## _cr09151 - Executive Summary

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### Executive overview
- Debt market in Thailand has made important strides since the financial crisis of 1997.
- Government progress: building an orderly yield curve and beginning to establish benchmarks.
- Secondary market liquidity constrained; recommended: reduce frequency of auctions and increase size of individual offerings.
- Primary dealers (PDs) need to shift from “broking” to greater underwriting and market making; review of the PD system warranted.
- Prospects constrained by likely limited financing need unless authorities secure flexibility to restructure existing portfolio or establish more meaningful benchmarks.

### Primary debt market — public debt instruments and issuance
- Public debt securities dominate: Treasury bills and government bonds represent 55 percent of the total B 3,085 billion outstanding of public debt securities.
- Public Debt Act (PDA) allows debt to be raised to finance: (i) the budget deficit; (ii) approved social and economic spending; (iii) debt restructuring; and (iv) onlending.
- Government bond types:
  - Loan bonds: standard wholesale fixed-rate bonds with tenors out to 20 years. As at end-December 2006, 30 different issues outstanding; average size B 35 billion; only 3 bonds exceeded B 40 billion; 7 were less than B 30 billion. Desired benchmark size indicated at least B 50 billion. Commitment to create and maintain benchmarks of at least B 40 billion at 7 and 10 years over 2006–2010.
  - Government savings bonds (GSBs): retail product in small denominations; make up around 25 percent of total stock of government securities. One bond issued in 2002 to restructure FIDF accounts for almost half the total outstanding; this will redeem in 2012. The SB129A redeems on September 12, 2009. Typical new issues B 500 million; GSBs currently sold with a tenor of 3 years. Four other savings bonds range from B 26 billion to B 54 billion, maturing in 2007, 2009, 2011 and 2014.
  - Treasury bills: issued at one, three and six month maturities; at end-2006 they made up 13 percent of government securities portfolio. PDMO intends to refinance around B 120 billion of bills with loan bonds in FY2007 (October 2006 to September 2007).
- BOT issuance:
  - As at end-Dec 2006, B 586 billion BOT bills and B 311 billion of BOT bonds; bills have maturities of less than 15 days; fixed rate bonds issued at 1 and 2 years maturity with new issues typically between B 50–70 billion. In March 2007, BOT introduced a 3-year floating rate note.
- State Owned Enterprise (SOE) issuers:
  - GHB had B 85.5 billion of bonds outstanding as of end-Dec 2006, representing 17 percent of the SOE market segment; all GHB issues but one are government guaranteed.
- FIDF treatment:
  - Securities issued by FIDF for liquidity needs are excluded from figures as used solely as collateral for rolling repo transactions. Government has issued securities and injected proceeds into FIDF to fiscalise FIDF losses.
- Scrip vs scripless holdings:
  - All retail savings bonds issued in scrip (certificated) form; wholesale instruments issued in scripless form with an option for scrip. As of end-April 2007, 31 percent of stock was held in scrip form. Civil and Commercial Code provisions require collateral to be pledged in scrip form; related Acts are being reviewed to allow scripless securities to be pledged to a greater extent.

### Primary market issuance program and implications
- Planned FY 2007 gross issuance of government bonds around B 365 billion.
- Preliminary FY 2008 gross issuance indicated to decline to B 222 billion; at this level PDMO will only be able to support 4 new benchmark bonds a year.
- Decline of Tbill stock and anticipated strength of the budgetary position suggest PDMO primary market activity could drop significantly in the medium-term unless new debt-creating flows generated (e.g., active debt exchanges, expanding scope of onlending to domestic debt).
- Domestic debt issuance could increase by around B 60 billion over FY 2008 and FY 2009 to meet financing of planned mass transit investment, based on assumption JBIC will provide a loan to meet remaining cost to central government—anticipated to be around B 90 billion.

### Primary market mechanics, auctions, and PDMO/BOT scheduling
- GSBs sold to retail investors at a fixed price and distributed through one of the commercial banks.
- PDMO and BOT use multiple price auctions to issue debt securities.
- Eligible competitive bidders: banks and other financial institutions, Government Pension Fund, Social Security Office, life insurance companies, provident funds, and co-operatives. Foundations, charities and nonprofits can submit noncompetitive bids only.
- 20 percent of total stock on offer reserved for noncompetitive bids; rarely used.
- Auction timing:
  - PDMO auctions Tbills on Mondays and bonds on Wednesdays.
  - BOT auctions of central bank bonds can be held on Tuesdays, Thursdays and Fridays.
- Typical auction sizes and frequencies:
  - PDMO: typically auctions a bond every week; typical auction size around B 5 billion. 7-year benchmark in second week of the month and 10-year bond in fourth week; often two bonds auctioned same day.
  - BOT (historical): up to May had 3 auctions of bonds a month typical size B 20–30 billion; under new schedule announced in May, BOT will on average have 1 bond auction a month.
- Pre-announcement practices:
  - PDMO: calendar of bond auctions announced at end of quarter for forthcoming quarter; Tbill calendar two weeks in advance.
  - BOT: announces auction schedule a month in advance.
- Observed issuance uncertainty: issuance highly cyclical and tied to government cash needs; example: last quarter of FY 2007 PDMO cancelled all further auctions of the 2024 bond while maintaining issuance of 7- and 10-year benchmarks.
- Recommendation: more active cash management and aggressive use of Tbills to reduce uncertainty and improve transparency.

### Primary dealer (PD) framework, performance, and reform options
- BOT manages PD system; nine PDs, all banks (securities companies do not meet capital requirements).
- PD responsibilities: participate in government securities auctions and BOT OMO outright sales; make markets in secondary market for government securities; submit reference yields to ThaiBMA daily.
- PD benefits: right to participate in meetings with authorities; right to be BOT counterparty in secondary market; access to Security Position Adjustment Facility (SPAF).
- Current effectiveness: PDs accounted for only 37 percent of secondary market activity in the last year.
- Contributing factors to low PD market-making:
  - Dealers do not maintain large trading books (many bonds held in “held-to-maturity” portfolios).
  - Frequency of auctions leads to a “broked” market where investors secure stock in primary auctions instead of accessing the secondary market. PDs often submit bids reflecting client orders (acting as brokers).
  - Example: one source typically held only B 100 million of the “on-the-run” securities on their trading book, covering only 4–5 typical trades.
- Policy options to improve market making and incentives:
  - Maintain requirement for PDs to provide firm two-way quotes in benchmark stocks while allowing normal spread to emerge.
  - Match tightened market-making obligations with improved benefits: exclusive right to submit bids in auctions; being authorities’ counterparty in secondary market operations; participation in meetings.
  - Consider incentives: “green-shoe option” allowing PDs to acquire additional stock after auction; noncompetitive bidding facility; direct payment of fees; allocation of portion of noncompetitive bid stock to PDs based on performance.
  - Illustrative allocation: allocate 10 percent of amount currently available for general noncompetitive bids to PDs, access determined by scored performance on factors including:
    - (i) participation for their own book in primary auctions;
    - (ii) share of total secondary market trading with clients;
    - (iii) provision of liquidity to individual investors on Bond Electronic Exchange (BEX), particularly holders of GSBs; and/or
    - (iv) market share of activity with customers in corporate debt market.
  - Use TBMA data to track PD performance; PDMO to determine weighting in consultation with BOT and explicitly communicate.
- Facilities to manage PD short positions and liquidity support:
  - Current SPAF allows PDs to repo bonds from BOT for up to one month but market participants indicate it does not meet needs.
  - Options: create a PDMO portfolio to lend bonds at short tenors—portfolio should hold quantities of all on-the-run bonds; ways to create portfolio include PDMO retaining some stock from each auction (Germany example) or creating and canceling new bonds on demand (UK example). PDMO could retain discretion to “tap” a bond at short notice.

