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Short sellers target Asia's booming US dollar bond market

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Asian companies are turning to the US 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.

[HONG KONG] Asian companies are turning to the US 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 and Reliance Communications.

"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.

One key reason it's becoming easier to short Asian US dollar bonds is that funds are buying more of the securities on borrowed money. The banks that extend that credit hold some of the bonds as security, giving them a greater supply of the notes to lend out to short sellers.

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On top of that, Chinese and other financial institutions are buying more of the securities themselves in their hunt for yield, driving sales in the region excluding Japan to a record US$310 billion this year.

The two trends have left banks and brokerages with more notes to lend out, which is deepening the repo, or repurchase, market. Those agreements to lend out the securities, retaking possession after a set time, mean that funds on the other side of the trade can sell the borrowed bonds in hope of profiting from price drops.

Greater Leverage

"We have found it easier and less expensive to short bonds," said Darryl Flint, chief investment officer at Double Haven Capital (Hong Kong). "There is more liquidity in the repo market."

Because the deals occur off organised exchanges, volume numbers are hard to estimate. But figures on buying by financial institutions underscore the shift. Banks took 30 per cent of new note sales this year, up from 17 per cent in 2014, JPMorgan Chase & Co estimated in a note this month.

"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.

That all threatens to shake up what's been a notably stable market, aside from some company meltdowns like Noble. In some cases Asian US dollar bonds have shown less volatility than US 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.

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