The Corporate Bonds Market in Kazakhstan
Damir Karassayev, President of Kazakhstan Stock Exchange
The evolution of the Kazakh securities market, largely assisted by the success of financial sector reform in the second half of the 90s, passed the point where corporate bonds, a type of financial instruments which had been new to Kazakhstan, emerged on the domestic market.
The first corporate bonds were issued in 1998, but the bond boom began in 2000. Since its inception, the Kazakh market in corporate bonds has been exposed to many influences, the most important of which were macroeconomic stabilisation and the growth of the national economy in 1999-2000, and the rise of a powerful class of domestic portfolio investors who, through the agency of pension funds, maintain a steady demand for this type of security. These factors provided a strong impetus for accelerated development and restructuring of the bonds market. Whereas early, more limited issues of corporate bonds were initiated entirely by small to medium-sized companies and second-tier banks, with the latter being the most active category of institutions dealing with corporate finance, starting in 2000 the major players, including national companies, have become involved in this segment of the stock market. With the entry of leading domestic companies and banks, the country’s bonds market diversified, as international bonds, including those denominated in foreign currency and intended for foreign investors, came into circulation. As a generalisation, the Kazakh market of corporate bonds is experiencing active expansion at present, along with positive changes in its structure, namely, a growth in the proportion of issuers representing the real sector of the economy, the enhancement of borrowing opportunities for businesses, a transition to international financial management standards, etc.
Corporate bonds as a means of encouraging investment in the Kazakh economy and other financial activities
Corporate bonds play an important role in the current phase of the country’s economic development. Most of all, these instruments are catalysing the evolution of the stock market. Given the persistent lack of other types of securities, corporate bonds have been effectively the sole force to have enlivened the sector and maintained its infrastructure in working condition over the last two years. However, apart from diversification of the securities market, the introduction of a new instrument of corporate finance represents important benefits for the country’s economy as a whole, the financial sector especially. The impact and advantages of corporate bonds circulation in Kazakhstan will be analysed below in the light of bilateral borrower / investor relationships.
Benefits for the issuer
The upward trends in the Kazakh economy in 1999 and especially in 2000 (which included an annual GDP increment of 9.6%, a positive foreign trade balance of $4.1 billion and reduction of inflation to 9.8%) brought about the pressing need to boost investment in the key sectors of economy. However, the situation in the money market was not favourable for adequate investment inflow (that is, cheap long term debt instruments) to the real economy sector. Under such circumstances, the issue of corporate bonds became an efficient borrowing arrangement for large companies, and a real (perhaps the only) alternative to bank credit (the correlation of credit and bond interest rates is shown in Figure 1).
A series of bonds issues by large Kazakh companies (primarily national companies and major banks) allowed them to raise considerable resources. These issue usually totalled $15-30 million, reflecting the average scale of respective investment projects and showing a well-balanced financial policy, especially in the instances where companies were making their debut as bond issuers. That investment was an ultimate goal of these operations is suggested by the long maturity terms of the bonds (5-8 years) and their low loan servicing rates, compared to international standards. An illustrative example is a $150-million issue, by Kaztransoil, of eurobonds with a 8.67% coupon rate, payable on principal in 2006. The distribution of these eurobonds, which was completed by July 2001, demonstrated the high reputation of Kazakh borrowers on international capital markets, and highlighted the potential of the domestic corporate bonds sector.
Corporate eurobonds issued by Kazakh companies are remarkable in that, first, they indicate the continuing integration of country’s financial markets into the global financial system and, second, they exemplify an issue which is highly efficient in all parameters, including maturity term, coupon rate and amount of investment raised. Their attractiveness is backed by Kazakhstan’s financial stability and good credit history in respect of sovereign eurobonds. Notably, the low bond equivalent yield of corporate eurobonds is associated, to a great extent, with the fact that the ratings of the major issuers correspond to Kazakhstan’s sovereign rating, which is quite high (Table 1).
As can be seen in Table 1, Kazakhstan is distinguished by a competitive rating among other developing markets, this situation being favourable to further issue of corporate eurobonds. Given the current macroeconomic conditions in the country, the ratings of domestic financial instruments are likely to grow, and this might imply positive changes to the borrowing terms, primarily in the cost of loan servicing. The probability of such a scenario is increasing in connection with the high liquidity of corporate bonds on the domestic market, since all important issues of these instruments (including eurobonds) are listed and being regularly traded on KASE. The latter factor, alongside the growing demand for reliable securities from institutional investors, is the key to the ongoing shrinkage in the bond equivalent yield of corporate bonds, which barely exceeds that of Kazakh eurobonds (Figure 2).