### Secondary market liquidity, structure, and key statistics
- Thailand: fourth largest bond market in regional sample but one of the most illiquid by turnover ratio.
- Table 1 indicators (End-2006) for Thailand:
  - % of GDP: Govt 38, Corp 19, Total 58
  - In USD billions: Govt 75, Corp 37, Total 112
  - Turnover ratio: Govt 1.3, Corp 0.1, Total 1.1
- Table 2 Thailand: Thai Bond Market, End-2006 (selected figures):
  - Government Bonds amount outstanding 1,469 (bn); % of Total Market 37%; Trading Value 631; Turnover ratio 0.42
    - Loan bonds 1,406 (bn); % of Total Market 26%; Trading Value 628; Turnover ratio 0.60
    - Savings bonds 423 (bn); % of Total Market 11%; Trading Value 4; Turnover ratio 0.01
  - Treasury Bills 228 (bn); % of Total Market 6%; Trading Value 1,500; Turnover ratio 6.58
  - State Enterprise Bonds 491 (bn); % of Total Market 12%; Trading Value 84; Turnover ratio 0.17
    - Guaranteed 325 (bn); Trading Value 52; Turnover ratio 0.16
    - Non-guaranteed 168 (bn); Trading Value 32; Turnover ratio 0.19
  - BOT Securities 897 (bn); % of Total Market 22%; Trading Value 1,968; Turnover ratio 2.19
    - BOT bills 586 (bn); % of Total Market 15%; Trading Value 1,445; Turnover ratio 2.47
    - BOT bonds 311 (bn); % of Total Market 8%; Trading Value 479; Turnover ratio 1.54
  - Sub-total Public Debt 3,127 (bn); % of Total Market 77%; Trading Value 4,183; Turnover ratio 1.34
  - Corporate Debt Securities 846 (bn); % of Total Market 23%; Trading Value 93; Turnover ratio 0.10
  - Foreign Issues 16 (bn); % of Total Market 0%; Trading Value 2; Turnover ratio 0.10
  - Grand Total 4,085 (bn); Trading Value 4,277; Turnover ratio 1.05
  - Memo: Financing Transactions 2,678
- Most liquid securities: Tbills, followed by BOT bills and BOT bonds (relatively short-term).
- Limited demand for capital, ample banking system liquidity, and weak private sector investment impede development of more liquid fixed income markets.

### Corporate debt market — size, composition, and constraints
- Corporate debt market represents about 15 percent of total debt issued and outstanding.
- 2006 TBMA-registered outstanding corporate debt totaled B 846 billion, including B 237 billion of short-term commercial paper.
- Long-term corporate debt remaining: B 475 billion weighted to maturities of five years or less.
- Tenors 10-years or longer: B 24 billion.
- 93 percent of all outstanding corporate debt rated A or better by one of two Thai rating services.
- 2006 issuance: 73 new corporate bond issues totaling B 145 billion. Individual issues ranged B 50 million to B 25 billion; majority tenor three years or less. In 2006, B 737 billion of commercial paper was issued.
- Market frictions:
  - Institutional investors constrained by prudential regulations to purchase mostly investment grade debt, effectively precluding issuance of below investment grade debt.
  - Primary underwriters are banks that can offer competing bank loans; underwriting not a priority.
  - Estimated supply: approximately 100 Thai companies would qualify for an investment grade rating, but many would be below A; active issuers approximately 25.
  - Five major banks dominate corporate bond underwriting.
- Offshore issuance:
  - Several Thai companies issued large offshore offerings despite higher transaction costs. In 2005 there were six offshore offerings totaling B 56.3 billion; in 2006 eight offerings totaling B 60.4 billion. Total of these 14 issues B 117 billion, ~20 percent of total registered long-term corporate debt outstanding in Thai secondary market.
- Foreign issuers of baht-denominated debt limited under MOF regulation 42/2006: only specified foreign entities may issue; prior MOF approval required for tenor, amount, use of proceeds, and issuer rating. Issues by foreign issuers must be for tenors longer than three years; if proceeds transferred offshore, MOF requires conversion from baht into foreign currency. A joint committee (MOF, BOT, SEC) meets semi-annually to consider applications.

### Secondary market trading activity, platforms, and infrastructure
- Trading volumes and patterns (2006 data):
  - Average number of trades in loan bonds 49-50 daily; average trade size B 53 million.
  - Average daily trades in corporate issues 18–19; average trade size B 20 million.
  - Total value of corporate bond transactions in 2006 B 92.5 billion, a little more than 15 percent of total outstanding value.
  - Total outstanding value of corporate bonds B 609 billion.
  - SOE bonds averaged 3–4 trades of average size B 96 million.
  - Foreign issuer issues (ADB and JBIC) in 2006: average daily trading volume B 6.59 million and annual turnover rate 10 percent.
- Trading venues:
  - BEX targets small retail transactions: Jan–July 2006 average trade size B 4 million; average monthly trade value B 21 million. Liquidity provided by authorized dealers; clients cannot submit own quotes.
  - FIRSTS (Fixed Income and Related Securities Trading System) launched March 1, 2006: Mar–July 2006 average trade size B 63 million; average monthly trade value B 20.6 billion. Clients cannot post bids/quotes but can send RFQs to multiple dealers and negotiate bilaterally.
- Market concentration:
  - Approximately 98 percent of trading concentrated in OTC wholesale market. Of OTC wholesale trading, 93 percent conducted over the telephone relative to 5 percent through FIRSTS.
- Reporting:
  - All trades in bonds registered by TBMA must be reported to TBMA within 30 minutes. TBMA publishes trade reports for government securities upon receipt and twice daily for corporate bond trades.
- Market-making and intermediaries:
  - Limited number of Thai banks operate trading desks and engage in proprietary trading; most secondary trading is agency or riskless principal rather than dealer risk-taking. Reported bid-ask spreads about five to ten basis points even for most liquid issues.

### Repo, derivatives, TFEX, and hedging constraints
- Repo market:
  - BOT plays dominant role via bilateral repo operations and operates BOT repo market as central counterparty.
  - 2006 BOT announced intention to close BOT repo market to promote private repo market development.
  - Requirements for transition: industry agreement on GMRA, collateral management functionality in securities depository, regulatory agreement on collateral and margining rules, counterparty risk management. TSD enhancements appear implemented; other technical issues stalled.
  - Regulatory impediments example: insurance regulator minimum haircut on repo transactions.
- Derivatives:
  - Interest rate swaps (IRS) market reported very active. Nondeliverable IRS very active in last 6–12 months, partly due to restrictions on foreign investors entering Thai market directly.
  - TFEX: only derivative product traded is an index future based on SET 50; next planned product an option on SET50 index. Interest rate futures contract planned; expected launch in 2006 delayed pending contract structure decisions. Delay partly reflects TFEX ownership/run by brokers not active in fixed income markets; mutual funds and banks (primary beneficiaries) have limited influence.
  - Regulatory limits: SEC mutual fund rules restrict derivatives to cash management and limited hedging; Department of Insurance requires prior approval for insurance companies to engage in IRS.
  - Hedging limitations and short selling: lack of effective interest rate futures and inability to short sell compounded by lack of ready borrowing facility. Enhancements of TSD to provide lending facility in conjunction with clearance and settlement for repo market recommended.

