South Africa

Pages203-214

Page 203

The South African government securities market has gone through various phases since the late 1970s. No formal and prevailing market rate existed before this period. The government periodically issued bonds at par, when needed. As the market started to develop, the government realized the importance of creating benchmark bonds across the yield curve to increase liquidity. By the early 1990s, a debt trap was looming, and the government intensified its focus on debt management. The govern- ment's macroeconomic framework under the growth, employment, and redistribution program was designed to, among other economic challenges, bring the total debt to manageable levels. As a result, the department of finance developed a framework of philosophies and principles to manage its debt. This led to guidelines and strategies to manage debt more actively.1

Today the central government, state-owned entities, and local governments in South Africa are responsible for issuing more than 95 percent of the total fixed-interest-rate securities in the market. The government has taken great care to prove itself a reliable and responsible borrower, domestically as well as abroad. The funding is concentrated in large, liquid benchmark bonds to provide liquidity to the market.

Currently, the government is able to finance the total funding requirement in a sophisticated, liquid, and well-regulated domestic market. Much attention has been paid to the structural, legal, and infrastructural sides of supporting market development. There is regular interaction with the Bond Exchange of South Africa (BESA), the Financial Services Board, and the South African Reserve Bank (SARB) to help with the proper control of the domestic market. The government has also maintained a transparent relationship with the market. Quality information has been made available, particularly on key budgetary figures and funding strategies. As a result, South Africa's debt management strategy has moved beyond the stage that characterizes most emerging markets, and it is closer to that of developed markets in the industrial countries.

The Domestic Market Before 1990

In the 1970s, new government bond issues were sold as periodic public issues. Typically, the secretary of finance would issue bonds at par three or four times a year, usually to coincide with the date of a maturing Page 204 bond. There was no active secondary market and, therefore, no prevailing market rate. However, several investigations of and reports on future developments in the capital market of South Africa highlighted the need for changes, among others the De Kock Commission, the Stals report, and the Jacobs report. In 1978, a broad consensus among all market participants was formed, pointing out the real need for market development.

In 1981, Eskom (the Electricity Supply Commission) was the first public entity to issue a bond at a discount to the market. The government soon followed. During the early 1980s, the government issued bonds on an open-ended tap basis until the allotted nominal amount, as specified in the prospectus, was fully issued. For each amount issued, a new bond was introduced to the market. During this period, there was no clear separation between monetary and fiscal policies. Primary issues were used for both financing government spending and open market transactions.

In the mid-1980s, important participants in the capital market established a forum with the South African government to discuss matters of mutual interest. The investment community was partly concerned about the Act on Prescribed Assets. This act was introduced in 1958 to create funds for semigovernmental institutions (such as universities and the South African Broadcasting Corporation) and developments in the former homelands. To fund these institutions, pension funds and insurance companies were obliged to invest part of their funds as prescribed assets in government bonds, government guarantee bonds, and bonds approved and specified by the registrar of pensions (e.g., homeland bonds). Moreover, the investment community was concerned about the small amounts of holdings being kept in a particular bond, some of which were illiquid.

The prescribed assets were a serious stumbling block in the development of financial markets. No prevailing market rate could be determined because of such requirements. The act was finally done away with in October 1989. When prescribed assets were lifted, the scene was set for further market developments in the South African capital market.

In 1989, the then department of finance consolidated several smaller issues to create benchmarks in 5-, 10-, 15-, and 20-year maturities. Furthermore, Eskom and other public entities began making two-way prices (i.e., quoting bid and offer prices) in their bonds.

Developments 1990-98
Developments in the domestic market
Development of the BESA

The development of a formal bond exchange in South Africa originated from recommendations made in the Stals and Jacobs reports. The authorities recognized that self-regulation by the market participants was more desirable and acceptable than imposed control. As a result, bond-trading firms who had run a voluntary association called the Bond Market Association since 1989 were licensed in 1996 as a formal exchange called BESA (the Bond Exchange of South Africa).

To develop the clearing operations, BESA adopted the Group of 30 recommendations on clearing and settlement. The exchange also established a recognized clearinghouse, UNEXcor (Universal Exchange Corporation). Today, BESA members are able to benefit from electronic trade reporting, matching, and settlement. Electronic net settlement takes place each trading day and is facilitated by four settlement agent banks and their Central Depository of South Africa.

Introduction of auctions and market making

In the early 1990s, the SARB had been appointed as the agent to issue, settle, and make a market in government bonds. In September 1996, the department of finance conducted a survey among members of BESA and certain foreign banks to obtain their views on how to improve issuance and secondary market-making activity in government bonds. As a result of the problems experienced with selling primary issues to the market on demand, South Africa decided to adopt the international practice of using regular auctions as a method of selling primary issues of government securities to the market. To ensure efficiency, liquidity, and transparency of the sec- Page 205 ondary market for government bonds, market participants also agreed with the principle of moving toward formal systems of market making. As a result, primary dealers were appointed, and their main responsibility was to make a market (quoting of twoway prices) and provision of liquidity in the secondary market for government bonds.

Auctions

Since 1998, the responsibilities of the SARB changed from being an issue, settle, and market-making agent in government bonds to conducting auctions of benchmark bonds according to a fixed program on behalf of the national treasury. The treasury, in a timely manner, informs all market participants about the year's public sector borrowing program, including the extent of the borrowing requirement, auction dates through an auction calendar, the maturity structure and size of issues, and the instruments to be issued. Seven days before the weekly auction, an announcement is made on what instrument will be issued. The auctions of benchmark bonds are open only to primary dealers.2

Appointment of primary dealers

In 1998, the national treasury appointed a panel of 12 primary dealers, consisting of 6 local banks and 6 foreign banks. The reasons for appointing primary dealers were to reduce refinancing risk for the government, improve the liquidity and efficiency of the government bond market, and create clear and transparent price formation. The introduction of a primary dealer system also supported the development of regulations for trading and investor protection and establishment of a more efficient clearing and settlement procedure. Other benefits of primary dealership include improved market analysis and research.

The criteria to be a primary dealer, set out by the national treasury, require both the local and nonresi- dent market makers to hold a specified minimum amount of rand-denominated capital in South Africa. This held capital is a demonstration by market makers of the capacity to deal with the inherent risks associated with market making. In addition, it shows a firm commitment toward developing the domestic market.

Some requirements were identified to be put in place before the appointment of market makers. It was also decided that a gradual approach to change was necessary to avoid undue...

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