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SOUTH AFRICA IN THE GLOBAL MARKETPLACEJanuary 2016

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South Africa in the Global Marketplace | January 2016 | 1

SOUTH AFRICA IN THE GLOBAL MARKETPLACE

2 FOREWORD Recovery demands we hold the NDP’s course

3 ECONOMIC OVERVIEW Battling against the elements

7 NATIONAL TREASURY INTERVIEW Fighting back against a world of worries

11 INTERNATIONAL BONDS Rarity value adds appeal to global deals

13 SOVEREIGN AND SUB-SOVEREIGN ROUNDTABLE South Africa keeps careful eye on capital markets access

22 DOMESTIC BOND MARKET Domestic bond market keeps South Africa on top

24 CORPORATE ISSUERS ROUNDTABLE Companies face up to tricky markets and global pressures

33 BANKING SYSTEM Solid banks well placed to withstand economic challenges

35 A FINANCIAL HUB FOR SUB-SAHARAN AFRICA Jo’burg: bags of potential, needs support

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Note: this report was written and edited before Moody’s changed South Africa’s rating outlook to negative and affirmed its Baa2 rating on December 16.

001 Contents SA.indd 1 16/12/2015 18:22

2 | January 2016 | South Africa in the Global Marketplace

FOREWORD

THE WORLD’S economy is yet to recover fully from the global financial crisis of 2008. Global recovery is uneven, plagued by weak commodity prices and geopolitical tensions. Growth in the United States’ economy has gained momentum, but the uncertainty around the US Federal Reserve’s policy path has stoked volatility in financial markets. The slowdown in emerging economies is particularly concerning, with China’s economic deceleration having far-reaching consequences for South Africa. Countries have to get used to a ‘new normal’ of lower economic growth and South Africa is no exception.

The government is alive to South Africa’s economic challenges and is taking several crucial steps to address them. Structural reforms to address the bottlenecks which have constrained growth are being implemented. There have been improvements in energy security due to a variety of measures we took, which include a fiscal package to assist Eskom. The National Development Plan (NDP) remains the cornerstone of government policy initiatives that are aimed at lifting economic growth to a level that will enable us to address poverty, unemployment and inequality.

Over the past 20 years, South African authorities have taken great care in ensuring that a credible capital market is built. The government is now able to use the domestic bond market as its main source of financing, and whilst it is the single largest issuer, there is active participation by state owned companies, financial

institutions and other corporate issuers. The domestic bond market ranks amongst the deepest and most liquid amongst South Africa’s emerging market peers. This deep liquidity, together with a free-floating exchange rate, has acted as a shock absorber in times of market volatility. It has also allowed for record high non-resident participation in the local market.

South Africa has built a reputation of sound economic and budget management. Notwithstanding the two shocks to the fiscal framework that occurred in 2015, our commitment to sound public finance management remains. Our approach to fiscal policy is based on three principles — namely counter-cyclicality, intergenerational equity and debt sustainability — with debt sustainability being the main focus.

The challenges we face intensify the need to accelerate the implementation of the NDP, particularly those initiatives that will stimulate economic growth, broaden employment and economic opportunities; and progressively address poverty and inequality. These challenges propel us to stay the course of prudency, recognising that this is the way we can sustain and build further on the gains we have made since the dawn of democracy. Sound fiscal management is the foundation upon which we can build further progress. As a country, we cannot claim true sovereignty without macroeconomic stability and robust public finances. These are essential in enabling us to accomplish the goals of the NDP.

Recovery demands we hold the NDP’s course

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ECONOMIC OVERVIEW

IT IS HARD to find an economist with a positive view on South Afri-ca. Long-standing home grown problems have combined with unstoppable external shocks to cre-ate an environment with very little room for short-term optimism.

“We are at a particularly diffi-cult juncture,” says Peter Worthing-ton, senior economist at Barclays in Johannesburg. “There are a number of domestic and international fac-tors impacting on us negatively.”

Domestically, these vary from drought — “not much the govern-ment can do about that” — to elec-tricity shortages, “which are of our own making but cannot be fixed overnight”, says Worthington. One could add unemployment, twin def-icits and a moribund political envi-ronment to the list.

“Then globally, we are going into a brand new era,” Worthington says. “Nobody knows how coming out of quantitative easing in the world’s most important economy is going to play out. But we can say for sure that, combined with a China slow-down, it will not be good for com-modity prices and it will not be good for countries that have high financing requirements, which we do, and which are heavily reliant on commodity prices, which we are.”

The mood is best summed up when Goolam Ballim, chief econo-mist and global head of research at Standard Bank in Johannes-burg, is asked if there is any scope for a positive view on the South African economy. After a pause, he responds with a plaintive and almost painful: “No.”

Events are proving Ballim right: three years ago, at a time when a consensus held that South Afri-can growth would begin acceler-ating and keep a heady pace for years ahead, he suggested that the country was “in a state of peren-

nial malaise”, and would find itself locked on a low growth path of, at best, 2% a year. He described an economy that “is not recession-ary but zombie-like: no discernible accelerating pulse, but some level of forward momentum”.

Since then, his thesis has proven accurate, but with, if anything, greater vulnerability because of the subsequent slowdown in China and problems at home. He describes a “wilting political economy, with exceedingly low levels of business and consumer confidence translat-ing into halting spending and lim-ited new fixed investment.”

When GlobalCapital spoke to Ballim, Fitch had just downgraded the country to BBB- and S&P had cut its outlook to negative. “The rat-ing agencies have been damning since 2012,” he says. “But judicious.”

Powered downIndeed, Moody’s, seeing trouble ahead, downgraded South Africa in November 2014, and if anything things have turned out even worse

than the agency expected because of the unpredictable drought.

“That has exacerbated the slow-down, so the outcome in terms of growth is even weaker than we anticipated,” says Kristin Lindow, senior vice president in the sover-eign risk group at Moody’s.

There is a tendency to suggest that South Africa, as clearly the most developed country on the Afri-can continent, must be less exposed to the commodity price downturn than less developed peers. That might be true on a relative basis, but it does not mean South Africa isn’t suffering.

“South Africa is still very much dependent on commodities, and processed commodities, in terms of its export mix,” says Lindow.

Drought itself is a problem whose impact is difficult to quantify, since it is only now really taking hold and it is not clear how long it might last. Worthington says agricul-ture directly only constitutes 2.3% of South African GDP, but it has knock-on effects to numerous other

With foreign direct investment (FDI) commonly touching $20bn, a renewed focus on education and long overdue investment in the power sector, South Africa is clearly worth investing in. But there are plenty of challenges, not least the moribund domestic economy, electricity shortages, rising US rates, drought and a China slowdown. As a result, there will continue to be short term pain, but the outlook for the long term is brightening. Chris Wright reports.

South Africa battles against the elements

Thirsty work: although agriculture directly only constitutes 2.5% of GDP, the drought has knock-on effects to numerous other industries

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ECONOMIC OVERVIEW ECONOMIC OVERVIEW

industries and the economy more generally, through farm incomes, bank credit and trade balances.

It is significant that South Africa will this year become a net maize importer for the first time. The drought might also lead to wide-spread water shortages, with dams averaging 62% of capacity, though they have been far lower during two previous droughts in the 1980s and 1990s.

Electricity is unreliable, which helps nobody. “It is a constraint, because if businesses don’t know there will be an affordable and reli-able supply, they won’t attempt energy intensive projects,” says Worthington. “A lot of potential investment projects may simply be sitting on the sidelines because the cost-benefit analysis can’t be done.”

In fact, electricity is so much of a problem that it no longer just con-strains growth, but makes the very idea problematic.

“If we grow any quicker [than 1%], we run into electricity issues,” says Dennis Dykes, chief economist at Nedbank in Johannesburg.

Similarly, Ballim notes that the last few months have brought respite from frequent brownouts, “but admittedly that respite was forged out of a weak economy and low demand from heavy min-ing”. While this is clearly a double-edged sword, it has at least allowed national utility Eskom to maintain and stabilise power supply.

“It is damning that this comes as

a consequence of weak economic growth, but it is to be cherished that it provides the occasion for main-tenance and greater stability of the grid. If there’s an upswing, we will have a relatively more robust grid to build upon.”

Under pressureThen there are headwinds at the individual level. “The consumer is under a bit of pressure,” says Dykes. “Interest rates are going up, and what’s not commonly understood is that on new loan origination the spreads have increased.”

Before the financial crisis, mortgages might have been sold at prime minus 2%; now, prime plus 1.5% is more common. “So the same level of prime is actually hurting the consumer a bit more than it did in the prior years,” he notes.

Indebtedness, while not as high as some developed markets, is high in the context of recent South Afri-can history, with household debt to income ratios around 77%. “So if we have big interest rate increases, it will bite quite a bit.”

To Dykes, the biggest prob-lem is “the lack of employment generation. We saw a bounce back from the financial crisis to 2012-13, but subsequent to that it has been very flat.”

Furthermore, what bounce has taken place has been in public sec-tor employment. “On the private sector side, there has been no job creation for the last seven years,” he

says. That naturally impacts dispos-able income, consumer spending and ultimately industry.

At a policy level, Dykes believes “the government instinct is to become more interventionist and to try to do more things itself, where-as the actual solution is for it to withdraw”.

Electricity regulation, he says, is a case in point: with a few regulatory changes and offtake agreements, “things like co-generated electric-ity could be ramped up significant-ly and we’d be solving the energy problem in the short term, generat-ing fixed investment spending, with very little risk to the government. But there’s a concern about letting go.”

Despite that, renewable ener-gy has been a true success story of recent years, built on power pur-chase agreements. “It’s an example of what can happen if the regula-tory environment is conducive,” Dykes says.

Meanwhile, awaiting greater free-doms, the private sector is in most industries quite limited: “Baseload capacity building mode,” as Ballim puts it, “maintaining existing operations without any sense of risk taking.”

He highlights the mobile telephony industry as an example of how things can work where the private sector is left to unleash its capital and the government sticks to creating the right environment for it to thrive.

Johannesburg is one of the areas where the ANC could lose its majority

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ECONOMIC OVERVIEW ECONOMIC OVERVIEW

“Mobile telephony stands as the poster child of that healthy balance between the state in the regulatory fold, and private sector pursuing execution,” he says.Budgetary bright spotNevertheless, it’s not all bad news. The banking sector is in good shape, institutions are strong, and no other African state has a compa-rable financial market. Additional-ly, Lindow points to “an important improvement in the tax base and tax compliance”, improving pub-lic finances and leading to a budget deficit roughly in line with what Moody’s had expected even though economic growth has been below expectations.

Better still, South Africa budgets very conservatively on tax buoy-ancy.

“They were very explicit about that,” Lindow says. “They show a degree of budget transparency that earns South Africa the num-ber three ranking in the world in that respect.” By underpromising on the tax collection side, they have avoided disappointing market par-ticipants, and shown discipline in budgeting.

Noisy politicsNo discussion of the economy can ignore politics. South Africa is a vibrant democracy: it is now 21 years since its first true multiracial election in 1994, so a whole generation has now come through with the expecta-tion of being able to effect change at the ballot box.

“The political situation is very noisy in South Africa, increasingly so as the political framework matures,” Lindow says. The dominant African National Congress party is part of a tripartite alliance, and like all such things, it has fault lines. “It had com-mon goals at the time of democrat-ic transition, and continues to have common goals, but with very differ-ent opinions on how to get there,” says Lindow.

There are likely to be local, munici-pal elections in the second quarter of 2016, and these could be pivotal. Worthington believes they are “the most important elections South Africa has had since 1994. For the first time, significant metropolitan areas are up for play, in the sense that the ANC may not win a majority.”

Worthington cites Johannes-burg, Tshwane (where Pretoria is), Nelson Mandela Bay (the renamed Port Elizabeth constituency) and Ekurhuleni as places where the ANC could lose its majority.

“I am very curious to see what happens with the local govern-ment elections, and for the ANC, the stakes are very high. The met-ropolitan areas are the economic powerhouses of South Africa and therefore of vital interest to politi-cal parties.”

A poor showing by the ANC might have consequences at the national level. Dykes says: “From the national political perspective, the response if the ANC gets a severe wake-up call in the local elections could be positive — pull our socks up and get things moving before the general election — or negative, with it becoming even more interventionist.”

Surely a wake-up call has already been offered in the last general election, where the ANC saw signifi-cant slippage — especially in the Gauteng province, which includes Johannesburg.

Some believe the solution is a new president.

Certainly, among economists and fund managers, there is a sense that potential change is a plus.

“Healing the political economy would be the most seismic interven-tion we could have,” says Ballim, though he does feel that tentative positive steps have been made over

the last two years: spending nearly in line with budgets, compared to three previous years of fiscal over-reach. “This seems to signal the political establishment has begun to tentatively appreciate South Africa’s precarious financial position.”

Charles Robertson at Renaissance Capital shares the widespread outlook of South Africa having low GDP growth and a weak currency, but says “the good news is the pros-pect of political change — which you don’t have in Russia, Turkey or Brazil. So in terms of there being some potential shift in the coun-try’s direction, South Africa is a lit-tle bit stronger in EMEA than most of its peers.”

Robertson takes a slightly more positive view of policy than many who are in the country, perhaps because of the peers he compares South Africa to.

“It’s changed in the last five years. There is an improved focus on edu-cation, the wages of teachers are going up, and there is investment in electricity, which helps to explain the large current account deficit. These are shifts that will produce rewards on a five to 10 year view, but the market is impatient.”

From Tallinn to TehranCorruption remains a considera-ble challenge in South Africa. The latest Transparency International survey showed that four out of five South Africans believed corruption to be on the rise.

Renewable energy has been a true success story in South Africa

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ECONOMIC OVERVIEW

Robertson notes that South Afri-ca’s peer group, in per capita GDP terms, in the mid-1990s were coun-tries such as Poland and Estonia. Their corruption ratings are now “streets ahead” of South Africa he says, and so is the per capita GDP. Today, its contemporaries — on both corruption and per capita GDP — are Iran and Romania. “South Africa is not in a great place, if it is being compared to Iran,” he says.

Like any twin deficit — fiscal and current account — emerg-ing market, South Africa appears exposed to the US Federal Reserve raising rates, though the impact this will have is difficult to be sure about.

Lindow notes “it has relied on capital inflows to finance its current account deficit, and these are non-debt creating inflows. South Africa doesn’t have a very substantial external debt burden: it’s actually quite small, by emerging market standards. Its net external posi-tion is in deficit by less than 10% of GDP.”

Nevertheless, to avoid its already-pressured central bank reserves diminishing, it does need to main-tain capital inflows in order to fund the current account deficit. “With a negative investment climate in the country, and a general aversion to emerging markets, that is always a risk,” she says.

This time it’s differentThe positive view is that the bad news has long since been digested. “It’s different this time,” says Wor-thington. “We’ve already had pres-sure on the currency — we have a very flexible exchange regime — but we have not seen meltdown in the financial markets. We may see further pressure after a Fed liftoff, but I doubt it’s going to be a melt-down — so much is already priced in.”

Robertson is not quite so sure. “It’s particularly exposed because it’s the easiest currency to short if you want to short EM,” he says. “It’s the perfect proxy, and it is very easy to do. It’s also not expensive because interest rates are not par-ticularly high at around 6%.” Also, the rand’s fall is problematic for imports, though it has been positive for exports and the current account deficit.