### Investor base, mutual funds, and regulatory constraints
- Institutional holdings (2006/2006 Q3 figures and related):
  - Insurance industry: B 813 billion in debt investments (2006).
  - Fixed income mutual funds: B 640 billion in debt investments.
  - Provident investment funds: B 391 billion.
  - Social Security Fund: B 341 billion.
  - Government Pension Fund: B 321 billion.
- Mutual fund industry (development metrics):
  - General Mutual Funds: No. of Funds — 2005: 584; 2006: 716; Mar. 2007: 724. NAV (Million Baht) — 2005: 775,392; 2006: 1,040,697; Mar. 2007: 1,135,173.
  - Capital Protected: No. of Funds — 2005: 54; 2006: 112; Mar. 2007: 120. NAV (Million Baht) — 2005: 49,837; 2006: 104,371; Mar. 2007: 104,167.
    - Fixed Income Funds (Capital Protected): No. of Funds — 2005: 50; 2006: 103; Mar. 2007: 110. NAV (Million Baht) — 2005: 49,523; 2006: 103,431; Mar. 2007: 101,835.
    - Mixed Funds (Capital Protected): No. of Funds — 2005: 4; 2006: 9; Mar. 2007: 10. NAV (Million Baht) — 2005: 314; 2006: 940; Mar. 2007: 2,332.
  - Non-Capital Protected: No. of Funds — 2005: 530; 2006: 604; Mar. 2007: 604. NAV (Million Baht) — 2005: 725,556; 2006: 936,326; Mar. 2007: 1,031,006.
    - Equity Funds: No. of Funds — 2005: 151; 2006: 164; Mar. 2007: 172. NAV (Million Baht) — 2005: 82,565; 2006: 89,752; Mar. 2007: 96,186.
    - Fixed Income Funds: No. of Funds — 2005: 221; 2006: 303; Mar. 2007: 315. NAV (Million Baht) — 2005: 341,792; 2006: 536,448; Mar. 2007: 643,077.
    - Mixed Funds: No. of Funds — 2005: 150; 2006: 124; Mar. 2007: 104. NAV (Million Baht) — 2005: 282,044; 2006: 263,867; Mar. 2007: 243,092.
  - Property Fund for Public: No. of Funds — 2005: 8; 2006: 13; Mar. 2007: 13. NAV (Million Baht) — 2005: 19,155; 2006: 46,259; Mar. 2007: 48,651.
- Holdings of public debt securities (Q3 2006, million baht):
  - Government Loan Bonds outstanding: Banks 264,256; Mutual Funds 10,563; Insurance Companies 293,708; Pension and provident funds 250,386; Total Outstanding 1,060,250.
  - Tbills: Banks 75,329; Mutual Funds 115,112; Insurance Companies 4,993; Pension and provident funds 18,147; Total Outstanding 260,000.
  - BOT bonds: Banks 344,552; Mutual Funds 199,829; Insurance Companies 9,689; Pension and provident funds 78,227; Total Outstanding 780,695.
  - SOE bonds: Banks 100,724; Mutual Funds 12,286; Insurance Companies 48,202; Pension and provident funds 97,763; Total Outstanding 344,203.
- Mutual funds: fixed income funds typically buy assets to match fund expiration; many are closed-end with short lifespans and strong preference for short-term debt. Mutual funds accounted for 28 percent of secondary market activity in 2006.
- Regulatory constraints on mutual funds:
  - Mutual funds may hold only 15 percent of assets in illiquid securities and no more than 5 percent of assets may be issued by one entity. Definition of illiquid includes bonds with maturities greater than three years, below investment grade corporate debt or unrated corporate debt.
  - Mutual fund operators prohibited from creating a below investment grade mutual fund.
  - Private placements limited to B 100 million and to no more than ten non-institutional investors; PPs must be filed with SEC and TBMA and are included in illiquid security definition.
  - Post-2005 commercial paper regulation: only investment grade rated companies and banks may issue commercial paper through a public offering; unrated issuers may sell commercial paper via private placement to qualified institutional buyers subject to illiquid security limitations. Listed companies must file short-form registration and unlisted companies must file free-form registration with audited financial statements and issue must be rated with TBMA. At least three asset management companies must purchase first offering of issue.
- Tax and foreign investor treatment:
  - Mutual fund profits exempt from capital gains tax.
  - BOT reserve requirements (introduced December 2006) require foreign investors in debt instruments to maintain a 30 percent reserve in a non-interest-bearing account.
  - Foreign investors subject to 15 percent withholding tax on income from corporate bonds (government bond holdings exempt).
  - Prior to December 2006, foreign investors held estimated B 130 billion of Thai debt securities. Following reserve requirement, foreign ownership declined to estimated B 60 billion.

### Securitization, tax frictions, and market development impediments
- Securitization activity limited: fourteen securitizations total value B 40 billion; typically fixed rate, investment grade tranches (AAA to A).
- Banks originating securitized debt must obtain prior BOT approval.
- Market infrastructure gaps: need credit rating infrastructure to analyze underlying assets and access to transaction/repayment history for modeling.
- SBT (Specific Business Tax) is a gross tax on interest earned by financial institutions; remains at 3 percent despite proposal to reduce to 0.01 percent. Practice exists of netting out flows (untested) and use of FX forwards to create synthetic term money positions as a consequence.

### Recommendations — Government debt market (selected)
- Build more effective benchmarks:
  - Address both flow of new issuance and structure of existing stock.
  - PDMO should maximize issuance potential; consider on-lending in B to SOEs to increase size of individual loan bonds (would require amendment to PDA; current provisions envisage onlending in foreign currency).
  - Consider replacing BOT issuance of bonds with government bonds, with funding deposited at BOT on same terms (tenor and rate) — would require PDA amendment.
  - PDMO could consider buybacks or debt exchanges to consolidate existing bonds into newer benchmarks (PDA provisions currently restrict ability; amendment required).
- Reduce frequency of auctions:
  - Move from offering bonds of similar tenors every one or two weeks to about once a month to incentivize secondary market activity and greater market-making by PDs; larger issue size would require more meaningful underwriting commitment from PDs.
  - Coordinate auction frequency change with PD framework review.
- Review PD framework:
  - Clarify priorities (underwriting primary market; market-making in secondary market; broader fixed income market development).
  - Design incentives and tools to promote desired behaviors; PDMO should lead design, monitor, enforce, and strip nonperformers of status.
- Expedite proposed amendments to the PDA to address constraints on PDMO actions.

### Recommendations — Corporate debt market and investor regulation (selected)
- Broaden issuer pool and product diversity:
  - SEC should eliminate prohibitions/restrictions on mutual fund investments in below investment grade public offerings to allow small/medium companies (sound but unrated) access to debt markets and let professionally managed mutual funds assess risk/reward.
  - Expand or eliminate SEC limits on size of private debt offerings to allow efficient private placements to large institutional investors.
  - Reexamine 2005 commercial paper regulations to avoid excessive regulation of short-term financings needed for business.
- Re-examine restrictions on foreign borrowers and foreign issuance:
  - Reexamine MOF approval requirement for foreign issuers and requirement that funds raised in baht be converted into foreign currency if funds taken offshore.
  - Promote foreign nonresident issuance as a means to enlarge market.
- Securitized products to expand investment-grade supply:
  - Opportunities: bank loan portfolio securitization; collateralized mortgage obligations; covered bonds.
- Credit enhancements recommended: over-collateralized pools; guarantees or credit risk swaps with originator; multi-tranche structures; purchase of repayment insurance from third party insurer.
- Regulatory changes for institutional investors and mutual funds:
  - Transition from merit-based to disclosure-based regulation for mutual funds and collective investment schemes.
  - SEC should consider permitting:
    - creation of mutual funds that invest primarily or entirely in below investment grade debt;
    - less restrictive rules on definition of illiquid securities;
    - mutual funds to engage in repos, reverse repos, and OTC derivatives if consistent with disclosed strategy;
    - greater flexibility on risk structure for real estate trusts;
    - a transparent waiver/exemption procedure for concentration limits;
    - funds to invest in private offerings from unrated companies;
    - institutions to invest in offshore offerings without requiring translation of documents; and
    - institutions to invest in offshore private offerings.
- Encourage competition among intermediaries:
  - Eliminate ceiling on licensed securities brokers and fixed commission rates to promote competition, innovation, proprietary trading and underwriting activity.
- Other market infrastructure recommendations:
  - Resolve technical issues in private repo market via industry working group (BOT to coordinate) including banks, mutual funds, insurance companies, pension companies, SEC, TSD, TBMA, and insurance regulator.
  - TFEX should prioritize development of standard bond derivative and interest rate derivative products.
  - Permit netting between banks and securities firms for capital adequacy and cross-settlement when products created.
  - Reduce SBT to proposed 0.01 percent and in due course eliminate SBT.

*Source: Executive Summary and selected chapters, Fixed Income Markets in Thailand (IMF staff note).*

### Executive Summary ......................................................................................................

### _cr09151 - Executive Summary

### Executive overview
- The debt market in Thailand has made important strides since the financial crisis of 1997.
- The Thai government has made significant progress in building an orderly yield curve and is beginning to establish some benchmarks.
- Liquidity in the secondary market is constrained and would be enhanced by reducing the frequency of auctions and increasing the size of each individual offering.
- Primary dealers will need to shift from a “broking” operation to greater underwriting and market making services; a review of the primary dealer system is warranted.
- Prospects for government securities market development are constrained by likely limited financing need going forward unless authorities secure additional flexibility to restructure the existing portfolio or establish more meaningful benchmarks.

