10 January 2013

Nigeria: Bonds - the Next Big Trend in 2013


ADEBOLA ADEBAYO analyses the broader implications of bonds for the capital market, investors, and the economy, especially in the light of a recent appointment of a company as stockbrokers for FGN bonds.

The Nigerian Stock Exchange (NSE) has witnessed a number of stimulating initiatives in 2012, initiatives designed to encourage growth in capital market activities and give the market depth. For instance, market makers were finally introduced early in the year to provide liquidity, following on the heels of an exchange traded fund, ABSA NewGold, introduced late last year as "cost-effective diversification opportunities for investors". In April 2012, The stock exchange signed on with NASDAQ OMX to upgrade its trading platform early in 2013, The NSE Lotus Islamic Index was launched to track Shariah-compliant stocks, listing rules were revised, and recently, the central government stopped value added tax (VAT) and stamp duties charged on market transactions. CEO of The NSE, Oscar Onyema, had promised, at a recent Investors Forum, that The NSE will "continue to maintain laser focus on transforming The Exchange and reforming the market to be more transparent, efficient and innovative and liquid."

These initiatives are targeted at transforming the Nigerian market to make it more attractive for local and foreign portfolio investments and engender investor confidence. The equities market has responded well to these actions. The year-to-date performance of the broad index has been very impressive; from a loss of 17.42% in 2011, the market has gained over 30% in 11 months to end November at 27,514.18 points compared to 20,730.63 in 2011.

But perhaps the most profound market initiative this year is the liberalisation of the bond market; The NSE's attention to the roll out of a retail-focused, fixed income trading platform, possibly to take root early next year, to provide the much needed liquidity in bonds is an important step to diversify and deepen the market. The exchange has identified Fixed Income Market Makers (FIMMs), who would constantly provide a two-way quote, as critical to the success of the platform. To underline the importance of FIMMs, government recently appointed Stanbic IBTC Stockbrokers Limited, a member of Stanbic IBTC Holdings Plc, to act as broker to its bond issues, as a way to streamline FGN Bond activities. Before the appointment, banks and discount houses were licensed by the DMO to act as primary dealer and market makers (PDMMs). "We are expanding into the retail market for the bonds and we need a reputable stock broking firm to assist in secondary marketing," Reuters quoted a DMO source as saying.

Some of the benefits of market making in bonds may need to be better communicated to investors if the expected growth is to be achieved. One of the key benefits of market making in any asset class is the ability of the market maker to provide a two-way quote (bid and offer prices) and thus provide liquidity for the asset. For instance, Stanbic IBTC Stockbrokers, as market maker for government bonds, would provide bid and offer prices for the bond at all times to ensure asset liquidity and a robust secondary market for it on the exchange. Other benefits for the investor include the ability to diversify portfolio, easy access to transact on government bonds on the stock exchange, enhanced earnings capacity from coupons on bonds, and the opportunity to exit the bond even before maturity. The expected increased activity in bonds will no doubt rub off on the capital market in terms of transaction volume and value. An active secondary market for bonds, which engenders transparency, will act as a lodestone for fresh foreign portfolio investments in the economy through the capital market.

Analysts and informed investors are excited by the prospects in the market in the coming year and some are already considering their options. "We envisage a positive outlook for the economy, particularly with the growing interest of foreign investors in the Nigerian economy. Foreign Direct Investment (FDI) is expected to grow further as more foreign capital seeks outlets in emerging economies," a report by Partnership Investment, a stockbroking firm, said. Much of this interest is expected in fixed income assets, particularly bonds. Already, the numbers in that sector are staggering. Data compiled by Bloomberg show that "Standard Chartered Plc and Citigroup Inc. led banks in selling 28 naira-denominated credit-linked notes this year [2012] worth N64.08 billion ($407 million), with 70 per cent of issuance coming since Aug. 23. Only two such notes totaling $23.5 million were sold in all of 2011." And for the first time, JPMorgan Chase & Co included the Nigerian government bonds in its GBI-EM indexes, which has helped strengthen interests towards naira-denominated debts.

The volumes of secondary trade in the country's bond market, according to Emerging Markets Strategist, Standard Bank Plc, Mr. Samir Gadio, "now almost exceed those of Egypt and Morocco and represent about 20% of South Africa's turnover in normal times." Last month, the DMO raised N50 billion from the reopened 16% June 29, 2019 and 16.29% January 27, 2022 FGN Bonds and has revealed that it plans to raise N240 billion from bonds this quarter. State governments have also suddenly become active in the bond market. Ondo State raised N27 billion in January while the Lagos State Government recently raised N80 billion from its planned N167.5 billion bond issuance programme. Chellarams Plc., a consumer goods company, early this year issued a N0.540 billion bond for expansion. Unfortunately, many local stakeholders are still generally ignorant of the opportunities represented by market making in bonds.

To be sure, the Nigerian bonds market, mostly driven by federal government bonds, has traditionally been a closed one, with participation limited to high net-worth individuals, discount houses, commercial banks, and non-bank financial institutions as principal investors. While it is a safe asset to stash cash in at a reasonable return, it is mostly unattractive because it is illiquid. The implication is that the primary market for bonds is very well advanced while an active secondary market is non-existent. Investors are obliged to hold on to the asset until maturity. The appointment of Stanbic IBTC Stockbrokers will certainly change this dynamics, making the bond market more fluid.

The market crash of 2008 was a boon for the bond market. There has been a considerable growth in volume and value traded since then, and the market has continued to grow as risk appetite and confidence in the equities market remain low. Turnover for the 3- and 5-year tenor bonds has been at 56% and 40%, respectively. Other key drivers of growth are the high interest rate regime (the average coupon rate on FGN bond is 12%) and government's continued financing of deficit using local debt. Traded federal government bond, regulated by the Debt Management Office (DMO), has typically been done over-the-counter (OTC). It currently has a market capitalization in excess of N3.8 trillion, going by data from The Nigerian Stock Exchange. Based on current performance, analysts have projected a 67% growth in FGN bonds by the end of 2013. The growth may be higher as the market becomes liquid and open to retail investors.

However, there are genuine fears that a thriving bonds market may eventually crowd out the equities market, considering that investors are still generally wary of equities. Equally, analysts are worried by governments' dominance in the bonds market - federal government bonds, for instance, account for over 50% of issues and over 60% when state government bonds are added.

The combination of high volume of government bonds and high coupon rate will likely stifle activities on corporate bonds and deny businesses much needed capital for expansion and growth. However, for a market still in its infancy, policies and initiatives will continue to be fine-tuned in such a manner that the entire spectrum of the capital market benefits all stakeholders. Here, the experience of Stanbic IBTC Stockbrokers, via its Standard Bank heritage, will come in handy. In South Africa, where Standard Bank is quite dominant, both the equities and bonds markets are dynamic, offering investors a rich bouquet of options to enhance opportunities in Africa's largest economy.

It is certain though that with these initiatives, there will be opportunities for smart investors to diversify their portfolios, enriching them with the new products on offer on the exchange to enhance returns, even as the market becomes increasingly transparent, efficient, innovative and liquid, as promised by Mr. Onyema.

Adebayo, a writer and communications consultant

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