ABSTRACT
The study focuses on the development of government bond market in Nigeria. It explores the history, structure, performance and key issues related to the development of bond market with the broader context of domestic, regional and global bond market development. The Nigeria government bond market provides valuable lessons for other emerging market economies also seeking to build bond market. The sophistication of the local bond market is not enough to make it appealing to foreign borrowers. Market development demands an enabling market infrastructure and a background of macro-economic stability, diversified market participants, an appropriate regulatory and supervision environment.
TABLE OF CONTENTS
Page
Title Page……………………………………………………………………………………i
Certification………………………………………………………………………………….ii
Approval Page………………………………………………………………………………iii
Dedication…………………………………………………………………………………..iv
Acknowledgement……………………………………………………………………..v
Abstract……………………………………………………………………………………..vi
Table Of Contents………………………………………………………………..vii-x
List of Tables…………………………………………………………………………………xi
List of Figures………………………………………………………………………………xii
CHAPTER ONE: INTRODUCTION
1.1. Background of Study………………………………………………………1-6
1.2. Objective of the Study……………………………………………………………..6-7
1.3. Scope of the Study…………………………………………………………..7
1.4. Limitations of the Study…………………………………………………….7
1.5. Significance of the Study…………………………………………..7-8
CHAPTER TWO: LITERATURE REVIEW
2.1. Introduction………………………………………………………………10
2.2. The Development of Bond Markets in Emerging Markets………….10
2.2.1. Introduction…………………………………………………………10
2.2.2. Rationale for Developing a Domestic Bond Market……..11
2.2.2.1.Introduction ………………………………………11
2.2.2.2.An Alternative Source of Domestic Debt Finance……….11-12
2.2.2.3.Lower Cost of Capital…………………………………12-13
2.2.2.4.Broadening of Capital Markets………………………..13
2.2.2.5.Efficient Pricing of Credit Risks…………………..13-14
2.2.2.6.Promotion of Financial Stability……………………14-15
2.2.3. Critical Success Factors…………………………………………………15
2.2.3.1.Introduction…………………………………………….15-17
2.2.3.2.The Political Situation…………………………………………..17
2.2.3.3.The Macro Economic Situation………………………..17-18
2.2.3.4.Supervision and Regulation…………………………………………18-20
2.2.4. Other Bonds Markets……………………………………………20
2.2.4.1.Introduction…………………………………………20-21
2.2.4.2.Asia…………………………………………………………………………….21-22
2.2.4.3.Europe………………………………………………………………………….22-24
2.2.4.4.The United States……………………………………………………24-26
2.2.4.5.African Bond Markets………………………………………..26
2.3. Summary…………………………………………………………………………..26
CHAPTER THREE: RESEARCH METHODOLOGY
3.1. Research Design………………………………………………………………….29
3.2. Nature and Sources of Data………………………29
3.3. Population and Sample Size…………………………….29-30
3.4. Techniques for Analysis………………………………………30
CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS
4.1. Introduction……………………………………………………………………..32
4.2. Size and Performance of the Nigeria Bond Market…33-37
4.3. Listing……………………………………………………………………………38
4.4. Enabling Legislation………………………………………………38-39
4.5. Basic Framework to Analyze and Evaluate the Nigeria Bond Market………39-40
4.5.1. Nigeria Bond Market Analysis and Interpretation…41
4.5.2. Stable Macro Economic Policies…………………………………….41-43
4.5.3. Stable Political Environment………………………………………43
4.5.4. Robust Legal Environment ………..43
4.5.5. Market Infrastructure……………………………………..43-44
4.5.6. Diversified Market Participants……………………44
4.5.6.1.Issuers…………………………………………………………………………..45
4.5.6.2.Investors…………………………………………………………………….45-47
4.6. Conclusion………………………………………………………………………47
CHAPTER FIVE: CONCLUSION AND RECOMMENDATIONS
5.1. Summary of Conclusions…………………………………………………..49-50
5.2. Lessons and Challenges for the Rest of Africa……51-52
5.3. Recommendations……………………………………………………………..52
Bibliography………………………………………………………………………..53-55
LIST OF TABLES
Table 1.1: Transformation of the Domestic Debt Stock by Instruments – Dec.31 2002 Compared to Dec.2009.
Table 1.2: Progression of the Tenor Elongation.
Table 2.1: Transformation of the Domestic Debt Stock Outstanding by Holder Type – Dec. 31, Compared to Dec. 31, 2009.