### Primary debt market — public debt instruments and issuance
- Public debt securities dominate the Thai bond market; Treasury bills and government bonds represent 55 percent of the total B 3,085 billion outstanding of public debt securities.
- The Public Debt Act (PDA) allows debt to be raised to finance (i) the budget deficit; (ii) approved social and economic spending; (iii) debt restructuring; and (iv) onlending.
- Government bond types:
  - Loan bonds: standard wholesale fixed-rate bonds with tenors out to 20 years. As at end-December 2006, there were 30 different issues of loan bonds outstanding with an average size of B 35 billion; only 3 bonds exceeded B 40 billion; 7 were less than B 30 billion. Desired benchmark size indicated at least B 50 billion. Commitment to create and maintain benchmarks of at least B 40 billion at 7 and 10 years over 2006–2010.
  - Government savings bonds (GSBs): retail product in small denominations; make up around 25 percent of the total stock of government securities. One bond issued in 2002 to restructure FIDF accounts for almost half the total outstanding; this will redeem in 2012. The SB129A redeems on September 12, 2009. Typical new issues of savings bonds are B 500 million; GSBs are currently sold with a tenor of 3 years. Four other savings bonds range from B 26 billion to B 54 billion, maturing in 2007, 2009, 2011 and 2014.
  - Treasury bills: issued at one, three and six month maturities; at end-2006 they made up 13 percent of the government securities portfolio. The PDMO intends to refinance around B 120 billion of bills with loan bonds in FY2007 (October 2006 to September 2007).
- BOT issuance:
  - BOT issues ultra-short central bank bills and bonds for monetary policy purposes. As at end-Dec 2006, there were B 586 billion BOT bills and B 311 billion of BOT bonds; bills have maturities of less than 15 days; fixed rate bonds issued at 1 and 2 years maturity with new issues typically between B 50–70 billion. In March 2007, BOT introduced a 3-year floating rate note.
- State Owned Enterprise issuers:
  - SOE bonds largely government guaranteed. Government Housing Bank (GHB) had B 85.5 billion of bonds outstanding as of end-Dec 2006, representing 17 percent of the SOE market segment; all GHB issues but one are government guaranteed.
- FIDF treatment:
  - Securities issued by FIDF for liquidity needs are excluded from figures as they are used solely as collateral for rolling repo transactions. Government has issued securities and injected proceeds into FIDF to fiscalise FIDF losses.
- Scrip vs scripless holdings:
  - All retail savings bonds issued in scrip (certificated) form; wholesale instruments issued in scripless form with an option for scrip. As of end-April 2007, 31 percent of stock was held in scrip form. Legal provisions of the Civil and Commercial Code require collateral to be pledged in scrip form; related Acts are being reviewed to allow scripless securities to be pledged to a greater extent.

### Primary market issuance program and implications
- Planned primary issuance program for FY 2007 envisages gross issuance of government bonds around B 365 billion.
- Preliminary indications for FY 2008 indicate gross issuance of bonds will decline to B 222 billion; at this level PDMO will only be able to support 4 new benchmark bonds a year.
- Decline of Tbill stock and anticipated strength of the budgetary position suggest PDMO activity in the primary market could drop significantly in the medium-term unless new debt creating flows are generated (e.g., active debt exchanges, expanding scope of onlending to domestic debt, etc.).
- Domestic debt issuance could increase by around B 60 billion over FY 2008 and FY 2009 to meet financing of planned mass transit investment, based on an assumption that JBIC will provide a loan to meet remaining cost to the central government—anticipated to be around B 90 billion.

### Corporate debt market — structure and regulatory constraints
- The corporate debt market suffers from too few issuers and too little diversity of offerings.
- Contributing factors:
  - Limited corporate need for long-term financing due to weak private sector investment.
  - Ready availability of alternative financing by commercial banks at competitive rates.
  - Regulatory policies that emphasize investor protection by imposing substantial limitations on institutional investors to purchase mostly investment grade debt, effectively precluding issuance of below investment grade debt.
- Recommendation direction:
  - Transition from merit-based regulation of corporate issuers and institutional investors to a disclosure-based regulatory system that opens the debt market to a larger and more diverse pool of corporations and allows institutional investors the freedom to make investment decisions based on disclosed risk and return assessments.

### Policy and regulatory recommendations (selected)
- Regulatory changes to consider:
  - Removing limitations on below investment grade debt offerings.
  - Expanding the size of private placement offerings.
  - Reducing regulatory burdens on issuers of short-term commercial paper.
- Investor-side regulatory relief to consider:
  - Permitting creation of mutual funds that invest in high yield securities.
  - Reconsidering the definition of an illiquid security and/or reducing restrictions on investment in illiquid securities.
  - Permitting institutions greater flexibility in engaging in hedging strategies.
  - Permitting institutions to invest in offshore offerings.
  - Allowing institutions to resell private placement securities in the secondary market.
- Market structure reforms:
  - Discard long-standing limitations on the number of securities firms to promote greater competition among financial services intermediaries.
  - Review the primary dealer system to encourage underwriting and market making rather than pure broking.
- Market infrastructure and hedging:
  - Improve availability of appropriate derivatives products to hedge interest rate risk.
  - Introducing the anticipated futures contract on TFEX will be a significant step.

### Secondary market liquidity and investor base
- Thailand is the fourth largest bond market in the regional sample but one of the most illiquid by turnover ratio.
- Table 1 indicators (End-2006) for Thailand:
  - % of GDP: Govt 38, Corp 19, Total 58
  - In USD billions: Govt 75, Corp 37, Total 112
  - Turnover ratio: Govt 1.3, Corp 0.1, Total 1.1
- Table 2 Thailand: Thai Bond Market, End-2006 (selected figures):
  - Government Bonds amount outstanding 1,469 (bn); % of Total Market 37%; Trading Value 631; Turnover ratio 0.42
    - Loan bonds 1,406 (bn); % of Total Market 26%; Trading Value 628; Turnover ratio 0.60
    - Savings bonds 423 (bn); % of Total Market 11%; Trading Value 4; Turnover ratio 0.01
  - Treasury Bills 228 (bn); % of Total Market 6%; Trading Value 1,500; Turnover ratio 6.58
  - State Enterprise Bonds 491 (bn); % of Total Market 12%; Trading Value 84; Turnover ratio 0.17
    - Guaranteed 325 (bn); Trading Value 52; Turnover ratio 0.16
    - Non-guaranteed 168 (bn); Trading Value 32; Turnover ratio 0.19
  - BOT Securities 897 (bn); % of Total Market 22%; Trading Value 1,968; Turnover ratio 2.19
    - BOT bills 586 (bn); % of Total Market 15%; Trading Value 1,445; Turnover ratio 2.47
    - BOT bonds 311 (bn); % of Total Market 8%; Trading Value 479; Turnover ratio 1.54
  - Sub-total Public Debt 3,127 (bn); % of Total Market 77%; Trading Value 4,183; Turnover ratio 1.34
  - Corporate Debt Securities 846 (bn); % of Total Market 23%; Trading Value 93; Turnover ratio 0.10
  - Foreign Issues 16 (bn); % of Total Market 0%; Trading Value 2; Turnover ratio 0.10
  - Grand Total 4,085 (bn); Trading Value 4,277; Turnover ratio 1.05
  - Memo: Financing Transactions 2,678
- Treasury bills are by far the most liquid debt security, followed by BOT bills and BOT bonds (which are relatively short-term).
- Limited demand for capital, ample liquidity in the banking system, and weak private sector investment are overriding factors impeding development of more liquid fixed income markets.

### Final observations and priorities
- Greater liquidity in the secondary debt market will be achieved by increasing the supply of debt issues and providing institutions greater freedom to buy and sell.
- Enhancing financial intermediaries’ ability to act as active liquidity providers requires more appropriate derivatives and hedging tools.
- Progress on regulatory liberalization, market infrastructure (including TFEX futures), and primary dealer function reform are priority actions to position the Thai market for future growth.

