Expansion of the Kenyan Bond Market
6 juin 2014
Governor of the Central Bank of Kenya, Professor Njuguna Ndung’u
Q: Could you discuss the key elements that have led to the rapid expansion of the Kenyan bond market (i.e. infrastructure, institutional support, policy) and best practices that could be extended to other African markets?
Development of Kenya’s bond market has been a dynamic process built on some basic elements that can be applied to other African Markets. At the macro level, Kenya has established and strengthened institutions leading to credibility in implementing sound fiscal and monetary policies, improved the legal and regulatory environment, and liberalized its financial system and improved payments and settlement arrangements. This is the bedrock on which other reforms were undertaken. The elements that led to rapid growth of the Kenyan bond market are discussed briefly below;
A sound legal and regulatory regime: Initially, the country had a poor legal framework that did not properly anchor some debt market activities in the law. The lack of a legal basis hindered implementation in the market giving rise to avoidable risks and uncertainties.
The Kenyan Government therefore enacted laws to provide the basic framework for how the bonds markets would operate in the country in particular how public debt will be procured and managed. The Internal Loans Act, Cap 420 (repealed) and now the Public Finance Management Act of 2012 provided the legal framework for the Minister for Finance to borrow on behalf of the Government from the domestic market through issuance of Treasury bills and Treasury bonds, with the Central Bank of Kenya appointed the fiscal agent. The law now provides for the establishment of a public debt management office, a sinking fund and provides for bond exchanges and buy-back operations which were not previously catered for.
Market involvement and participation through stakeholder initiatives such as the Market Leaders Forum (MLF): The MLF was established in 2001 as a consultative stakeholders’ forum meant to promote Government Securities to investors and to advise the Central Bank and Government (Treasury) on various developments in the financial markets that have direct bearing on the performance of the new bond issues. Membership of the forum is drawn from Commercial Banks, Fund Managers, National Treasury, Diaspora Representative, Insurance Companies and Investment Banks. The Monetary Policy Committee sits in to harmonize with its policy stance.
The success of the Kenyan market can be credited to the fruitful deliberations and decisions made by this forum over the last decade. The MLF provided a good feedback channel for the Government allowing it to better understand the needs of the market.
A clear debt management strategy: The key driver for this strategy was a desire to reduce refinancing risk, particularly in the domestic debt portfolio and develop the domestic debt market further. The Medium Term Debt Strategy (MTDS) has been very important in supporting the goal of lengthening the maturities on Government Securities. The strategy has helped align domestic borrowing towards issuing more medium to long term Treasury Bonds than Treasury Bills. The result of this has been the ratio of Treasury bills to bonds is now 27:73 in 2014. The average life of all securities stands at 5 years in 2013 with the average life of bonds at 7.1 years.
Wider Investor Base: Liberalization of the pensions and insurance sectors resulted in greater demand for medium and long term bonds. This is because the new laws included investment guidelines that established limits on a variety of investments by these institutions. Of significance was a requirement that pension funds and insurance companies invest up to 70% of their assets in Government Securities. This requirement helped open the debt markets to a new category of investor that, traditionally, is keen on medium to long term investment.
In an effort to increase participation from the retail sector, the Central Bank reduced minimum amounts required to invest in Treasury bills and bonds from Ksh.1,000,000 for both to Ksh.100,000 and Ksh.50,000 respectively. The purpose of this initiative was to encourage retail investors to increase their levels of savings by providing wider investment options and also the larger objective of promoting financial inclusion. This strategy has been a success with over 17,000 new Central Depository for Securities (CDS) accounts being opened since 2009.
Introduction of Benchmark Bonds: In an effort to develop a liquid secondary market for government securities and a reliable yield curve, the Bank identified specific maturities of 2, 5, 10, 15, 20, 25 and 30 years to serve as its benchmark issues. Bonds issued in these tenors have been re-opened to increase their sizes and to avoid clustering of maturities. This was critical towards addressing the Bond Market fragmentation problem and creating liquidity necessary for developing a firm and reliable yield curve.
