Developing corporate debt market
When the Governor of State Bank of Pakistan said at a conference last week that it was critical to move from purely banking loans market to a vibrant debt and capital market, he was only stating the obvious.
The size of the listed corporate debt market at less than one per cent of GDP pales in the face of most countries, where the government —as the largest issuer of debt securities — provides the volume required for a liquid secondary market.
The same day, the Securities and Exchange Commission of Pakistan (SECP) approved regulations governing exchange traded funds (ETFs) for the Karachi Stock Exchange.
The stock market, predominantly engaged with trading in just the equities, the regulators have been aware of the savers’ thirst for more investment avenues. And the need for a corporate debt market has always stood at the top of corporate regulators’ agenda. Yet, the lukewarm efforts have scarcely met with success. It is now that the two main regulators—of the corporate and the banking sectors—have decided to join hands to push forward in bulldozing the barriers that bar the development of corporate debt.
The SBP Governor disclosed that the central bank and the SECP had set up a ‘joint task force’ to draft framework for establishing a vibrant corporate debt market. The task force would develop guidelines for registration of corporate debt while collaborating with credit rating agencies to streamline the issuer and instrument rating process.
But it is precisely the credit rating agencies that less transparent corporates won’t want to face. A senior banker says that most closely family- owned corporates do not present the true financial figures and instead prefer to cook books, to avoid taxation.
“Transparency and full disclosure are necessary in the financial statements for securing a high rating from the rating agencies so that their instruments of debt floated at the market receives warm welcome,” he said. Corporates are, however, reluctant to approach the bond market because of the disclosure requirements and their preference to minimum possible documentation.
“The corporate culture in the country must change, so that the family-owned businesses are not constrained from future growth,” says the banker. He points out that only a few companies had issued Term Finance Certificates (TFCs) at the stock market and most of them were hugely discounted, which discouraged more corporates to enter the debt market.
Former chairman and President of National Bank of Pakistan Ali Raza told Dawn that a joint effort by the SECP-SBP in development of corporate debt market was a big step in the right direction. He agreed that a vibrant corporate debt market would not only facilitate the provision of diversified investment avenues but would also help improve the savings. It would enable borrowers to raise efficiently priced financing for crucial infrastructure projects. Corporate debt market was important as a source of long term financing, and also offered competition to banks.
Most corporates find it cheaper and easier to mobilise funds from the banking sector at say 13-14 per cent against collaterals, than to go to the market with debt instruments, he said. Ali Raza stressed that it was in their own interest that corporates developed alternative avenues of financing and shed overwhelming dependence on bank borrowings.
As is seen in high-income countries and even those in the region, there should be a balance between debt and equity in financing of projects, he said. The figure of aggregate country debt looms large, but almost 95 per cent of it is government debt.
Corporate debt instruments are few and those are also scarcely traded, the NBP former chief pointed out.
The SBP Governor says in an uncertain macroeconomic environment, banks were reluctant to advance long-term loans to the private sector and often resort to short-term lending. Without a vibrant corporate debt market, firms find it difficult to raise funding for long-term investment projects. Debt markets would allow channeling funds directly from savers to the private sector, providing savers with an alternative to bank deposits.
The risk-free nature of investment in various National Saving Schemes (NSS), where adhoc rate adjustment and the ability to redeem prematurely, dominates any corporate bond in the market. “The private sector, therefore, has to issue bonds that carry a higher interest rate than NSS rates to compensate for the risk of default that the private sector carries, but in doing so, the issuance of corporate sector debt is made more expensive,” the banking regulator said.
Sayem Ali, Country Economist at Standard Chartered Bank Pakistan ( SCB), was scarcely impressed by the proposed initiative of joint task force to develop corporate debt market. He thought that the fire to light up the corporate bond market was fuelled by the need to comply with the funding programme of international agencies for development of the country’s capital market.
He said that in Pakistan there were too many debt instruments of the same tenure, say three-year or so, which included Sukkuk, PIBs, Bonds and NSS. The economist recommended for a fewer or even a single instrument for same tenure, which would help reduce cost of borrowing, enhance liquidity and assist in price discovery.
Secondly, Sayem Ali referred to a lack of developed mortgage market, which would help corporates to leverage their assets for investing in bond market. Pakistan mortgage market was 0.8 per cent of GDP, while it was cent per cent in US and 10 per cent in most emerging markets, Sayem Ali observed.
In respect of luring investors to the debt market, a meeting of the Board of Directors of Karachi Stock Exchange held on Nov 29 last year had decided to grant approval in principle for the development of trading platform and system for Government Securities– Treasury Bills (T-Bills) and Pakistan Investment Bonds (PIBs), through the bourse. Some stock brokers expressed enthusiasm over the opening up of a window to an alternative avenue of investment and a brand new market product. But the cynics alluded to an already present Over-the-Counter (OTC) market at the KSE which invested in Government Securities, the counter was used mainly by banks, financial institutions and some wealthy individuals. “Foreign investors scarcely stepped into the OTC market for lack of absolute transparency in dealings,” said a detractor. He argued that in most developed markets, the size of bond markets were five and even ten times the equity market. After numerous false starts, it has to be seen if the SECP-KSE joint task force for development of corporate debt market, is able to push it hard on the runway to a smooth and safe takeoff.