Table 2.2: Domestic Debt Growth Trends from 2004-2009.
Table 2.3: FGN Bond Primary Market Issuance 2003-2009.
Table 2.3.1: Domestic Debt Issuance by Tenor, 2009.
Table 3.1: FGN Bonds Secondary Market Trades (OTC), 2006-2009.
LIST OF FIGURES
Fig. 1: Framework for Assessing Municipal Bond Development (Leigland Framework).
Fig. 2: Framework for Assessing the Nigeria Bond Market’s Success.
Fig. 3: Analysis of the 6th FGN Bonds 2009 Allotment.
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF STUDY
The current administration’s commitment to rebuilding Nigeria’s dilapidated infrastructure as a catalyst for economic development has brought to the fore the need for a functional bond market given the developmental needs of the economy. The recent period of economy growth witnessed in Nigeria can only be sustained with continuous investment in infrastructure and the expansion of industrial output. The dearth of adequate financing has been identified as one key factor inhabiting this much needed investment in critical infrastructure such as down and mid stream petroleum distribution, telecommunication and transportation. Additionally, substantial long term financing would be required to rejuvenate Nigeria ailing power sector, it comatose refineries and the provision of socio-economic development in education and healthcare. Moreover, recent effort by the FGN to diversify the economic and make it more market driven means that funds would also be needed to expand existing facilities to meet the increased demand expected of a more efficient economy over the long term.
The Bond Market remains a fundamental financial market as risk pricing and investment valuation models rely on its data. While a functional domestic bond market is necessary for capital investment, monetary authorities also use bonds to define the yield curve and to ensure stability of short-term rates. An active sovereign prevents the economy from overheating as it allows large temporary overflows from the money market. The Bond Market therefore plays such a vital role in ensuring the health of the economy that the monetary authorities must be concerned with its structure and operation.
Nigerian Bond market is principally regulated by the ISA and the Rules and Regulations of the Nigerian Security and Exchange Commission (SEC). Although the Nigerian Sovereign Bonds have been in existence since the 1970s, but was said to be inactive. Government issued paper was very short-term and limited in scale. Treasury bills had maturities of 91 days and below and this created inconsistencies and irregularities in the federal government’s borrowing costs. The DMO, in a bid to restructure the Federal Government of Nigeria’s deficit funding from shorter to longer tenured borrowing instruments, improve and lengthen the yield curve in the domestic money markets, and to encourage long-term savings, introduced the sale of Federal Government of Nigeria bonds in October 2003, with the launching of four Federal Government bonds of maturities ranging from three years to ten years. The bonds were sold to investors through all licensed banks and discount houses in the country. However, most of the investors adopted a “hold to maturity” approach and therefore little or no secondary trades were carried out.
The DMO extensively restructured Nigeria’s domestic debt portfolio. In 2005, it commenced a textbook bond market development programme. This began with the initial issuance of 2 and 3 year bonds for which there was appetite, and gradually and predictably increased to issues of 5, 7, 10 and now 20 year bonds. However, the regular monthly issuance of the federal government bonds of increasing tenor generates a sovereign yield curve which serves as a benchmark for pricing other securities, including corporate bonds. This is a very powerful strategy to support growth by generating long term funding sources for government financed development projects such as infrastructure, but more importantly, will help to realize the potential of Nigeria’s vibrant private sector to create wealth and jobs by opening this source of domestic funding.
In December 2004, the Nigerian domestic debt stock had an outstanding amount of N1, 370.32 billion, compared to the N1,329.72 billion as at December 2003. This figure had an increase of N40.63 billion or 3.1 percent over the previous year’s figure. This however, was the lowest annual growth in the domestic debt stock for eight years(DMO 2009).
This increase of N40.63 billion in the domestic debt stock was made up of new issues of Treasury Bills valued at N46.52 billion, which was partly offset by repayments of Treasury Bonds and FGN Development Stocks valued at N5.67 billion and N0.22 billion respectively.
As at the previous year (2003), the Treasury Bills remained the dominant instrument, accounting for N871.57 billion or 64 percent of the total domestic debt stock. The balance of the total domestic debt stock was made up of Treasury bond (N424.94 billion or 31 percent), Federal Republic of Nigeria Government Development Stock (N1.25 billion or 0.1 percent) and the first FGN Bonds (N72.56 billion or 5.3 percent).
In the year 2004, the DMO made plans to build on the success of the first FGN Bonds floatation that were first issued in 2003. The DMO embarked on the arrangements to commence the issuance of bonds on a regular basis in small tranches that market could accommodate.
