AMMAN, 9 February 2004 — In the boardrooms of corporates in Jordan, Kuwait, Egypt, UAE, Lebanon, Bahrain, Oman and other Arab countries, serious considerations are being given to the prospects of borrowing medium to long-term money in the region’s domestic bond markets. The advantage is not only to lock in historically low interest rates for say a five year period, but also to diversify sources of funding, reduce the corporates’ overdependence on lending from banks and have the advantage to repay the principal amount borrowed in one bullet repayment upon the maturity date of the bond. Equally important, companies will be able to capitalize on the process of issuing bonds to enhance financial transparency and improve the corporate image of the issuer.
The corporate bond markets in the Arab region are still in their early stages of development, with total value of corporate bonds issued at in the region’s domestic markets not exceeding $3 billion, compared to the total capitalization of Arab stock markets close to $300 billion by the end of 2003. Not only the primary markets — where new securities are issued — are thin, but also the secondary markets for bonds are illiquid. Bond trading makes up less than 0.5 percent of total trading on the region’s stock exchanges. Investors, typically banks, social security and insurance companies, tend to hold bonds to maturity. Getting a competitive quote on a corporate bond listed for example in Jordan and Morocco could take days, compared to seconds in the Eurobond market.
There has been a huge increase in government bond markets in the region in the last ten years. Nearly all the major Arab countries issue treasury bills and bonds, with an estimated total of $150 billion of government bonds outstanding by the end of 2003. The trend began in the mid 1980s, when several Arab countries started operating under deficit budgets financed mostly from local funds. Saudi Arabia, Kuwait, Oman, Egypt, and Lebanon have particularly active government bond markets, with discount facilities adding liquidity to these instruments. However, most of the bond issues in the region have maturities ranging between two and five years with only Saudi Arabia and Egypt issuing government bonds with maturity reaching seven years.
The corporate bond markets in Kuwait and Jordan are the most advanced in the region. There were 23 corporate bonds outstanding by the end of 2003 in Kuwait with a total value of $1.96 billion. Only three were dollar denominated bonds and 20 were issued in Kuwaiti Dinars. In Jordan, the total value of the 13 corporate bonds listed on the Amman stock exchange exceeded JD130 million ($183 million) by the end of 2003 of which only two were denominated in dollars.
Not only the primary market, where new securities are issued are thin, but also the secondary markets where corporate bonds are traded remain generally illiquid. Investors are basically reluctant to part with any bond allocations they receive from primary market issuers due to the lack of continuous flow of bonds coming to the market. This naturally results in thin trading and considerable mispricing of existing issues.
The presence of excess liquidity in the domestic banking system should not be a reason to delay the development of the local corporate bond market. The argument that banks can provide all the capital that corporates need does not always hold. A viable local bond market would provide “patient capital”, i.e. a new source of long term financing for corporate borrowers, that would help reduce their over dependence on short term borrowing from banks.
In the US market for example, corporates depend on the bond market for more than 50 percent of their financing requirements. The shortage of medium to long term funds at fixed interest rates is perceived to be a significant impediment for industrial growth in the region.
Corporate bonds will give issuers the chance to maintain their credit limits with banks, and provide them with alternative funding sources at prices and conditions not available in the local market. Corporates who want to issue bonds should have solid financial positions and demonstrate their ability to pay the interest and the principal due upon maturity. The proceeds of the bonds should be clearly spelled out in the bond prospectus and adhered to in practice. While corporate bonds normally cost the borrower less than bank loans, nevertheless certain fees have to be incurred when issuing bonds. The investment banking institution charges an underwriting and placement fees that range between 0.5 percent-1 percent of the total amount issued. There is also a cost incurred in the preparation and printing of the prospectus. Other fees include legal expenses, registration and custody fees among others. On average, total costs of issuing a corporate bond will add around 0.1 percent annually to the stated interest rate on the bond.
Government bond markets in the region need to be deepened even if the borrowing requirements of the public sectors are low and there is plenty of liquidity through bank savings. Not only would government bonds help to establish a benchmark for pricing of corporate bonds, but also the yields on these bonds could serve as a reference point in the derivative markets and could also be used as discount rates to value equities and when appraising investment projects. Government bonds of different maturities should be issued to determine a yield curve that would make it easier for arrangers of corporate bonds to come up with the right price for new bond issues in the primary market.
Although standards of reporting have improved, especially for the incorporated and publicly traded companies, yet more is needed to enhance the transparency of public or private shareholding companies who are planning to tap the local bond market. Bonds do not require collaterals or guarantees and are usually issued to companies that have solid financial positions. Full and transparent disclosure is needed, otherwise no reputable investment bank will be willing to underwrite and place the bond issue. The secondary bond market also needs to be supported by an institutional infrastructure that includes, among other things, ability to list and trade dollar denominated bond issues and the presence of active market makers. Jordinvest is among the very few financial institutions in the region with sufficient expertise to price, underwrite and sell a corporate bond issue.
There is a growing trading culture in the region as seen by the rising number of individual investors in the local stock markets. The challenge is to transfer the same process to the local bond markets, where trading bonds rather than holding them to maturity becomes the norm. So far bond holdings by individuals are still negligible and there is a need to expand the number of participants in the local bond markets.
Bond markets rely, even more than equity markets, on strong corporate governance, transparency and full disclosure, viable legal system, contract enforcement, international accounting standards and active market participants. Another factor that is also hampering the development of the region’s bond market is the lack of market makers with access to liquidity. An efficient bond market will not only promote the general development of the countries of the region, but will also reflect it.
(Henry T. Azzam is the CEO of Jordinvest)