That said, the same trend could spur FDI. “This rand-dollar rate is extremely competitive now,” says Robertson. “A billion dol-lars invested in South Africa a few years ago was worth something, but put in $700m today and it’s worth a lot more.” Perhaps BMW’s R6bn ($393m) investment to build its X3 model in Pretoria, announced in November, is a sign of this.

“There are two things happening that will change the story for South

Africa a little,” he says. “A better current account thanks to horribly weak GDP, and better foreign investment. Put the two together and the picture looks brighter.”

FDI is distinctive: unlike most emerging markets, South Africa has a very large domestic financial system so the financing of direct investment usually happens within it rather than cross-border.

“This is actually a very positive thing, but is not very well under-stood by financial markets,” says Lin-dow. “If investments needed to be financed by foreign banks, you would see the flows of finance coming in. But because they’re financed domes-tically, you don’t see the flows in the balance of payments. That doesn’t mean that FDI doesn’t exist; statistics show that FDI was equivalent to 40% of GDP at the end of 2014.”

And while net FDI figures are low, that’s just because there is a lot of outbound investment from South Africa too. Inflows commonly touch $20bn, says Robertson, “clearly sug-gesting that people do think South Africa is worth investing in”.

So a bleak outlook, but not hope-less. “The stable outlook suggests to us that we think the situation can be overcome,” says Lindow, “but there are considerable downside risks related to the growth story and the socio-economic problems that confront the country.” s

Grootvlei power station near Balfour, Mpumalanga province: electricity is so much of a problem that it no longer just constrains growth, it makes the very idea problematic

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NATIONAL TREASURY INTERVIEW

: South Africa faces a great many pressures both exter-nal (the China slowdown and commodity prices) and inter-nal (from the electricity supply to the drought), and economists tend to be predicting low GDP growth of around 1.5% in 2016. What reasons are there to be positive about the prospects for growth in South Africa?

National Treasury: Growth over the last few years has been con-strained by a number of interna-tional and domestic factors. The sluggish and unbalanced global recovery has delayed the increase in demand and trade while uncer-tainty around policy normalisation, particularly monetary policy in advanced economies, has increased volatility surrounding emerging markets.

To respond to global risks we require a resilient economy that is able to continue to attract much needed investment. The govern-ment has responded by main-taining the Budget 2015 decision to reduce the fiscal deficit while directing funds, in line with the National Development Plan, to infrastructure and social pro-grammes that will help unlock domestic investment, exports and jobs growth.

Domestic factors have concen-trated on the supply side, weigh-ing on confidence. These have included prolonged labour strikes, production stoppages related to repairs and maintenance, electric-ity constraints and increasing con-cerns around the political environ-ment.

Addressing these constraints will allow for faster real GDP growth. The government has committed to a number of reforms, including

short and long term, to do so. Short term reforms that have already started to have a positive impact include the active role of the Com-mission for Conciliation, Media-tion and Arbitration in settling wage disputes; the implementation of the five point electricity plan resulting in improved progress in stabilising electricity supply; and the adoption of the requirement to complete a socio-economic impact assessment of all proposed legisla-tion and regulation changes prior to them being passed, to improve policy co-ordination. The Depart-ment of Planning Monitoring and Evaluation is also taking steps to strengthen monitoring and evalua-tion across government.

In addition, the public sector remains committed to increasing economic infrastructure, evident in the R800bn capital expenditure spending planned for the Medi-um Term Expenditure Framework (MTEF), raising potential growth. The Ports Regulator of South Africa

has begun a 10 year programme to ensure tariffs better reflect the cost of using port assets such as berths and quay walls.

Outcomes from the Mining Phakisa project are expected to bode well for efforts to transform and optimise the contribution of the industry to the economic and social development of mining relat-ed communities and the country as a whole. It will enhance the indus-trialisation of the economy, raise skill intensity, create employment and support inclusive growth.

The Mining Phakisa is aimed at developing interventions that will meaningfully impact on the short and medium term challeng-es facing the mining cluster and put in place institutional mecha-nisms that will entrench collabo-ration between stakeholders. Five workstreams were put in place, with several initiatives formulat-ed under each stream, including: reviving investment and access to affordable and reliable infrastruc-

South Africa’s economy is under siege from a host of challenges both global and domestic — and many of them beyond the country’s control. How can a country thrive when dire unemployment is combined with electricity shortages and a worsening drought, and when everything from Chinese growth to commodity prices and vulnerability to Federal Reserve interest rate rises seem to be conspiring against it? In an interview with GlobalCapital, the National Treasury presents a more positive narrative: of resilience, transformation and the promise of progress. South Africa intends to realise its potential.

Fighting back against a world of worries

South Africa has struggled with brownouts, but the government is committedto increasing investment in the country’s electricity infrastructure

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NATIONAL TREASURY INTERVIEW NATIONAL TREASURY INTERVIEW

ture; saving and upskilling clus-ter employment; building sus-tainable communities; harnessing upstream and downstream link-ages; and advancing the cluster in terms of research and development and next generation mining tech-niques.

The Phakisa programme will be overseen into the Presidential Mining Consultative Forum driv-en through a collaborative Mining Cluster Principal Forum incorpo-rating government, labour, busi-ness and community. This process is still on-going with the detailed planning still being finalised.

The government is further com-mitted to increase policy co-ordi-nation and more specifically the implementation of the nine priori-ties the President announced in the SONA 2015.

: What progress is being made in improving the availability of reliable and pre-dictable electricity in South Africa, and what more needs to be done?

National Treasury: Progress is being made on four fronts, which include increased supply and transmission and distribution infrastructure; stabilisation of existing supply; increased non-coal based electricity and policy pro-grammes and legislative changes.

Eskom continues with its new build programme and has added the first unit of Medupi coal fired

power station, 794MW, to grid in 2015. Further additions are antic-ipated over the Medium Term Expenditure Framework: four units of 333MW of pumped storage at Ingula throughout 2016 and 2017; and the Medupi unit 5 and Kusile unit 1 between March and July 2018. There is also ongoing pro-gress on transmission lines (102km added) and substations (1120MVA added).

Increased maintenance of exist-ing plants, assisted by better plan-ning processes is set to improve plant performance and lifespan. Eskom plans to return to 80% plant availability by 2020. In addition, other operational efficiencies have been improved, including better levels of coal stock days and better transmission performance.

In terms of independent power, significant progress has been made. The total number of commissioned renewable energy projects stands at 92, representing total private sec-tor investment of R193bn; and is expected to add 6,327MW of capac-ity to the national grid.

The Department of Energy (DoE) issued a notice of a request for bids (RFB) under the recent-ly announced cogeneration inde-pendent power producer (IPP) procurement programme and has indicated that the bidding pro-cess for the remaining 1,800MW of renewable technologies will be fast tracked for delivery on to the grid by 2019/2020. A further deter-

mination of 6,300 MW for renewa-bles is being considered. An addi-tional 2,500MW of coal, 3,000MW of gas, 800MW of cogeneration and 2,600MW of imported hydro power for connection to the grid are planned for between 2020 and 2025.

This will greatly increase private participation in the grid, change the market structure and dynam-ics, whilst addressing the electric-ity constraints to support future economic growth.

The government continues to support the development of coal and gas power. A request for pro-posals on independent coal pro-ducers has been issued and has received strong response from the market. The final adjudication is underway and will be announced in Q1 2016. Four cogeneration bid windows have also been run in 2015 and the determination for cogen-eration may be increased by a fur-ther 1,000MW depending on mar-ket response.

A market exploratory RFI for gas was issued in May 2015, which will be followed by official RFPs, most likely in the beginning of 2016. In total, a 17,000MW should have come online by the end of 2022.

To support these activi-ties, numerous other regulatory reforms, pilot projects and incen-tives have been initiated. For example the Gas Use Master Plan (GUMP) is being developed to assist in charting required regulatory changes to enable the gas sector. Managing demand is an important part of the strategy to electricity sustainability.

The pricing of electricity is becoming more cost reflective, which is helping to ration demand. Furthermore, an exploratory RFI has also been issued for technolo-gies on demand reduction, load shifting and energy efficiency ini-tiatives with a view to developing a determination and a procurement programme in the future. Sched-ule 12L of the income tax act gives incentives for private companies to install new equipment or cogenera-tion to improve energy efficiency.

The Manufacturing Competitive-ness Enhancement Programme provides budget funding for energy efficient investments (in equip-

The Mining Phakisa project is expected to improve the health ofSouth Africa’s mining industry, which faces numerous challenges



NATIONAL TREASURY INTERVIEW NATIONAL TREASURY INTERVIEW

ment or process improvements) and various embedded genera-tion programmes are being piloted by metros (like Johannesburg and Cape Town), development banks and technology partners (CSIR). The Industrial Energy Efficien-cy Project, which was launched in 2010, has exceeded performance targets by recording 860GWh of energy production and 800,000 tons of CO2 emissions savings as at May 2015. The project has also pro-duced 78 graduates from its expert level industrial energy efficiency courses.

: South Africa has had notable success in renewable energy under power purchase agreement strategies — what les-sons can be learned from this and applied more widely?

National Treasury: Pent-up investment demand exists in South Africa. This can be released at the right offtake price. The private sector (including FDI) is willing to invest if the programme is run properly, with clear guidelines, and the investment prospect is good. This demand can be used to relieve capital constraints on public bal-ance sheets.

Private sector participation and the build of smaller plants can assist in decreasing the time to release constraints. Larger build programmes have long lead times. Under such programmes domes-tic constraints, such as high skilled labour, can lead to delays in project completion with very high econom-ic costs.

Independent systems market operators are not necessary to transform the electricity sector. Through the IPP process one can introduce private participation into the process and keep grid stability, while at the same time transform-ing sources of energy demand and all at a healthy pace.

There have been many lessons about project and contracts man-agement; and different financing and build options even where there is uncertainty.

: South Africa’s insti-tutional strength makes it a nat-ural hub for sub-Saharan Afri-

ca. What is being done to take advantage of that potential from an economic growth perspec-tive?

National Treasury: China’s shift towards greater consumption, along with regulatory reform in India and investment expansion in Africa, provides new opportunities for South African firms to export manufactured goods and services, and to strengthen regional link-ages.

South African firms have invest-ed heavily in mining, telecom-munications, banking, construc-tion and retail in the region, which absorbs one-quarter of South Afri-ca’s manufactured exports and 14% of its total exports.

A numbers of initiatives to enhance South Africa’s ability to benefit from its role as a natu-ral hub for Sub-Saharan Africa are underway.

Regional infrastructure projects seek to upgrade infrastructure and remove impediments to two-way trade flows. In May, the SADC approved a $3.5m feasibility study for a regional project to expand and transmit Mozambique’s hydro power and diversify South Africa’s electricity supply. The free trade area agreed by the SADC, East Afri-can Community and Common Mar-ket for Eastern and Southern Africa aims to bring together a market of 600m consumers. Participants have agreed on tariff liberalisa-tion and related rules, and the next phase will focus on trade in ser-vices.

As part of the 2002 SACU Agree-ment, South Africa is currently engaging with other Member States to identify regional value-chains with mutual-benefit in order to enhance regional industrialisation. Given South Africa’s industrial advantage, this provides an oppor-tunity for South African firms to collaborate with regional firms to increase the region’s produc-tive capacity, diversify the region’s economies and boost intra-African trade.

South Africa consistently engag-es in Capacity Development within SACU, SADC and the broader Sub-Saharan Africa regions. Some of the initiatives involve building capac-

ity in public governance, fiscal pol-icy, and revenue collection in other African countries. This allows South Africa to contribute towards regional economic growth through fiscal sustainability and good gov-ernance in the region.

The National Treasury has pro-posed a special type of South Afri-can corporate holding compa-ny, registered with the Financial Surveillance Department of the Reserve Bank.

African listings on the Johan-nesburg Stock Exchange. Debt and equity instruments issued by entities in the Common Monetary Area will be classified as domestic assets, and the listing process will be streamlined.

Listing and trading of foreign referenced assets in foreign cur-rency. The JSE will be allowed to offer African agricultural commod-ity derivative contracts in foreign currency subject to certain require-ments. This will help African farm-ers to hedge risk.

: Countries with twin deficits tend to be seen as the most vulnerable to Fed interest rate rises. Is South Africa, and its currency, vulnerable? Is there anything you can do about it?

National Treasury: The South African government’s consolidat-ed budget deficit declined to 3.6% of GDP in 2014/15 from 4.1% in 2012/13. Despite revenue pressures and increased financial concerns around state owned companies, government remains committed to reducing the budget deficit to 3.0% by 2018/19. The expenditure ceiling adopted in the 2015 Budget remains in place.

The current account deficit recorded 5.4% of GDP in 2014 (past five years: -4.0%). Expenditures on the current account have been driven by public sector investment which is highly import intensive.

The government remains com-mitted to increasing productive capital stock in South Africa, sup-porting medium to long term growth. This implies that import growth will remain robust. Weak global demand and low commodity prices threaten exports.

The weaker rand, improved



NATIONAL TREASURY INTERVIEW

growth in main trading partner countries, opportunities for exports to the rest of Africa and policies to increase competitiveness through releasing domestic constraints are expected to provide support. The current account deficit is expect-ed to remain below 5% of GDP over the MTEF.

The misalignment between domestic savings and investment means that South Africa is depend-ent on foreign inflows to fund its deficits. Compared to other emerg-ing market countries, South Africa has deep and liquid domestic capi-tal and financial markets which assist in funding any shortfalls. This has been the primary source of funding. In 2014, 64% of govern-ment bonds were owned by resi-dents.

Exposure to foreign denominat-ed debt is limited with only about 9% of debt denominated in foreign currency. This limits South Africa’s exposure to currency fluctuations and the impact of this on debt and debt service costs.

: How would you like South Africa to look economi-cally in five years’ time, and how will you get there?

National Treasury: In five years’ time, the National Treasury would like to see SA with a higher rate of

growth, at the 5% the NDP envisag-es. Reforms under way through the medium-term strategic framework will put our economy on this high-er growth path. The government has rolled out a wide array of ini-tiatives to promote energy efficien-cy, bolster competitiveness, boost skills and job creation, cut red tape and improve business confidence.

The efficacy of government sup-port is under review to ensure that it best supports growth and employment outcomes. The gov-ernment is also stepping up its work with municipalities, in part-nership with the private sector, to reshape SA’s cities and improve their contributions to economic growth.

The National Treasury sees an economy where the unemploy-ment rate has fallen and we have more people, especially the youth, in jobs and able to participate in the benefits of growth. Concerted effort by the government to sup-port labour intensive industries and the services sectors will help to achieve this.

Lower barriers to entry will ensure that small businesses can start up and thrive, growing to larg-er firms. Increased competition will spur the innovation that South African businesses are so well known for and improve the liveli-hoods of South Africans, as well as

raising our competitiveness global-ly. A growing South African econo-my will be increasingly interlinked with our regional partners, each creating opportunities for mutual growth.

These changes contribute to the vision of the NDP which provides a framework to address binding con-straints in the economy and build our economy to the one we all want it to be.

The challenge is to ensure that we do not become complacent. The weak global economic environment highlights the importance of focus-sing on creating internal engines to growth by implementing struc-tural reforms in South Africa. We are committed to working hard to ensure that reforms we identified as priorities in the NDP and the MTSF are implemented.We need a sincere conversation between social partners and preparedness to embrace new ideas.