*Source: Executive Summary, Fixed Income Markets in Thailand (IMF staff note).*

### 15.      With the exception of the GSBs, which are sold to retail investors at a fixed price and

### _cr09151 - 15.      With the exception of the GSBs, which are sold to retail investors at a fixed price and

### Primary issuance and auction mechanics
- GSBs are sold to retail investors at a fixed price and distributed through one of the commercial banks.
- The PDMO and BOT use multiple price auctions to issue their debt securities.
- Eligible competitive bidders include all banks and other financial institutions, the Government Pension Fund, the Social Security Office, life insurance companies, provident funds, and co-operatives.
- Foundations, charities and other nonprofit organizations can submit noncompetitive bids only.
- Twenty percent of the total stock on offer is reserved for noncompetitive bids; however, this is rarely used.
- Auction timing:
  - PDMO auctions Tbills on Mondays and bonds on Wednesdays.
  - BOT auctions of central bank bonds can be held on Tuesdays, Thursdays and Fridays.
- Typical auction sizes and frequencies:
  - PDMO: typically auctions a bond every week; typical auction size is around B 5 billion. 7-year benchmark in the second week of the month and 10-year bond in the fourth week; often two bonds auctioned the same day.
  - BOT (historical): up to May had 3 auctions of bonds a month of a typical size of B 20–30 billion; under the new schedule announced in May, BOT will only have on average 1 bond auction a month.

### Auction scheduling, predictability, and cash management
- PDMO and BOT pre-announce auction schedules:
  - PDMO: calendar of bond auctions announced at the end of the quarter for the forthcoming quarter; calendar of Tbill auctions two weeks in advance.
  - BOT: announces auction schedule a month in advance.
- Despite improved commitment to schedules, issuance of government loan bonds remains highly cyclical and somewhat uncertain, reflecting PDMO issuance being tied closely to government cash needs.
- Example of unpredictability: in the last quarter of FY 2007, PDMO cancelled all further auctions of the 2024 bond while maintaining issuance of the 7- and 10-year benchmarks.
- Market participants can adjust for gaps but express a preference for more certainty and predictability.
- Recommendation: more active cash management and more aggressive use of Treasury bills as part of cash management could reduce uncertainty and improve transparency of the issuance calendar.

### PDMO issuance for SOEs
- PDMO acts as issuing agent for SOEs; these bonds are sold through a paper-based, uniform price auction with single bids submitted by dealers by hand.
- Size of these issues is generally small—typically only B 1–2 billion—and typically allocated to a single bidder.

### Primary dealer (PD) framework: roles, current performance, and reform options
- Institutional setup:
  - BOT currently manages the PD system; there are nine PDs, all banks (securities companies do not meet capital requirements).
  - Principal PD responsibilities: participate in government securities auctions and BOT’s OMO outright sales; make markets in the secondary market for government securities; submit reference yields on government securities to ThaiBMA at the end of each day.
  - Principal benefits to PDs: right to participate in meetings with authorities; right to be BOT’s counterparty in the secondary market for government securities; access to the Security Position Adjustment Facility (SPAF).
- Current effectiveness:
  - PDs accounted for only 37 percent of secondary market activity in the last year.
  - Contributing factors:
    - Dealers do not maintain large trading books (many bonds held in “held-to-maturity” portfolios).
    - Frequency of auctions leads to a “broked” market where investors secure stock in primary auctions instead of accessing the secondary market. PDs often submit bids reflecting client orders (acting as brokers).
    - Example: one source typically held only B 100 million of the “on-the-run” securities on their trading book, covering only 4–5 typical trades.
- Market dynamics and implications:
  - Reducing auction frequency would create a greater need for market-making and could spur a review of the PD framework to ensure it is “fit for purpose.”
  - Before redefining PD benefits and obligations, authorities should define objectives (e.g., building a more liquid market).
- International examples and tools:
  - Brazil introduced a “second-turn” or “green shoe option” allowing PDs to acquire additional stock following an auction at the clearing price; access determined by PD performance in primary and secondary markets.
  - European practice: authorities specify trade size and quote spread PDs must meet; however, given current liquidity, defining an appropriate spread is difficult.
- Proposed PDMO policy options to improve market making and incentives:
  - Maintain a general requirement for PDs to provide firm two-way quotes in benchmark stocks while ensuring competition and incentive structures allow the “normal” spread to emerge.
  - Match tightened market-making obligations with improved benefits: exclusive right to submit bids in auctions; being authorities’ counterparty in secondary market operations; participation in meetings.
  - Consider incentives such as access to a “green-shoe option,” a noncompetitive bidding facility, direct payment of fees, or allocation of a portion of noncompetitive bid stock to PDs based on performance.
  - Illustrative allocation: allocate 10 percent of the amount currently available for general noncompetitive bids to PDs, access determined by scored performance on factors including:
    - (i) participation for their own book in primary auctions;
    - (ii) share of total secondary market trading with clients;
    - (iii) provision of liquidity to individual investors on Bond Electronic Exchange (BEX), particularly holders of GSBs; and/or
    - (iv) market share of activity with customers in the corporate debt market.
  - Use TBMA data to track PD performance; weighting of factors to be determined by PDMO in consultation with BOT and explicitly communicated.
- Facilities to manage PD short positions and liquidity support:
  - Current SPAF allows PDs to repo bonds from BOT for up to one month but market participants indicate it does not meet needs (limitations of BOT’s portfolio and available bonds).
  - Options include creating a PDMO portfolio from which bonds could be lent at short tenors—portfolio should hold quantities of all on-the-run bonds.
  - Ways to create such a portfolio: PDMO could retain some stock on its books from each auction (Germany example) or create and subsequently cancel new bonds on demand (United Kingdom example).
  - PDMO could also retain discretion to “tap” a bond at short notice to address excess demand, though this may not help individual PDs rebalance positions.

### Primary market for corporate debt: size, composition, and constraints
- Size and composition:
  - Thai corporate debt market represents about 15 percent of the total debt issued and outstanding.
  - In 2006 outstanding corporate debt registered with the TBMA totaled B 846 billion, including B 237 billion of short-term commercial paper.
  - Remaining long-term debt: B 475 billion weighted to maturities of five years or less.
  - Tenors 10-years or longer: B 24 billion.
  - 93 percent of all outstanding corporate debt is rated A or better by one of the two Thai rating services.
- Issuance activity:
  - In 2006 there were 73 new corporate bond issues totaling B 145 billion.
  - Individual issues ranged from B 50 million to B 25 billion; majority tenor three years or less.
  - In 2006, B 737 billion of commercial paper was issued.
- Market structure and frictions:
  - Market is relatively homogeneous: medium term notes and short-term commercial paper by investment grade issuers.
  - Factors limiting market depth:
    - Institutional investors prefer investment grade debt rated A or above due to prudential regulatory restrictions limiting purchases below investment grade.
    - Primary underwriters are banks that can offer competing bank loans; underwriting not a priority business for them.
    - Prudential regulatory restrictions limit or prohibit sub-investment grade and unrated public and private companies from issuing debt; these limits also apply to public issues of short-term commercial paper.
  - Rating and demand dynamics:
    - Thai rating agencies consider BB to be investment grade, but institutional investors are reluctant to purchase debt rated below A and seek a “margin of safety.”
    - Estimated supply of issuers: approximately 100 Thai companies would qualify for an investment grade rating, but many would be below A; the number of Thai companies that actively issue debt is approximately only 25.
    - Regulatory concentration limits further constrain institutional purchases from single issuers.
- Underwriting and bank lending dynamics:
  - Five major banks dominate corporate bond underwriting.
  - Excess banking system liquidity and competition between underwriting and commercial lending reduce underwriting incentives.
  - Corporates rely primarily on commercial bank lending, internal cash flow, or foreign parent borrowing. Thai bank loans typically fix rates for six months then float; firms often use OTC interest rate swaps to convert floating to fixed.
- Offshore issuance and foreign issuer access:
  - Several Thai companies have issued large bond offerings offshore despite higher transaction costs relative to domestic offerings.
  - Anecdotal constraint: difficulty issuing a debt offering greater than US$20 billion in the Thai market due to limited number of large institutional investors and concentration limits.
  - In 2005 there were six offshore offerings by Thai corporations totaling B 56.3 billion; in 2006 there were eight offerings totaling B 60.4 billion. The total value of these 14 issues is B 117 billion, equivalent of almost 20 percent of the total value of all registered long-term corporate debt outstanding in the Thai secondary market.
  - Foreign issuers of baht-denominated debt have very limited access under MOF regulation 42/2006: only international financial institutions, foreign governments, financial institutions of foreign governments, corporations from ASEAN+3 countries, and other foreign corporations deemed appropriate by MOF may issue; prior MOF approval required for tenor, amount, use of proceeds, and issuer rating.
  - Issues by foreign issuers must be for tenors longer than three years; if proceeds are to be transferred offshore, MOF requires conversion from baht into a foreign currency.
  - A joint committee (MOF, BOT, SEC) meets semi-annually to consider applications by foreign issuers based on Minister-approved guidelines.

