David and Goliath: the South African debt market
South Africa’s debt market when measured in terms of debt issued comprises but a fraction of the world’s debt markets combined, yet it constitutes the lion’s share of the African debt market. It boasts sophistication and efficiency that match those of many of the bigger debt markets in the developed world. It is thus both a David and a Goliath. In its former role, it is often a taker of global financial market developments that from time to time ripple out globally, while in its latter role it is a leader on the continent, and possibly even among emerging markets elsewhere.
At the end of 2009, the South African debt market had listings with a market capitalization value of $139.5 billion (ZAR 1 028.2 billion). The bulk of this debt stock comprised central government debt ($78.6 billion); debt issued by corporate entities (including banks which are dominant in the corporate category) accounted for $25.8 billion, or 18.5% of total. However, if the listings of securitization instruments are included, then the private sector’s share of issuance rises to 31%.
Indeed, amid declining fiscal deficits and hence government borrowing, and an environment of macroeconomic stability, corporate listings were able to grow over the past seven years, gaining in relevance within the domestic debt market. However, in 2008 and 2009, there was a marked decline in securitization listings, as this segment absorbed the negative repercussions of the global financial crisis. Corporate funding requirements also slowed as South African economic growth dipped.
Turnover in the South African debt market is relatively large, and is dominated by repo transactions which account for two-thirds of total turnover. In 2009, turnover amounted to $ 1.8 trillion (ZAR13.8 trillion) while in 2008 the bond market registered a record turnover of $2.1 trillion (ZAR19.2 trillion) due to a surge in trading during the height of the global financial crisis. Research conducted by the Bank for International Settlements in 2007 using 2005 data also concluded that the South African bond market was the sixth most liquid bond market in the world, when measured in terms of turnover ratio. Most of this liquidity, admittedly, is concentrated in a handful of government issues because of their size. Indeed, the lack of liquidity in corporate bonds due to the relative dearth of issuance and, consequently, buy-and-hold preferences, in truth often creates pricing complications when trades do occur. But these phenomena tend to be characteristic of bond markets generally
Sources: WFE, JSE
The evolution of the South African debt market has, in many respects, resembled that of others globally, with government debt issuance giving rise to pricing and risk benchmarks against which private sector issuers could enter the market. The first issuers of bonds in South Africa were the National Treasury and the parastatals Eskom (electricity utility), Telkom (telecommunications utility) and Transnet (transport utility). The first private sector bond was issued in 1992. In the early 1980s, the parastatals made a market in their own paper in order to spur liquidity and lower prices, and the government followed suit in the early 1990s. As the market began to take shape in the 1980s, a Commission of Enquiry was established to investigate the best way to regulate it. Self-regulation by market participants was proposed as a viable option, and this ultimately laid the foundations for the establishment of a formal exchange-based marketplace. Bond issuers, intermediaries, banks, brokers and investors became members of the Bond Market Association (BMA) in 1989 but it was only on 15 May 1996 that the Association was formally licensed as an exchange.
The Bond Exchange of South Africa (BESA), as a self-regulatory organization, was responsible for drafting and implementing a set of listing rules, membership requirements and a code of conduct for trading on the secondary market. At the time of the licensing of the Exchange, thanks to the work undertaken by the BMA, the bond market already boasted a Central Securities Depository founded in 1993. Also, the Universal Exchange Corporation (UNEXcor) started off in 1994 by providing a system that enabled the confirmation of matched trades, and ultimately undertook the electronic net settlement of bond trades. The BMA members had also put into place a Guarantee Fund to reduce trade-associated risk. Although the marketplace was formalized under the aegis of an exchange, trading continued to take place over the counter as it had throughout the 1980s and early 1990s. A central trading floor had come into existence following the formalization of the market, but it was closed by the Exchange in 1998 as the voice-broking of trades had by then increasingly migrated to telephone.
