2. The Issuance Market : Method, Type and Composition

2.
The Issuance Market : Method, Type and
Composition
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2.1.
Description of the Issuance Market
The public bond market, similar to any market, consist of both the Primary and Secondary
sides. Issuer-driven activity (=new issue) prior to settlement date is considered "primary"; any
buying or selling by investors past the new issue settlement date is considered "secondary".
2.2.
Issuance Type
The chart below explains the various types of issuance methods.
Public
Private
Direct Offering
Fixed Percentage
Public Auction
Indirect Offering
Allocation
Underwritten
Total Underwriting
Residual Underwriting
Direct Offering
Indirect Offering
2.2.1. Public and Private Placement
(1) Public
Solicitation to sell randomly to a large number of investors
(2) Private
Solicitation to sell to a small number (usually less than 50) of investors only
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2.2.2. Public Offering and Reverse Inquiry
(1) Public Offering
Issuance is done with pre-determined issuance amount.
(2) Reverse Inquiry
Issuance is done with no pre-determination of amount. The issuer will only sell that amount
which was collected during the pre-determined public offering period. Only Bank
Debentures (those issued by financial entities) are allowed to issue in this manner. Any
securities house can sell a specific issue on a reverse inquiry basis.
2.2.3. Direct Offering
Direct Offering takes the form of direct solicitation by the issuer to investors. Since this type
excludes the intermediary (in the case, the Securities Company), the issuer can achieve cost
savings in terms of commissions. However, since public bond issuance requires specialized
knowledge, and good distribution network, large issuance is impossible. In addition, issuance
can fall through if the issuer is not able to collect the pre-announced amount at the time of
closing. In most cases, this normally takes the form of private issuance. Otherwise, the issuer
needs to be very familiar with the offering procedures. However, Financial Regulation in
Japan is based on publicly issued direct offering.
(1) Fixed Percentage Public Offering
The issuer fixes the coupon and issuance amount and takes in bids. Allocation is done
based on the subscription percentage.
(2) Public Auction
The issuer allows the auction participants to place bids at their desired levels and for desired
amounts. Final issuance detail will be determined based on the bidding result. Unlike the
Fixed Percentage offering, Public Auction is a competitive auction in which the issuer will
take in bids based on the lowest yields placed until it reaches the desired issuance amount.
Issuance method can be done on a "Price-based Auction" or "Yield-based Auction" basis.
Issuance type can be "Dutch Style" or "Conventional Style".
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¬ Price-based Auction
In coupon bonds, the issuer pre-determines the coupon and issuance amount (discount
bonds only fix the issuance amount), and participants place bids based on price. The
lowest yields will be taken in first until the planned issuance amount is met.
Á Yield-based Auction
The issuer will only fix the issuance amount. Participants place bids on a yield basis,
allocation will be done based on lowest relative yield.
® Dutch Style
The total amount bid will be allocated at the lowest price (or highest yield). A single
price (or yield) fixing method.
¯ Conventional Style
The price (or yield) at which each participant placed the bid becomes the issued or trading
price (yield). A multi-price (or yield) fixing method.
Price Based
Conventional
Dutch
Yield Based
Conventional
Dutch
Public Offering
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2.2.4. Indirect Offering
Indirect Offering is a method in which the issuer requests a specialized intermediary (such as
a bank or a securities firm) to process the offering on behalf of the issuer. By doing an
Indirect Offering, the issuer can take advantage of the bank or securities company's
credibility, secure funds via a large network of investors. Indirect Offering can be separated
into Allocated Offering and Underwritten Offering.
(1) The public bond issuer requesting a third party (Administrative Agent) to manage the
administrative duties related to the offering takes part in an Allocated Offering. The firm
will prepare the necessary documents and conduct the offering on behalf of the issuer.
However, in case of a Corporate Bond issuance, since the company has no obligation to
close the offering if enough investors are not found, issuers generally will prefer a
combination of an Allocated and Underwritten Offering.
(2) Underwritten Offering
¬ Total Underwriting
Total Underwriting is made possible by the issuer requesting the selected firm to
underwrite the entire issue. This type of issuance enables the issuer to borrow the
required funds in a timely and assured manner without publicly offering its bonds. In rare
cases, the underwriting firm will hold the position as an investment, but in most cases, the
firm will re-sell the bonds into the secondary market after having paid for the bonds with
internal funds.
