X P Guma: The challenges facing the bond market in South Africa
Remarks by Dr X P Guma, Deputy Governor of the South African Reserve Bank, at a High-level
workshop on "Developing Bond Markets in Emerging Economies", Frankfurt am Main, 9-10 May 2007.
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1. Introduction
Honourable Ministers, distinguished guests, fellow participants, ladies and gentlemen, let me
begin by thanking the organisers of this workshop for having invited me to participate. It is
always beneficial to interact with persons of the calibre present at this
The initial invitation was subsequently upgraded to that of "speaking for about 15 minutes to
shed some light on the challenge faced in South Africa"; a task to which I will devote the next
14 minutes. Upgrades are not always without some pain!
2. A brief review of the South African experience
There exists at present a relatively sophisticated bond market in South Africa, which market
has shown significant growth and development since the 1980s when the government issued
bonds only on demand: that is, on an open-ended tap basis. At that time, there were no
government (or other) benchmark bonds; nor could any refined yield curve be discerned
because it did not exist.
Issuance and secondary-market trading were dominated by government and
quasigovernment issued debt, the major issuers being the National Treasury, the Landbank and
public utilities such as Eskom, Telkom and Transnet. The South African Reserve Bank
(SARB) served as the principal underwriter.
Following an investigation by a Commission of Inquiry chaired by Dr J. Jacobs1, the market
opted for self-regulation in the form of the Bond Market Association (BMA), comprising bond
issuers, intermediaries, banks, brokers and investors. The SARB was a founding member of
(and active participant in) this Association which attempted to formalise the market, achieve
greater depth and increase transparency.
In 1996, the BMA was granted an exchange license and was transformed into the Bond
Exchange of South Africa (BESA), a development that was facilitated, in part, by the decision
taken by the government in 1989, to consolidate smaller issuances in order to create
benchmark bonds and, thereby, enhance the liquidity and efficiency of this market. In
addition, trading on the gilts floors of the Johannesburg Stock Exchange came to an end in
November 1995, shifting to the BMA which then operated an informal screen and telephone
trading system with the Universal Exchange Corporation Ltd (Unexcor) serving as the
clearing house. The Rule Book and the principles underlying the operation of the market
were approved in March 1996 and BESA was licensed (and started) to trade on 15 May
1996.
Some major developments subsequent to this time include the introduction of electronic
trading, matching and settlement; the immobilisation and later, dematerialisation of bonds
listed on BESA, the development of a series of total-return indices for government and
corporate bonds and the development of a more refined yield curve.
Since the late 1990s, the South African bond market has increased in depth and
sophistication. Developments include the introduction of inflation-linked bonds, floating rate
notes, a strip programme (an acronym for Separate Trading of Registered Interest and
Principal), retail bonds and municipal bonds. The corporate bond market has also grown
substantially from net issuance of more than R10 billion in 2001 to net issuance of almost
R70 billion in 2006.
The development of the corporate bond market has been assisted by the decline in issuance
of government bonds, a low interest rate environment - at least in relative terms-, mergers
and acquisitions, the narrowing of spreads and improved liquidity. Significant also has been
the expansion of the regional dimension of this market with the raising, by the Mauritius
Commercial Bank, of R350 million - the first inward-listed bond to be raised by a
nonresident in South Africa.
Regarding sophistication, it is the case that the role of the SARB has changed. In the past,
the SARB served as an underwriter and then as a market-maker, quoting two-way prices in
the secondary bond market. These activities ended in 1998 when the government adopted a
system of regular, weekly, pre-announced auctions. A panel of 12 primary dealers - all being
banks - was appointed to participate in the auctions which were, and still are, conducted by
the SARB.2
3. The current conjuncture
The introduction of the Global Bond Index Emerging Markets (GBIEM+) by JP Morgan,
which tracks changes in emerging-market local-currency bond prices, has been particularly
helpful to South Africa, given that most of the country's debt is denominated in local
currency, contrary to the practice in most other emerging markets. In addition, it also implies
more dedicated bond inflows into our market, possibly of a more lasting nature. Another area
of the bond market, which has seen significant issuance over the years, is that of the
Eurorand bond market. The demand for randdenominated bonds issued by highly rated
nonresident institutions contributes positively to the value of both the rand and domestic bonds.