The progress made by the BMA and subsequently the Exchange had resulted in increased post-trade efficiency in the bond market. The introduction of a system of primary dealers for government bonds in 1998 and the participation of inter-dealer brokers (IDBs) also spurred a sharp upturn in bond trading in the South African market. What continued to be missing, however, was pre-trade price transparency and centralized price discovery. In an attempt to foster the development of these essential ingredients, the Bond Exchange introduced a system called BATS (Bond Automated Trading System) in 2000. The system had a number of functionalities, including transparent, centralized price formation and automated trading, as well as trade capturing and matching for OTC trades. Despite market participants’ assurances that such a system would be supported and utilized, BATS reverted to being a trade capturing and matching engine only, which rendered it unsustainable. Consequently, price formation continued to remain opaque and the Exchange was prompted to provide a more cost efficient mechanism for the reporting and matching of trades. Such a system, called BTB, was disseminated to the members in 2004. Later in the same year it was supplemented by ZAPrices, which aimed to provide some level of price transparency by collating the bid and ask quotes of the principal market-makers and the inter-dealer brokers on one screen and distributing it to key newswire services such as Reuters and Bloomberg.
In the South African bond market, inter-dealer brokers (IDBs) contribute towards increased liquidity. At the same time, because of the vital role the matched-principal IDBs play in allowing major dealers to cover their positions with each other, opacity is perpetuated. The South African bond market is, after all, largely a wholesale market on which trades are less frequent relative to trades on the equity market. As is characteristic of bond trades, they are also far bigger in value and are concluded between a limited number of major players. It is in the latter’s interest not to reveal total position size to the market. While bilateral trading risk is thus well-managed and minimized, this is also one of the reasons for which automated trading has not worked in the bond market.
In 2004, the Bond Exchange went on to gain permission to list fixed-income derivatives and, in 2005, to introduce a platform for the capturing and matching of OTC fixed-income derivatives trades. Also in 2004, the Exchange reorganized its governing structures and re-aligned the various stakeholder groups; but it remained a mutual organization until December 2007, when it demutualized and corporatized. Subsequently, the Johannesburg Stock Exchange (JSE) purchased BESA and successfully merged the bond business into its group in June 2009.
The JSE’s interest-rate division, as the business is now known, has been liaising with all market stakeholders to bring about renewal to the market and to increase efficiency. Prior to acquiring BESA, the JSE had, in its own right, started a bond market offering in 2005 that revolved around a central order book trading platform, albeit with little success. The two businesses have thus been merged, and the Exchange is seeking a comprehensive solution that will address a number of priorities: pre-trade price transparency; improved infrastructure and efficiency across the bond trading chain; and expansion of the fixed-income market, especially in the derivatives space.
Domestic legislation for securities markets, principally in the form of the Securities Services Act (34 of 2004), which came into effect on 1 February 2005, does not prescribe any transparency or execution requirements for the bond market. It does, however, require off-market trades in listed securities to be reported to the Registrar of Securities. The Act is currently under revision, but there are preliminary indications that there will be no changes that will substantially alter the way the bond market is regulated and operated. The JSE, as a self-regulatory organization, will therefore continue to determine its own requirements for the market, with due consideration for the strong relationship network that characterizes the trading environment. An exchange can, after all, only add value to its member participants if it facilitates the trade, clearing and settlement process at the lowest cost possible and, in so doing, creates a liquid and efficient market.
The domestic bond market is not isolated from global developments that shape financial markets, and thus potentially faces widespread competition. South African bonds are traded and settled off-shore as well, constricting the efficiencies that generally arise from a fully-centralized marketplace. In addition, while the Exchange has in recent years welcomed foreign bond issuers, among which a supranational entity, some domestic issuers have placed fixed-income securities off-shore to tap a wider investment pool. Ultimately, however, up to 85% of the central government’s borrowing requirements are satisfied in the domestic market, sustaining domestic issuance and liquidity, while as the economy grows, the investor pool is expected to widen.
About Monica Ambrosi
An economist for 8 years prior to joining the Bond Exchange of South Africa (BESA), Ms Ambrosi was appointed senior strategist at the Johannesburg Stock Exchange (JSE) in July 2009, when BESA was successfully merged into the JSE