The year of booming bonds

China and other developing nations have the potential to make bonds a new engine of economic and financial reforms

Booming bond issuance and investment have been the pervasive themes throughout the global financial markets in 2012. The bond market not only met the needs of investors in the midst of the global financial crisis, but also provided strong support to companies and banks, becoming an engine for the world's economic growth.

It thus makes sense that amid market uncertainty investors regarded bond investment as a safe haven and flocked to this area. Over the past four years, according to JP Morgan's estimates, more than $2 trillion has flowed into fixed-income funds globally while equity funds have suffered an outflow of money.

For the first time in more than 50 years, United Kingdom pension funds are holding more bonds than equities, because they need stable, fixed returns to pay pensioners. In the United States, and European and Asian countries, some of the biggest pension funds have been switching to fixed income.

Bonds have also been the asset class of choice for private banks that conduct wealth management businesses, because they want to focus on wealth preservation for their clients amid volatile global stock markets and business uncertainty.

Not surprisingly, the European sovereign debt crisis and banking plight partly contributed to the boosting of bond markets. Europe's companies have usually relied far more heavily than their US counterparts on borrowing from banks, rather than from markets.

However, the situation has now changed. Since banks in Europe undertook deleveraging after being hit by the crisis, shrinking their balance sheets, they now have fewer capabilities left for lending. Thus, companies are being forced to go directly to markets to raise funds. As a result, corporate bond issuance has surged. In the eurozone periphery countries, good companies can borrow money from bond markets at significantly lower costs than from their own banks.

Bond markets play a key role in refinancing manufacturers, real estate property developers, banks and governments. According to Dealogic data, the global corporate bond market nearly doubled from $5 trillion in 2008 to $9 trillion this year.

Given that commercial banks have reduced their real estate loans, many property developers are on a record year of bond issuance, disenchanted as they are with the traditional banks. In addition, the funding shortfall in the real estate sector is expected to grow when Basel III regulatory changes are imposed on global banks. Previously, many banks would lend long-term loans to real estate developers by obtaining short-term funding to make a profit on the spread. The new regulation will require banks to match funding and lending more closely, therefore, removing some of the incentives to lend to this sector.