Ideas & Debate

Here is how to revive wilting local corporate debt market

Default on maturing notes by firms has dampened demand over years. FILE PHOTO | NMG 

As the price rally in the domestic bond market continues largely on account of high liquidity in the system, there is no mention of corporate bonds.

Indeed, the primary domestic corporate bond market, where private companies sell debt instruments to investors, is long dead.

The last primary issuance was back in April 2017 when East African Breweries Ltd (EABL) sold five-year (or medium term) notes raising Sh6 billion (which was the last tranche of a Sh11 billion medium term issuance programme).

There are currently 20 listed corporate bond notes at the Nairobi Securities Exchange, out of which seven notes are maturing in 2019, with another six maturing in 2020, barring any further defaults.

That calls for replacements. But in a market brought on its knees by recent corporate failures, what will it take to revive it? The answer is two-pronged: first is how issuers and the capital market can provide counter-default enhancement structures; and second, corporate credit ratings.


Nearly all corporate bond issues are unsecured subordinated, which means that, in the event of a default, holders of those debt notes can only be paid after the janitor has been paid, which is not abnormal. However, with pension funds being the largest investors in these issues, and consequently having lost money, there is a lot at stake and they certainly will be asking for enhanced structures in future issues. There are two forms of enhancements that, in my view, can get the market back up.

First is credit wraps. Indeed, credit wrapping is a type of credit enhancement whereby a bond issue is insured and the insurer guarantees to meet, in part or full, interest and principal payments if the issuer goes into default.

In advanced markets, lower credit-rated investment grade debt issuers employ credit wraps to achieve high ratings for their issues.

In the ratings scale of most rating firms (including Agusto&Co ratings company), triple or double (AAA or AA) ratings usually imply an issuer has impeccable financial condition and the strongest capacity to meet its debt obligations. Single A, triple and double B (A, BBB or BB) are considered to be lower investment grade ratings. And of course below that is the junk category.

If a debt issuer is rated triple or double A, then they may not need to employ enhancements. However, if they have Single A, triple and double B (A, BBB or BB) ratings, then investors will ask for enhancements. Multilateral entities, such as the International Finance Corporation (IFC), are well-known credit wrappers.

The second form of enhancement is credit default swaps (CDS), which is a form of derivative provided by the capital markets. Derivatives, as you now know, are financial contracts whose values are derived from the value of an underlying asset, such as commodities, stocks, residential mortgages, bonds or even loans. There are three main types of derivatives: forwards (or futures), options, and swaps.

A credit default swap is an arrangement where a “buyer” (typically a bond investor) agrees to pay an agreed amount to a “seller” of the swap (an investment bank in most cases) and in return will receive a payment if a certain event occurs, such as a default.

Because the buyer (or the bondholder) does not need to own the underlying security, a CDS can provide a bondholder with protection against defaults; but also, this unique characteristic often invites speculative activities.

The Nairobi Securities Exchange’s derivatives platform is now live and, therefore, products such as credit default swaps are soon domestic realities. Essentially, the era of name borrowing is over and it will take institutional memory loss to restore it. Which won’t happen anytime soon.