The DMO commenced the smoothening and restructuring of the Treasury Bills in 2004. The restructuring entailed extending the maturities of the existing Treasury Bills by issuing tenors of 6, 12, 24, and 36 months, to refinance part of the existing 91-day Treasury Bills.
The 2005 bonds issuance programme which had a floatation of N140 billion over the period July to December 2005, had the objectives of restructuring the existing stick of Nigerian Treasury Bills into longer-tenured bonds, and to help sustain the momentum of reviving, deepening and developing the Nigerian capital market (DMO, 2005).
The debt deal in 2005 not only removed a significant financial burden from the government, allowing it to spend its resources on public service delivery and social sectors, but it enabled the DMO to refocus its energy on the core business of public debt management – “establishing and executing a strategy to manage the government’s debt in order to raise the required amount of funding, pursue its cost and risk objectives, and to meet any other public debt management goals the government may have set, such as developing and maintaining an efficient and liquid market for government securities” (IMF and World Bank, 2002).
The next landmark in the development of the bond market occurred in August 2006, when a primary dealership/market maker network was established. The Primary Dealers/Market Markers (PDMMs) are the only institutions authorized to deal directly with the DMO in bond auctions. The establishment of this system was to facilitate the emergence of a liquid and vibrant secondary market for government securities, in line with global best practices (DMO 2006).
Prior to the establishment of the of the system, DMO requested for expressions of interest (EOI) to the PDMMs in the FGN Bonds from financial institutions, of which a total of thirty-two (32) EOIs were received (DMO 2006).
The purpose of the PDMM system is in two-fold:
- To ensure the total take up at primary auctions of government bonds.
- To provide liquidity in the secondary bond market.
Apart from underwriting every bond issue, the PDMMs, are also required to make two-way price quotes on the bonds to their customers and other PDMMs in all market conditions upon demand. This means there has been viable and vibrant secondary market trading in FGN bonds issued by the DMO since August 2006.
The strategy for the development of Nigeria’s bond market from 2008-2012 is organized on a medium term basis with an annual securities issuance work plan. In developing this work plan, the Federal Government conducts wide consultations with market participants through regular monthly meetings held with Primary Dealer Market Makers (PDMMs), usually before each FGN Bond auctions. (DMO, 2008).
Bond issuance in 2008-2012 will continue to aim at developing the bond market and creating a benchmark for the issuance of other instruments. This will be achieved through the issuance of long-tenured instruments. It also aim at providing low cost funding for the FGN, subject to the control of risks within acceptable limits, and developing the market for long-term debt instruments, thereby creating a benchmark yield curve for other financial instrument in Nigeria.
The Work Plan for the bond issuance programme in 2008-2012 will include advertisement of Offer Circulars, conduct of auctions, post allotment activities and development of indicators for domestic debt sustainability.
The 2008-2012 Bond Issuance will include the following features:
- Following the continued sophistication of the appetite of the market, a variety of instruments such as floating rate and index-linked securities may be introduced;
- With growing sophistication and capacity in the market and also in order to optimally allocate government resources, the multiple pricing auction system may be introduced;
- The FGN Bonds auctions, which are presently conducted monthly, may be made more frequent as demand for the bonds continues to soar, particularly with limitations on re-openings; and
- The submission of bids will be done on the day and within a specified timeline or duration while settlement takes place on T+2.
- The restructuring of short-term debt instruments to long-term will continue until the ratio of 25:75 short-term to long-term debt ratio is achieved. (DMO, 2008).
The curve of tenors on debt instruments has increased sharply and impressively in the six years since the launch of the Access Bank government bond index. Today, the government has issued bonds with a 20 year tenor. This reflects the growing confidence in the market’s capacity to absorb Government bonds and in the sophistication of the instrument to serve as a key conduit for state funding. While investors’ search for a stable asset class has proved a strong catalyst for the market’s expansion, investors are attracted to government bonds for some technical reasons, such as their tax exemption status.
The corporate bond market is also developing, and this may be attributable to the need for inexpensive long-term debt capital by companies coupled with investors’ apathy to equity investments, following the impact of the global economic recession on the values of stocks. Companies including Guaranty Trust Bank Plc, UACN property Development Company Plc, United Bank for Africa Plc and Flour Mills of Nigeria Plc have successfully issued bonds in the Nigeria capital market while a number of other corporate bond application are before the Nigerian SEC.
