CMA closes in on hybrid trading system

By James Anyanzwa

Dealers at the bond market will soon be able to trade in securities away from the Nairobi Stock Exchange (NSE).

This follows a move by stakeholders in the capital markets to introduce a hybrid model of trading bonds.

The Capital Markets Authority (CMA)’s bond steering committee is developing new rules for the Over-The-Counter (OTC) bond trading model, as well as reviewing relevant legislations to operationalise the system.

"The process is underway, and we shall advise as soon as the draft amendments and regulations are ready for public exposure and comment," Ms Stella Kilonzo, the authority’s chief executive told the Financial Journal (FJ).

Ms Stella Kilonzo, chief executive CMA

Kilonzo reckons that introducing an alternative platform for trading bonds would increase overall liquidity, open the market for more players as well as enhance efficiency in bond trading.

Currently, shares and bonds are traded through the NSE.

The market regulator, however, contends that the proposed hybrid system will accommodate the existing matching of trades at the NSE and the OTC market.

OTC is a negotiated market between two parties where participants in the bond market trade debt instruments directly without going through the market intermediaries — brokers and dealers — in the secondary market.

"The key benefit under this structure is that we will be able to create trading platforms for both institutional, as well as the retail end of the market," says Kilonzo adding that," investors will have the choice of trading under the current market structure and through the OTC in a hybrid model."

The CMA’s bond steering committee, which Kilonzo chairs, was created to oversee the overall implementation of an OTC market for bonds.

The committee, which has been meeting since June last year, seeks to put in place arrangements for an OTC market, and to define the model and its operating platform.

It comprises of the CMA, Nairobi Stock Exchange (NSE), and Central Depository and Settlement Corporation.

Others are the Ministry of Finance and the Central Bank of Kenya (CBK).

Also represented are the Kenya Association of Stockbrokers and investment banks.

The implementation of OTC market is among the reforms CMA is instituting at the bond market in order to attract more issuers.

Commercial banks, which are major players in the bond market, have been pushing to trade bonds away from the NSE.

But an initial proposal to introduce the OTC model to run parallel with the NSE never settled well with brokers.

The OTC market model has been successful in countries with vibrant bond markets.

High net worth investors

However, although the model has low listing and compliance requirements, it is restricted to high net worth investors, such as fund managers, insurance companies, pension funds and banks, which are normally regarded as having capacity to carry out due diligence of their own.

There is a huge potential in the local capital markets, going by recent subscriptions to both Treasury and corporate bond offers in the country.

Last year, the Government raised a significant amount of funds to finance infrastructure development through the first 12-year Sh.18.5 billion infrastructure bond.

The issue was oversubscribed by 45 per cent, and attracted a total of Sh27 billion, against a target of Sh18.5 billion.

Similarly, the CFC Stanbic bond, the KenGen Infrastructure bond, the Safaricom bond and the Government’s second infrastructure bond were equally over-subscribed.

Attractive market

According to data from the NSE, the bond turnover stood at Sh 26.75 billion at the end of January, representing a 67.82 per cent increase from December last year.

The average coupon rate for corporate bonds stands at approximately 11.45 per cent ,while the 91-day and 182-day T-Bill rates have been on a gradual decline, to 6.22 per cent, and 6.7 per cent respectively.

Compared to the average commercial lending rate of 14.85 per cent, the bond markets continue to remain attractive with regard to sourcing of medium to long-term capital.

The availability of information to all market participants through the Automated Trading System (ATS) has also ensured that there is information symmetry, while the ability to complete a trade within three days of the transaction (T + 3) has increased trade turnaround times.

"The NSE is currently on course to introduce further developments in the bond market, which are geared towards increasing the liquidity and access to the bond markets," says Peter Mwangi, the bourse chief executive.

CMA is optimistic that more issues both from the Government and the private sector will be realised this year.

"This year, we expect more issues, starting with the floating of a Sh14.5 billion bond through another infrastructure bond," says Kilonzo.

Already, CMA is strengthening the legal and regulatory environment to a disclosure-based regime for issuing and trading of bonds to bolster efficiency, transparency and reduce systemic risk.

Kilonzo says strengthening and integrating the clearing, depository and settlement systems will enhance the match towards attaining a "true" Delivery Vs Payment (DVP), and improve the attractiveness of the bond market to investors.

Efforts are also underway to strengthen and integrate the clearing, depository and settlement systems.

Other measures include training and capacity building, financial education of investors and issuing of longer dated bonds.

Growing concerns

The hybrid model of trading bonds was imported from South Africa, which controls 98 per cent of the continent’s bond turnover.

There has, however, been concerns that the OTC model would kill competition in the bond market by locking out foreign investors, insurance companies, fund managers and pension schemes and eventually distort the price discovery mechanism.

The local debt market is expected to play a key role in mobilisation of domestic resources to finance the flagship projects identified in the country’s vision 2030.

Over the years, there have been a number of initiatives undertaken to increase liquidity in the bond market, including automation of the bond trading.

The market’s poor performance has been attributed to increased competition from direct bank lending as a debt option, manual trading platform and settlement system, low culture of credit rating bond issues, and low investor awareness and financial literacy levels among issuers and investors.

—[email protected]