These engagements will be use-ful to maintain a stable labour rela-tions environment, improve con-fidence and promote broad-based development. We are working hard to improve policy coherence, and certainty, to proceed with our infrastructure projects, to strength-en planning and focus on invest-ment in urban hubs, economic growth zones and to take advan-tage of trade opportunities. s

South Africa’s ports regulator has embarked on a 10 year programme to ensure that its tariffs better reflect costs



INTERNATIONAL BONDS

FOR INTERNATIONAL bond buy-ers, a deal from South Africa is something of a rarity.

Over the past decade, it has sel-dom produced more than six inter-national benchmark deals a year.

Even at the height of the emerg-ing market debt boom in 2013, when Russian and Turkish bor-rowers raised $52.7bn and $16.9bn of Eurobond funding respectively, total issuance from South Africa failed to reach $7bn. 2015 saw just five global benchmarks from the jurisdiction worth $3.7bn in total.

The main reason for this lack of activity, say bankers, is the avail-ability of cheap funding in local markets thanks to a highly liq-uid banking sector and an estab-lished domestic bond market with a strong institutional inves-tor base which. Both offer funding in maturities usually only avail-able in the international arena (see pages 22 and 33).

Andrew Dell, CEO of HSBC Africa, notes that nearly half of domestic bond issuance in South Africa is with maturities of seven years or more.

“The classic emerging market model is that if you want tenor you go offshore and if you want tighter pricing you go onshore,” he says. “In South Africa, you can get tenor onshore in the bond market and even, in some cases, in the loan market.”

As a result, the only reasons for South African borrowers to go off-shore are if their funding require-ments cannot be met locally or they have cashflows in hard currencies.

The former category mainly con-sists of state-owned giants Eskom and Transnet, both of which have huge infrastructure programmes to finance. Electricity producer Eskom was one of the few South African borrowers to tap the international markets last year, pricing a $1.25bn

10 year in February at a yield of 7.375%.

Logistics group Transnet has not issued in Eurobond format since November 2013, when it took advan-tage of healthy support for emerg-ing market currencies among global investors to print the first interna-tional rand denominated deal from a local corporate. But in December, its CEO Siyabonga Gama said the firm was considering a Eurobond issue this year to fund its $26bn infrastructure programme.

Bankers note, however, that the

cost of swapping hard currency into rand reduces the appeal of interna-tional markets for parastatals.

“The cross-currency swap is very expensive and banks charge a lot for long dated cross currency credit lines,” says Mohammed Nalla, head of strategic research at Nedbank Corporate and Investment Banking (NCIB) in Johannesburg.

FX revenuesAs most of South Africa’s private sector corporates are able to find liquidity in the domestic market for their needs, Eurobonds tend to be targeted by those with international operations or foreign currency revenues.

Thus 2015 saw benchmark dollar deals from miner Petra Diamonds and technology giant Naspers, while global pulp and paper

group Sappi refinanced a clutch of high coupon deals through a euro denominated senior secured bond. Furniture retailer Steinhoff also raised euros with a €650m Schuldschein issued by its Austrian subsidiary in May.

The energy and chemical con-glomerate Sasol and retailer Edcon have also issued hard currency benchmarks in the past, as have miners AngloGold Ashanti and Gold Fields, although none has been in the market since November 2013.

Financial borrowers from the jurisdiction have also been quite regular visitors to the Eurobond market in the last decade. Last year, however, saw only one benchmark transaction in the form of First-Rand’s $500m five year in April.

Adil Kurt-Elli, head of CEE and sub-Saharan Africa DCM at HSBC in Johannesburg, says this is because South Africa’s banks are fund-ing themselves predominantly in the domestic bond market and, for hard currency requirements, via syndicated loans.

Yet while South African issues may be rare, they have tended to receive a warm welcome from international investors. Simon Ollerenshaw, head of debt capital markets for CEEMEA at Barclays, says this is partly due to the appeal of individual credits.

‘Genuinely different’“The names that do emerge from South Africa are often genuinely different from exposures that inves-tors can get elsewhere,” he says. “Naspers, for example, is a global media company with no peers, while Petra Diamonds is one of very few publicly listed compa-nies offering pure diamond mining exposure.”

Bankers say international demand for South African Eurobonds is usually boosted by

South African issuers are rarely seen in international markets, but have traditionally received a warm welcome. Will that still be the case in 2016? Lucy Fitzgeorge-Parker reports.

Rarity value adds appeal to global deals

“The names that do emerge from South

Africa are often genuinely different

from exposures that investors can get

elsewhere”

Simon Ollerenshaw, Barclays

011-12 eurobonds.indd 11 16/12/2015 17:31


INTERNATIONAL BONDS

the scarcity value of both individual names and overall supply from the jurisdiction.

This received an additional fil-lip last year from the sharp decline in volumes of Eurobond sales from other major emerging markets. Russian supply has all but vanished since the start of the Ukraine crisis, while issuance from each of Brazil and Turkey fell to just $7bn in 2015.

Kurt-Elli says South African cred-its could have taken greater advan-tage of the lower levels of engage-ment from emerging market peers.

“Most corporates are cash-rich at the moment, however, so there has been little requirement for term funding despite the low-rate envi-ronment and this gap in the mar-ket,” he says. “Any additional fund-ing risked becoming a negative carry on the balance sheet.”

December developmentsWhether international investors will remain as supportive of South African names this year following the rapid succession of negative news in early December — Fitch’s downgrade of the sovereign rating, the firing of respected finance min-ister Nhlanhla Nene and the subse-quent rout of the rand — remains to be seen.

Speaking before Nene’s ousting, Kurt-Elli noted that the National Treasury had played a crucial role in ensuring continued investor support.

“They have done a great job of communicating with the market on the developments in the domestic economy and the steps they are tak-ing to meet each of the challenges the government faces,” he said. “This has been key to creating a constructive mindset around South African credit.”

South Africa’s sovereign CDS spreads jumped from 290bp to around 330bp and the rand plum-meted to a record low following the news of Nene’s replacement with David van Rooyen. The sacking of the latter just three days later and the reinstatement of long-stand-ing former finance minister Pravin Gordhan, however, went some way towards calming market unease.

Meanwhile, bankers say the poten-tial loss of South Africa’s investment grade ratings need not be a barrier to

international issuance.“International investors are fix-

ated on ratings and will focus on the macro issues outlined,” says NCIB’s Nalla. “However, a junk rating need not mean no access to capital, as there remains reasonable appetite in the junk space, albeit at a price.”

Certainly, as Ollerenshaw points out, last year’s commodities bear market failed to deter investors from buying much lower rated African sov-ereign risk.

“The fact that Cameroon was able to come to market recently demon-strates that there was still demand for Africa, although the macro environ-ment has deteriorated further since that deal” he says.

“In an environment where emerg-ing market supply globally is down sharply, South African issuers should continue to find good interest from investors, but the market will be watching how the current situation develops and whether that has an impact on the economic story.”

But even if demand remains stable bankers say a rush of international issuance from South Africa this year is unlikely. “For South African cor-porates, cash balances will remain strong, while on the FIG side levels of demand for dollars will continue to be muted,” says Kurt-Elli.

He notes, however, that changes to South Africa’s regulatory regime could, in due course, put pressure on the syndicated loan market.

“In that case the bond versus loan conversation might become more rel-evant,” he says. “We could also see international markets come more into focus if banks’ capital require-ments exceed the capacity of the domestic investor base.”

Sovereign focusIn the shorter term, however, it is the potential for sovereign rather than financial issu-ance that will likely be the focus of attention for bank-ers and investors alike.

The National Treasury has not accessed the interna-tional markets for more than a year. Its last outing was a landmark sukuk debut in September 2014, while the most recent global bench-mark was a $1.7bn dual-cur-rency deal — comprising a

$1bn 30 year and a €500m 12 year — that was priced in July of that year.

The borrower undertook an exten-sive non-deal roadshow in Europe and the US in November. Bankers are divided, however, on the question of whether the sovereign will issue in the near future.

Nalla says a rapid return to the market is unlikely. “We don’t nec-essarily expect South Africa to go back to the Eurobond market at this stage,” he says. “We do see continued issuance in hard currency as it feeds reserves and helps with redemp-tions but this will depend on how the funding requirements evolve in the medium term.”

Kurt-Elli, however, notes that the Treasury tends not to issue interna-tionally just for budgetary purposes.

“They raise international capital to set the benchmark for the rest of the market,” he says. “They will do something but they will select their moment appropriately and take into account potential competing sup-ply coming from other South African borrowers.”

Given December’s market upheav-als, this seems unlikely to be a prob-lem in the short term. However, bankers say it is equally likely that the National Treasury will want to wait for some normalisation in spreads before accessing the market.

One adds that if markets do stabi-lize in the short term, a €750m sover-eign Eurobond redemption in April could provide an opportunity for policymakers to test investor appetite and reset the curve for other South African borrowers.

That, and much else, will depend on the ability of the old but new min-ister of finance Gordhan to reassure markets. The coming months are likely to be nervous ones for issuers and investors alike. s

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

2009 2010 2011 2012 2013 2014 2015

$bn

South African Eurobond issuance 2009-15source: Dealogic

011-12 eurobonds.indd 12 16/12/2015 17:31

South Africa in the Global Marketplace 13

Sovereign and Sub-Sovereign Roundtable

: We’re gathering at the end of a fairly rocky year in the emerging markets with oil prices down and a US Fed rates lift off almost upon us. Perhaps some of the issuers could start us off by telling us a little bit about the South Africa sover-eign and SOC funding plans for next year?

Tshepiso Moahloli, National Treasury: We have a three year rolling budget and at the time of the 2015 budget we had planned to raise of R172.5bn in long-term funding for [the fiscal year] 2016/17 in the domestic capital market. The long-term funding in the domestic capital market comprises fixed rate bonds, inflation-linked bonds and retail savings bonds. Due to

the downward revision of gross tax revenue in 2016/17, the funding requirement has since been revised upwards to about R180.5bn for 2016/17 during the 2015 medi-um-term policy budget statement. So for 2016/2017 we are looking at funding about R180.5bn through long term bond issuance and a net issuance of about R26bn in short-term financing through Treasury bills in the domes-tic capital market.

In foreign currency bond issuance we’re planning to issue $1.5bn equivalent. The timing will depend on mar-ket conditions. We have not stipulated what currency or tenor will be tapped at this stage, the issuance is oppor-tunistic and as such we will assess the market at the time and determine what currencies and tenors to tap then.

Participants in the roundtable were:Adil Kurt-Elli, managing director, head of CEE and sub-Saha-ran Africa debt capital markets, HSBC

Ben Hlatshwayo, capital markets manager, Development Bank of Southern Africa

Anthony Julies, deputy director-general, asset and liability management division, National Treasury of the Republic of South Africa

Lucretia Khumalo, senior vice president of public sector, HSBC, Johannesburg

Khomotso Letsatsi, group head of treasury, financial strategy

and planning, City of Johannesburg

Tshepiso Moahloli, chief director of liability management, National Treasury of the Republic of South Africa

Andre Pillay, senior manager funding execution, Eskom Treasury Department

Phetolo Ramosebudi, group treasurer, Transnet

Bruce Stewart, head of DCM origination, Nedbank

Thuli Zulu, head of state-owned companies public sector coverage, Absa

Francesca Young, moderator, GlobalCapital

South Africa keeps careful eye on capital markets access

The Republic of South Africa had a difficult end to 2015. Fitch cut the country’s credit rating one level on December 4 to BBB-, the lowest notch in investment grade, and in line with the assessment of S&P, which lowered its outlook to negative from stable on the same day. Just days later, President Jacob Zuma abruptly replaced his finance minister, Nhlanhla Nene, with David Van Rooyen and then a few days later — after strong local and international criticism — reappointed Pravin Gordhan. who had held the job between May 2009 and May 2014.

The country’s growth has disappointed over the last year and is expected to continue to do so, as power shortages and job strikes take their toll.

Meanwhile, the government’s decision not to tighten fiscal policy in the face of weakening revenue and rising debt levels has been heavily criticised, with Fitch naming it as one of factors behind the downgrade.

At GlobalCapital’s roundtable, held in Cape Town on November 26, South Africa’s National Treasury, sub-sovereign issuers and leading bankers discussed how best to access the capital markets at this difficult point in time, and their outlook for the South African economy.

013-21 Sov & soc roundtable .indd 13 16/12/2015 18:03


14 South Africa in the Global Marketplace

Phetolo Ramosebudi, Transnet: I’m sure you’re all well aware of the R337bn MDS [market demand strat-egy] capital investment programme for the next seven years. Because of developments in the market we are looking at optimising our capital spend and deferring some of the projects that are in our current seven year plan. For the capex size we are now looking at, we will need funding of around R125bn for the next seven to 10 years. The current capex that we have been funding for this year is around R28bn and we are looking at about R23bn for the next financial year.

When we went out on the non-deal roadshow the idea was just to update the investors in terms of our capex plans and update investors as to changes in man-agement.

Around 60%-70% of our planned capex is to upgrade and re-fleet the rolling stock. A large proportion of that will go towards locomotives — we have, in the last year tendered for about R50bn in terms of the locomo-tives. Of that R50bn rolling stock funding requirement we have already raised more than 90%.

Going forward, we will of course look at all sources of funding and sukuk could be one of those after the National Treasury set the benchmark in that market last year.

Andre Pillay, Eskom: Eskom has a R237bn funding plan over the next five years.

The funding will be through the local bond market, the international bond markets, DFIs and ECAs.

: Could you go into detail about how you view the attractiveness of the loan markets versus the domestic and international bond mar-kets?

Ramosebudi, Transnet: We have just finished a sig-nificant loan transaction.

Given the current size of our capex, we’re looking for liquidity above all in the markets we enter. We have an auction programme that we tap for most of our listed instruments, but we are not able to get big enough sizes for what we need.

As a complement to the auctions we have engaged DFIs [development financial institutions] funding as well as other sources of funding. In the last day or two we have just closed a loan of R12bn from local banks, following our conclusion of a $2.5bn CDB [China Development Bank] loan. You can’t get that size in the current domestic bond market.

Moahloli, National Treasury: The sovereign funds its financing requirement predominantly in the domestic capital market and has been able to tap the longest maturities in both fixed rate and inflation-linked bonds.

Our foreign currency issuance is really just to help meet part of our foreign currency commitments and provide a benchmark for state owned companies and other entities that would like to tap certain interna-tional capital markets. And of course to also diversify our funding sources and investor base —that’s what we tried to achieve with the sukuk issuance in 2014.

For the sukuk issuance we saw a completely different investor base participate in the deal compared to our usual conventional bond issuances. On a conventional bond we usually see over 80% of the demand coming out of the US and Europe whereas for the sukuk we

saw around 60% of the demand being from the Middle East and Asia.

But there are challenges when looking for diversifi-cation of funding in new markets. You are either deal-ing with markets that are quite niche, where only short tenors are available or low volumes, and some require certain guarantees by certain entities.

So these markets — at the right time they make sense but at other times they don’t. We’ve adopted a strategy where we have been taking advantage of low interest rates and issuing long dated bonds. We have also switched out of shorter dated bonds into longer dated bonds. In doing that, we have created some space in the short to medium part of the curve, which means that in an environment of increasing interest rates, we can consider issuing in short-medium tenors and pay lower rates.

