The vulnerabilities of the emerging Asian dollar corporate bond market: A perspective of open-ended funds¹

Open-ended funds (OEFs) have increasingly invested in dollar bonds issued by corporates in emerging Asia (EMA). While this enables EMA corporates to tap more dollar funding, the resultant build-up of dollar leverage has made these corporates more vulnerable to refinancing risk should there be a sudden fall in OEFs’ bond demand. We find that 16% of EMA dollar corporate bonds were held by OEFs immediately before the March 2020 episode. In times of market stress, OEFs’ liquidation of these bonds could lead to a surge in dollar funding costs and disrupt the ability of corporates in the region to obtain dollar funding. The impact is significantly larger for corporates subject to higher debt burdens. In response, these debt-ridden corporates become more likely to fill the funding gap by bank credit, exposing creditor banks to higher credit risk. The findings point to rising interconnectedness between OEFs and banks through their common exposures to EMA corporate bonds. This could be one channel through which a shock on dollar funding tightening can be magnified, resulting in spillover effects and adding vulnerabilities to the region’s financial systems. This warrants policies that strengthen OEFs’ liquidity management and closer monitoring of the asset quality of corporate loan portfolios of banks.