- Residual Underwriting
In this case, the issuer will enter into an underwriting agreement with the securities'
company in which the underwriter signs the offering agreement and asks the firm to
initiates the Public Offering on the its behalf. The agreement also requires that the
securities firm will take on any residual amount (the amount, which is not sold at the
initial offering) on its books. By this form of offering, the issuer can be assured issuance
of the promised amount. Most syndicated public bonds and Corporate Bond issues take
this form.
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2.3.
Composition of the Issuance Market
2.3.1. The Composition
The primary market for Non-JGBs consist of the issuer, investor, underwriting firm (bank or
securities company), and trustee (commercial bank or trust bank).
Issuer
Underwriting Firm
(Sec. Co., Bank)
Investor
Trustee
(Commercial Bank, Trust Bank)
2.3.2. The Issuer
Currently, the following issuers publicly underwrite its bonds: Japanese Government (based
on Fiscal Low), Local Government (based on Local Fiscal Low), Special Entities (statue of
Governance, Corporations (Business and Special Law Related to its Operation).
2.3.3. The Underwriter
The underwriter will accept the role of managing all aspects of issuance, with the purpose
offering the specific securities. In addition, the underwriter agrees to underwrite the residual
issuance on its own in order to launch the issue successfully.
In order to diversify the residual risk (the amount not sold at initial offering), underwriting
usually takes the form of group syndication. In this case, the lead underwriter will act as the
sole agent to the issuer, and signs the underwriting and offering agreement with the issuer.
The other members in the syndication will coordinate amongst themselves to underwrite their
allocations (which they many hold an their books if not sold). While both banks and securities
companies are allowed to underwrite new issues generally, banks are essentially limited to
Government, Prefecture & Municipal, and Government Guaranteed issues only. Corporate
Bond underwriting by banks is restricted under the Japanese-Style Glass-Steal Law (which
requires segregation of banking from that of the securities business) established under
Securities Transaction Law 65.
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2.3.4. The Trustee
In the past, Corporate Bond issuers were required to select on "Administrative Agent" (in this
case a commercial bank or trust bank) to perform the administrative duties such as preparing
the agreement and application, performing the legal work and coupon payments, etc. While
this process was termed "voluntary", it was common practice. However, commission charged
for such management was high compared to international standards, and in reality, the Agent
was involved in the entire issuance process, making new issue process both costly and
cumbersome. For this reason, the "Administrative Agent" requirement, commercial Law
301), was abolished in June 1993. The Commercial Law was changed to protect investors,
which required that "Trustee" should be set up to manage the administrative duties after the
bonds are issued, (however, if the nominal issuance size is larger than 100 million yen, or if
the total nominal amount divided by its minimum denomination is less than 50, then,
”Trustee” is voluntary). The role of the Trustee is to have the authority to conduct servicing
of interest and coupon payments (both legal and otherwise) and to act on behalf of investors if
voted upon by the majority of investors.
2.3.5. The Fiscal Agent (FA)
Similar to the Trustee system, Fiscal Agent system exists. Fiscal Agent can be applied if the
nominal issuance size is larger than 100 million or if the total nominal amount divided by its
minimum denomination is less than 50. Unlike the Trustee role, the Fiscal Agent is set up
only to perform the administrative duties on behalf of the issuer (for example, make coupon
payments).
2.3.6. The Collateral Management Company
A Corporation issuing a collateralized security is required to establish a Collateral
Management Company under the trust agreement with the issuer. The management entity
takes responsibility of protecting investors from the collateral available to them. In the worst
case, the Management Company has the legal recourse to sell such collateral to pay any
principal or interest due to investors.
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2.4.
Method of Maturity
v Lottery Style
v Even
Amortization
v Redemption
Before Maturity
v Redemption
v Buy-back
(Par Call)
v Buy-back
(Market Call)
v Buy-back
(Market Call)
v Partial
Redemption
(Lottery Style)
v Bullet
Redemption
v Bullet
Redemption at Maturity
2.4.1. Even Amortization Style (Regularly Scheduled Redemption)
Instead of redeeming a full principal amount at the final maturity, after a specified
unredeemable period, the issuer redeems a pre-determined amount of the principal based on
pre-scribed schedule (once a year or at every coupon date), and redeems the remaining
principal at the final maturity.
