Monday, August 9, 2010

Giving Ghana a bond market

Last week Access Bank Ghana organized a seminar with the theme “developing an active bond market” which attracted immense interest. Toma Imirhe, examines Ghana’s bond market, its usefulness, structure, challenges and potentials.

In organizing a bond seminar last week, Access Bank Ghana rode into what is supposed to be traditional investment banking territory rather than the realm of commercial banking. Indeed, the prospect of bond financing presents the prospect of smaller lending volumes for Ghana’s commercial banks, and since their interest spreads on lending are notoriously wide (indeed they are reported to be the widest in Africa) this could translate into lower profitability.

However Access Bank last week put its own short term interest aside and sought to promote the wider interest of corporate Ghana and the national economy. As Yomi Akapo, the bank’s managing director succinctly puts it “At Access Bank we strongly believe that an active bond market will help create alternative sources of financing and more importantly free up capital for businesses through the issuance and trade of corporate bonds. We also believe that a well structured and fortified bond market would position Ghana’s economy to hedge against the wave of financial instability and the rather slow recovery of many financial systems across the world.

Creating such a bond market in Ghana though is going to require lots of effort. Currently, the total value of the bonds listed on the Ghana Stock Exchange is about GHc1.9 billion, nearly all of it in the form of government treasury bonds. There are 78 government bonds currently listed on the GSE, with tenors ranging from two years to five years but only three private sector corporations have issued corporate bonds. Compared with the United States then, Ghana’s bond market is infitesimal; America’s bond market is worth over US$31 trillion currently, of which some US$20 trillion is in the form of corporate bonds.

While it is certainly unfair comparing Ghana’s bond market with America’s, the rudimentary stage of its bond market’s development is illustrated by the fact that neighboring Nigeria’s bond market is now worth some US$16 billion which is more than ten times the size of Ghana’s.

There is an unanimous desire, held by government policy makers, regulators, and the private sector alike, that Ghana needs a bigger, better bond market.

“Bond financing strengthens the financial sector and diversifies financing channels in the economy away from traditional bank financing and stock markets, as well as providing new channels for investing long term savings” acknowledges Kwesi Amissah Arthur, governor of the Bank of Ghana. “Deep and liquid bond markets provide government with opportunities to issue long-dated instruments and to effectively, manage debt without disturbing macroeconomic stability. The establishment of a well- functioning and efficient domestic bond market paves the way for both government and private companies to access long-term funds for growth and development”.

Indeed, Ghana has tried to do just this. In early 2002 government set up a Bond Market Committee to make recommendations for the development of the bond market in Ghana. One of its recommendations was that “government’s public debts issuance programme should go beyond fiscal policy considerations to market development considerations. Benchmark government issues are required with fixed rates and longer maturities to enable corporate bonds be priced appropriately.”

In response to this recommendation since 2004 medium term government securities of two, three and five year duration have been issued, not only to raise debt for government but also to provide benchmark securities and yield curve to give direction to the market.

Instructively all those bond issues have been fully subscribed. However, in 2008 and early 2009, government was forced to suspend its medium term bond issuance programme as high inflation and an inverted yield curve (under which short term securities offered higher yields than long term ones, thereby making the latter unattractive) took hold.

However, so far this year, with the return of a proper yield curve, government has been able to do four successful three year fixed rate bond issues. Instructively however, government has not regained enough confidence to resume five year bond issues. Equally instructive is the fact that much of the demand for the three year bonds issued so far this year came from foreign portfolio investors.

Importantly, major efforts have been made since 1996 to provide the requisite infrastructure to facilitate the primary issue and secondary market trading in government securities including bonds. These include the introduction of a primary dealer system and an electronic auction bidding system, the establishment of a Central Securities Depository, and introduction of a gross settlement system, a bond trading system and a securities depository for the GSE.

Government is now looking to extend the tenors of its bonds, eventually even beyond the five years achieved for a few issues in 2007 and 2008.

Actually, government did come close to issuing seven year bonds before macro-economic instability put paid to its plans. Now government looks at its Nigerian counterpart which is issuing bonds with tenors of up to 20 years with a certain degree of envy.

