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Banks to get priority in bonds buying shake-up
Experts reckon that for the plan to work, the lenders will need to have preferential access to new bonds so as to build up their holdings effectively for liquidity purposes, while influencing and streamlining price discovery.
Selected commercial banks will get priority in buying Treasury bonds under a proposed shift outside the auction system, which is expected to revitalise government paper trading and lower returns.
The Central Bank of Kenya (CBK) has issued draft regulations for the creation of a separate market for bond trading or over the counter (OTC) where the banks or market makers will set the price and buy nearly the whole government paper.
This will make the top banks wholesalers of government securities, with the role of buying in bulk and selling to other investors.
Under the planned OTC, the banks or market makers will submit bids to the government indicating how much they would pay for all the bonds being offered.
The government chooses the price that is informed by the ability of the banks to resell to other investors for a profit.
The CBK has set a resell margin of 25 basis points, indicating that market makers will sell a bond at 12.25 percent to other investors for government paper acquired at 12 percent.
This model guarantees the State ready demand for its bond issues and results in getting a lower price or return from the sophisticated bankers.
It contrasts with the current model where investors bid for bonds in a public market that determines the prices of the government paper.
The market makers are expected to buy and hold government securities from the CBK with the aim of providing a steady supply to the retail buyers in the secondary market, where bond holders trade in the securities.
The bankers will also stand ready to buy bonds from investors at the secondary market with a two-way quote or quoting both the buying and the selling price of a bond—providing liquidity and price stability.
Market makers quote both a buy and sell price and guarantee bonds availability by holding government paper themselves in inventory, which requires deep-pocketed investors like banks.
“The purpose of the pilot market makers programme is to establish a wholesale secondary market for benchmark government securities by identifying top Kenyan banks to perform market making roles and act as liquidity providers,” the CBK said in draft guidelines for the establishment of an OTC bonds market.
“For performing secondary market obligations, market makers are incentivised through…priority rights to tap sales, (becoming a) member of bond market forum through which they will be consulted on issuance plans, liability management operations (LMOs) and debt strategy.”
Experts, however, reckon that for the plan to work, the lenders will need to have preferential access to new bonds so as to build up their holdings effectively for liquidity purposes, while influencing and streamlining price discovery.
In the current primary market setup, any investor can participate in a bond auction, quoting their desired price and yield.
This makes it hard to predict prices in a setting where there is also no guarantee of full subscription for the CBK.
Giving banks preferential access would see non-bank participants in the primary market lose the privilege of quoting competitive bids, which worked for the benefit of investors last year as the government borrowed at costly rates.
Returns on government bonds hit a peak of 18.5 percent last year from an average of 12 percent in 2022.
They have since receded to an average of 14 percent as the State seeks to lower its borrowing costs.
In the secondary market, however, investors will benefit from improved liquidity, allowing them to buy or offload their bonds more quickly, and at fairer prices due to the presence of the market makers.
“The market makers plan will only make sense if the banks will have exclusive access to the primary market, or like the case with Uganda, retain the sole right to offer competitive bids if other non-bank parties are allowed to participate in primary auctions,” said a banker, who spoke on condition of anonymity.
Introducing market makers in the primary bonds market will provide the government with a guarantee of uptake for its bonds at predictable prices, removing uncertainty over its ability to raise debt from the domestic market.
In the draft OTC guidelines, the CBK said that it is looking to address the challenges of pre-trade price discovery, market liquidity and improve market transparency through the market makers’ plan.
The banking regulator reckons that tapping banks for the market making role will trigger a “deeper and more efficient government securities market, supporting the Treasury’s efforts to mobilise resources, reduce borrowing costs, and attract foreign investment.”
The introduction of the OTC market will impact other market players, notably the Nairobi Securities Exchange (NSE) and investment banks.
The secondary bonds market is currently hosted at the NSE, where bond investors normally trade through stockbrokers and investment banks, who charge a commission for facilitating trades.
Stockbrokers charge a commission of 0.03 percent per bond trade, with the NSE taking a share of these commissions as fees.
A competing OTC market will open an alternative route for bondholders to sell and buy securities, risking bourse’s fees.
For the market intermediaries, there will still be an avenue for income since they can still charge their clients a fee to trade on their behalf in an OTC market.
The CBK has not disclosed whether it will be setting up its own platform or ride on existing ones, such as the NSE’s own OTC platform that was licensed last year.
“The NSE can get around the potential loss of revenue by offering its OTC platform to be used for the market maker plan,” added the banker.
NSE chief executive officer Frank Mwiti separately told the Business Daily that the bourse was still reviewing the draft guidelines to understand how the CBK’s proposal would affect the bourse.
Banks also have a separate OTC platform via the East African Bond Exchange (EABX), which has been derailed by the CBK, which is yet to offer rights to plug into the regulator’s bonds settlement platform.
The EABX platform, which received approval from the Capital Markets Authority (CMA) in early 2024, was supposed to rival NSE on bond trading.
Insiders at the CBK, however, said that there was concern about the emergence of two yield curves under the parallel secondary trading system, hence the regulator’s reluctance to give its nod to EABX.
