What is a Bond Pricing Agency (BPA)?
A BPA is a market neutral entity whose role is to provide fair valuations on bonds.
What does it do?
The BPA generates fair valuations for all the issues in the Ringgit bond market to enable investors to ascertain the value of their investments.
What does market neutral mean?
The BPA must not be controlled by any one party to ensure its valuations are not biased. The Securities Commission’s guidelines define limitations on the shareholding structure to make sure undue influence is not exerted by any one party. This is a fundamental issue that MUST be addressed so that the market has full confidence in the valuations generated by the BPA.
What is fair valuation?
In the absence of traded prices, fair valuation is a globally accepted concept that provides theoretically derived prices based on observed trading activity. Fair values represent reference prices as a guide for the disposal value of the bonds should they need to be sold.
Why is fair valuation needed?
Bonds make up a significant percentage of investments held by asset managers, unit trusts, banks and insurance companies. Investors need to know the value of their bond holdings to make correct investment and risk management decisions. This becomes a problem when there is a lack of prices for bonds for Marked to Market practice.
What is Marked to Market (MTM)?
In simple terms, it means valuing investments against market prices. This means that the value of the investment represents its disposal value, ie how much it is worth if it needs to be sold. MTM practice is the globally accepted method for valuation of investments and complies with accounting standards and risk management requirements.
Why are there no prices for bonds?
Due to the OTC (Over the Counter) nature of the bond market, there is no official published closing prices for bonds. This is in contrast to exchange traded instruments such as equities where the exchange publishes a list of closing prices daily (for example, Bursa Malaysia closing prices)
So how were bonds valued in the past?
Due to the lack of a dedicated valuation source, bond valuation was a hit and miss affair involving simple estimation, interpolation and extrapolation without any consistent study or methodology.
What is the danger of that?
If bond holdings are valued simply by estimation, there is a very real danger that the bonds are wildly over or under valued. With bond structures becoming more sophisticated by the day, it is clear that this approach will not suffice. Also, the lack of a consistent and verifiable methodology leaves valuations open to abuse and manipulation.
How will a BPA solve this problem?
By generating daily closing fair valuations via a consistent methodology for all bonds in the market, the BPA will provide a reference price for investors to value their bond holdings
Are there a lot of bonds in Malaysia?
The Malaysian bond market is the second largest in Asia ex Japan. There are over 2000 bonds issued as of January 2006 with a total value exceeding RM 140 billion. However on any given day less than 2% are traded. The valuation of the remaining 98% therefore becomes an issue.
Is this a problem with the Malaysian market?
No, this situation arises due to the inherent nature of bonds which are held as long term investments and are relatively rarely traded. It is seen all over the world, even in developed markets like the US.
Do other countries have BPA’s?
BPA’s exist in markets that are rapidly growing such as Korea and Mexico. In advanced markets such as the US, bond valuations are generated by specialist companies and their valuations are used by investors voluntarily to comply with corporate governance, public interest protection and accounting reporting requirements.
Why don’t we follow the US?
The Malaysian bond market is still developing. The level of market maturity has not yet reached a point where voluntary fair valuation has been adopted as in the US. Given this fact, the SC has determined that a BPA-based approach would be most suitable and effective.
How does the BPA generate these fair valuations?
The BPA generates its valuations via a consistent and transparent methodology that uses data such as observed trades, rating information, historical behaviour, yield curves and issuer financial data. With this methodology, fair valuations can be generated for EVERY individual bond in the market on a daily basis, even though these bonds are illiquid or untraded.
Is the methodology sound?
The methodology is based on globally accepted bond pricing models, and is consistent with practices in developed markets. The entire methodology is vetted and approved by the Securities Commission to ensure it is transparent, consistent and immune to manipulation. In addition, the SC requires the BPA to have strict standards for the control and security of the data, and a feedback mechanism through which market players can comment on the valuations.
Will the BPA affect trading?
In fact, with the availability of reference prices for illiquid and untraded bonds, market participants will have a starting point to begin trading these bonds. Ultimately, the BPA will act as a catalyst to spur trading volumes.
Who are the users of BPA services?
Anyone who has investments in Ringgit fixed income instruments and need an independent consistent and verifiable source to value these investments. From a wider perspective, all market participants will find relevance in the range of services provided by the BPA.
What other benefits can the BPA provide?
Due to the nature of its work, the BPA is effectively a repository of comprehensive data on all the bonds in the market. Bondweb Malaysia holds a vast database of current and historical data on trading, credit, stock and facility information, yield curves, statistics, issuers, tenders and so on. This database has great value as an information source for all market participants and is made available to clients as a value added service. The benefits of such easily and freely available information to the market will manifest itself in the form of more active trading, finer price discovery, enhanced risk management and optimal capital allocation.
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