We have already started seeing some re-pricing of the curve in anticipation of rising interest rates. The futures market is pricing in a probable December hike by the US Fed. Of our total debt portfolio, more than 70% of the debt is fixed rate. As such the impact of rising inter-est rates is not so significant unless we issue more debt because of the discounts to achieve the same cash targets.

We should be in a position to adjust our strategy in such a way such that our debt servicing costs do not overwhelmingly increase. From our tax revenues, cur-rently for every R1 in tax revenue about 11c goes towards debt servicing costs. We do not want to be pay-ing much more because that would mean crowding out of expenditure on health or education or infrastructure which would benefit society as a whole.

Pillay, Eskom: The loan market remains an attractive alternative funding source for Eskom and the local and international bond markets are also accessible for this credit. However, weakening in the sovereign and Eskom’s credit profile has had a significant impact on the risk per-ception of Eskom and so the tenors and cost of funding available in these markets. Eskom does, however, remain a compelling issuer and asset class and therefore these markets will remain accessible. The local markets offer potential diversity and it is easier to execute deals in this market when there is sufficient appetite and competitive pricing. Eskom will continue to consider and assess all markets and fund opportunistically.

: At this time last year the National Treasury was keen to make sure that deals such as

Tshepiso MoahloliNATIONAL TREASURY




the sukuk would not be one-offs, but since then Middle East liquidity has become much more con-strained because of the lower oil price. Is maintain-ing a presence in that market still a priority for you?

Moahloli, National Treasury: Because sukuk supply from us has been small, there is still appetite, but that market is very short in tenors — if you are not a fre-quent issuer you can only go up to five years. The vol-umes are available but the restriction on our side is the short tenors. We are still managing a lot of refinancing risks and with a low growth environment where you are not sure about your future revenue flows, you have to be cautious about front loading the curve.

But it’s a great market to keep in the mix and even if we are not planning an immediate issuance in the sukuk market, we will still do non-deal roadshows and engage with investors to maintain our presence for future issuances.

The other aspect of that market which is quite dif-ferent to how we usually fund is that it requires assets and asset-based structures so is perhaps better suited for project financing. So the SOCs [state-owned compa-nies] are in a better position to utilise such structures rather than the sovereign. When the sovereign funds in this way, we don’t really have assets so we have to knock on Phetolo’s door to ask if Transnet has assets we can use for the structure, or ask Ben if we can structure the deal using DBSA’s assets. It is challenging, but that doesn’t necessarily mean we won’t be going back, the market remains open for us.

Adil Kurt-Elli, HSBC: There was a huge amount of internal work that the National Treasury went through with the various domestic stakeholders to facilitate the legislation to enable this to happen. That investor com-munity now has an opportunity to get access to South African credit — that exposure wasn’t technically pos-sible in the past.

The challenge going forward is that in terms of it being a frequently available and suitable product, sukuk is still a niche product for this geography. But selectively, when market conditions are right, we do see that investor community adding efficient accretive value to South Africa’s fundraising.

The investor community that buys sukuk is not sole-ly dedicated Islamic, so when conditions are difficult for the dedicated Islamic investor base — for example now that Middle East liquidity is under stress because of lower commodity prices — while you can still pull the trigger on a sukuk, your statistical mix within that investor base will now be skewed more heavily towards your traditional conventional buyers that oth-erwise buy the regular sovereign bonds. So you have to be careful not to cannibalise the conventional bond demand. Also, given the short-term nature of sukuk instruments, it is important not to also fill the short end of the curve.

As this becomes a more frequent product for the region, it’s very much the SOEs that could look to benefit because of their asset pools. That fits in with a number of other funding tools that could be used such as infrastructure based bonds, or other sorts of alternative financing arrangements to create diversity within their funding and protect these issuers in times of volatility.

A lot of the investment strategy that is going on in

South Africa right now is about the five to 10 year plan, not about the short term liquidity need. It’s really important for the likes of Transnet, DBSA or Eskom to build that future capacity for economic delivery in the coming years which means looking to fund on a long-term basis.

Thuli Zulu, Absa: In the vanilla markets, which are not as bespoke as sukuk, there have been a lot of African sovereigns and SOC issues in this financial year but there is great appetite for high sub-investment grade issuers and lower investment grade issuers such as South Africa. Issuance from South Africa has not been as much as expected from investors and our read is that there is some scarcity value for this country. The macroeconomic environment is not perfect and the pricing is not where it was six months ago, but there is still huge appetite for South Africa.

Kurt-Elli, HSBC: The rates cycle has meant that we’ve ended up with significant yield and spread compres-sion across the emerging markets as investors moved into the asset class — because it was still good value relative to where developed markets were providing yield. Portfolio managers reallocated from developed markets into the emerging markets. So there was a migration of that liquidity over the last five or six years and South Africa in particular has benefited from that.

In addition to that in 2015 we’ve seen a lot of geo-political risk starting to impact other emerging mar-kets. Brazil and Russia have remained offline and in Turkey we’ve seen limited supply compared to previ-ous years — across the credit spectrum, not so much at the sovereign level — which has meant that for South Africa Inc it’s almost been a free run at the market.

The market windows have been there but the fund-ing needs haven’t been there to justify pushing into it, which is a shame.

As we start to see a pick-up in terms of the under-lying benchmark rates, provided South Africa Inc is prepared to pay that additional premium to get deals done, they can still take huge advantage relative to their international peer group.

Pillay, Eskom: All markets with potential liquidity remain an option for Eskom. We have included the Middle East on our list as a potential source of liquid-ity for the medium to longer term, though we do not currently have a presence there.

Given the funding plans of Eskom, we want to access

Thuli Zulu,ABSA




a market with the potential for multiple issuances or a funding programme. We would also want the Middle East market to present us with the right tenor, pricing and volumes versus other funding instruments and options.

: But there have been overall emerging market fund outflows over the last year — does this pose a risk to South Africa as one of the main beneficiaries when there were inflows?

Kurt-Elli, HSBC: As we start to go through the rate rise, people are going to take profit and liquidate inventory in order to reposition their portfolios.

Having said that, there has been little new South Africa paper for investors to engage with this year, so there are still considerable amounts of cash to be put to work and there will always be dedicated emerging market funds. So now it is a question of price and the willingness to pay the premium as we go through that rates cycle.

Deals are still getting done. Away from South Africa, if we look at the funding that, for example, Poland has done this year, whether it be opportunistically in Swiss francs with a negative yield or very efficient funding in euros, it’s clear the EM outflows aren’t having too much of an effect. We’ve seen that happen again and again across Latvia, Lithuania, Romania. There’s no reason why South Africa won’t also benefit from that support.

Also, at a sovereign level, South Africa is index eligi-ble, so there is also that core investor community that will support its paper.

Anthony Julies, National Treasury: The South African experience with regards to non-resident hold-ing of local currency debt has been different to that of other emerging markets — we have in fact not had bond outflows during times of extreme market volatil-ity.

Just after the crisis, around 10% of our total local currency debt was held by non-residents. That number peaked in 2014 at around 37% of total local currency

debt and has come down to around 33% currently. There has been a decline in the percentage of non-

resident holdings as a percentage of total local currency debt but the actual holdings, in absolute terms, have not come down. So we’ve actually not had an outflow, but the rate of growth of locally held local currency

debt has been larger in relation to non-resident debt.

Bruce Stewart, Nedbank: The anxiety of global mar-kets is always around the risk that this poses to the South African rand and that always sits at the back of our minds as a weakness.

When the US had quantitative easing, it was great for EM. Europe was in disarray and the emerging mar-kets benefited. Then the Europeans had quantitative easing and the emerging markets weren’t that great and the US looked good because their rates were going up. There’s been this structural change in the flow of money that’s allied to the interest rates cycles. It’s cre-ating indigestion in the emerging markets.

The economic growth also doesn’t just require more capital. South African corporates hold north of R400bn on their balance sheets without having to go to the capital markets to fund. Hoarding money like that is inefficient for the economy as a whole but the oppor-tunities for growth are just not being seen.

Moahloli, National Treasury: What differentiates South Africa from other markets is that we have a size-able local pension funds and some of the assets in cash. That helps in periods of sell-offs when non-residents feel uneasy. But I agree with you — the money that is not being put to work could be used for infrastructure spending and ensuring that the institutions like DBSA and IDC [Industrial Development Corporation] that are given mandates to drive infrastructure projects are able to do their work.

Ben Hlatshwayo, Development Bank of Southern Africa: Where a lot of the cash is sitting on the balance sheet, it also allows institutions like ourselves to diver-sify our sources of funding. For example the DBSA has always focused on issuing rand bonds at the long end of the curve and at some point were converting rand to fund our dollar projects. We have now closed those positions and we are now funding all our dollar requirements out of the dollar market and our rand funding out of the rand market.

Our requirements are not as sizeable as the National Treasury’s, so the public Eurobond market is unsuit-able — our dollar requirement [over the next year] is just under $500m — so instead we’re active in the loan market. We’ve just concluded several dollar loans with three Japanese banks and also two loans with local banks, borrowing dollars in the short end of the curve.

Bruce Stuart,NEDBANK

Anthony Julies,NATIONAL TREASURY




However, as our projects are of a long term nature, we’re embarking on a strategy where we’re trying to find ways in which we could raise dollars for longer tenors.

In contrast to the National Treasury, where they don’t feel comfortable being guaranteed, we feel that if there is an opportunity for us to be guaranteed by a triple-A entity and that could have a positive impact on our cost of funds and allow us to issue long term debt, we’re more than happy. We’ve engaged two mul-tilaterals with the possibility of getting guarantees and for us to be able to issue long term — that’s still in the works. We’re pursuing a diversification strategy where we are prodding a number of markets.

In particular, the Japanese market looks interesting to us. We’ve just done two roadshows in Japan. One of those was to meet the second tier banks that have shown a lot of interest, but the Japanese market is such that it’s very active in the short end and being a new issuer in the market, we haven’t been able to find demand longer than five years. But because of the negative yields or low yields that they are used to, the levels at which we have come in, although historically low by our standards, represent a yield pick-up for them.

On the second roadshow that we did, which was in early November, we were engaging the pension funds and money managers. That also went well and was with the objective of issuing longer tenor debt. In the Japanese market, that requires either a JBIC guarantee or a World Bank guarantee. The work is still ongoing but in terms of the rates that we could get from the Japanese market, we’ve been very impressed — this will have a good impact on our cost of funds.

Khomotso Letsatsi, City of Johannesburg: For the City of Johannesburg, we have developed a 10 year financial development plan and are rolling out infra-structure to the tune of R100bn. We have done the first three years of this, so have already rolled out R30bn. We fund predominantly through three sources — internally generated funds, which account for around 40%-45% of the total, around 30% from exter-nal borrowing and then rest is from conditional grants.

We have done a lot of DFI funding, and have raised money from the DBSA and the AFD (Agence Française de Développement) and we’re in talks with Germany’s KfW. But we are restricted in terms of forex so even if we issue in foreign currency, we enter into a cross-currency swap so that rand hits our books. We’ve been

able to raise concessionary funding where even after the cross-currency swap we are funding at a rate cheap-er than we’ve been able to raise with the commercial banks and in the debt capital markets.

We predominantly use DFIs to extend our dura-tion because of the nature of the assets that we fund as municipality — the DBSA, for example, are able to extend funding of 20 years but commercial banks are limited to around 10 year amortizing structures.

In the local bond markets we also find it difficult to go out to as far as 15 years — you start paying up on credit spreads.

There is an instrument that we are looking that incorporates a land value capital mechanism. We are working with the World Bank and the City Support Program at the National Treasury on this and will be implementing a pilot based on the Dunkeld area if the feasibility study is positive. It’s an instrument that should work for us, given the nature of the pro-grammes that we are rolling out such as ‘Corridors of Freedom’ which will change spatial planning in the City of Johannesburg — we’re densifying and bringing people closer to economic activity.

For this kind of high impact investing, we need to look at other alternative financing mechanisms rather than relying on the strength of our balance sheet.

Another instrument we’re looking into is a pool financing mechanism where we would syndicate a number of issuers within the Gauteng city region. For example, the three metros have now rolled out their BRT (Bus Rapid Transit) project, but if we had consoli-dated all of that it would have been much more effi-cient and brought down the cost of funding.

Pillay, Eskom: Eskom has low foreign participation in its local debt. So, portfolio outflows only impact us via the secondary effect of a change in sentiment around South Africa and Eskom, and the effect of that on cur-rency volatility. That can make the FX activity of Eskom challenging and costly. The energy sector remains topi-cal both in terms of its investment and social benefits, so we expect to see potential inflows of investment appearing counter-cyclically from the traditional portfo-lio outflows and inflows that are being discussed.

: Is the bank lending environment changing?

Letsatsi, City of Johannesburg: Yes. Over the past few years they’ve been much more risk averse. There are increasing financial covenants that make it very difficult to close deals with the banks.

Hlatshwayo, Development Bank of Southern Africa: With Basel regulations coming in we’re seeing banks become really stingy around duration. From a business perspective, it has actually been good for the DBSA. Because of the Basel requirements, it costs the banks more to lend in long tenors. We are not governed by the Banks Act but by the DBSA Act and that precludes us from certain capital requirements, so going forward we can strengthen our business, especially in the municipal-ity sector and other sectors that require long duration because we’ll be able to support those initiatives better than the banks.

Ramosebudi, Transnet: I’m not sure if it’s the nature of the type of credit that the banks are exposed to

Khomotso Letsatsi,CITY OF JOHANNESBURG




for Transnet — tangible infrastructure — but in this financial year the tenors the banks have been offer-ing us have been very favourable. We’ve done two or three transactions with the banks for 15 year and 18 year tenors and the pricing has been good, which is an improvement on my previous experience with the banks.

The pricing is in line with the changes in the Basel requirements, but it’s still very competitive in terms of the volume. If you want a tight spread, it’s better to go to the bond markets but you may not get sufficient volume to cover your requirement.

Kurt-Elli, HSBC: Over the last few years, banks are being more heavily scrutinised around the way that they calculate risk-weighted assets and capital deployed and it is creating some constraints around the long end. We saw that initially happening in the reaction to the project finance market, we’re now starting to see that in term finance markets as well.

The change is region by region, depending on your primary regulator. We’ll see an increasing divergence in terms of the number of banks that can continue to offer the type of duration and liquidity that is ideal for these sorts of financing situations, and those that will struggle to be able to support it.

When you have a constriction in the total market, whether that be liquidity or the number of players, it becomes less efficient over time.

As a result of this, global banks have been working towards mitigation strategies and the creation of mul-tiple channels of liquidity and diversity of funding for their clients so that they can continue to achieve the ambitions and the strategies of those clients.

We’re going to go through an interesting couple of years now, but it will be a divergent one, dependent on which region the bank you’re talking to comes from. But this is why capital markets work is so important, and why the National Treasury has done a fantastic job at delivering on its mandate to open and maintain markets. It’s now incumbent on the other stakeholders within this market to continue that work and develop their own profiles within the market.

Ramosebudi, Transnet: But sometimes it is difficult to get the size of bonds that you need, especially when the National Treasury is in the market. Because they are wolves! They gobble up everything!