The reduction in bond equivalent yield, which represents the merit of the issuer’s financial policy, is in the interests of attracting investment into the real sector of the economy. On the other hand, the relatively low profitability of corporate bonds is a disincentive to investors, and calls for certain investment benefits to be in place to make up for the low coupon rate.
Benefits for the investor
The attractiveness of any financial instrument for investors is composed of three principal qualities: profitability, marketability and reliability. Presented below is an overview of Kazakh corporate bonds, assessed on the above three parameters.
A. Marketability. High liquidity is a characteristic of Kazakh corporate bonds that distinguishes them from other non-public securities traded on the domestic market. Basically, the status quo is contributed to by the presence of the institution of market makers on the Kazakh stock market, and the sustained demand for dependable securities by institutional investors.
Market makers (large broker / dealer firms) provide holders of corporate bonds of a given series with the opportunity to sell them without significant loss on exchange, which is achieved through the ongoing management of dual quotation of and trading in such «supervised» bonds by these firms. All non-public securities on the KASE «A»-listing are handled by market makers and, therefore, feature higher liquidity. Remarkably, the vast majority of corporate bonds traded on KASE are listed «A». Not all series of corporate bonds, however, are so marketable, principally because this sector of the Kazakh financial market is still taking shape. The ongoing efforts to raise the marketability of corporate bonds have been conclusive. At the moment, the liquidity of corporate bonds is distinctly superior to that of all other financial instruments (particularly, shares) from the same issuers.
An additional marketability potential of corporate bonds ensues from the fact that these instruments are always reasonably in demand by institutional investors, primarily pension funds (precisely, pension asset management companies, PAMCs) and commercial banks. The former, PAMCs, form the principal market for bonds, as they are bound by strict requirements to secure their investments. Therefore, public securities occupy a major proportion of their portfolios (Figure 3). However, since public securities are known to have the lowest dividend yields, PAMCs are forced to constantly seek to improve their general profitability with other financial instruments. In the absence of an adequate supply of the «blue chip» category of securities in the Kazakh market, corporate bondshave become the main focus of attention for PAMCs. The demand for bonds is tending to increase, following the ongoing expansion of PAMCs. As is shown in Figure 4, PAMCs are dominant in the structure of corporate bond buyers.
Second to PAMCs are second-tier banks, which are pursuing the expansion of their assets, being required to do so by the collective deposit insurance system introduced in Kazakhstan. The latter measure, along with the economic growth seen recently, has accelerated the capitalisation of domestic banks and boosted the demand for quality financial instruments.
In general, one of the many positive implications of financial sector reform during recent years was the formation, for the first time ever, of so-called excess liquidity in the financial system. This is a surplus of capital which, seeking an efficient application, eventually served to strengthen the market in corporate bonds. Another important achievement of the reform was that the securities market became accessible to many new players, such as insurance companies. In addition, a number of new financial institutions were founded in 2000, including the state-owned Development Bank, whose stated goals and activities suggest that they are likely to become involved in bond transactions in future. An important potential buyer of corporate bonds is the State Pension Fund (whose assets total about 60 billion tenge), which, at present, is not entitled to purchase securities of this type; however, when the Fund is privatised, this ban will be lifted. Thus, the current situation in the Kazakh financial sector and the growth in assets of its major players (Figures 5-7) allow us to conclude that the demand for corporate bonds will remain steady in the near future, which in turn guarantees the high liquidity of these instruments.
B. Reliability. Kazakh corporate bonds feature a fairly low risk level, a quality contributed to by a variety of conditions. The three principal factors working to enhance the reliability of these instruments are as follows:
First, there is a rigid two-level system of requirements imposed on bonds issue, the first level being the regulatory system of the National Committee for Securities (the body responsible for registration of emissions), and the second being the requirements of listing on KASE where corporate bonds are traded.
Second, the overall stability of the country’s economic and financial systems, proved during the world financial crisis of 1997-98, further raises the «safety margin» of Kazakh bonds. Table 2 illustrates Kazakhstan’s rating history against the background of depression of international financial markets.
