CMA eyes new fund to back corporate bond issuances, reduce risk of investor losses

Kenya’s once vibrant corporate bonds market has undergone lean times in the past five years, at times facing real fears of a total collapse due to investors’ fear of losing their funds to shaky issuers.

Although there are now encouraging signs of a gradual recovery, following successful issuances by student hostel developer Acorn Holdings, Family Bank and Centum Real Estate, much still needs to be done if the segment is to recover its lost glory.

The corporate bond market had a portfolio size of Sh71.3 billion and 28 listings in 2014 but has now shrunk to just three investment-grade bonds — the three mentioned above—with a total outstanding value of Sh11.7 billion.

Corporate bonds now account for just 0.13 percent of the NSE’s secondary bonds market turnover that is averaging Sh78.4 billion per month this year (government bonds: 99.87 percent).

Most of the issuers who were in the market in 2014 redeemed their bonds and opted for other alternative sources of funds including loans from banks, shareholders and development finance institutions.

On June 28, EABL made an early redemption of its Sh6 billion bond, nine months ahead of the originally scheduled maturity date of March 28, 2022.

Much of the heavy lifting in the efforts to revive the market will fall on the Capital Markets Authority (CMA), with the market now demanding concrete policy changes to protect investors in case of issuer failure.

Collapsed lenders

It was under the CMA’s watch that investors sunk Sh6.82 billion into bonds issued by Imperial and Chase banks in 2015, only for the two lenders to collapse within the next 10 months and set off the loss of confidence in the corporate bonds segment.

South African SME financier Real People has at the same time been struggling to redeem its overdue bonds worth Sh1.3 billion and has pushed the final maturity to 2028.

Now, the capital markets regulator is eyeing a proposed new fund to breathe new life into the segment, either by guaranteeing new issuers, subsidising the cost of issuance or providing liquidity support at maturity to pay bondholders in case of issuer distress.

Luke Ombara, CMA policy and market development director, told Business Daily that the regulator has been planning the fund for some time, guided by the credit guarantee fund that has been offered to the money markets by the Central Bank of Kenya (CBK) and Treasury for SMEs.

“We thought that while SMEs were going to look for short term capital to remain afloat during Covid-19 period, it was just a matter of time before the pandemic was managed and then they would turn to finding long term capital to expand and compensate for what had happened in their businesses during the Covid-19 period,” he said.

“We are looking at what could provide some kind of guarantee, for example for an SME that is looking to issue a debt instrument like a bond, but we have also examined other roles that this fund could play.”

One of the other roles the fund could play includes subsiding some of the issuer costs — both regulatory and those due to nominated advisers (Nomads) — which have been cited in the past as some of the reasons why small firms avoid issuing bonds when raising capital.

“We have got some support on the fund from our development partners with whom we are still in the early stages of discussion on some aspects including how much will be put in as seed capital,” he added.

Market stakeholders

One of the hurdles the CMA has to clear in getting the fund up and running is achieving buy-in by market intermediaries, who bristled at the prospect of having to contribute to the fund when it was first mooted some time back.

The market stakeholders — mainly stockbrokers and investment banks — pointed out that this would add another cost layer on their already strained earnings, while investors would also not welcome another transaction levy on their trades. “Just because of this apprehension we decided to get together with the NSE and the CDSC (Central Depository and Settlement Corporation) to come up with a concept paper, which we are currently reviewing on the best model that we should adopt,” said Mr Ombara.

As it is, there is already an investor compensation fund (ICF) that is managed by the CMA, but one with very different objectives to the new one being proposed.

The ICF compensates investors who suffer loss resulting from the failure of a licensed stockbroker or dealer to meet one’s contractual obligations, up to a maximum payout of Sh50,000 per investor.

The ICF is funded in various ways, which include contributions from licensed trading participants, a transaction charge on NSE trades at the rate of 0.01 percent on shares and 0.004 percent on bonds and from the financial penalties imposed by the CMA on operators for non-compliance with its rules and regulations,

Further, when there is an oversubscription of securities sold by public offer, the interest earned on excess funds between the offer closure date and the date the securities are credited to investor accounts is put in the ICF.

Crucially, bondholders cannot be compensated the ICF as it only takes care of stock market investors who fall victim to distressed brokerage firms.

This, therefore, is the reason why the investors in the Chase and Imperial Bank bonds were left high and dry when the lenders collapsed while in their debt, and why Real People bond investors have had little choice but to accept several deferments of their bond maturities.

These issues with troubled issuers are the reason why the CMA is looking to expand the mandate of the proposed fund to include an option to provide liquidity support at the end of the life of high yielding but distressed issuances.

To do this, the regulator is looking to borrow heavily from a similar venture by the Thailand Securities and Exchange Commission (SEC), which has published proposed regulations on the establishment of a Distressed Bond Fund (DBF).

The Thai regulator wants its rescue fund to take the form of a mutual fund, which would buy out the bondholders upon the maturity of a distressed issuance at a moderate discount, and then look to recoup the investment when and if the issuer regains their footing and can meet the debt obligation.

Those looking to put up a DBF will, however, be limited to institutional and ultra-high-net-worth investors.

According to Mr Ombara, the CMA, like its Thai counterpart, is also eyeing the private sector to drive its proposed distressed bond fund, and these players need to be willing to participate in a high risk, high yield arena.

“The one that addresses liquidity concerns would mirror a hedge fund, so it is something that we would encourage the private sector to set up in the form of a mutual fund for example,” he said.

Such an arrangement could have spared the investors in the Real People bond the long wait until 2028 to access their funds.

It would also open up the market for new high yield issuances that would deepen the bonds market.

This is because it de-risks the bonds for investors due to the guarantee of a way out even if the issuer falls into trouble, working much in the same way a government guarantee encourages lenders to give loans to state corporations that they wouldn’t otherwise dare lend to.

The local bond market has already seen the positive effect of a back end guarantee of redemption in play, through the Acorn green bond (Sh6.3 billion total).

This bond enjoys a partial credit guarantee of 50 percent of the principal and interest by GuarantCo — a fund backed by the governments of the UK, the Netherlands, Switzerland, Australia, Sweden, Germany and the International Finance Corporation.