The SOEs are in a hard position. If you go to the capi-tal markets, and you are near to the National Treasury, you find it difficult to raise what you are looking for — especially when they are doing something themselves in financing.

And new markets are not always beneficial. For example, when looking to tap Japan, the negative or low interest rates offered look good, but then you have to switch back into rand and the basis swap removes all the benefit of going to a new market.

Because the National Treasury doesn’t have a man-date that requires hedging, it would be better for them to extend their proportion of foreign funding, so that it allows the SOEs to fund themselves in the domestic space.

Julies, National Treasury: The government also pro-vides a lot of support for its SOEs — infrastructure financing and spending is a priority of the government.

This is why we provide support in form of guaran-tees where necessary, such as to Eskom. The govern-ment guarantee portfolio is significant. That is an important component of our support of the SOEs and helps to finance infrastructure in a cost-efficient man-ner.

When the guarantees are utilised, they are done so effectively and in a manner that supports the objective of debt sustainability.

Kurt-Elli, HSBC: The depth of the domestic market is very strong, but it’s also highly concentrated in a num-ber of state owned companies, the financial institutions and the National Treasury. There’s not a particularly deep corporate market. Without that diversification play, the asset managers here domestically are credit constrained with regards to putting on new inventory with the same institutions.

Hopefully we’ll see that constraint loosening though. As the corporate market becomes more active and therefore starting to dilute portfolio concentration in the SOCs, we should see limits go up for the state com-panies, which will allow them to start matching their needs with the right durations and currency. At the moment the only other solution is to go offshore, but in offshore funding there are limits in terms duration for the hedge.

That’s something that we do need to look at — we need to work out how to solve the hedge part of that equation, with some innovation, or on the other side of that, an adjustment in the issuers’ accounting policy, as it were, within the SOCs, so that they are entitled to take a little bit more of that FX risk over a longer duration.

Lucretia Khumalo, HSBC: We can also perhaps look at adding other products, such as project bonds, which are asset backed. That would open up some other pockets of funds within the current investor base that would allow them to invest — they then think of these assets not so much as ‘more Transnet’ but as different asset classes. This might assist in driving down pricing over the long term. It would also be useful if we open up the local market to sukuk. This is a product that will help reach other asset managers who are unable to invest in the current market due to their funds being earmarked for shariah-compliant investments.

Diversifying the product set helps, whether in the local market or offshore.

Lucretia Khumalo,HSBC




Pillay, Transnet: We are certainly looking at opportu-nities to crowd-in the banking sector. The banking sec-tor has had to deal with changes in the regulatory envi-ronment but this appears to have settled down, so the liquidity in the banking sector is a definite source of potential funding. The products and liquidity have to be harnessed to complement our current funding ini-tiatives but this liquidity can provide flexibility in any issuers’ funding programme. However the constraints of local banks are also result of the macro constraints of the economy — i.e. their own cost of funding and credit profile.

: How does this affect pricing?

Hlatshwayo, Development Bank of Southern Africa: For us as issuers, the important thing when switching product from a conventional bond — whether it’s to a green bond or a project bond or something else — is how does that affect pricing?

Given the amount of work required to engage in a new product, the legal requirements and the money you need to spend to be able to do some of these products, there needs to be a pricing advantage to move away from conventional bonds.

Up until such a time that green bonds or project bonds have some price advantage over conventional bonds the development of those markets is going to struggle locally.

Letsatsi, City of Johannesburg: The City of Johannesburg did the inaugural municipal bond issue in this country in 2004. That first issue was difficult but the municipal bond market now sits at around R47bn, and we have been able to reduce our cost of funding over that time. We paid a 20% interest rate on loans that were taken out in 1998 but access to another market has reduced that cost of funding drastically over time. The initial costs were worth it.

Yes, it will be painful, but it will be the same with green bonds. We went in first to issue a domestic green bond, and I don’t believe we paid more than we would have for a vanilla bond. The green bond was sold at 185bp over South Africa government bonds, 60bp lower than the previous conventional bond.

Green bonds is an instrument where there is a clear the use of proceeds. The South African market was not ready to absorb this, so we had to provide the usual balance sheet and guarantees that apply to any other instrument. But going forward these instruments should be able to be ringfenced and targeted specially to green investors.

If you look at where the world is going around cli-mate change issues, it’s obvious we need to grow this market so that there is funding for new technology. Over time, our step into this market will be worth it from a cost point of view as well as from an environ-mental point of view.

Kurt-Elli, HSBC: Creating a new asset class allows a portfolio manager to look at several instruments from the same issuer. In total, they can then look to put more money to work in you by tapping slightly differ-ent pockets within the same fund.

Social and environmental agendas are very much coming to the fore, not just in the investor community here, but also globally, to the point where I actually think over time, we will see predominantly issu-

ance of SRI instruments rather than the conventional bonds where we don’t pay attention to the use of pro-ceeds.

With the very sophisticated domestic market that exists in South Africa, there is an opportunity here to do some interesting work and be at the forefront of this change globally through the domestic market.

Moahloli, National Treasury: The Johannesburg Stock Exchange and other market participants are driving some projects to promote project and green bonds. Once you start understanding the nuances of issuing these bonds and their tradability they become much more attractive, and it starts lowering the cost of bor-rowing over time. But the issue of cost-benefit is a real one, and even before issuing the sukuk we had to ask ourselves the same question. So you have to take a long-term view in terms of trends and prospects of the new markets.

The dollar market has given us depth, volumes and tenor. But what happens when the market closes? The euro market shut for many years. So you pay up in advance so that at some point later you are not forced to pay up. Over time you reap the benefits of being a trailblazer, but initially it doesn’t feel like that.

Julies, National Treasury: There are instances where we may want to go beyond just funding an entity — so for example, not just funding for Transnet or the City of Johannesburg, but to support a sector. At this point in time we have an energy crisis which needs to be resolved.

So we then have to work out how we can bridge that need, and bring in all the funding sources that are available. We’re doing it, in effect, through project bonds that finance a particular sector being the renew-able energy sector. The cost of funding renewable energy (IPPs) was initially high, but it’s come down substantially, and that debt is not on Eskom’s balance sheet. That’s one way we’ve found of going beyond the limitations of an entity balance sheet.

Hlatshwayo, Development Bank of Southern Africa: I am encouraged by the JSE playing a role as the regula-tor and providing a platform, because if there is encour-agement from the JSE then obviously they have done the initial work from a regulatory and legal perspective. That means that for us as issuers the cost of tapping the market with a new kind of instrument comes down substantially.

Adil Kurt-Elli,HSBC




Zulu, Absa: There are of course challenges with regards to South Africa growth and we all know that cost of funding is driven by credit ratings. Where are SOEs and the National Treasury drawing the line in terms of containing debt growth? Generating revenues is of course necessary to be able to service debt.

Julies, National Treasury: A sustainable fiscal path is an important objective. We are revising our growth expectations and revenues and are being careful not to breach our expenditure ceiling. But because the growth has not performed as projected we have slipped in terms of our consolidation projections of debt to GDP.

We, as a government, are very mindful that this can-not continue. It’s precisely this kind of slippage that may lead to a downgrade — we are very conscious of being able to maintain our investment grade ratings. We have demonstrated that the slip in debt to GDP has not been the result of government having spent more — we have not breached our expenditure ceil-ing.

In the outer year of our medium term framework, we plan to achieve a current surplus, with govern-ment revenues exceeding current expenditure. And part of the revenues in those later years will there-fore be financing capital/infrastructure expenditure. Sustainability of the fiscal framework is also about what is it that we are financing with the kind of debt that we are incurring. The recent slippage is the result of underperforming growth and revenues, but we are very much still com-mitted to the consolidation path as outlined in the 2015 medium-term budget policy statement.

Ramosebudi, Transnet: The government cannot spend beyond its means and neither can the SOCs. You need to manage your riches appropriately.

Transnet, as I mentioned earlier, has a R337bn capex programme for seven years, but because of the current macroeconomic situation we are cutting down and deferring some of the capex. But we’re not abandon-ing those projects because they are making a contribu-tion to the economy. You need to continue to invest in those projects that have positive revenues attached so that they help support the company going forward.

Letsatsi, City of Johannesburg: The impact of the 2008 recession was subdued in South Africa because the government enacted a counter-cyclical approach to

minimise the impact. The DBSA is a development financial institution,

and that means it has to come in when the market is not working to cushion the impact on the economy. It fills the gap when the private sector is holding back and not investing.

Hlatshwayo, Development Bank of Southern Africa: Government and government institutions are there to cushion the economy when it is going through a rough patch, as it is currently, and that means investing counter cyclically, but it has to be done responsibly.

We are starting to see new clients that we haven’t seen before. A capital injection from government has given us a bigger ability to borrow and we are making an impact with that in both the South African market and wider African market.

We cannot just sit back. This economy has a goal — it’s got to keep alive in these hard times, and it’s up to government and government institutions to play their role in doing that.

Kurt-Elli, HSBC: To take a parallel with the corporate environment, a corporate that sits there and every day manufactures widgets will at a point in time get over-taken — it needs to keep evolving or developing itself. It’s the same for a fiscal policy and an economy: you need to keep investing for it to grow.

This year we’ve seen in the corporate market that many are willing to risk a downgrade by increasing leverage in order to acquire new businesses and new technology to secure a longer-term growth trajectory. It’s exactly the same at a government level, whether it’s in South Africa or elsewhere. Where you don’t make the investment, in five or six years’ time the drag factor on the economy is far more significant than the potential risk of a near-term downgrade.

So while we need to pay attention to ratings out-comes, if you take a short-term only view it’s easy to make the wrong investment decisions for the long-term sustainable growth within the economy. One must also recognise that there are going to be negative factors outside of their control, for example, commod-ity prices falling. So the answer to that is to diversify the economy, invest in education and improve the power sector — those are factors within their control.

: What is the growth target now set at for the next few years?

Moahloli, National Treasury: For 2016, it’s 1.7%, in 2017, 2.6% and 2018, around 2.8%.

In February we increased taxes, we also reduced expenditure. At the time of the 2015 budget we were projecting growth of 2% for 2015 but six months later we had to revise that target down to 1.5% due to among other things, slower global growth, lower com-modity prices and electricity constraints.

Julies, National Treasury: There’s some wider acknowledgement that South Africa is not a 1.5% growth economy. It’s argued that the labour problems and the continuous labour strikes have significantly impacted economic growth negatively over the years. Labour strikes have easily taken away one full per-centage point of growth in our GDP in 2015. So if we can deal with the strikes then that is already a big

Phetolo RamosebudiTRANSNET




improvement. Then we have had the issue of Eskom and the load shedding in the past year. Load shedding is estimated to have taken another one full percentage point away from our 2015 growth.

If you were to add just that two percentage points to the current projected growth for 2015, we could easily have hit growth of 3.5%. There is a huge dif-ference between an economy growing at 3.5% and an economy growing at 1.5%, especially when you consider we’re projecting an increase from the 2015 growth number in future years. Just imagine the posi-tive impact on our projected fiscal path in an environ-ment where we have resolved the labour issues and meaningfully addressed the energy challenge in South Africa.

Kurt-Elli, HSBC: And this would then initiate a virtu-ous circle in terms of performance, because that then drives more cash into the real economy, more spend-ing power, and so forth.

The only drag is potentially the commodity cycle, but, again, that’s not as significant as many make it out to be for the South African economy. This is not a commodity-only economy — far from it. It’s impor-tant to look at the breadth of the economic growth here because that is actually a really interesting diversification story contrary to a lot of other African economies.

Moahloli, National Treasury: You also get a lot of regional diversification here. Several South African banks have been investing in the rest of the African continent to take advantage of the relatively high growth rates there. Insurance companies too. The structural nature of the income account has been changing, so we’re starting to see dividends being repatriated back and the income account has been improving.

The trade account has also improved with the depreciation of the rand. The extent to which you depend on external funding to finance the current account becomes less and less as we slowly deal with the structural issues.

Hlatshwayo, Development Bank of Southern Africa: The government’s initiatives of reindustrialis-ing the country have had a setback given the power situation, but if you solve the power situation, you start that virtuous circle. It’s a positive spiral, from an economic growth perspective. The power issue is really significant.

We’ve just run into a drought now, so that might also have an impact on the economy. But, obviously, these issues are out of the hands of policymakers, which I hope the rating agencies acknowledge.

: Do you think that Fitch’s deregistering from South Africa will prompt any change in inves-tors’ view of the country as a whole?

Julies, National Treasury: It does not directly affect the sovereign as Fitch continues to rate the country, it’s more the corporates that will be affected.

The sovereign is rated by four rating agencies and we are continually being rated by all four on an annu-al basis. It was a business decision by them —Fitch decided that as part of their own strategy, they wanted to deregister in South Africa. It’s not just here — they’ve been moving some of their businesses to Hong Kong. It’s not something investors should read a lot into at a South Africa sovereign level.

Ramosebudi, Transnet: Because we are rated by sev-eral agencies, it is has absolutely no impact at all on us.

Zulu, Absa: Even the corporate ratings that are going to be withdrawn have been given some time, so there is a period of normalisation that the FSB [Financial Services Board] has allowed for. We’ve advised our customers that have a Fitch rating to look for a dif-ferent rating. In some instances, our clients had dual ratings or an international rating that can be converted into a local scale rating for local investors, which is a relatively easy process. But those that were solely dependent on a Fitch rating are finding it more diffi-cult because the methodology of each rating agency is different, so it takes more time. The FSB’s determina-tion to give the process some time has been welcomed as it’s given the corporates a grace period to rectify the situation if they wish.

Pillay, Transnet: The deregistration of Fitch should not necessarily negatively impact views of the country. The other two rating agencies remain active in the country. The markets are firmly aware of the rationale for the decision to deregister Fitch and that it is not based on the ratings of Fitch on South Africa or on any of its issuers but on the regulation of Fitch as a ratings agency. s

Ben Hlatshwayo,DBSA

Francesca YoungGLOBALCAPITAL



DOMESTIC BOND MARKETDOMESTIC BOND MARKET

IN ANY reckoning of South Africa’s competitive advantages over com-parable developing countries, its domestic bond market would almost certainly feature somewhere near the top.

Large, liquid and sophisticated, it not only offers a wide range of funding options to banks and corpo-rates alike but also provides essential support to the wider economy.

Key to the market’s success is the existence of a well established local institutional investor base — some-thing that has tended to elude other major emerging markets. While relatively small in terms of the number of participants, this group of 12 or so pension funds, insurance firms, asset managers and bank treasuries has deep pockets and has been supportive of issuance from a wide range of borrowers.

This high level of local engage-ment has traditionally been helped by a lack of appetite for foreign risk among South African institutional investors. Trent Wilkins, a CEEMEA debt capital markets banker at Barclays in London, notes that while asset managers do have the flexibility to invest offshore, many are more comfortable investing in a local market that they understand and avoiding the currency risk that comes with offshore investment.

“It is also an onerous task to go through the appropriate due dili-gence for other markets, so there will always be a natural bias to local opportunities across various asset classes,” he adds.

South African investors’ ability to participate in external markets is also limited by regulatory restrictions on the amount of foreign currency denominated assets permitted in portfolios. By contrast, foreign inves-tors’ appetite for South African domestic bonds has increased sub-stantially over the past decade.

According to the National Treasury, holdings of local government securi-ties by non-residents jumped from just 13.8% in 2009 to 35.9% in 2012.