Infrastructure Development (Automated Secondary Trading System): With the adoption of the Automated Trading System (ATS) in November 2009, trading of Government Bonds increased exponentially. ATS linkage between the Nairobi Securities Exchange (NSE) and CBK facilitated simultaneous exchange of securities and cash settlement using the Kenya Payments and Settlement System (KEPSS) infrastructure. Transactions are dealt on delivery versus payment mode (DvP), ensuring efficiency of trading transactions, timely price discovery and security. This has resulted in improved market confidence in securities trading and increased demand for securities in primary auctions. Trade turnover in Government Bonds at the NSE has risen threefold from Ksh.107.85bn in 2009 to Ksh.466.07bn in 2010 and Ksh.453bn in 2013.
The Bank is also in the process of automating the auction process through the introduction of Internet banking to allow investors to access their holding statements and transact online. This will also allow retail investors to open investor accounts and bid for Government Securities through their mobile phones in an initiative called Treasury Mobile Direct. These two initiatives are intended to increase efficiency in the auction process and open up the market to more retail participants.
Ease of Access: Both corporate and retail investors are allowed easy access to the auctions and the Central Bank as Fiscal Agent does not charge any fees to the investors. This makes investment in Government Securities an attractive option in addition to its high returns compared to the lower returns to savings and time deposits in commercial banks.
System Integrity: Behind the success of the Kenya Government Bond Market is the integrity of issuance process, transparency by all involved regulatory and oversight bodies.
Q: With respect to local currency versus euro denominated issuances, how far have you come?
Kenya’s Bond market has grown considerably in terms of size, depth and liquidity over the last decade. As an indication of this success in the Government Bond market, outstanding bonds have increased tremendously from Ksh.36.85bn ($430.5mn) in 2000 to Ksh.1,151.43bn ($13.38bn) in April 2014. The ratio of Treasury Bills to Bonds has reversed from 73:27 in 2001 to 26:74 currently, supporting the development of the secondary market yield curve.
Save for a USD600mn syndicated loan contracted by the National Treasury in 2012 to shore up under-performance in domestic borrowing, Kenya has not issued Euro denominated instruments. The initial attempt to access the international bond market was in the 2007 debut sovereign issue which failed to take off owing to unfavorable market conditions. This activity has been revived and the country is in the process of issuing a sovereign bond during 2014.
Q: Could you elaborate on Kenya’s experiences with Diaspora bonds, the lessons learnt and proposed initiatives, given the increased interest that these bonds are now receiving amongst other African countries?
Currently Government bonds issuance are available to any person or institution, resident or non-resident, including Kenyans in the Diaspora. However, to be eligible to invest, non-residents must have a local account with a commercial bank and investment bank. Alternatively, they can invest through local commercial banks or local investment banks through a nominee arrangement.
In recent years, initiatives which include aggressive marketing and awareness have been undertaken through Kenyan missions abroad to encourage the Kenyan Diaspora to invest directly in the Kenya Government securities. An appropriate online mechanism is also in place to support this initiative. In the year 2012, a special infrastructure bond was issued with specific emphasis on diaspora with mixed outcomes.
On a more structured approach, the Government of Kenya is preparing a Diaspora Sessional Paper that will provide guidance on how to further improve Diaspora participation in local investments through Government bonds to tap Diaspora savings so as to finance strategic public infrastructure projects and other key development priorities that will be undertaken.
Lessons Learnt in the Diaspora Issuance:
There have been challenges in implementing the Know Your Customer (KYC) requirements to safeguard against anti-money laundering. This has to do with logistical challenges in marketing bonds to Kenyans spread throughout the world in the Diaspora and to still comply with procedures for opening of investment accounts and payment costs.
Restrictions in Marketing the Bond in Foreign Jurisdictions: As you are aware there are stringent regulatory rules in the target source markets related to marketing of foreign government securities in some jurisdictions.
Exchange Risks: Given that the bonds are issued in local currency, there have been fears among the Diaspora of exchange rate risks for the non-resident investors. We however, do not consider such fears as significant as there has been remarkable stability in the Kenyan shilling exchange rate.
Proposed Initiatives: Some of the mitigating strategies identified include: Marketing and Advertising financial services through partnerships with other agencies–e.g. with online Investment platforms, through Kenyan Missions abroad and by way of participation in Diaspora forums and conferences. Furthermore website online application facilities and the use of Investors banks for AML-KYC purposes are being considered.