2.4.2. Lottery Style
In Lottery style redemption, a specific bearer form based on a serial number determined by a
lottery will be redeemed. The amount redeemed is on the notional amount. Therefore, the
redemption will be made at par regardless of its marked-to-market value. If the bond to be
redeemed has over-par value, the holder will suffer a loss. The holder is not allowed to reject
the redemption, and no interest will be paid from the date redemption determined by a lottery.
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2.4.3. Buy-back (Par Call)
After a specified unredeemable period, a partial or a full amount of principal can be bought
back by the issuer prior to maturity at the issuer’s discretion. In the case of a partial buyback, redemption is determined by a lottery. In most cases, the amount to be bought back at
each redemption is contracted at the time of issuance, and the redemption is made at some
premium over the notional amount. Such contract is concluded to enable the issuer to buy
back their obligation when they have extra funds at hand. In the domestic bond market, the
redemption of this style is barely seen with some exception (CBs etc.).
2.4.4. Buy-back (Market Call)
The issuer can buy back a bond at the secondary market at any time from the next day of the
issuance date. (Note that “Buy-back” mentioned here is different from “buy-back” as a
variation of even amortization.) “Sinking Fund System” exists to facilitate “Buy-back”.
Under this system, the issuer will accumulate funds at specific timing and use the funds for
buying back a bond. A typical sinking fund is the “Government Debt Consolidation Fund”
that has been established to decrease the outstanding balance of JGBs.
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2.5.
Issuance of Government Guaranteed Bonds
Underwriting Syndicates are formed for each Government Guaranteed Bond issuer, similar to
Prefecture & Municipal Bonds. Most securities firms and financial institutions are members
of those syndicates. It is also similar to Prefecture & Municipal Bonds in that the issuer
enters into an underwriting agreement and an offering agreement with the underwriting
syndicate, and the underwriting syndicate is obliged to take on any residual amount (which
was not sold at the initial offering) on its books.
“Political Cooperation Purchase” of Government Guaranteed Bonds also exists. This system,
which is aimed to help Government Agencies’financing needs, persuades cash-rich investors
such as life insurance companies or various mutual aids associations to buy Government
Guaranteed Bonds based on a pre-determined schedule. A syndicate of securities firms
handles the offering.
Final issuance details of Government Guaranteed Bonds and public Municipal Bonds are
released on the day following the 10-year JGB auction, and are underwritten by many
underwriters. The issuance price is usually fixed at a much more expensive level compared to
the their secondary market level. This is due to the fact that, although the issuance amount is
generally small, regional investors purchase a large part of issuance on a regularly scheduled
basis. One final issuance detail is fixed for the entire Government Guaranteed Bond and the
entire public Municipal Bonds, which means there is no price difference based on individual
issuer’s name, and the investors who purchased unpopular issues will suffer a loss as a result.
In near future, pricing should vary depending on issuer should happen.
Annual issuance amount is ¥1.5 ~ 2 trillion for Government Guaranteed Bonds and approx.
¥2 trillion for public Municipal Bonds. In most cases, one underwriter underwrites private
Municipal Bonds. The final issuance detail is slightly different depending on underwriter.
Annual issuance amount is approx. ¥8 trillion, 60 ~ 70% of which is usually issued during
March to May. Issuance has been increasing rapidly in the last few years.
2.6.
Issuance of Bank Debenture Bonds
Coupon is determined around the 10th day of each month based on the level of the secondary
market. Bank Debenture Bonds are issued through public direct offering and reverse inquiry.
In a public direct offering, investors directly underwrite the bonds from the issuer. Excluding
JGBs, only Bank Debenture Bonds are issued by this method. In a reverse inquiry, broker
dealers purchase the amount they want from the issuer on the issuance date. Annual issuance
amount of each name is, on the average of the last 5 to 6 years, approx. ¥3 trillion for IBJ,
¥1.7 trillion for Shochu, ¥1.3 trillion for Nochu, ¥2 trillion for LTCB, ¥1.5 trillion for NCB,
¥1 trillion for BoTM, and ¥600 billion for Zenshinren. Except for IBJ, Shochu and Nochu,
issuance amount is generally decreasing. In particular, BoTM has ceased issuing Bank
Debenture Bonds by October 1999, and began to issue Bank Straight Bonds.