David Renwick, head of global finance for Barclays Africa in Johannesburg, says this rapid rise in interest has been partly due to the high liquidity in domestic govern-ment bonds.

“This drives liquidity in the rand market and enables investors to enter and exit the market on a fairly effi-cient basis, which is a differentiator to many emerging markets,” he says.

Andrew Dell, CEO Africa for HSBC, agrees that ease of access is key to the market’s appeal for foreign investors, along with the supportive approach taken by policymakers to incoming investment.

“The central bank is very flexible around foreign participation in the domestic government bond market and accessing the market is an easy process for global investors,” he says.

He also notes that, unlike in many emerging markets, South Africa’s domestic bond market is very well developed from a structural and reg-ulatory perspective.

Inevitably, say bankers, investor enthusiasm for local South African risk has recently been somewhat dampened by increasing cur-rency volatility and a difficult

macroeconomic environment. Foreign holdings of local government debt, which had remained roughly stable from 2012 until early 2015, have been on the decline over the past 12 months both in outright terms and as a proportion of total out-standing issuance.

“Foreigners only bought around R10bn ($629m) worth of South African domestic bonds [in 2015] versus having received coupons in the region of R40bn, which implies they have reduced their exposure to the jurisdiction,” says Mohammed Nalla, head of strategic research at Nedbank Corporate and Investment Banking (NCIB) in Johannesburg.

On a more positive note, Dell points out that, while nonresident holdings of domestic government debt may have suffered a decline, flows have not been all one way.

“There have been plenty of days and weeks of net inflows over the past few months,” he says.

Whether investors will continue to prove as supportive of the market fol-lowing the market upheavals of early December 2015 remains to be seen.

Nevertheless, bankers say foreign flows into the South African market will likely continue, at least in the short term, provided a degree of sta-bilisation can be achieved.

“The existence of a strong local investor base is a great help in reassuring international asset man-agers in this type of environment,” says one.

Instrument rangeThe strength of support from insti-tutional investors has also been a crucial factor in the development of a wide range of bond market instruments — another feature that sets South Africa apart from many emerging market peers.

Inflation-linked notes have proved increasingly popular over recent

A strong institutional investor base, high liquidity and a wide variety of instruments make South Africa’s domestic bond market one of the most sophisticated in the developing world. Lucy Fitzgeorge-Parker reports.

Domestic bond market keeps South Africa on top

“There is a degree of nervousness

around securitizations…

There is a definite preference for

more vanilla, less structured

transactions”

David Renwick, Barclays

022-23 Domestic Bond Market.indd 22 16/12/2015 17:30


DOMESTIC BOND MARKETDOMESTIC BOND MARKET

years and account for 15% of out-standing domestic bonds at the end of March 2015, according to National Treasury data. Pension funds have naturally been among the main buyers, taking roughly half of all inflation linked issuance, but the asset class has also attracted strong support from banks and other finan-cial institutions.

To date, the government remains the largest issuer of inflation linked bonds, but the format has also been used by some state owned companies and financial institutions.

Floating rate funding is also readily available. FRNs accounted for 15% of outstanding issuance in March last year, with banks and corporates pro-viding the bulk of sales.

“There is a good mix of instru-ments in the domestic market,” says Renwick. “Where there’s not, and if there’s specific demand at some tenor or in a particular format, a fairly deep swap market means it can be comfortably swapped out.”

Nalla notes that the variety avail-able could be expanded still further if, as planned, the Johannesburg Stock Exchange introduces a listed swap market.

Covered bond futureThe range of instruments on offer could receive a further addition over the next few years if regulators decide to permit the introduction of covered bonds. The format is pro-hibited in South Africa but a lifting of the ban was reported to have been under discussion at a meeting of the country’s Financial Markets Liaison Group in November 2015.

Bankers noted, however, that the development of a covered bond market would likely require a higher degree of comfort with securitization than has so far been shown by South African investors.

“There is a degree of nervous-ness around securitizations, and as issuance has recently declined inves-tors have been less keen to spend time trying to understand the asset class,” says Renwick. “There is a defi-nite preference for more vanilla, less structured transactions.”

By contrast, local investors have shown no reluctance to buy bonds in much longer maturities than are gen-erally available in emerging markets. More than half of all domestic bonds

are sold with tenors of seven years or more, with the seven to 10 year space seeing the highest levels of activity. This eliminates one of the usual drivers of international issuance for South African credits, say bankers, given that Eurobond market funding is considerably more expensive on an all-in basis for rand-based borrowers.

Domestic bonds are, however, less competitive against local bank market funding, in terms of both the pricing and maturities available.

“Traditionally, one of the advan-tages of the bond market was that it offered longer tenors than bank funding,” says Renwick. “However, local banks are awash with liquidity and have strong capital bases so can push tenor out quite far at present.”

Renwick adds that structure remains a differentiator, in the sense that for stronger credits bond market transactions can be done on a very covenant-lite basis. As against that, he notes, corporate bonds rarely tend to offer amortisa-tion features.

“By contrast, as bank debt is usu-ally held on balance sheet, the amortising component can be fairly high,” he says.

The ready availability of cheap bank funding largely accounts for the still relatively low volumes of issu-ance by corporates in the domestic bond market, according to bankers.

Corporate bonds: room to growApart from state-owned companies such as Eskom and Transnet, whose outstanding bonds accounted for 13% of the total at end-March 2015, South Africa’s companies are fairly rare visi-tors to the market.

Combined with the small number of large investors, this makes for a largely illiquid market, says Renwick.

“There is not a lot of depth on the primary side so liquidity in sec-ondary is limited,” he says. “It still has the characteristics of a buy-to-hold market dominated by a small number of key asset managers.”

Market participants are hopeful of an increase in both the number of corporate issuers and the volume of issuance but most agree that this is unlikely in the very short term, given the negative macroeconomic outlook.

“The corporate rand market has all the makings of a market that can

grow further,” says a Johannesburg-based banker. “The main hurdle is that in a challenging economic envi-ronment fewer corporates have a demand for funding that are suitable for fixed income securities.”

Bankers also note that the collapse of African Bank, a former market reg-ular, at the end of 2014, dented the appetite of local investors for new, lower-rated corporate borrowers.

It has not, however, discouraged

them from buying increasing vol-umes of subordinated debt from South Africa’s stronger banks, which have stepped up issuance of tier two securities to meet new capital requirements at the end of 2015.

“There has been a large increase in bank issuance related to the Basel III regulations,” says Nalla. “Bid to cover ratios for these issues have been very robust indicating strong demand.”

He notes that increasing regula-tory pressures also has the potential to make bond market funding more attractive, by putting a squeeze on local bank liquidity.

“The impact of higher capital charges on the cost of funding from banks will make bond market funding more competitive,” he says. “The market’s appetite for diversi-fied risks will also serve to support this trend.”

Overall, however, bankers say rapid development of the domestic bond market is unlikely — partly due to the economic environment but also to its already high level of sophistication.

“The South African bond market will continue to develop steadily but without dramatic shifts,” says Dell. “This is not a nascent market that is in a high growth, high innovation phase. It is a well developed market with well established players on both sides of the equation.” s

“The impact of higher capital

charges on the cost of funding from banks will

make bond market funding more

competitive”

Mohammed Nalla, Nedbank

022-23 Domestic Bond Market.indd 23 16/12/2015 17:31


Corporate Issuers Roundtable

: Where do you see the most exciting capital markets funding opportunities in the next year?

Resimate Baloyi, MTN Group: We see funding opportunities mainly in the local bond market. With our funding outlook we really will be upscaling our DCM activities. We’re in the process of doubling the size of our programme from R10bn to R20bn.

We prefer using the domestic market to the Eurobond or international private placement market because we are keen to match the currencies of our funding to our sources of income. Most of our needs in the next year will be to fund our South African operations.

For operations outside South Africa, when we need funding we raise it the local markets of those

operations. We typically only use the international bond market for acquisition opportunities, and so we don’t see ourselves going into that space in the next year unless such an opportunity arises. Carosin Buitendag, Dawn: We originally intended to go to the domestic bond market about two years ago, but we instead did a major corporate transaction where we sold 51% of our WaterTech subsidiaries. This transaction created sufficient funding so we were able to pay off all our debt. At the moment we’re busy reconsolidating as our business model has changed — which has larger trading and logistics components than manufacturing which is most capital intensive.So at this stage if we go to the market, it will be for working capital or potential new acquisitions. We will perhaps look to go to the domestic market

Participants in the roundtable were:Resimate Baloyi, senior manager, group projects & structured finance, MTN Group

Carosin Buitendag, group treasurer, Dawn

Keith Flemmer, loan sales, Barclays

Shrigan Gounder, head of distribution, Nedbank

Simon Howie, co-head of South Africa fixed income, Investec Asset Management

Adil Kurt-Elli, head of CEE and sub-Saharan Africa debt capital markets, HSBC

David Rajak, capital markets and investor relations executive, Bayport

David Renwick, managing director, Barclays

Bruce Stewart, head of DCM origination, Nedbank

Francesca Young, moderator, GlobalCapital

Companies face up to tricky markets and global pressures

Though the South African economy is struggling, its corporates are still sought-after in the international and the domestic bond and loan markets. But the risks of expanding businesses within Africa were highlighted last year by the $5.2bn fine on South African telecommunications company MTN. And as Basel III is introduced in the country, it will become more harder, or at least more expensive, to tap the loan market for maturities of five years or more. Meanwhile, the US rate rise will surely make the international bond markets more expensive for South African borrowers.

At GlobalCapital’s roundtable, held in Cape Town on November 26, representatives from companies, banks and institutional investors gathered to discuss the changing environment for corporate issuers and investment in them.

024-32 Corp roundtable .indd 24 16/12/2015 18:04



next year, or the year after.We have a couple of African enterprises outside of

South Africa, but we will fund those in South Africa and send the money from here. Absa did a study a while ago that showed that it’s cheaper for us to do that. And having a centralised treasury here, we’re more comfortable managing the risks of the South African market too. David Rajak, Bayport: We are quite a diverse group — we’re a Mauritian holding company with operations with seven countries in Africa and two countries in Latin America so we fund everywhere. We fund at the centre through listed bonds and through DFIs [development financial institutions], and we fund in the countries through listed bond programmes, unlisted bond programmes, bilateral bank funding and DFIs as well.We are also, apparently, the largest high yield issuer in Scandinavia! Our last issue was for Skr1.1bn which was the largest high yield issue done in that market this year.

The appetite for Africa seems to be more out of Europe and Scandinavia than South Africa at the moment. I’m sure that will change, but African local currency appetite seems more offshore than onshore.

: It’s been a tough year for South Africa’s economy in general — how has that affected appetite for corporate debt from the country?

Bruce Stewart, Nedbank: The appetite is of course correlated with the economic environment, but the question should be split up into two parts.

Firstly, what’s the demand like for corporate South Africa? That has its own issues in terms of what is the outlook for economic growth. The top 100 South African corporates sit with excess cash of more than R400bn on their balance sheets. That’s lazy money which would be better employed in acquisitive growth or other growth, but the opportunities simply aren’t available for that. This excess of cash means that corporates that would otherwise be borrowing don’t have a requirement to go to the capital markets at all.

Secondly, from an issuer’s perspective, the

execution risk of South African capital market transactions is at the highest it’s been. Investor confidence has been shaken and business indexes are reflecting a gloomy picture. There’s a lot of uncertainty and a fair amount of volatility, which makes this generally quite an oppressive space to be operating in. There is also a lot more scrutiny of investor mandates by their trustees, which makes the interaction between investor and borrower much more tricky.

There’s always going to be opportunity here and there’s always going to be growth but we’re going through a tough part of the cycle at the moment.

Adil Kurt-Elli, HSBC: The offshore appetite really hasn’t been tested with private sector issuance this year — certainly not in any meaningful way — and as a result those that do come to the market find that there is a lot of support.

But we’d like to see many more of these issues so that the South African private sector becomes a more substantial part of investor portfolios. If they do that, they will then get the right level of affection and attention when they do come to the market on a continuous basis, which will create more certainty around execution.

Equally though, the window of opportunity for South African corporates to go to the international markets has certainly been there this year, in part because other emerging markets have been constrained.

The market dynamic has been very supportive in terms of both the size of books that we’re able to garner for these issues and also the pricing we’re able to achieve.

We’re now reaching an inflection point where rising US rates are going to weaken the South African rand further and we’re also going to see several of the markets that were constrained this year coming back — for example Brazil, Turkey, and to some extent Russia. Argentina looks like it’s going to start issuing again and we’ve seen Mexico starting to fill the void in the Latin America space. There will be more competition next year.

South African issuance will still come, but there will be question over the premiums that will need to be paid by issuers to get them away.

: At this time last year there was a buzz around the corporate private placement market both internationally and domestically. Is there still the same appetite for this kind of deal both from issuers and investors?

Simon Howie, Investec Asset Management: From an investor’s perspective, private placements are very attractive. You have the certainty of a deal where the deal gets brought to you, you can consider it and negotiate on it and then you’ve got an investment.

The primary market here meanwhile, is like a blind Dutch auction, which is unfortunate. You’re not quite sure what you’re getting and that makes the markets very difficult to use. We live in a market where liquidity is very low, but that hasn’t actually been a problem to date.

Carosin Buitendag DAWN




We think of liquidity for each issuer in terms of: how many other investors will have credit lines in place for this name? How well known is it? How would you move it if you needed to? That’s much more important than how many investors participate in any specific deal. So we think a regular issuer of private placements is perfect. The liquidity will not be dissimilar to any other issue.

The private placement market is still one that’s flourishing — it’s doing well to the cost of the primary market — because the structures are no different, only the allocation process.

Stewart, Nedbank: As issuers’ appetites for debt are reduced because of volatility, if there’s going to be a public R500m issue, it’s understandable that investors think it’s just not worth getting out of bed to do the credit work. These days you have to do heaps of credit work to justify an investment and you may not even end up with a decent piece of it after doing all that. So a lot of investors that would normally participate stand back, and that has negative knock-on consequences for the depth of the market and the perception of it, and often the success of transactions.

Rajak, Bayport: When we place deals in Sweden, the issuer gives the rate to the market and that’s the rate you’re going to place at. You say this is how much we’re looking for and give a maximum and minimum size of deal, this is the rate and the price is agreed upfront — it’s pre-negotiated. So if an investor wants a deal at 5% or 8%, he does his credit work at that rate. It’s much more straightforward.

Stewart, Nedbank: But you can’t guarantee the size of deal if you’re doing that.

Rajak, Bayport: No, but investors know that if they’re coming in, this is the price. For our last deal we said we were going to do a minimum of Skr700m at a certain price, and the book was oversubscribed so we ended up printing Skr1.1bn.

Stewart, Nedbank: But if he goes in at that price he’s still not guaranteed to get the allocation he wants.

Howie, Investec Asset Management: You might have your allocation cut back but there will be an allocation.

Rajak, Bayport: You can also put in orders that are fill or kill and there are cornerstone investors who say they will come in upfront and back this if this is the price it’s going to be as long as they’re guaranteed their full allocation.

A big investor can go in and know that if he wants to get a certain percentage of the deal or minimum size he’s got it when the auction opens. And it helps me as an issuer because I know we’re opening books and I’m 80% covered.

Stewart, Nedbank: So it works well as a private placement compromise.

