey
Recent forays by the triple-A-rated Asian Development Bank (ADB) into
the Taiwanese dollar (MT$) bond market have laid the foundation for the
development of a long-term MT$ swap market. Currently, the MT$ swap market
is liquid only out to three years, but the ADB has issued and swapped its
bonds at seven years-and is now examining the prospects of doing the same
at the 10-year tenor.
The ADB, based in the Philippines, issued its first MT$ bond in 1995
when it placed MT$2.6 billion of seven-year notes in the domestic bond market,
becoming the first non-Taiwanese issuer ever to tap the market. When the
proceeds of these notes were swapped into floating-rate U.S. dollars, the
ADB also captured the distinction of becoming the first entity to execute
a long-dated swap in the MT$ market, says Juan Limandibrata, the senior
treasury officer in Manila. This issue was jointly lead, managed by Chiaotung
Bank of Taiwan and China Trust Commercial Bank with a syndicate of eight
managers. The swap was written by Chiaotung.
Last year, the ADB came back to the Taiwanese market with a much bigger
MT$7 billion seven-year note, led by China Trust and Grand Cathay Securities
with a team of three syndicate managers. This time, the swap was chiefly
written by Citibank with a smaller portion taken by China Trust.
On both occasions the swap was written into floating U.S. dollars, as
the great proportion of ADB's loans are U.S. dollar-denominated. The ADB
organized a competitive bidding process involving five banks, which included
domestic names and overseas banks with local subsidiaries in Taipei. Limandibrata
declines to disclose the exact sub-LIBOR level achieved in these swaps,
but says that each time the after-swap cost of funds was "well through"
what could have been achieved in the developed bond markets. The ADB hopes
to hit LIBOR less 1020 basis points in its more orthodox strategic
transactions, but these transactions "considerably exceeded that level."
The first bond issue in 1995 was almost certainly cheaper to the borrower
on an after-swap basis than the second because it was priced flat to government
bond yields. The 1996 issue, by contrast, was priced at a spread of 17 basis
points to the government bond curve. Limandibrata says that the second offering
was priced more generously to achieve secondary market liquidity and to
target institutional investors who had not bought tickets in 1995.
The ADB was pleasantly surprised by the strength of the swap bids for
both issues, as the MT$ swap market has no real liquidity beyond three years.
This means the houses winning the deals were not able to lay off the position
in the interbank market. In developed, liquid swap markets, a house that
pays into a new issue swap normally looks to offset this position quickly
in the interbank swap market by receiving a fixed rate-hopefully at a rate
that is significantly wider than the one at which it paid into the new issue.
In the Taiwanese market, however, the swap houses must offset the positions
through their corporate lending programs, which provide a regular supply
of fixed-rate MT$.
Nonetheless, the liquidity of the MT$ swap market will improve as more
borrowers seek to place bonds and swap back into U.S. dollars. Consequently,
more houses will be willing to run books beyond three years as profit-making
The ADB could have placed the bonds in the short-term sector of the market
where swap market liquidity is deepest, but it wished to establish a long-term
benchmark to match its loans, all of which are long-term. Moreover, the
Taiwanese government is a big issuer at three years and the ADB did not
wish to compete for buyers. This also deterred it from issuing at 10 years,
which was originally its favored maturity.
The bulk of the notes were placed in Taiwan. Foreigners can buy Taiwanese
paper by opening a local bank account in Taipei. The issue of these bonds
and the consequent swap business falls within the ADB's traditional mandate
to help developing countries not only in the form of loans but also by fomenting
activity in nascent capital markets.
Of its 1997 budget of U.S. $2.6 billion, U.S. $600 million has been allocated
for borrowing in the Asia/Pacific bond markets-all of which, of course,
must be swapped back to floating U.S. dollars. The ADB is contemplating
another issue in MT$, and is also looking at the Hong Kong dollar, the Korean
wan, the Thai baht and the Indonesian rupiah markets, says Limandibrata.
Before any borrowing decision can be finalized, quite lengthy discussions
with the relevant governments must first be completed, he adds.
Hong Kong Heats Up
Q: What derivatives products are the most active in Hong Kong?
A: In Hong Kong equity is king. There was a 70 percent increase
in volume in futures and options on the Hang Seng Index in a year where
most volume was flat to off. There are also lots of warrants issued on individual
stocks and baskets such as the Hang Seng Index. And there's a new stock
exchange in Kuala Lumpur that's active.
Q: What about the over-the-counter market?
A: The swap market in Hong Kong is quite active now since the
monetary authority created a Hong Kong interbank rate. Now there is a yield
curve to trade from. The swaps range from three months all the way out to
10 years. In fact, we launched a swap contract that's different from the
swap contract that was started before. It's now averaging 1,100 contracts
Q: Who are the biggest players in Hong Kong?
A: A lot of derivatives players came to Hong Kong when Japan cooled
off. Things are changing rapidly. There are a lot of investment banks in
Hong Kong, and that's where the derivatives are. Morgan Stanley was first,
and Hong Kong Shanghai Bank is also very big. We see a lot out of the French
banks such as Banque Nationale de Paris and Banque Indosuez. There are a
lot of investment banks moving into Singapore.
Q: What about the currency markets? Who's leading the pack?
A: Hong Kong is the fifth-largest currency center in the world.
The currency market is dominated by the Bank of China, Citibank and NatWest.
Q: Are you worried about what will happen when China takes over
A: I see it as a great opportunity. Our market is 6 million now,
and when China takes over we'll be 1.2 billion. We're planning to launch
a new index of Chinese stocks in the near future and build a proprietary
electronic system to complement the open outcry system.