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2.7.
Issuance of Corporate Bonds
Electric Power Company (or Utility) Bond, Corporate Bond with the largest outstanding,
concentrates its issuance in April and October. The amount issued per issuer for one issue is
normally 20 ~ 100 billion yen. No specific timing exists for issuance of other Corporate
Bonds. Most issuers issue Corporate Bonds when they have funding needs and the market
condition meets their target. Typical issuance size is ¥10 ~ 30 billion. Annual issuance
amount of the entire Corporate Bond market has averaged 8 ~ 10 trillion yen in the last few
years.
In theory, a final issuance detail should be determined based on the secondary market
conditions and investors’needs, in reality, keen competition in the underwriting business is
pushing up the issuance price to expensive levels. Some issuance is fixed at too expensive a
price, a price that is specified by the issuer. For this reason, most new issues collapse in price
once they trade in the secondary market.
2.7.1. New Issuance Registration System
“Corporations, who have submitted a Bond Issuance Registration Form (“Hakkou Tourokusho”) to the Finance Minister that specifies the type of bond to be issued and the planned
issuance amount, can issue a bond at any time if the amount is within the registered planned
issuance amount, without submitting a Securities Notification (“Yuuka Shouken Todokedesho”). The corporation, however, is required to submits the Bond Issuance Registration Form
Addendum (“Hakkou Touroku Tsuiho Shorui”) which specifies the necessary information
such as the issuance detail and the reference disclosure.”
2.7.2. Uniform Price Offering Method
The initial public offering of Corporate Bonds is made by the uniform price offering method.
The final issuance detail is determined by the managing underwriters based on investors’
demand. During the initial public offering, the bond must be sold at the issuance price, and
no discounting is permitted. Unlike the proposal-based method, in which market making is
allowed during the initial public offering, market making is not allowed in this case until the
initial public offering is completed.
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2.8.
Issuance of Prefecture & Municipals Bonds
Local Governments are supposed to specify the preferred issuance amount for each individual
project, and submit the plan to the Ministry of Home Affairs. Home Affairs Minister and the
Finance Minister together create the “Prefecture & Municipal Bond Plan” based on each
Local Government’s plan. “Prefecture & Municipal Bond Plan” specifies total approved
issuance amount, planned amount by project, and the classification of source of funds
(allocation of fund sources among Trust Fund Bureau, Postal Life Insurance, Japan Financial
Corporation for Municipal Enterprise, and the private sector) etc.
Planned issuance amount of public bonds and private bonds is separately specified.
“Prefecture & Municipal Bond” in a broad sense implies Local Government’s financial
obligation which goes over one fiscal year. What is referred to as “Prefecture & Municipal
Bond” in the fixed income market refers to securities issued to financial institutions and other
investors through the public and private offering process.
Municipal
Bond
Issuance
Underwritten by Trust Fund Bureau, Postal Life Insurance
Underwritten by Japan Financial Corporation for Municipal Enterprise
Underwritten by (offered to)
private sector entities
Public Municipal Bond
Private Municipal Bond
Delivery Municipal Bond
vUnderwriting Organization
Each Local Government issuer has an underwriting syndicate (which consists of securities
firms and financial institutions) for its public bond issuance. In a private bond issuance, the
designated financial institution of the Local Government forms an underwriting syndicate if
the issuance amount is large, and underwrites full issuance if the amount is relatively small.
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2.9.
Issuance of Samurai Bonds
Yen-denominated bond issued by non-residents such as foreign governments and
international organizations. It is usually called “Samurai Bond”, with issuance, coupon
payment, and redemption in Japanese Yen. Samurai Bonds are regulated by the Securities
Transaction Law, the Law concerning Foreign Exchange and Foreign Trades, the Corporate
Bond Registration Law, and other Japanese domestic laws. Since Samurai Bonds are always
issued on an uncollateralized basis, issuers’qualification is scrutinized in order to protect
investors’interests. Determination of the issuance detail is flexible compared to domestic
bonds, which is required to reflect the actual market condition at the time of issuance. Yendenominated bond issued in the Euro Bond market is called “Euro Yen Bond”.
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