Rajak, Bayport: Maybe the South African market needs to consider these methods as an option. I’ve been a big proponent of bookbuilds in the past but, as markets develop, things change.

Howie, Investec Asset Management: The blind auction process for me has run its course. It worked initially but now both arrangers and issuers are incredibly frustrated. Issuers can’t get any feedback from the market because investors have learnt that it’s not to their benefit to show their hands.

We’ve always tried to be very open and we still give issuers information, but we hear that most investors don’t, which means that issuers are then going into a difficult market completely blind. Investors who said they were there feel no obligation to be there on the day because it’s a blind auction. There’s no commitment and there’s actually an incentive — some people seem to think — to misguide arrangers and issuers as to where pricing might be.

: For international bonds, how much South African demand do you actually rely on to get these deals away?

Rajak, Bayport: For deals in Sweden, zero.

Kurt-Elli, HSBC: There are strict selling restrictions

David Rajak BAYPORT

Simon Howie INVESTEC ASSET MANAGEMENT




about selling inbound into South Africa on primary international bonds.

Rennick, Barclays: But you do find that South African investors will get involved after the deal though credit-linked notes or other intermediary structures.

Howie, Investec Asset Management: We do try to get involved in the primary — there aren’t really restrictions. What we do we find, though, is that we get treated very badly because the issuers are using these deals to try to diversify their funding sources. The South Africans who go offshore often pay higher credit spreads in that market, but the last thing they want is to take from their domestic pool of funding.

Kurt-Elli, HSBC: That is true. When printing an international deal, we can take reverse enquiry, but when a domestic account puts an order into the book, then the issuer will quite rightly turn around and say that’s cannibalisation of their domestic liquidity pool. Issuers want to keep that whole, therefore, would want to ensure allocations are focussed towards the offshore demand that they don’t normally access through our rand issuance. This does make sense, but it’s frustrating for the asset managers in South Africa because the international deals typically offer a great premium to the domestic deals and they miss out on the new issue premium offered.

But in the secondary market, there’s good flow, which again drives demand in the offshore bonds because the offshore investors know that they can pick up these bonds and then very easily sell them on to domestic players at a profit if they choose.

: How does the recent weakening of the rand affect your outlook for the South African corporate international and domestic bond markets? Do any currencies outside the dollar look attractive for issuance?

Rajak, Bayport: We haven’t done dollar bonds but every incremental dollar you raise is now worth 20%-30% more versus a deal in your local currency than it was a year ago.

Kurt-Elli, HSBC: Any South African corporate raising debt in a foreign currency has typically been trying to match their cashflow or asset base with that liability. All the recent fundraising that has been done internationally has been event driven — the euro Shuldschein done by Steinhoff, for example.

So the impact of a rand devaluation is cushioned as issuers typically have some cash flows coming in that they can match against the foreign currency liabilities.

The risk of anyone playing the arbitrage game is that any of the value of the arbitrage — in terms of the lower rate available by issuing in euros — gets eroded by the swap costs of turning it back into rand, so the issuer doesn’t always get the upside.

The market may see some upside as investors

round trip on the other side of it and play the differential but that’s an aside. So arbitrage is not the key driver at the moment in South Africa in terms of onshore versus offshore issuance.

Rennick, Barclays: I agree. And whether you’re hedging Swiss francs back into rand or Swedish kronor back into rand or dollars back into rand, the same issue exists.

Kurt-Elli, HSBC: We’re going to need to see much more interaction between South Africa corporates and the international investment community before we start migrating through the product spectrum. We’re not even seeing sizeable volumes in the vanilla, hard currency dollar space yet, so to ask investors to look at something more complicated is a step too far at this stage. Eventually though, all these kinds of trades will work because the South African issuers coming to market are typically top tier, well respected credits that are extremely well run with good management — they just need bigger profiles with international investors.

Stewart, Nedbank: But they’ll only do this if they need the foreign currency because South African corporates are always going to find that it’s cheaper to fund in their local currency.

Rajak, Bayport: Only if the local market is deep enough for them.

Shrigan Gounder, Nedbank: Yes, so Transnet has a problem because, for them, it’s potentially not. But this market adapts, maybe not quickly but it does eventually develop and evolve to cater for the funding needs prevalent at the time. That’s what we’ve observed in the renewable energy space for example. There has been an emergence of credit funds to support and profit from the funding requirements under the programme.

Right now though, corporate issuance is declining but funds under management earmarked for the fixed income arena are not. So where’s it going? It seems to be being deployed in more stable, more generic investments while perhaps looking for more creative products.

Bruce Stewart NEDBANK




High yield corporates are a corner of the market where offshore demand outstrips local appetite, but for higher rated credits you want to raise your capital in South Africa first and foremost because the pricing is so much more in your favour.

Baloyi, MTN Group: We issued our first international bond last year in dollars. We also considered euros and yen. If we were to look at the international space again, one of our objectives would be to open another source of liquidity. We have a dollar 144A issue already outstanding, so next time we would look to perhaps issue in euros just to lay down a benchmark in that market.

: So contrary to what the other participants are suggesting about these other non-dollar international markets being unattractive, MTN would potentially go into the euro market over the building out its dollar curve?

Baloyi, MTN Group: Yes, rather than building out dollars, this is what we would look to do, unless there is an easy, attractive deal on the table there for the taking. We are also still considering yen, though we’re not sure how deep that market would be for us at this point. But the euro for us definitely seems the obvious next step — we’re keen to take a long term outlook and perhaps issue paper just to create a presence in the market and get investors familiar with our name.

: But having only one dollar bond outstanding so far, is it really necessary to diversify the pool of funding? Surely there’s still huge demand in dollars for MTN?

Baloyi, MTN Group: Not really. We continuously assess the market and ask bankers to tell us how much we can issue in the next 12 months without worrying about increasing the price we are paying for debt significantly. At a price, there is liquidity for us in dollars, but to keep costs manageable at this point it’s worth us looking at issuing in other currencies.

: What’s your biggest concern with regards to the South African debt capital markets in the coming year?

Howie, Investec Asset Management: For me, it’s how tough it is here to build diversified portfolios. There’s such limited issuance from the corporates. There’s plenty of bank issuance and we see the biggest opportunity there — in both senior and tier two bank paper. So the supply side is a little bit of a concern. But that said, there is also a declining amount of money available for funds — end investors’ allocations to fixed income is not increasing to either bonds or credit.

Credit is going through a difficult phase — we’ve had a couple of defaults in this market. So there’s not a lot of new money within the market, you’re trying to get your portfolios more balanced, and then the biggest concern is the general increase in

fundamental credit risk. There’s no doubt there has been a deterioration in the macro environment, which is creating a build up of credit risk.

Also, as issuers in the market have moved down the credit rating scale, and there are a larger total number of issuers, the probability of default starts to catch up with you.

There are several issuers that have been in the market for a while — some have strengthened but a lot have deteriorated. Some of these names we don’t even hold but if there is a problem with a listed South African bond, there are ramifications throughout the whole market.

There’s definitely the potential for some defaults next year — the probability is that they won’t default, but there are a couple of issuers that if the environment deteriorates much more, then they could hit some problems.

Gounder, Nedbank: That’s compounded by the fact that the local market hasn’t been fully pricing in credit risk for a while now. In many instances the need to deploy local currency liquidity, coupled with the shortage of quality assets has resulted in loan pricing remaining at artificially low levels — the excess liquidity from banks is potentially masking deeper fundamental credit issues in the market. There’s massive competition for lending among the big banks.

: From domestic banks or international as well?

Gounder, Nedbank: Primarily domestic banks for local currency lending but for select transactions, you do find international banks surprisingly competitive in rand loans as well. It all depends on the relationship they have with the borrower and their willingness to write a marginal deal to protect existing business or secure new business with the client going forward.

Howie, Investec Asset Management: This is one of the reasons why you haven’t seen a lot of corporate issuance in the local bond market. There’s still a lot of liquidity in the big banks within South Africa so there’s huge amount of price tension

Shrigan Gounder NEDBANK




between the banks, as well as fewer and fewer terms and conditions on the lending, so the bank lending competes directly with the bond market. And you can get the same tenors in loans as you can in bonds.

Stewart, Nedbank: Because of a heightened risk awareness in the bond market investors are keen to increase the covenants in the documentation of those bonds, which detracts from what a bond market should actually be about. Bonds should be covenant light, easily tradable and understood and there should be plenty of investors involved. But we’re in a very unique domestic situation at the moment, and there’s been a blurring of the lines between bank lending and bonds.

: But Russia’s international bond market pre-sanctions worked well with the loan market despite covenants quite often being included in bond documentation. Why is South Africa different?

Stewart, Nedbank: Yes, but those were more standard covenants that didn’t get into intricate detail about the interest rates or gearing.

Howie, Investec Asset Management: We have to be careful in the domestic market because we’ve got national scale ratings and it would be easy to look at our single-A and triple-B rated investments and think well of course they don’t need covenants because they’re investment grade rated. But the reality is that a lot of these names are actually high yield. If you were investing in an international bond there would definitely be covenants in there.

There has definitely been some blurring in our market of banks participating in the bond market and most investors, such as ourselves, playing actively in the loan market. We work alongside banks sometimes participating in syndicated loans. There’s overlap and so competition between us, but the banks are offering cheaper funding at this point.

Baloyi, MTN Group: But if in the loan market all the covenants required exist, I don’t understand why they are needed in the bond market because investors can rely on cross-default. A breaching in the loan facilities would trigger a default in the bonds, so why create a duplicate?

: In 2014 when African Bank was rescued by the South African Reserve Bank investors were forced to take a closer look at the financial sector. Is it a surprise to you that bank liquidity available to compete for lending opportunities is still so high?

Gounder, Nedbank: Not really. Corporate lending activity has been relatively modest since the 2008 crisis, particularly when it comes to jumbo underwrites and so you find banks are willing to absorb a substantial portion of the additional regulatory Basel III costs rather than pass it on to borrowers to remain competitive. Some banks have also revised their return expectations on

individual loans, focusing rather on client ROEs to accommodate the slower local economic environment.

Howie, Investec Asset Management: African Bank was first and foremost an unsecured lender and secondly a bank, so the unsecured lending market is still under pressure and finding it difficult to find funding, but the banks in our market — particularly the large banks — are seen as systemically important.

We don’t really have a Treasuries market in South Africa in the short end so it’s what people use instead. It’s a safe haven trade — when investors get concerned, they actually move money towards the banks.

Kurt-Elli, HSBC: The external observation is that on the lending side South African banks are making hay while the sun shines. There is going to be a significant regulatory impact of Basel III being introduced and the additional capital requirements, and with the imposition of the AT1 market, it is all likely to be quite expensive for this region. We haven’t seen the effect of that tracked through yet in terms of asset pricing, so the local banks can, at the moment, remain extremely competitive. There’s little new inventory available to put on loan books and the loan books are naturally running off so it’s unsurprising the lending is aggressive.

But as we start to see the capital race kick in — in the same way that we’ve started to see it in the European markets — there’s going to be a more divergence between banks’ ability to price at that competitive rate. Because of that, long term the loan margins are likely to go up.

This will be positive for the banks given the impact on margins. But it’s also going to be exciting for the asset managers that play in both the corporate funding and on the banks’ capital issues as they’ll be able to achieve pick-ups on current levels in both those markets. The asset managers will also find an increase in the uptake of offered loan pricing, because they will be pricing these deals without having to apply the same level of capital weightings.

Adil Kurt-Elli HSBC




Howie, Investec Asset Management: This transition may just take longer than we’d like!

Kurt-Elli, HSBC: It may not happen in 2016 necessarily.

Howie, Investec Asset Management: Or even the year after.

: Is there evidence of new entrants to this market — the Japanese banks for example — pursuing this business?

Baloyi, MTN Group: We’ve seen an improved appetite for our debt from Japanese banks in particular. We’ve tried to execute rand transactions with Japanese banks but pricing is a bit challenging under the current environment. But two years ago we were closing deals at rates cheaper than what was available from the South African banks. So the appetite from that region is definitely there, but less so at this exact point in time. We also have discussions with the Chinese banks but we haven’t seen anything tangible that looks like we can close. So to date, we are not convinced that they are really open to spending money in this part of the world.

Gounder, Nedbank: One or two Indian banks have also opened branches in Johannesburg in the past two years. They are looking to take small positions in syndicated or bilateral transactions.

They have African aspirations so they seem to want to use South Africa as a base from which to grow in Africa over the long term.

Stewart, Nedbank: There are a couple of Chinese banks that are making their presence felt. The likes of China Construction Bank and Bank of China have grown their domestic balance sheets three to five times in the last four or five years, running their branch operations with tier one equity capital from their motherland.

: Does that leave this region more exposed to the economic slowdown in China?

Stewart, Nedbank: They’re not significant enough players that it will make much of a difference, but certainly there’s an increased level of caution.

Flemmer, Barclays: It just adds to the competition. Chinese banks have turned up in a big way in the last couple of years — Bank of China and CCB have put over R40bn of rand assets into the market, so that’s been in direct competition with the banks.

But they’ve also been funding domestically in this market too. They’re paying preferential rates for retail and corporate deposits, which is also competing with the banks that were already present in this space.

Gounder, Nedbank: Some European banks left in a hurry during the credit crisis of 2008, retreating to their home markets. This withdrawal of support has caused local corporates to view support from

these banks with a degree of scepticism. Some time has passed since then though and lessons have been learned so I’m sure European banks are now more successful in forging relationships with local corporates.

: There is a lot of talk about the macroeconomic risks inherent in South Africa, but one of the biggest shocks was the $5.2bn fine put on MTN by the Nigerian authorities. How concerned should investors be about the growth of companies within Africa but outside of South Africa?

Howie, Investec Asset Management: We’ve been investing for around five or six years north of the South Africa border, and you go in knowing what the risk environment is — the risks are heightened.

The MTN fine was a surprise but if you’ve got a well constructed, well diversified portfolio, that helps — you learn over time that there’s always something that can come out of leftfield so you build your risks so that no one name should be able to make or break the portfolio. The MTN saga was unexpected but clearly the environment is very tough across Africa so there are heightened risks right now.

A lot of work is done to understand the macro and the fundamental credit risks of each entity. You have to sit on cash until you’ve got a really good compelling reason to put that cash to work, and in an environment like this opportunities do come.

Renwick, Barclays: I completely agree. Barclays has had capital committed to some African countries for up to 80-100 years. In the next 12-18 months those that have patient capital and understand the markets will be rewarded with interesting opportunities. We will see a lot of players exit. Those that didn’t understand and came in for the yield pick-up won’t be there anymore, whereas those institutions that have a good understanding of the African continent will thrive, provided they’re prudent.

Baloyi, MTN Group: I can’t speak directly about the Nigeria fine but generally if you’re going in to do business in Africa the regulatory environment is something that you need to accept. That risk is

Keith Flemmer BARCLAYS




there and it’s a high risk, but you need to decide whether that’s a bullet you want to bite.

Even on the banking side we’ve seen Zambia introduce all sorts of new regulations that backfired before they withdrew them. Ghana has gone through something similar. MTN has been paying fines — some that it can’t even justify years later — but that’s just this kind of regulatory environment. You do the best that you can but ultimately you have to accept that the risk is there.

