News Column

The Debut Sovereign Eurobond - the Issues That Need Attention

June 2, 2014

Karen Kandie

The next few weeks will see Kenya issue its debut Eurobond, finally joining its Sub-Saharan peers as a player in the international arena of Sovereign Eurobond market.

Other countries that have already made debut issues include Ghana, Rwanda, Angola, Nigeria, Gabon, Seychelles, Zambia, Cote d'Ivoire, Senegal, Namibia and Nigeria. Looking at the list of Sub-Saharan issues, the issuance by the largest economy in East Africa is long overdue, and it is just time so to speak.

Issuing a Eurobond is simply raising money or borrowing directly from lenders, thereby by-passing financial intermediaries such as banks, in a currency other than the home currency.

The Eurobond may be denominated in dollars, euro, yen, pounds or any other currency other than the domestic currency, depending on the requirements of the issuer. The most common denominations are dollar and euro.

While South Africa has issued Eurobonds for a number of years, Ghana became the front-runner Sub-Saharan country to issue a Eurobond of $750m in 2007 that was oversubscribed four times.

This started what has been referred by some economists as a borrowing spree by African Sovereigns with more than 10 countries having made their maiden issue so far.

Kenya has one of the most developed capital and bond markets in Africa with the government being a regular issuer at the Nairobi Securities Exchange for both Treasury Bills and Bonds. Perhaps the freezing of donor funds in the 1990s against the Moi regime is to thank for the vibrancy of our market. For when the donors froze all foreign aid, the government was left with no option but to turn to domestic borrowing.

The government became a regular issuer, providing a benchmark and paving way for corporate issuers and the effect of this was a deepening of the bond market. So when it comes to matters "bond issuance" Kenya is at home with both expertise and experience.

And yet, a Eurobond issuance offers different dynamics from a domestic bond by virtue of its international nature and its being denominated in foreign currency.

On the plus side, it gives the country the opportunity to diversify from traditional sources of foreign financing, such as concessional loans and foreign direct investment.

Let the truth be told though, sovereign bonds are much more expensive than concessional funds by far. For instance, average coupon rate for the first 10 African countries to issue sovereign bonds was 6.2 per cent with an average maturity of 11.2 years.

Compare this with their foreign debt that carried an average interest rate of 1.6 per cent with a maturity of 28.7 years! We are speaking of an entirely different ball game here, aren't we? Yes, we definitely are no doubt about that.

And then there is the other issue of sovereign credit rating. At a credit rating of B+ (Standard & Poors) Kenya is three notches below investment grade, and is categorised as "speculative grade" of investment.

This is more or less like the rest of the African peers except Namibia, and this attracts significant risk premiums. The so called "vulture funds" love these types of investments.

Hopefully a conservative interest rate estimate for the Kenya sovereign Eurobond may come in the region of 6-8 per cent going by the country's credit rating and continuing positive fundamentals holding.

Nevertheless, Sovereign Eurobonds continue to attract immense interest within Africa notwithstanding the associated costs. For one, African leaders are simply tired of being micromanaged with this and that condition as prerequisites for concessional loans.

They yearn to engage as equal partners and to be treated with mutual respect in the international arena. True to speak, begging is never a virtue and our leaders are tired of bowl in hand year in year out. Whether our governance structures are adequate to protect the mwananchi from the excesses of the leaders is open to question.

Two, the concessional loans are no longer adequate to meet the increasing financing needs, especially the need for funding infrastructure projects - such as electricity generation, roads, airports, railways - and there is therefore a dire need for alternative sources of funding.

This is more so as the more advanced economies experience slow economic growth and they can no longer sustain concessional loans and aid. The Eurobonds will fill this financing gap.

The good news is, some African countries such as Zambia have managed to raise funds at interest rates lower than those of some of troubled Eurozone countries in spite of having lower credit ratings.

Nevertheless, if foreign debt has been a burden in the past, the future with Sovereign Bond is going to be even more burdensome. This calls for different rules of engagement when it comes to managing this nature of debt, it simply cannot be business as usual.

The seemingly late entrance of Kenya into the international Eurobond market, gives us an opportunity to learn from the other issuers, including lessons learnt from the near collapse of the Eurozone economies.

One, a comprehensive, risk sensitive debt management structure is a must have. One of the risks of a bond issue is liquidity to meet bullet payments at maturity.

Unless this is well managed, we could easily find ourselves going for another bond issue to meet bond repayment obligations, setting up a spiral of never-ending bond issuance that adds little value to the country.

In fact even in our very own domestic market, some corporate issuers have had to come to the market every time a previous issue reaches its maturity, to finance its retirement.

Now, the only people who will not complain about this nature of arrangement are the bond arrangers and myriad of advisors, who will reap their fees in each issue cycle.

Two, a debut issue has to be well planed, with clear use of the proceeds that will not compromise the creditworthiness of the country. Generally speaking, sovereign bond proceeds should fund key infrastructure projects that have a 'multiplier effect' on the economy and high investment returns.

Consequently, strategic considerations have to be made on the size, maturity, choice of floating versus fixed rate and currency of denomination.

Thirdly, the balance sheet will require dynamic management to avoid the accumulation of negative implications arising from currency and maturity mismatches.

For instance if the Kenya Shilling depreciates significantly in the life of the bond, we face exchange risk as more Shillings will be required to service the debt. If the bond matures earlier than the funded projects, we will be forced to divert resources from other sources to service the debt.

Fourthly, macroeconomic policies and governance structures need to be continuously strengthened to foster positive economic growth and achieve macroeconomic stability in the medium to long term.

Fifth and equally important considerations include the choice of advisors; be they arrangers, placing agents, legal advisors and, if need be, underwriters.

These have to be well chosen and managed, in view of the conflicts of interest inherent in their participation in such transactions to ensure the interests of the country are protected.

The jurisdiction of issuance has to be chosen to give the issue the highest possible visibility and greatest chance of successful subscription. Now is the time for Kenya.

Karen Kandie is a financial consultant and a PhD student in Finance at Catholic University of Eastern Africa


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Source: AllAfrica


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