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The $28trn global reach of Asian finance

THE COUNTRIES of East and South-East Asia are renowned, even envied, for reshaping global supply chains. Less well appreciated is the extent to which they have redrawn the map of global capital flows. After a buying spree over the past decade or so, the region’s ten biggest economies now hold nearly $28trn in foreign financial assets, more than three times the amount in 2005 and equivalent to a fifth of global assets held by foreigners. Once-staid institutions that are little-known in the West—from obscure Japanese banks and Taiwanese insurers to South Korean pension funds—now wield heft in markets for assets ranging from collateralised-loan obligations in America to high-speed rail lines in Britain. East Asia has long been recognised as a contributor to the global “savings glut”, a concept popularised by Ben Bernanke, then a governor at the Federal Reserve, in 2005. The scale of Asia’s foreign holdings has only grown since, as the region has become richer and older. The Economist has looked at figures for the gross foreign financial assets for ten East and South-East Asian economies. We define these as total gross foreign assets excluding foreign direct investment by multinationals. The measure captures investment portfolios and bank lending, among other things. The combined foreign financial assets of our ten countries rose from around $8trn in 2005 to nearly $28trn in 2020, increasing the region’s share in global foreign-held financial assets by five percentage points (see chart 1). The composition of Asia’s savings hoard has also changed, strikingly so in some places. When Mr Bernanke conducted his analysis foreign-exchange reserves held by governments and central banks in our set of ten economies accounted for about half of a country’s foreign financial assets, on average. These had been stockpiled after the Asian financial crisis of 1997-98 as a bulwark against future currency collapse, and were held in safe, liquid assets. The average share of reserves has now fallen to nearer a third. Meanwhile, two-thirds of the stockpile now reflects an explosion in portfolio and other financial flows, as institutional investors in the region have hunted for yield (see chart 2). The shift is drawing the attention of financial watchdogs. In December the Bank for International Settlements (BIS), a club of central banks, concluded that Asian institutional investors had contributed to dollar funding stress in March 2020, as covid-19 first began to spread and markets panicked. Yet much about these financial interlinkages, and the risks associated with them, is still poorly understood. Our sample of countries can be split into three camps. The wealthiest handful—Hong Kong, Japan and Singapore—hold significant foreign-exchange reserves, but their hoards of other financial assets are between five and eight times larger. Their holdings are now mature, and slower-growing by regional standards. A bigger shift has taken place in South Korea and Taiwan. In 2005 almost half of Taiwan’s foreign financial assets, and two-thirds of Korea’s, took the form of reserves. Although reserve holdings have since more than doubled for both countries, portfolio and other assets have expanded at a far more rapid clip. Korea and Taiwan now own $1.5trn and $2.1trn in foreign financial assets, respectively, less than a third of which is held in reserves. In Malaysia, too, non-reserve financial assets now outweigh reserves two-to-one. By contrast, for a third set of countries, which include China, Indonesia, the Philippines and Thailand, reserves still retain a large share. The growth in foreign financial holdings has gone hand-in-hand with the transformation of conservative institutional investors into big players in distant corners of financial markets. A prime example is Norinchukin Bank, an agricultural co-operative based in Japan. It holds some ¥4.8trn ($42bn) in collateralised-loan obligations, securities made up of a portfolio of loans, most of which are denominated in dollars. Before it slowed purchases in 2019, it was widely considered the largest buyer of CLOs in America. Taiwan’s insurers, such as Cathay Life Insurance and Fubon Life Insurance, have become influential institutions in a number of international markets. Their total assets have nearly tripled over the past decade. And more of them are now held overseas. By the end of 2020 almost 60% of their assets were comprised of foreign investments, up from 30% in 2010. Such institutional investment is now so widespread that Formosa bonds, foreign-currency bonds issued in Taiwan by a range of global firms and governments, have exploded since the securities were designated as domestic rather than foreign debt, allowing insurers to skirt regulatory limits on foreign-security ownership. By the end of 2021 the outstanding value of dollar Formosa bonds alone was $195bn, compared with $84bn six years earlier. South Korea’s National Pension Service has also sought more overseas exposure, announcing a flurry of global ventures. Foreign assets made up 37% of the pension fund last year, nearly double the share in 2013, and the firm aims to increase that to 50% by 2024. The strategy is to chase returns not only abroad but also in less-liquid asset classes, before the fund’s benefit payouts start to increase in the early 2040s and its revenue surplus turns to a deficit. Malaysia’s Employees Provident Fund (EPF), which manages mandatory pension investments for the country’s private-sector employees, provides another illustration of Asian institutions’ foreign reach. Last year it launched what it called the world’s largest sharia private-equity fund, with BlackRock, HarbourVest Partners and Partners Group each managing a third of the allotted $600m. The EPF’s foreign assets have also climbed from 29% of the total in mid-2017 to 37% in mid-2021. The result of all this activity is that Asian institutional investors have become enormous swing buyers in certain markets. “They’re disproportionately large in Australia,” says Martin Whetton of Commonwealth Bank of Australia. The country, he says, is the third-largest location of assets for Japanese life insurers, and tends to make up about 10-15% of their portfolios. Mr Whetton points out that purchases of Australian dollar assets in North Asia are large enough to shift the country’s cross-currency basis (the premium traders pay to temporarily exchange currencies). Some institutions have made promises of guaranteed payouts to clients and, as interest rates have sunk to rock-bottom levels, have had little option but to hunt for yield in less highly rated or more illiquid asset classes. Industry insiders note that insurers in the region have moved increasingly into emerging-market debt and higher-yielding Asian bonds. Private, illiquid assets have also become more popular. Asian investors have long been drawn to private equity and property, says Anish Butani of bfinance, an investment consultancy. Now “we’re really seeing a surge of activity in infrastructure and private debt”. To observers such as the BIS and the IMF, all this signifies greater financial risks than when more holdings took the form of safe, highly liquid reserve assets. Cross-border financial flows can be volatile and flighty, transmitting stress from one part of the world to another, and posing risks both to the buyers and the markets in which they participate. Although many institutions must pay clients in their domestic currencies, few appear to hedge their entire foreign-currency exposure. Private assets are harder to sell quickly at reliable prices, potentially posing liquidity problems should investors need to pull out. Precise, coherent figures on the composition, riskiness and liquidity of holdings are still hard to get hold of, making it difficult to gauge the overall picture. But understanding what’s going could become more important, if China follows the path of East Asian economies. Its reserves of more than $3trn dwarf its other financial holdings. A shifting composition of foreign assets is not a matter of destiny, and would require some loosening of China’s capital controls. But even a marginal move towards more portfolio investment could produce huge flows of capital. “Chinese insurers have a lot of interest in investing overseas,” says Rick Wei of JPMorgan Asset Management. “They want to diversify their holdings, increase returns and match their liabilities with longer-term assets.” Even after more than a decade of rampant growth in Asia’s private foreign assets, more may be yet to come.

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