*Italic: IMF staff report excerpt from the provided content unit.*

### 37.      The MOF has approved a total of 5 debt offerings under this regulation. The Asian

### _cr09151 - 37.      The MOF has approved a total of 5 debt offerings under this regulation. The Asian

### Approved debt offerings and recent issuance
- The MOF has approved a total of 5 debt offerings under this regulation.
- The Asian Development Bank has made three offerings for a total of B 10.5 billion.
- The Japan Bank for International Cooperation has made one public offering of five year notes for B 2 billion.
- Citigroup issued B 2.6 billion of five year notes in a private placement.

### Primary market factors affecting secondary market activity
- Structure of supply:
  - Public debt market remains relatively fragmented and the corporate debt market is small, resulting in a general lack of effective benchmarks and a fragile yield curve.
- Frequency of government auctions:
  - Fund managers can manage inflows with no more than a few days to wait between new issues, reducing demand in secondary market and limiting dealers’ need to hold inventories.
  - BOT announced in May 2007 it would auction 1-year bonds once a month (from twice a month) and 2-year bonds on a quarterly basis (from monthly).
- Potential auction strategy changes (PDMO):
  - PDMO could follow BOT lead and have on average only 1 or 2 bond auctions a month, e.g., issuing the 7- and 10-year benchmarks every other month.
  - If financing need supports it, add a 5-year or 15 / 17-year on alternating months.
  - Ideally only one bond of similar duration offered a month—pairing 7-year with the long bond and 5-year with the 10-year—leading to an increase in average issue size of B 10–15 billion to achieve the current average total issue size.
- Market-making and underwriting implications:
  - Changing size and frequency would require PDs to provide greater underwriting services and warehouse inventory until fund managers need it.
  - PDs would need to commit greater risk capital; if incentives are not well aligned, behavior may not change, risking uncovered auctions and lower returns for fund managers.
- Benchmarks:
  - PDMO’s medium-term commitment to establish benchmarks at 7 and 10 years is positive.
  - Consolidating existing issues could quickly establish additional benchmarks.
  - PDMO needs to consider, with market participants, how many benchmarks it can credibly maintain and where on the yield curve they should be established.

### Repo market and transition to private repo
- Thai money markets include unsecured money, synthetic term money and repo; ample banking sector liquidity limits active use of money markets.
- Specific Business Tax (SBT) distortions lead term money trades to be effected through synthetic positions (FX forwards).
- BOT’s role:
  - BOT plays a dominant role in the repo market via bilateral repo operations and operates the BOT repo market as central counterparty.
  - In 2006 BOT announced intention to close the BOT repo market to promote development of a private repo market.
- Requirements for successful transition:
  - Industry agreement on technical factors: standard master agreement (GMRA), collateral management functionality in the securities depository, regulatory agreement on collateral and margining rules, and counterparty risk management.
  - TSD enhancements appear implemented, but progress on other technical issues has stalled, impeding ability to execute GMRA with counterparties.
  - Potential regulatory impediments may restrict certain market participants’ ability to participate on equal terms (example: insurance regulator minimum haircut on repo transactions).
  - BOT has requested the Financial Market Association (ACI club) to lead resolution of these issues.

### Derivatives and futures markets
- Interest rate swaps (IRS):
  - IRS market is reported very active.
  - Nondeliverable IRS has become very active in the last 6–12 months, partly due to restrictions on foreign investors entering the Thai market directly.
  - Foreign banks with presence in Thailand intermediate between on- and offshore markets; Thai domestic banks have limited presence in international swaps market due to not meeting international counterparty risk standards.
- Thai Futures Exchange (TFEX):
  - TFEX is the only financial futures/derivatives exchange in Thailand and is a wholly-owned subsidiary of the Stock Exchange of Thailand (SET).
  - Currently only one derivative product traded: an index future based on the SET 50. Next planned product: an option on the SET50 index.
  - Interest rate futures contract planned; expected launch in 2006 delayed pending decisions on contract structure (single bond vs basket; short-term vs long-term rate).
  - Delay partly reflects TFEX ownership/run by brokers who are not active in fixed income markets; parties that would benefit most (mutual funds, banks) have limited influence.
  - Success of such contract depends on banks having direct access to trading on the exchange.
- Regulatory constraints:
  - Under SEC regulations mutual funds may use derivatives only for cash management and limited portfolio hedging.
  - Department of Insurance requires prior approval for insurance companies to engage in IRS.
- Hedging limitations:
  - Lack of effective interest rate futures contract impedes hedging and is an impediment to secondary market liquidity.
  - Inability of intermediaries to engage in short selling is compounded by lack of ready borrowing facility.
  - Enhancements of the TSD system to provide a lending facility in conjunction with clearance and settlement responsibilities for the repo market should help address this.

### Secondary market activity and liquidity indicators
- Thailand’s secondary debt market is less liquid and less active than other East Asian countries.
- Trading and liquidity metrics:
  - Average number of trades in loan bonds was 49-50 on a daily basis in 2006, with an average trade size of B 53 million.
  - TBMA estimates in 2006 there were on average only 18–19 trades in corporate issues daily, with an average trade size of B 20 million.
  - Total value of all corporate bond transactions in 2006 was B 92.5 billion, a little more than 15 percent of the total outstanding value.
  - Total outstanding value of corporate bonds was B 609 billion.
  - SOE bonds averaged 3–4 trades of average size B 96 million.
  - Issues from foreign issuers (ADB and JBIC) in 2006: average daily trading volume B 6.59 million and annual turnover rate 10 percent.
- Corporate debt market characteristics:
  - Corporate debt represents 15 percent of all debt issues registered with the TBMA but generates minimal daily trading volume.
  - Commercial paper is typically bought and held to maturity; medium and longer term corporate notes are in short supply, discouraging secondary market trading.

### Secondary market infrastructure and trading platforms
- Trading venues:
  - Secondary market activity occurs in both OTC and on-exchange markets.
  - BEX (on-exchange) targets small retail transactions.
    - Jan–July 2006: average trade size B 4 million; average monthly trade value B 21 million.
    - Liquidity provided by authorized dealers; clients cannot submit their own quotes.
  - FIRSTS (Fixed Income and Related Securities Trading System) provides electronic platform for OTC market and inter-dealer trading.
    - FIRSTS officially launched by BEX on March 1, 2006.
    - Mar–July 2006: average trade size B 63 million; average monthly trade value B 20.6 billion.
    - Clients cannot post their own bids/quotes but can send “request for quotes” (RFQ) to multiple dealers and conduct bilateral negotiations off-line.
- Market concentration and trading methods:
  - Approximately 98 percent of trading is concentrated in the OTC wholesale market.
  - Of OTC wholesale trading, 93 percent is conducted over the telephone relative to 5 percent through FIRSTS.
- Reporting and publication:
  - All trades in bonds registered by the TBMA must be reported to the TBMA within 30 minutes.
  - TBMA publishes trade reports for government securities upon receipt and twice daily for corporate bond trades.

### Secondary market intermediaries and market-making
- Limited number of Thai banks operate trading desks and engage in proprietary trading; they do not actively provide liquidity or serve as market-makers for corporate debt.
- Most secondary trading is done on an agency or riskless principal basis rather than by banks or brokers as dealers committing risk capital.
- Contributing factors:
  - Limited supply and size of debt products.
  - Lack of a cheap and efficient borrowing/lending mechanism.
  - Lack of standardized interest-rate derivatives to hedge interest-rate risk.
- Consequences:
  - Lack of active intermediaries increases transaction costs and widens spreads.
  - Reported bid-ask spreads are about five to ten basis points, even for the most liquid issues.
- Market structure specifics:
  - No evidence of a formal inter-dealer market or inter-dealer brokers specializing in corporate bonds; secondary market for corporate bonds tends to be uncompetitive.