Q: In June 2012, reports stated that non-residents held only 0.9% of government securities. How does this compare with infrastructure bonds? What concrete measures have been taken to attract foreign investors in the government’s debt market?
As of April 2014, foreign participation in Government securities was 6.58% of total stock outstanding (including Infrastructure bonds). Infrastructure bonds attract the greatest number of foreign investors due to the attractive tax incentives. Kenya issues fixed coupon benchmark bonds with tenors of 2, 5, 10, 15, 20, 25 and 30 years on a regular basis with huge benchmark volumes of Ksh.25bn at the minimum at the short end, and Ksh.40bn at the longer end. Infrastructure bonds are, at most, issued once a year and have to be specifically provided for in the national budget estimates.
Measures taken to Attract Foreign Investors include: We have been issuing high volume fixed coupon bonds of standardized tenors and at predictable intervals (monthly) to attract both local and foreign based major players. In addition, principal redemption and coupon payments are done in local currency units and this minimizes exchange rate risks and transaction costs. These payments are made to local bank investor accounts and no fees are charged whatsoever by the issuing authorities.
Managing the Debt Registry at the Central Bank of Kenya, with high level of credibility, has enhanced market confidence in the Government Bond market and attracted more investors.
Additionally, the Central Bank does not charge any fees for opening the Central Depository for Securities Accounts for Government securities or for transactions relating to Government securities investments.
Q: Infrastructure bond issuances have been largely successful in Kenya. How can this be replicated?
For countries intending to introduce Infrastructure bonds, there is need to put in place a regulatory framework that provides incentives, such as withholding tax exemption, partial amortization of the bonds mid-stream; linking proceeds from the bonds to pre-selected specified projects coupled with media marketing.
The National Treasury identifies priority projects listed in the National annual budgets and with specified funding requirements. Such projects should be in sectors of high priority and targeted to benefit the larger public. This increases appeal of Infrastructure bonds to potential investors.
Q: What additional measures have been put in place to stimulate small investor participation in the debt market? (Apart from what has already been done - reduction of the minimum investment required to participate in Treasury Auction from KES 100,000 to KES 50,000 and Treasury Mobile Direct). How will Treasury Mobile Direct run?
Treasury Mobile Direct (TMD) will facilitate mobile phone-based investments by the retail segment and ease redemption of maturing debt. It will be targeted at investors wishing to invest small amounts especially for those without bank accounts. This project will also eliminate paper based transactions.
The infrastructure will include a middleware system that links the Bank IT system and the mobile phone network operators, then to the customer mobile phone. The mobile phone menu will be upgraded to include investments in Government securities and redemption. Periodic coupons will be paid through the registered mobile phone numbers –mobile money.
Q: As Kenya is leading the regionalization process of Eastern Africa markets, could you elaborate on the progress of this initiative with respect to regional bond issuances?
There are several initiatives underway within the East African Community to promote issuance of EAC regional bonds.
So far, although not specifically targeted to regional bonds issuance, the EAC recently launched the East Africa Payments System to facilitate real-time cross-border payments. This will enhance the settlement process and will support uptake and payments for regional bonds when they are launched.
Q: What is the outlook for the Kenyan bond market?
The Kenyan bond market prospect is very bright as we look forward to building on the successes we have had over the years. We expect the bond market to play a larger role in mobilizing funding for capital expenditure in Kenya in line with the Country’s Vision 2030 strategies and objectives.
Minimum issue amounts will be increased with time so as to sustain issuance of benchmark bonds of standard tenors so as to create liquidity of outstanding issues and attract bigger players in the market.
It is also expected that a Government Securities Market Makers programme (a kind of primary dealer programme) will be put in place in the medium term to cater for wholesale primary issuance in addition to further automation such as internet banking and Treasury Mobile Direct to cater for the retail segment. Furthermore, OTC trading of bonds is nearing its launch and we expect this to increase secondary trading volumes thus attracting more players in the bond market.
It is also envisioned that bond switches/exchanges and buy-back programmes will be put in place following the provisions in the Public Finance Management Act which allows these innovations.