TITLE:

CANT SEE THE WOOD FOR THE TREES

SHEDDING LIGHT ON KAURI BONDS
A SUMMARY
BY :
SHALIKA THILAKAWARDANA
(20120457)
Shalika42@gmail.com

FOR :
BUSINESS FINANCE
BF 4.704
ROHIT SELVARATNAM

Summery
The kauri bond market introduced from its small beginning market 2004 and with rapidly growth
over $16.8 billion of Kauri bonds currently outstanding today. This market has become popular
with issuers and investors alike who had previously invested in New Zealand dollar instruments
via the Euro-kiwi and, to a lesser extent, Uridashi markets.
Kauri bond is dominated in New Zealand dollars that are issued by a non-New Zealand issuer.
Foreign investment has been rising due to reserve bank decision to accept highly rated (AAA)
kauri bonds as security in its operation. This highly rated New Zealand dominated debts led to
investors to tap into New Zealand market at competitive borrowing rates. Kauri bonds were
eligible to use as collateral in the domestic market operation in July 2007. There was rapid grew
in kauri market in year 2007 and 2008 in the domestic operation.
Global financial crisis affected in kauri bond market in negatively with the downturn in the
global economy such as Investors lost their confidence, New Zealand dollars fell. Consequently,
value of the currency became low. Thus, US dollar and Euro currencies became cheaper to
issue kauri bond.
Over 75% of Kauris issued for 3 to 5 years, and some of kauris for 7 to 10 years. The average
deal size of kauri is $198 million (Figure 3) .It has trend to increase from 2008 and by 2014, the
record value is $260 million (Figure 4). The deal size is depended on funding needs of issues and
investors demand. In 2014 investors demand was the key driven factor to expand the kauri bond
demand market.

Morgan Stanly was the early kauri issuancer between 2007 and 2010. Since 2007, Kauris issuing
authority has been taken to highly rated superantional, semi government and agency issuers
(SAA)
Kauri bonds are popular in New Zealand market, because of two main reasons identified as
diversification and cost. Market diversification is to get the advantage of stability in overall in
overall funding, if there is financial or economic downturn in one market at the given time
then, funding may gain from another alternative market. Variety markets have allowed to issuer
to consider favorably in different places at different times that led to minimizing overall funding
cost.
Local bank is the biggest investor in kauri bonds. Bankers hold the kauri bonds
including liquidity management purpose. Domestic insurance company and fund managers also
invest in kauri bonds to maintain the high credit rate on their assets. New Zealand has a strong
fiscal position and sound financial system. New Zealand dollars are attractive and provide high
returns compares to other traditional currencies.
There is a strong demand for Asian central bank reserve portfolios, yet too high interest is
expressed in commodity currencies. During the time period of 2013- 2104, 7 0% to 80% of
kauris were bought by offshore investors. Offshore kauris holdings are lower than nonresident
holding of NZGBs (Figure 5) because of NZGBs has strong liquidity offer and investors are
comfortable and families to NZGBs rather than Kauris.
Most of the investors do not require New Zealand dollar funding the pricing in the swap market.
This is an important component of the deal at origination. This will determine the ultimate
funding cost in the desired currency. This led to competitive funding cost and recently pricing
3

has been favorable with the wide New Zealand dollar swap spreads. The issuer can swap the
fixed rate New Zealand dollar borrowing for a fixed or floating rate borrowing in their desired
currency. The flows in the swap match the maturity date of the bond on maturity date both
transactions are reversed. The issuer repays US dollars and receives New Zealand dollars
through the swap and repays the investor.
There are key success factors which are driven to demand the kauri bonds, Aside from price,
These include, sentiment toward NZD product more broadly; alternative issuance; relative value
and broad risk appetite. Kauri bonds are attractive in the market because of high credit rating
thus lower risk to investors.
Issuers get benefits through a wider basis swap spreads by reducing the cost. The issuers view of
perspective they may be able to issue tighter margin to swap which is higher than NZGBs. The
upcoming New Zealand maturity profile and risk appetite are considered as the other factors
which are influencing kauri supply in the market. Kauri assurance rose when its cheap then the
basis swap spread is more positive and New Zealand swap spreads are wider (Figure 8).
Strong issuance was happened during the period of late 2013 and early 2014. There is record of
second highest of $ 5.5 kauri bonds were issued, factors supporting increased issuance during
2013 included recovering global risk appetite, investors search for yield amidst low global
interest rates, and favorable pricing conditions.
The factors remain continued to date such as appetite for risk remains high, volatility remains
low but the swap spreads are not much attractive to the issuers. Overall kauri bond market is not
highly progressive to issuer same as last year yield to heavy maturity profile in this year.

Conclusion
The Kauri market is still relatively young and requires further development. Local banks have
purchased the security in reasonable volume and are holding them as a liquid asset on their
balance sheet, thus diversifying these assets.
The main reason for the growth of the Kauri market has been the Reserve Banks decision to
accept AAA rated Kauris as security in its domestic market operations. Local fund managers
have also purchased smaller quantities of this security and demand from offshore investors has
been typically strong. Local fund management market has shown mixed interest in the Kauri
market, due mainly to liquidity concerns. Issuers have been happy with their transactions to date
and a number of them are keen to issue more. There is remarkable issuance occurred in 2013 via
high basis swap spreads.
There are however some challenges ahead of this market as it attempts to grow and develop
further with more liquid tranches. The size of the local investor interest is likely to place a
constraint on the overall size of the Kauri bond market. However, recent local initiatives by the
Reserve Bank along with issuers who are keen to issue and develop the market further could see
this market grow and perhaps match the size of the New Zealand Government bond market in the
future.

Reference
Reserve Bank of New Zealand: Bulletin, Vol. 77, No. 2, June 2014
The Development of the Kauri bond market John Groom, Reserve Bank of New Zealand
www.rbnz.govt.nz/research.../capitalmarkets20june2008/3345557.pdf
https://research.bnz.co.nz/Research/NewZealand/Documents/NZ%20Fixed%20Income
%20Handbook%20Final.pdf
http://www.nbr.co.nz/article/asian-development-bank-launches-kauri-bond-sale-117770
http://www.radionz.co.nz/news/business/243604/world-bank-predicts-more-kauri-bonds