1. 9 TH FORUM ON AFRICAN PUBLIC DEBT MANAGEMENT AND BOND MARKETS “WHAT ARE THE LARGEST OBSTACLES IN DEVELOPING A LIQUID LCBM? WHAT IS THE MOST IMPORTANT CONTRIBUTING ROLE OF PUBLIC DEBT MANAGERS?” Evans Osano Johannesburg 15 June 2015

2. 2 Outline 1. Market Liquidity 1.Definition 2.Benefits 3.Influences on liquidity 4.Requirements 2. Benchmark issues 1. Features of benchmark securities 2. Benchmark building strategy 3. Devices to increase liquidity 3. Managing Refinancing Risks 1.Reduction in amount outstanding 2.Cash Cushion with central bank 3. Active cash management

3. Market Liquidity: Definition 3 Ability to buy or sell a security …for a large amount …fast …at little cost …with limited impact on market prices Liquidity has three important dimensions 1. Market depth - the size of trade required to change prices by a given amount. Indicator: ratio of turnover during a period to the average outstanding stock. 2. “Tightness” – cost of turning around a position over short period. Indicator: width of bid/offer spreads on trades. 3. Resilience - speed with which prices recover from a random, uninformative shock.

4. 4 Market Liquidity - Benefits Benefits Investors are willing to pay a premium for liquid securities the issuer’s cost of funding decreases Issuers can issue longer term maturities Liquidity creates a virtuous circle for both investors and issuers as it increases price transparency Traders – offers trading opportunities for intermediaries

5. Influences on Liquidity Source: Malcolm Knight, “Promoting Liquidity in Domestic Bond Markets”, BIS, May 2006 5

6. 6 Market Liquidity - Requirements Requirements for a liquid market sound macro-economics orderly market large amount outstanding diversified investor base price transparency (pre and post) In practice, liquidity is often supported by market makers

7. Outstanding Treasury Bond Issues 7 High number of bond issues fragments markets – inhibits liquidity and yield curve development Source: DSE, FMDQ, NSE, NTSA Government Bonds Outstanding

8. Government Debt Markets - Liquidity 8 Data for Uganda includes both T-bills and T-bonds. Data years: Kenya, Tanzania and Nigeria 2014; Uganda 2013-14; Rwanda and South Africa 2013 (no data for Burundi). Source: NSE, CBK, RSE, DSE, BoU, FMDQ, Nigeria DMO, JSE, SARB. Secondary Market Government Bond Turnover Ratios, 2013-2014

9. Building Benchmark Bonds 9

10. 10 Benchmark Issues - Features 1. Standard against which the yield of other securities can be measured - primary market issues - secondary market trading - derivatives markets - valuation of investment portfolios Distinct Features: 1. Widely traded bond 2. Large amount outstanding => fungible security 3. Balanced distribution 4. Generally a bond currently being issued ( « on the run ») 1. New issues openings at every placement 2. Competing issuance policies between two large issuers (e.g. MoF and CB) 3. Single purpose issues to match specific cash-flows (e.g. infrastructure projects) 4. Specific demand driven design of issues Fragmentation results in: 1. Illiquid markets 2. Higher and more volatile funding costs for the Government 3. Costlier and riskier portfolios for market Benchmarks Fragmentation

11. Benchmark Building Strategy – Key features Dynamics of Benchmark Building Benchmark building implies an active strategy with both issuance policy and outstanding issues Building the “benchmark yield curve” is a gradual process of lengthening maturities, following the consolidation of shorter terms Build benchmark size quickly Encourage early trading Use of reopening Develop cash management Launch regular benchmarks Regular price points on the yield curve for quotation Ability to issue long / short coupon instruments Manage refinancing risk Organize redemptions to avoid bunching Use liability management operations

12. 12 Benchmark Issues – Devices to increase liquidity ObjectiveProcedures Higher Outstanding volume (lower fragmentation) Re-openings Buy backs Exchanges Wider distribution among potential traders Sufficient size for benchmark Wholesale primary market participants Quantity limits for large auction participants Market Makers Program Devices used to increase liquidity of benchmarks

13. 13 Benchmarks – Balancing Act 1. Raises a refinancing risk at maturity 2. Risk is proportionate to the size of the amount issued 1. Minimum amount needed to ensure liquidity (function of usual trades in mkt & type and number of holders) 2. Maximum amount of refinancing risk that can be managed (function of usual amount bid in auctions and possible reduction in size prior to refinancing) 3. Time (maturity date) – nominal amount looks smaller in future

14. 14 Managing Refinancing Risks Reduce amount outstanding Liability management operations Target issues with a short remaining life to maturity Liquidity cushion with Central Bank – function of: Central bank’s constraints Level of remuneration paid Degree of comfort sought by debt management office Active cash management Borrow and redeposit Function of degree of development of money market

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