Fixed income board probably missing link

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TALK of a fixed income board at the Zimbabwe Stock Exchange (ZSE) is gathering momentum with a working party already in place, busy making consultations while CDS Mauritius, the consultant for the ZSE online trading system readies the platform to ensure smooth trading in the instruments.
Well-wishing Zimbabweans live in the hope that this becomes a reality. I for one do! The potential of a well-functioning bond market in attracting long-term debt capital, a commodity of great scarcity in Zimbabwe, is colossal and can be game changing. What interests me most however is how this opportunity is capable of opening doors to international capital that tolerates our indigenisation programme, while at the same time enriching governance among corporations.
I hold the view that should the powers that be come to the party and partner the private sector in creating an environment in which attributes desirable to international capital blossom via the fixed income board, one battle in the war to promote Foreign Direct Investment (FDI) will surely be on its way to be won. Capital hates risk, but loves yield and there exist an equilibrium point at which a bond market can satisfy both within the confines of the indigenisation and empowerment laws.
The fixed income board will ordinarily have the capacity to accommodate both government and private sector issues, but my focus is on the latter, which by definition are transferable debt securities issued by companies with a tenure that exceeds one year. Corporate bonds are just but one avenue, alongside equity share capital, bank lending, and others, through which companies fund their business and expansion needs.
They are particularly a stable and reliable source of long-term capital and in Zimbabwe only CBZ Holdings has an outstanding issue as per the latest Bloomberg listings. Bond issues among non-financial entities in Africa are also growing and so are their stature as an alternative to bank loans. Bonds are likable for their ability to lower costs of debt, while their tenure, which is often longer, is pivotal in creating and sustaining profitable enterprises.
For the investor, corporate bonds have many advantages, especially for individuals and funds that need stable and predictable income while protecting the original capital outlay. This is a perfect match for pension funds whose attribute of long-term obligations also matches the tenor for bonds. Pension funds, together with sovereign wealth funds probably form the world’s biggest savings pool which has lately become very mobile, roaming freely across international borders in search of yield. The opportunity for Zimbabwe resides in this mobility of capital which is very responsive to the allure of transparent, deep and broader fixed income markets.Advertisement

Sub Saharan Africa is improving significantly in terms of appeal to the fixed income investor. The resounding success of sovereign Eurobonds has demonstrated that the region is indeed a credible investment destination although corporate bonds issues are yet to be greeted with the same enthusiasm in the market.
Outside South Africa, debt markets are dominated by short-term government instruments with activity being confined to the domestic primary issues and very low secondary market trading. The market for corporate debt is essentially non-existent and where one is found, it is often very small and illiquid, but encouragingly growing. Zimbabwe’s initiative thus happens at a time that corporate bonds appeal is rising; hence it becomes prudent to expect that the initiative will be met with success.
As if the encouraging growth in Africa was not enough, the board is being proposed at an opportune moment when there is enough heat for all stakeholders to join hands and see to its success. For once the interests of bankers, stockbrokers, fund managers and even regulators look like they are all aligned. Our capital markets have proven to be too shallow, lacking both the breadth and depth to support revenue levels adequate to basic sustenance needs of all stakeholders.
Of note is the fact that if trends elsewhere in Africa are to be replicated, turnover on the bond market can significantly outstrip what the ZSE currently achieves with equities. This is an open secret to the stakeholders who all can do with additional revenue lines. It is therefore safe to assume that by this time next year, a fixed income board will be in place, the activity levels thereof, we can only speculate, but what is clear is that capital market stakeholders are in big enough trouble at least to see this one through.
Tradable bonds are not a new phenomenon to Zimbabwe. The ZSE was born out of bond trading with Londoners allocating to mining ventures seeking fortunes in the then untapped Rhodesia. As markets evolved, however, equities took over and today we have a market that survives largely on trading equities as opposed to bonds. This skew excluded a significant portion of saving pools, among them international pension funds that naturally seek a home in long-term fixed return instruments.
To remedy this, Zimbabwe ought to consult its history and re-create a well-functioning bond market. The country can however look to its unique multi-currency system that allows Zimbabwean companies to issue paper in hard currencies, a distinct competitive advantage that allows its companies to issue bonds that are immune to exchange rate risk.
But then, how can Zimbabwe exploit this window to benefit companies, especially those that are now indigenous? The Indigenisation and Economic Empowerment Act states that ‘at least fifty-one per centum of the shares of every public company and any other business shall be owned by indigenous Zimbabweans’.
Herein, in the first objective of the Act, lies the biggest impediment to capital flows. Rational investors only wish to invest where they can exert both control and influence, but the law here closes that door for foreigners. Being rational, they conform to what is normal and simply take their business where there are no such restrictions. However, debt instruments can be used to provide capital without necessarily upsetting the 51percent rule in just the same way as bank loans or some other form of loans are doing. The fixed income board goes further in that;
a)      Issuing requires the preparation of a prospectus which just like when one is listing equity, hence companies are subject to similar scrutiny to what we are used to when floating shares
b)      The presence of a board implies liquidity on an organised market and all the benefits, among them lower cost of capital and coverage by analyst follow such.
c)       Bonds are often issued with stringent covenants that can range from corporate governance issues and the assumption of extra debt. This can only help the company to be managed better.
d)      There is no limit to the amount that foreigners can hold in a bond. This allows flexibility in funding with the above attributes conferring benefits ordinarily enjoyed by equity holders.
Investors can, however, find instruments offering the same attributes on many exchanges in Africa and abroad probably offering higher yields and lesser risk than what is found in Zimbabwe. This is where authorities have to step in and improve the allure of Zimbabwe with measures, the examples of which are given below.
a)      Only government can ensure the cost of issuing and trading instruments in the secondary markets are very low taxation regimes. Bond market essentially thrives on disintermediation and if savings do not justify not getting a loan, it then becomes more efficient to just get a bank loan as opposed to issuing bonds. However, an active secondary market will ensure revenues foregone will be recouped over time.
b)      Zimbabwe simply doesn’t provide incentives to list. A case in point is Nairobi Stock Exchange (‘NSE’) which at one point in time was very small compared to the ZSE in terms of the number of issues. Authorities introduced a five year tax break for companies that came to the market and today the NSE  is much deeper and broader that our local bourse. The same can also be introduced for new bond listings with government once again getting long term benefits from increased tax related to trading.
c)       Specific statutes can be enacted to protect would-be investors in the corporate bonds in terms of remittance of earnings and capital as well covenants to help them to swiftly recover their investment in the event of a default.
The list can go on and on, but what is clear is that corporate bonds indeed occupy a sweet spot that can be exploited to raise funding without derailing indigenisation. The biggest benefit being that Zimbabwe will recapitalise industry without having to give up equity as per indigenisation law. As enterprises retire their bonds, the rejuvenated company will now be owned by be locals just as the Act intended.