### Investor base and behavior
- Institutional investor dominance:
  - Insurance industry: B 813 billion in debt investments (2006).
  - Fixed income mutual funds: B 640 billion in debt investments.
  - Provident investment funds: B 391 billion.
  - Social Security Fund: B 341 billion.
  - Government Pension Fund: B 321 billion.
- Investor behavior and regulatory constraints:
  - Post-1997 crisis regulatory regimes are ostensibly disclosure-based but impose significant prudential limits on Thai institutional investors.
  - Institutional investors tend to buy in primary offering, hold to maturity and prefer short-term notes; they move in unison and in one direction.
  - Prudential regulations limit incentives to trade actively, engage in repos or other lending activities, and invest in lower quality or longer-term notes.
  - Investment conservatism reflects investor memory of losses from the 1997–1998 crisis.

*https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09151.pdf*

### 65.      While the mutual fund industry in Thailand has increased significantly in size

### _cr09151 - 65.      While the mutual fund industry in Thailand has increased significantly in size

### Mutual fund industry structure and holdings
- Bond funds make up the bulk of products offered, followed by mixed funds (which will also include bond holdings).
- Mutual funds are major players in public debt securities markets:
  - As of end-Sept 2006, mutual funds held 1 percent of government loan bonds outstanding, 44 percent of all Tbills outstanding and 26 percent of BOT bills and bonds.
- Table 4 (development of the mutual fund industry) highlights:
  - General Mutual Funds: No. of Funds — 2005: 584; 2006: 716; Mar. 2007: 724. NAV (Million Baht) — 2005: 775,392; 2006: 1,040,697; Mar. 2007: 1,135,173.
  - Capital Protected: No. of Funds — 2005: 54; 2006: 112; Mar. 2007: 120. NAV (Million Baht) — 2005: 49,837; 2006: 104,371; Mar. 2007: 104,167.
    - Fixed Income Funds (Capital Protected): No. of Funds — 2005: 50; 2006: 103; Mar. 2007: 110. NAV (Million Baht) — 2005: 49,523; 2006: 103,431; Mar. 2007: 101,835.
    - Mixed Funds (Capital Protected): No. of Funds — 2005: 4; 2006: 9; Mar. 2007: 10. NAV (Million Baht) — 2005: 314; 2006: 940; Mar. 2007: 2,332.
  - Non-Capital Protected: No. of Funds — 2005: 530; 2006: 604; Mar. 2007: 604. NAV (Million Baht) — 2005: 725,556; 2006: 936,326; Mar. 2007: 1,031,006.
    - Equity Funds: No. of Funds — 2005: 151; 2006: 164; Mar. 2007: 172. NAV (Million Baht) — 2005: 82,565; 2006: 89,752; Mar. 2007: 96,186.
    - Fixed Income Funds: No. of Funds — 2005: 221; 2006: 303; Mar. 2007: 315. NAV (Million Baht) — 2005: 341,792; 2006: 536,448; Mar. 2007: 643,077.
    - Mixed Funds: No. of Funds — 2005: 150; 2006: 124; Mar. 2007: 104. NAV (Million Baht) — 2005: 282,044; 2006: 263,867; Mar. 2007: 243,092.
  - Property Fund for Public: No. of Funds — 2005: 8; 2006: 13; Mar. 2007: 13. NAV (Million Baht) — 2005: 19,155; 2006: 46,259; Mar. 2007: 48,651.
  - Source: SEC.
- Table 5 (Holdings of Public Debt Securities, Q3 2006) indicates holdings by investor class (values in million baht):
  - Government Loan Bonds outstanding: Banks 264,256; Mutual Funds 10,563; Insurance Companies 293,708; Pension and provident funds 250,386; Total Outstanding 1,060,250.
  - Tbills: Banks 75,329; Mutual Funds 115,112; Insurance Companies 4,993; Pension and provident funds 18,147; Total Outstanding 260,000.
  - BOT bonds: Banks 344,552; Mutual Funds 199,829; Insurance Companies 9,689; Pension and provident funds 78,227; Total Outstanding 780,695.
  - SOE bonds: Banks 100,724; Mutual Funds 12,286; Insurance Companies 48,202; Pension and provident funds 97,763; Total Outstanding 344,203.
  - Source: BOT.

### Fund behavior, product homogeneity, and market activity
- Most fixed income funds are closed-end funds with short lifespans and a strong preference for short-term debt to minimize NAV sensitivity to yield changes.
- Fixed income funds typically buy assets with maturity dates that coincide with fund expiration, enabling “buy and hold” strategies and limited active management.
- Funds investing in corporate debt prefer short-term notes and commercial paper, held to maturity for cash management.
- Mutual funds were one of the most active participants in the secondary market, accounting for 28 percent of activity in 2006.
- Mutual funds’ product similarity is reinforced by SEC rules and conservative strategies.

### Regulatory constraints on funds and issuers
- SEC rules for mutual funds:
  - Mutual funds may only hold 15 percent of assets in illiquid securities and no more than 5 percent of the assets may be issued by one entity.
  - The definition of illiquid securities includes bonds with maturities greater than three years, below investment grade corporate debt or unrated corporate debt.
  - Mutual fund operators are prohibited from creating a below investment grade mutual fund.
- SEC limits on private placements and commercial paper:
  - Private debt offering (PP) limited to B 100 million and to no more than ten non-institutional investors; all PP offerings must be filed with the SEC and the TBMA.
  - Private placements are included in the definition of illiquid securities, constraining mutual fund purchases.
  - Post-2005 commercial paper regulation: only investment grade rated companies and banks may issue commercial paper through a public offering; unrated issuers may sell commercial paper through a private placement to qualified institutional buyers (subject to illiquid security limitations). Listed companies must file a short-form registration statement and unlisted companies must file a free-form registration statement containing audited financial statements and the issue must be rated with the TBMA. At least three asset management companies must purchase the first offering of the issue.
- SEC has relaxed requirements on foreign investment grade issuers with MOF authority to issue debt in Thailand, permitting the same 3-year shelf offering rules available to Thai issuers and allowing an English language prospectus if making a related offering in other markets.

### Tax, foreign investor treatment, and investor composition
- Mutual fund profits are exempt from capital gains tax, creating an investment advantage for mutual funds.
- Insurance companies and pension and provident funds:
  - Together account for half the holdings of government loan bonds and over 40 percent of holdings of SOE bonds.
  - Holdings of shorter-term instruments are small—only 11 percent of BOT bonds are in their hands.
  - Insurance sector: more than 60 percent of insurance industry assets are invested in government and corporate debt (typically bought in the primary offering), yet the insurance sector accounted for only 3 percent of trading in the secondary market in 2006.
- Private investment funds (for high net worth individuals) were small but growing: as of February 2007, there were 1201 private funds under management with total assets of B 149 billion.
- Foreign investor constraints and effects:
  - BOT reserve requirements introduced in December 2006 require foreign investors in debt instruments to maintain a 30 percent reserve in a non-interest-bearing account.
  - Foreign investors are subject to a 15 percent withholding tax on income from corporate bonds (government bond holdings exempted).
  - Prior to December 2006, foreign investors held an estimated B 130 billion of Thai debt securities. Following the imposition of the reserve requirement, foreign ownership of debt securities declined to an estimated B 60 billion.

### Securitization and market infrastructure
- Thailand enacted a law in 1997 to create special purpose vehicles for collateralized debt products; the law was amended in 2004 to address legal impediments.
- Limited securitization activity to date: fourteen securitizations with a total value of B 40 billion. These offerings have typically been fixed rate securities with investment grade ratings (some with multiple tranches rated AAA to A).
- Securitizations have been secured by assets with defined cash flows; legal uncertainties and SEC review have prevented issues based on uncertain future cash flows.
- Banks originating securitized debt must obtain prior BOT approval.
- Market infrastructure gaps noted:
  - Need for credit rating infrastructure able to analyze underlying assets.
  - Need for ready access to information about underlying transactions and repayment history to enable modeling of pool performance and creation of tranches attractive to investors.
- Thailand lags other Asian countries in securitization and financial market deepening (Asian Bond Monitor references cited in source).

### Tax policy frictions affecting market functioning
- The SBT (specific business tax) is a tax on interest earned by financial institutions; it is applied gross and restricts activity in money markets, asset-backed securities markets, etc.
- Practice exists of netting out flows (untested) particularly in swaps transactions; market participants often use FX forwards to create synthetic term money positions as a consequence of the SBT.
- Despite a proposal to reduce the tax to a negligible level of 0.01 percent, it remains at 3 percent. Administrative cost of compliance will continue to be an issue even at a small rate.

