Editor’s letter

Deutsche Bank’s strip bond solution to Taiwan’s bond crisis at first promoted a flurry of criticism of Deutsche Bank’s terms with the Taiwan regulator and on the deal itself. Bankers complained they were being shut out of the market by the regulator’s insistence that Deutsche have first right of refusal on all strip bond transactions until the end of May – Deutsche’s reward for five months development work on the deal.

Others warned the price of the principal-only (PO) portion sold back to the funds did not reflect market value and could lead to significant losses should another surge in redemptions force the funds to sell the PO.

But as Deutsche Bank’s competitors scribbled better and better solutions on to the backs of envelopes and napkins, alternative proposals have yet to emerge from the Taiwanese regulator’s office unscathed. There are some innovative ideas, but they will hit barriers: a CDO solution, for example, would struggle to find enough onshore credits, while using offshore credits would only complicate the deal further and raise the transaction costs. (The topic of an all-Asian CDO is discussed in our structured credit special report beginning on p27). Furthermore, both CDO and CDO securitisation solutions need time-consuming agreement from ratings agencies, regulators and bond trustees.

Bankers are beginning to acknowledge the strip bond may indeed be the best way – as we followed up progress of the Deutsche Bank deals, it was harder to find critics. TW$25 billion of bonds have been stripped, and has begun to restore some order to the Taiwan bond market. Interest rates have moved in favour of the deals, and as Cynthia Chan, head of global markets for Deutsche Bank in Taipei says: “Most clients who did it are very happy right now; and wish they had done more.” One banker at a major Taiwan bank said: “It’s the most efficient way, the quickest way to strip out the riskiest part of the bond.” A significant benefit from Deutsche Bank’s work will be the introduction of a useful zero-coupon bond market in Taiwan. Chan says no such animal exists as yet – but the tradeable PO portion of the strip bonds can be used just like a zero-coupon bond, and there is no liquidity premium in trading it. Chan hopes it will be used by bond funds and major investment trusts as principal-protected assets. Congratulations are due to DB for getting a new product out, successfully implementing it and finding an innovative side-effect while its competitors realised – too late – that they had nothing of substance that would please the regulators. As our Taiwanese banker said: “We learned. We need to move faster.”