Another aspect of bond issuance which has been put on hold is municipal bonds. The immediate past Kufuor administration had made concerted efforts to put a legal and operational framework in place which would have enabled metropolitan, municipal and district assemblies to issue bonds to finance self-amortising infrastructural projects such as tolled roads, markets, schools, hospitals and the likes. However, the incumbent Mills administration has put this on hold, worried by the sheer degree of mismanagement of funds by the district local government under their respective mutual health insurance schemes. The current government frets that the proceeds of municipal bonds would be similarly mismanaged.

Proponents of municipal bonds however, argue that since such issues could be subject to the discipline of the stock market, their proceeds would be utilized properly. Government though is still not convinced, even though in neighboring Nigeria, state governments, themselves notorious for the financial mismanagement of their leaders, now issue bonds as well as the federal government itself.

Corporate bonds though are another matter and government wants to see these happen. So far only a few listed companies, financial institutions such as HFC Bank and Standard Chartered Bank have issued corporate bonds but instructively they have all been successful. However, investors are understandably more reticent about investing in corporate bonds than they are about investing in government bonds, which are in effect riskless.

Francis Andoh, head of the Bank of Ghana’s Treasury Department explains that there are micro-economic pre-requisites for firms with long-term financing needs to successfully issue bonds.

“They have to demonstrate their capability to efficiently utilize funds flowing from the proceeds of the bond” he says “and their ability to make appreciable returns on the funds to pay the periodic interest and to repay on maturity.” To do this requires efficient management of their resources, a proper accounting culture, and transparency in their operations.

They also need to secure favourable credit ratings which are the main guides for investors not only as to which bonds to invest in but also how they should be priced.

“There is therefore the need for credit ratings companies because credit reference bureau are not licenced to do credit ratings,” explains Ken Ofori-Atta, Executive Chairman of Databank. “There are several respected ones apart from the two which do sovereign credit risk ratings of Ghana itself- Standard and Poors and Fitch.” In Nigeria for example, a local credit rating agency, Augusto and Company has earned a strong reputation and is used even more regularly than the international ones.

On the upside, with regards to corporate bonds is the regulatory environment. “The issuing and listing requirement for corporate bonds are not as stringent as for equities” points out Ekow Afedzie, Deputy Managing Director of the GSE.

“Therefore bonds can be issued much more easily. The real challenges are those of investors confidence and the macro-economic environment”

Actually investor confidence does not derive only from a bond issuers ability to pay, whether it is government or a privately owned firm. There are also the crucial issues of pricing and liquidity.

With regards to pricing, that of government bonds is the most important since their pricing provides the benchmark for corporate bonds, which are then priced at a risk premium over the government bonds, the size of that risk premium depending on the market’s perception of the degree of risk inherent in the issuing company. “Market oriented government funding is the pillar of a domestic securities market” explains Jack Delaney, who is the United State’s Treasury Department’s resident adviser to Ghana. “Rates are determined by investor interest and this creates a level playing field and investor confidence. This may cost more in the short run but will be cheaper in the long run.”

Equally important is the issue of liquidity and this is why an active secondary market is crucial to the success of a bond market. Since few investors may want to hold, say a 10 year bond from issuance to maturity investors must be able to exit from their investment when they want to, by selling on the secondary market. “Having the ability to enter and exit the market will increase investor interest in owning the securities offered” says Delaney; and will also increase investor interest in owning securities with longer term tenors.” Developing a secondary bond market requires a high quality set of rule and regulations, a clearing and settlement system and competent banking system participants. Ghana already has the second pre-requisite and Access Bank Ghana whose parent bank, Access
Bank PLC is a major bond trader at home in Nigeria, is offering to train those who lack the skills in the third requisite.

The first requisite is now receiving attention too. A new bond trading system will be in place by the end of this year confirms Ekow Afedzie. “All dealers and brokers will be given access to the system and both Bloomberg and Thompson Reuters can disseminate trading information in real time.”

Indeed, the BoG’s Francis Andoh argues for the need for stronger industry association in bond market development. “Financial market participants need to be more visible and should make stronger impact on the development of the market” he says.

Last week’s seminar, organized by Access Bank is a step in that direction.

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