### Recommendations — Government debt market
- Build more effective benchmarks:
  - Address both the flow of new issuance and structure of the stock of existing debt.
  - PDMO should maximize issuance potential; consider on-lending in B to SOEs to increase the size of individual loan bonds (would require amendment to the PDA, current provisions envisage onlending in foreign currency).
  - At some point consider whether BOT issuance of bonds could be replaced by government bonds, with funding deposited at BOT on the same terms (tenor and rate) — would require PDA amendment.
  - PDMO could consider a program of buybacks or debt exchanges to consolidate existing bonds into newer benchmarks (current PDA provisions restrict ability; amendment required).
- Reduce the frequency of auction:
  - Move from offering bonds of similar tenors every one or two weeks to about once a month to incentivize secondary market activity and greater market-making by PDs; larger issue size would require more meaningful underwriting commitment from PDs.
  - Change in auction frequency should be coordinated with a review of the PD framework.
- Review the PD framework:
  - Clarify relative priorities (underwriting primary market; market-making in secondary market; broader fixed income market development).
  - Design incentives and tools to promote desired behaviors; PDMO should lead design and oversight and be ready to monitor, enforce, and strip nonperformers of status.
- Implement proposed amendments to the PDA:
  - Expedite Parliamentary process to enact Cabinet-approved amendments that address constraints on PDMO actions.

### Recommendations — Corporate debt market
- Broaden issuer pool and product diversity:
  - SEC should eliminate prohibitions/restrictions on mutual fund investments in below investment grade public offerings to allow many small or medium sized companies (which may be sound but unrated) to access debt markets and let professionally managed mutual funds assess risk/reward.
  - SEC limits on the size of private debt offerings should be expanded or eliminated to allow efficient private placements to large institutional investors.
  - SEC should reexamine the 2005 commercial paper regulations (e.g., requirement that SEC determine a company is financially solvent before issuing commercial paper) to avoid excessive regulation of short-term financings needed for business.

*Italic: IMF staff report content as provided in the supplied PDF excerpt.*

### 89.      Re-examine restrictions on foreign borrowers. Thailand should reexamine its

### 89. Re-examine restrictions on foreign borrowers

### Reexamine foreign issuance and capital flows
- Thailand should reexamine its restrictions on foreign issuance of baht-denominated debt, including:
  - the requirement that foreign issuers obtain MOF approval; and
  - the requirement that funds raised in baht-denominated bonds immediately be converted into foreign currency if the funds are taken offshore.
- Thailand has a surplus of investment capital that is greater than its domestic needs and a growing institutional investor base increasingly going offshore to find investments that meet portfolio needs and match liability requirements.
- Smaller markets such as Hong Kong SAR, Singapore and New Zealand have actively encouraged the issuance of nonresident corporate debt to enlarge their markets and make them more viable.

### Securitized products to expand investment-grade supply
- Finding: There is a limited number of corporations in Thailand able to issue investment-grade debt and needing additional capital.
- Recommendation: Innovative intermediaries could securitize other assets to create high quality debt instruments, which may also address other needs in the Thai financial markets.
- Specific opportunities:
  - a. Bank loan portfolio securitization
    - Currently, the major Thai banks have a substantial general economic downturn risk as over 80 percent of many banks commercial loan portfolios are loans to Thai businesses.
    - Transferring portions of a bank loan portfolio to an SPV, which issues collateralized loan obligations based upon a diversified pool of assets, could reduce national economic downturn risk, free up capital for new loans, and create attractive debt securities for institutional investors.
  - b. Collateralized mortgage obligations
    - Few lenders offer long-term fixed rate mortgage products because of potential interest rate risk.
    - Pooling mortgages to back long–term mortgage backed securities would allow lenders to offer long-term fixed rate mortgages without significant duration mismatch and would meet insurance companies’ demand for long duration assets.
  - c. Covered bonds
    - Because of historical concerns over securities issued by an SPV with no recourse beyond the underlying pool, consideration should be given to promoting the use of “covered bonds” as an alternative securitization structure.

### Credit enhancements
- Recommendation: Use credit enhancements to create investment-grade products, including:
  - over-collateralized asset pools;
  - guarantees or credit risk swaps with the originating entity;
  - multiple tranches of securities with different repayment rights; or
  - purchase of repayment insurance from a third party insurer.

### Expand and diversify the investor community
- Regulatory changes to expand the number of issuers must be accompanied by parallel changes to provide institutional investors with greater investment flexibility.
- Current Thai regulation has tended to limit corporate issuers to large and safe investment-grade companies and has restricted institutional investors to these companies.
- Institutional investors should have greater freedom to make investment choices so that investor protection does not unduly impede asset managers from making sound investment decisions consistent with disclosed strategies.

### Regulatory changes for institutional investors and mutual funds
- a. A major contributor to the lack of corporate debt is regulatory restrictions limiting institutions’ ability to invest in unrated or below investment-grade debt; because likely investors are prevented from investing, potential issuers cannot issue.
- b. If the SEC introduces greater flexibility into the private placement process, it should provide institutional investors the ability to resell private offerings to other qualified institutional investors.
- Transition recommendation: Move from merit-based regulation of mutual funds and other collective investment schemes toward disclosure-based regulation, allowing fund operators greater freedom consistent with accurate and full disclosure of investment strategies and limits.
- The SEC should:
  - a. Permit the creation of mutual funds that invest primarily or entirely in below investment grade debt.
  - b. Adopt less restrictive rules on what is an illiquid security.
  - c. Permit mutual funds to engage in repos as well as reverse repos and to engage in OTC derivatives transactions, if consistent with fund’s investment strategy and if practices are clearly and fully disclosed.
  - d. Provide greater flexibility on risk structure for real estate trusts.
  - e. Establish a procedure for granting waivers of concentration limits when appropriate and make the process for obtaining waivers/exemptions transparent.
  - f. Permit funds to invest in private offerings from companies that are unrated.
  - g. Permit institutions to invest in offshore offerings without requiring translation of offshore offerings documents.
  - h. Permit institutions to invest in offshore private offerings.

### Encourage competition among intermediaries
- The Thai capital market would benefit from greater competition among intermediaries; the current ceiling on licensed securities brokers and regulated commission rates do not promote competition and innovation.
- a. Debt underwriting is almost entirely by banks, competing with commercial bank lending. Eliminating limits on new broker licenses and fixed commission rates would increase competition, forcing brokers to develop new business models including proprietary trading and debt underwriting competition.
- b. Intermediaries must develop alternative sources of investment-grade rated debt by securitizing quality assets or revenue streams or developing credit enhancement programs. A broader and more diverse group of intermediaries is more likely to create new and profitable investment products.

### Re-examine restrictions on investment abroad and expand investor base
- Thailand’s surplus of investment capital means Thai investors will benefit from investing capital overseas; continued restrictions on Thai intermediaries and constraints on access of foreign borrowers will limit growth prospects and place Thailand at a competitive disadvantage.
- Expansion in size and diversity of the institutional investor community, including foreign investors, could improve efficiency and liquidity. Foreign banks are more active than Thai banks in proprietary trading, which improves secondary market liquidity.
- Authorities should carefully examine policies on foreign investment; capital account restrictions can have unintended consequences, often resulting in an increase in offshore synthetic deals, outside the control of policy makers.

### Other markets: repo, derivatives, netting, and SBT
- Resolve outstanding technical issues in the private repo market:
  - The BOT should coordinate an industry working group to resolve residual technical issues impeding wide adoption of the standard GMRA for the private repo market, with participation from banks, mutual funds, insurance companies, pension companies, the SEC, TSD, TBMA, and the insurance regulator.
- Introduce futures contracts:
  - The TFEX should prioritize development of a standard bond derivative and interest rate derivative product to enable traders to hedge interest rate risk from maintaining inventories of debt securities.
- Facilitate netting:
  - Regulators should permit banks and securities firms to net outstanding positions for capital adequacy compliance and to cross-settle positions on the listed and OTC markets when these products are created and traded.
- Reduce SBT:
  - The authorities should not delay in reducing the level of the SBT to the proposed 0.01 percent. In due course, the SBT should be completely eliminated.

*Italicized source: Excerpt from IMF staff report chapter on Thai capital market reforms.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09151.pdf_