As is shown in Table 2, Kazakhstan’s key rating, long-term loans in foreign currency, varied in a narrow range - from ?+ to ??, whereas those of other countries even happened to fall partially into the default zone. Since the ratings of most corporate bonds issues are equal to the sovereign rating, the latter directly mirrors the high reliability of Kazakhstan’s securities.
The third stability factor is the reliability and the large size of the issuing companies themselves. The fact that the vast majority of bonds traded on KASE belongs to the national companies, including large industrial and financial corporations, in itself guarantees the stability of this sector. However, to provide stronger grounds for this statement, a brief analysis might be necessary of the financial indexes of major Kazakh bond issuers (Table 3). The large scale of business of these entities allows them to be treated as trustworthy borrowers. Their operation features large profit volumes, which is an important precondition for bonds servicing, and large amounts of capital of their own, including a high book value of their assets. Bond issues by these companies are relatively small, as compared to their key financial indices, and this suggests that these borrowers are unlikely to face any difficulties in paying the coupon or the principal.
Over the 2nd half of 2000, the average profitability of corporate bonds dropped from 12.3% to 11%. This downward trend continued in 2001, during the first five months, resulting in an average coupon rate of 10.4%. Nevertheless, a comparison of profitability of Kazakh corporate bonds with that of other investment options comes out in favour of the former, which suffices to keep them fairly attractive. As was mentioned above, PAMCs, having been set strict limitations in respect of the choice of investment alternatives, are the main buyers of bonds. Other instruments allowed for this category of investors, such as public securities and bank deposits, are even less profitable. As an option, pension funds may invest in foreign bonds rating not lower than AA, but the profitability of these securities is about half that of Kazakh corporate bonds (Table 4).
It should be noted that investors have a means of improving the profitability of corporate bonds through trading on the stock exchange, which represents an important advantage over any other investment option (e.g. bank deposits or foreign securities not traded domestically). An example of rigging the profitability of bonds by trading on KASE is shown in Figure 8.
Thus, after the first few years of the history of corporate bonds in Kazakhstan, it can be concluded that these securities bring numerous benefits to all the parties involved, and have a tremendous influence on the country’s financial and investment sector. An analysis of the current state of the bonds market confirms this conclusion.
The bonds market in 2001
In 2000, the capitalisation of the Kazakh corporate bonds market jumped from $30 million to $180 million, and by 1 June 2001 it amounted to $280 million. Figure 9 illustrates the dynamics of the capitalisation of the bonds market.
During 1998-20011, 36 issues of non-public securities for a total of 38,137,609,000 tenge were registered, including 25 issues denominated in foreign currency (37,655,087,000 tenge, or $274,730,800). By 1 April 2001, there were 23 outstanding bonds issues totalling 37,054,029,000 tenge, including 21 issues denominated in foreign currency (36,945,029,000 tenge, or $269,680,000). In 2000, 13 bonds issues were listed on KASE, and during the first five months of 2001 another six issues were listed.
1As of 01.04.01. Source: Report of the National Commitee for Securities of the Republic of Kazakhstan, for the 1st quarter of 2001.
The structure of the Kazakh corporate bonds market has the following characteristics. The maturity terms of bonds traded at present vary from 1 to 8 years. Most bonds listed on KASE (16 issues out of 19) are in the «?» category, a proportion which reflects the high degree of stability of the Kazakh bonds market in general, since these issue account for more than 90% of the total pool of bonds. The high reliability of corporate bonds also ensues from the issuers’ structure (Table 5), dominated by the largest Kazakh banks and industrial corporations (73%).
The market in corporate bonds features a high degree of organisation, with nearly 99% of bonds being listed and traded on KASE. Corporate bonds are playing an increasingly important role in stock exchange trading. Thus, in 2000, KASE’s most actively traded instruments included the bonds of the Halyk Savings Bank of Kazakhstan (1,306,925,500 tenge, or 9.4% of the total secondary market trade volume), Kaztransoil (1,027,843,900 tenge, or 7,4%, respectively), Kazakhstan Temir Zholy (699,672,500 tenge, or 5%), Kazakhoil (416,734,600 tenge, or 3%). The trend towards a greater proportion of corporate bonds on the Kazakh stock market persisted in 2001. In the first quarter of 2001, these bonds accounted for 50.1% (3,061,093,600 tenge) of KASE’s trade in all non-public securities; in other words, bonds took a decisive lead in the domestic stock market. In the light of the above dynamics, the future for corporate bonds in Kazakhstan appears very promising.
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