The government debt consolidation process has allowed the cost of borrowing to decline
markedly. Sound debt management has been such that new issuance is spread across the
maturity spectrum of the yield curve. The bond market has become a more appealing
corporate finance tool and, as such, corporate listings have become more popular. Since the
very first listing of a corporate bond (South African Breweries) in 1994, the corporate bond
market has increased considerably in size. Innovation in this sector has been impressive -
from issuance of vanilla bonds to securitisations and commercial paper. Not only do these
innovations offer debt at lower interest rates than vanilla bonds, but also provide lower
income groups with access to home mortgage finance.
The introduction of inflation-linked government bonds in 2000 was a further significant
innovation and is quite helpful in providing monetary policymakers and analysts with
important information on inflation expectations through readings of the so-called breakeven
inflation rate. Whilst much has been achieved, there are still many opportunities and
challenges ahead. Non-government bond issuance has increased sharply; however, banks
continue to account for the bulk of this issuance. In addition, the buy-and-hold approach to
corporate bonds and inflation-linked bonds, in particular, renders these segments of the
bond market relatively illiquid. The municipal bond market is still in a developing stage but
can certainly contribute to enhancing the breadth and depth of the domestic bond market.
Finally, the significant amount of infrastructure spending planned for the next few years is
likely to boost the supply of corporate bonds and therefore increase liquidity in this market.
The corporate bond market has increased in size from accounting for 5 per cent of the total
bond market at the end of 2001 to almost 30 per cent today. This increase in corporate
sector issuance was mainly due to the reduction in the supply of government bonds, lower
financing costs and an upbeat corporate sector. In 2006, net issuance in the
nongovernment sector amounted to R41,0 billion (excluding securitised assets).
Net issuance emanated mainly from the corporate sector, with only R7,2 billion emanating
from parastatals and municipalities. Issuance in the corporate market has increased, with
both new and old issuers active in the domestic market. For the bond market as a whole the
number of issuers has increased, by 38 to 99 while the number of listings increased by 348
to 725 from 2004 to 2006. Of this, corporate bonds in terms of issuers increased almost
twofold and listings threefold to respectively 83 and 563 over the same period.
4. Legal and regulatory framework that supports the development of capital markets
According to the Bond Exchange of South Africa the purpose of a legal and regulatory
framework is to strengthen and develop the debt capital market, to monitor the debt capital
market, and to provide investor protection. The framework is also important for the
development of the debt capital market since it provides for an institutional organisation to
enforce the rules. Many exchanges across the world have developed as self-regulatory
organisations under the supervision of a national regulator.
Debt capital market regulation should provide:
1. rules, processes and procedures to deal with listings of bonds, trading, trade
capture, matching of trades, clearing and settlement, surveillance, dispute
resolution, failed trades, default procedures, appeal processes;
2. sanctions regarding market manipulation and providing misleading information;
3. licensing, monitoring, sanctions and penalties of inter-dealer brokers;
4. licensing powers, duties and responsibilities of self-regulatory organisation and
supervisory bodies;
5. ownership, transfer, pledge of securities and security depositories;
6. internationally accepted accounting standards, practices and corporate
governance;
7. capital adequacy requirements;
8. legislation to prevent money-laundering, fraud and other white collar crime;
9. legislation to permit institutional investment into debt capital markets.
To encourage local and foreign investment into debt capital markets, governments have to
ensure that the legislation and regulations that govern the debt capital markets comply with
international standards. BESA has ensured that the rules of the exchange are
G30compliant. It continuously strives to benchmark its rules according to international best
practice.
5. General debt capital market infrastructure
Moreover, according to BESA, it is essential to develop an appropriate infrastructure for a
debt capital market which inter alia consists of:
1. financial intermediaries or an inter-dealer broker network to support the bond
market and promote liquidity;
2. a platform for electronic trade capture and matching;
3. an efficient settlement system that meets the BIS recommendations, e.g. DvP,
T+3;
4. a central securities depository to facilitate transfer of ownership of scrip;
5. centralised distribution of market information;
6. a centralised pool of liquidity, e.g. central and transparent price dissemination from
a central platform.
Whether or not these requirements are supply-leading, demandfollowing or some
permutation of these and other determinants remains moot.
Conclusion
The challenges to which the bond market will have to respond appear, to me, to be principally two.
First, the market will have to adopt to the fiscal stance of central government. This stance will reduce
the need for government to fund itself through this market, in the near- and medium terms.
Second, I suggest, the market will need to address the problem of "original sin" on the sub-continent:
that is, the inability of adjacent emerging and developing economies to raise financing in their own
currencies beyond their own borders. Resolving this dilemma on a regional basis constitutes a
formidable challenge - as does the resolution of most sins!
Thank you for your attention.