Renwick, Barclays: This is one of the challenges that we face as financiers as we try to bring sophisticated products into new markets. Particularly outside of South Africa, there isn’t legal precedent in a lot of these countries for these structures so when defaults happen it can be very complicated. Some of the docs are driven by English law and New York law, but then you have local regulations that you’re trying to overlay. That makes restructuring very, very complicated.

Kurt-Elli, HSBC: Even when African Bank went through its default and its restructuring, what ought to have been a straightforward contractual based process ended up being quite a protracted negotiation.

It focuses the mind now as to how the Basel III regulations that are about to come in can be adopted and adapted to best effect — whether that be relating to the trigger for point of non-viability, or other features of the new capital structures that are coming through.

There’s an emerging markets learning curve but the people involved in these markets, whether on the buy side or sell side, are going into this with eyes wide open as to transparency and risk profiles.

: So the MTN fine for not registering subscribers has been widely accepted by the market as a risk of doing business in Nigeria rather than a risk of doing business with South African corporates?

Baloyi, MTN Group: Yes, that’s the sense that we are getting. It’s not seen as a South African corporate issue — it’s an issue with regards to the regulatory environment in which we operate.

Renwick, Barclays: I can’t talk on behalf of all investors but the reality is MTN has a very strong balance sheet and very strong cashflows.

Kurt-Elli, HSBC: And we’re increasingly seeing EM investors isolate specific country risks from whole regions — so for example, Russia’s impact on CEE credit has been limited and recent Turkish spread widening has also not affected the rest of the region. So here, South African corporate spreads aren’t moving because of an event that’s taken place elsewhere in the region.

Commodity prices are having much more of an effect in terms of yields than some of these other isolated regulatory events.

: The South African debt capital markets are some of the most sophisticated in the emerging markets. But here, is over regulation an issue?

Howie, Investec Asset Management: Yes. I mentioned that the biggest challenge we have is building diversified portfolios. That’s by far the biggest challenge we have — not the fact that regulation isn’t tight enough on specific issuers. As the market develops it’s getting worse. We now have a ratings act, which has resulted in Fitch Ratings leaving the country, and there are tougher and tougher debt listing requirements, so there are more entities that are going unlisted.

All these things make the environment tougher and means there are fewer issuers, which make us less able to build that diversified portfolio we need.

So there is a balance to be had. The levels of disclosure you need to provide to tap the offshore debt market, even the unlisted market, are very high and it’s at a similar level to tap the domestic market — I’d say the Johannesburg Stock Exchange (JSE) listing requirements are too onerous.

Regulation doesn’t always help. In South Africa it goes a little bit too far.

Rajak, Bayport: In the Swedish market only after the issue is done, do you create the debt prospectus. So you only incur the significant legal costs and need to get the regulatory approval done once you know you’ve got the transaction done, at which point you have a certain number of days to get it listed.

Stewart, Nedbank: Our JSE prides themselves on being the best regulated, but they mean the most regulated, which is not necessarily the same thing.

They appear to be instigating a sophisticated equity listings regime and migrating a lot of the terms and conditions that apply to equity listing to their debt listing requirements — they seem to want to create one homogenous set of listing regulations for debt and equity.

The equity market is a retail-focused market and the JSE has some obligation to protect individual people on the street. But the debt capital market, by contrast, is more of an institutional market

Resimate Baloyi MTN GROUP




that doesn’t need the same level of regulation and protection.

To that end the JSE seems extremely focussed on content and not sufficiently focussed on context. There’s not enough of an understanding about the value of having free-flowing debt capital markets available as a distribution for capital and how that can affect your economy.

: Do you see the regulator gaining that perspective over time or is it just as likely that the reins will get shorter and shorter?

Stewart, Nedbank: Unless market participants actively engage them to enlighten them and help to remove the blinkers it’s going to be difficult for their perspective to change.

Howie, Investec Asset Management: It is moving the right way. We’re engaging them a lot through ASISA — the Association for Savings and Investment — looking at perhaps a professionals’ market existing on the JSE. There is progress being made and we are being heard. There have been some good hires recently made on the JSE so we see it moving in the right direction.

Stewart, Nedbank: It just may take longer than we expected!

Kurt-Elli, HSBC: Do you think if there’s an adjustment to create a professional investor disclosures market — similar to what we have in the European space — that will unlock more volumes from the private sector issuers? Is this the inhibitor?

Renwick, Barclays: It is one of the central issues. There are definitely potential issuers that we know of that because of the new disclosure requirements are opting to stay in the bank market.

Howie, Investec Asset Management: We were starting to get going on the high yield bond market — there were five or six issuers — but one after another they’ve delisted. They come to you pleading that they want to get out of this listing regime

because they have to act like public companies in terms of disclosure. We’ve allowed that because seeing the situation we’ve adapted our investment mandates so we can invest in unlisted companies. But overall this isn’t healthy for the market.

Rajak, Bayport: But surely they knew that this would be the case going into the listing in the first place?

Howie, Investec Asset Management: Yes, but it has changed along the way. It became more and more onerous.

Stewart, Nedbank: An unintended consequence of the 2011 New Companies Act was that you no longer could be a private company listed on the JSE debt side. So you had companies like Mercedes Benz and Sappi — which were established and accessing good capital flows — pushing back against this together with a lot of corporate South Africa.

What they’re asking is not impossible so they’ve fallen in line, but it creates a little bit of stickiness to the process that didn’t need to be there. You do that too often and you create an aversion to the whole debt listing.

Flemmer, Barclays: The slowing of the high yield bond market was sad. It’s a pity because we were doing a lot of the origination for these issuers and the great thing about it was that you had the clients, investors got their yield pick-up and the issuers were left with the enough flexibility to run their businesses.

: Do you foresee Fitch deregistering from South Africa as having any longer term impact on corporate yields and spreads?

Howie, Investec Asset Management: No, it won’t have any real impact. But what it has done is caused a huge amount of unnecessary work and a huge amount of cost for issuers. There is the small credit quality impact of an extra external check for our clients having been removed, but it’s only a small impact. It’s a real shame — Fitch had a long history in this market and is a recognisable international rating agency — but it’s not a disaster.

Rajak, Bayport: Under the requirements of some investor portfolios though, is the rating that has been removed a stipulation? Do issuers now need to get a new rating to replace the Fitch rating to stay included as an investment?

Howie, Investec Asset Management: A lot of issuers do need new ratings now and they have had to bring other rating agencies in. Particularly on the structured finance side that is not easy.

The timeframe for this is also short, so there’s a lot of noise, a lot of distraction, a lot of time and energy being spent on this which could have instead been spent on bringing the issuers to market or that they could have focussed on growth.

It’s a great opportunity for other agencies though. s

Francesca Young GLOBALCAPITAL



BANKING SYSTEM

THE SOUTH AFRICAN economy faces troubling times. Frequent power outages are battering produc-tivity, household debt has soared and commodity prices have plummet-ed. To cap it off, real gross domestic product (GDP) growth entered nega-tive territory for the first time since 2009 in the first quarter of 2015.

The government hasn’t escaped the strain. The country now teeters on junk rating after Standard & Poor’s revised its sovereign rating to BBB- in June, and Fitch did the same on December 3.

Confidence crumbled further on December 10 when president Jacob Zuma fired his well-respected finance minister, Nhlanhla Nene. Many saw Nene as the last line of defence against the country’s growing public debt.

In the wake of the announcement the shares of Nedbank, FirstRand and Standard Bank dived 5%-8% lower, and the rand tumbled to a record low against the dollar. Shortly after, on December 11, Fitch downgraded the ratings of all three banks to BBB-.

Solid foundationsBut South African institutions are expected to remain robust, notwith-standing the challenging backdrop. An important determinant of their resilience will be their strong levels of capital.

Indeed, “the capital strength of South African banks was partly a rea-son why they didn’t suffer the effects of the 2008 financial crisis as acutely as banks in other parts of the world,” says Andrew Dell, CEO Africa at HSBC in Johannesburg.

The four biggest domestic lenders had already met their 10.75% common equity tier one requirements for 2019 by the time the South African Reserve Bank released the country’s Basel III capital framework in October 2012.

According to PwC research, Fir-

stRand bank had the highest total capital ratio as of September 2015, at 16.7%. Standard Bank followed close-ly behind at 16.1%, after which came Nedbank and Barclays Group Africa, at 14.5% and 14.1% respectively.

“The South African Reserve Bank is conservative, prudent and rather careful as a regulator,” Dell explains. “It sometimes interprets global regu-latory frameworks in a somewhat conservative way. That can be a con-straint but it also means there is more of a safety net in place.”

Earnings remain solidAccordingly, South Africa’s financial institutions continue to deliver steady profits.

The country’s largest four domes-tic banks had an average return on equity of 18.2% in the first half of 2015, and combined headline earnings were up 17.7% on the same period the year before, according to PwC.

Moody’s expects core revenues to remain robust over the course of the year. The ratings agency says banks will profit from healthy non-interest income, as well as stable net inter-est margins stemming from predomi-nantly floating rate loan books.

But rising interest rates are likely to dampen banks’ profitability ratios, restricting loan growth and squeez-ing the already highly indebted South African consumer.

“With the current interest rate cycle

indicating that rates are rising in South Africa the trade-off in the bank-ing sector of low impairments and good profitability will be impacted,” says Gary Tamblyn, deputy treasur-er at Nedbank Corporate and Invest-ment Banking in Johannesburg.

“We are expecting a deterioration in asset quality in the next 12-18 months, which is usually our main concern during periods of stunted economic growth,” adds Nondas Nicolaides, vice president and senior credit officer at Moody’s. “There will be higher levels of loan loss provisions, and earnings growth will certainly be impacted.”

A response to increasing loan impairment charges has been to move away from riskier household lending, targeting the country’s lowly lever-aged corporates instead.

It is perhaps surprising, then, that Capitec — a mass-market retail bank established in 2002 — maintains unsecured consumer lending as a prominent part of its growth strategy. Given the experience of African Bank in 2014 (see box on page 34), many are still understandably worried about the associated risks.

But in the case of the country’s big-gest lenders, the build-up of non-performing loans is unlikely to spiral into a default risk and, says Nico-laides, any increases will “be manage-able and shouldn’t have a significant impact on banks’ balance sheets and profits”.

Regulatory hurdlesBut some challenges will require South Africa’s banking system to adapt.

Meeting the requirements of the Net Stable Funding Ratio (NSFR) has consistently been identified as an obstacle for South Africa, whose banks remain largely reliant on short-term wholesale funding.

The ratio, established within the context of Basel III and effective in

South Africa’s well capitalised banks are profitable despite strong economic headwinds, but obstacles remain as the country’s financial institutions look for long-term and stable sources of funding. Tyler Davies reports.

Solid banks well placed to withstand economic challenges

“The South African Reserve Bank

is conservative, prudent and

rather careful as a regulator”

Andrew Dell,HSBC

033-34 Banking System.indd 33 16/12/2015 17:33


BANKING SYSTEM

2018, is aimed at improving liquid-ity mismatches by ensuring that a healthy quota of a bank’s long-term assets are funded by long-term, stable funding.

But the Reserve Bank is responsive to these changes, and is looking into ways to help its banks comply with international regulations.

“A large proportion of funds invest-ed internally in South Africa is man-aged by asset managers, and therefore classified as wholesale funding under the Basel III regulations,” says Ned-bank’s Tamblyn. “Previously noth-ing from a wholesale source with a duration of zero to six months could be counted as available stable fund-ing, but our regulator has recently suggested that a rating of 35% will be applied to the zero to six months wholesale line.”

However, even in its revised form, the NSFR will be challenging for South African banks, whose capacity to raise longer term funds is limited.

“What you’ve got in South Afri-ca, therefore, is a situation whereby banks are holding increasing amounts of government debt in order to meet those requirements,” says Tamblyn.

Not only does this drag the future of the country’s strong financial insti-tutions further into the struggles of the national economy, but, he says, “holding increasing amounts of gov-ernment debt will also reduce the effectiveness of South Africa well established domestic debt markets.

“At some stage, as we head towards NSFR implementation, if they don’t soften some of its application in a South African context, then you are going to find it could reduce the liquidity of the SA bond market to the point of it being a concern.”

Alternative fundingThe ratio’s introduction could therefore be a catalyst for the growth of the coun-try’s already well developed domestic capital markets, as banks seek to trim bal-ance sheets and lengthen the tenor of their funding profiles.

For example, the Reserve Bank is now said to be con-sidering allowing its banks to issue covered bonds, hav-ing previously opposed the instruments, citing fears

about subordinating the interests of depositors.

As convenient sources of long term funding, the introduction of covered bonds to South African capital mar-kets could be an important factor in helping banks become compliant with stricter liquidity requirements.

But David Renwick, head of global finance at Barclays Africa in Johan-nesburg, is sceptical about the capac-ity for the growth of covered bonds in the country.

“There is still quite a lot of work to be done before [the regulator] gets comfortable with a bank pledging a specific set of assets to support a fixed income security,” he says. “There has been a securitization market in South Africa for some time, and that market is fairly deep from a structural com-plexity perspective. But it isn’t par-ticularly deep in terms of volume. In my view, secured products remain limited as an alternative source of

funding at this time.”

Staying close to home?There is some temptation to venture into international markets and sup-plement funding with foreign curren-cies.

But the burden of an emerging market credit profile has raised the cost of funding to unfavorable levels. “Credit and yield curves are reasona-bly steep in many foreign currencies,” says HSBC’s Dell. “So banks tend to be averse to paying up for longer tenors.”

“Because of the very well developed pension fund and asset manager com-munity in South Africa, local banks can readily raise long term rand liabil-ities,” adds Renwick. “Over time, how-ever, they may face difficulties access-ing hard currency, long-term funding to support their growth. Emerging markets are showing deteriorating credit quality and the impact of that, coupled with rising US interest rates,

means that access to dol-lar market liquidity is going to come at a much higher price in the future.”

With strong econom-ic headwinds threaten-ing growth and structur-al imbalances threatening liquidity, South Africa’s banks have substantial challenges to confront. Capital strength has kept them in good shape once before during financial troubles, it may need to do so again. s

Tangible common equity-to RWAs of rated banks, by system

In 2014, the South African Reserve Bank stepped in to place African Bank under curatorship, after the lender’s strong fo-cus on the unsecured consumer credit market led to an unsustainable build-up of bad loans.

The central bank established a “good bank” out of African Bank’s healthy loans and assets, as part of broader re-structuring plan. The actions set a new precedent in dealing with failing banks in South Africa.

“There always used to be a perception that banks were protected by the sover-eign, but that all changed when African Bank went under curatorship,” says Bruce Stewart, head of debt capital markets

origination at Nedbank Corporate and In-vestment Banking in Johannesburg.

“It altered the risk profile of South Af-rican banks and how they are perceived domestically. That’s been reflected in the pricing of all debt needed to comply with Basel III requirements such as the Net Sta-ble Funding Ratio.”

“When African Bank was running into difficulty, I was impressed the Reserve Bank saw an issue developing and acted so decisively to stop the situation deterio-rating further,” adds Andrew Dell, CEO Af-rica at HSBC. “It wasn’t a formal resolution scenario — as the framework was not in place — but it was certainly a proactive ap-proach to dealing with a struggling bank.”

0%

2%

4%

6%

8%

10%

12%

14%

BRAZIL RUSSIA INDIA CHINA S.A.

2011 2012 2013 2014

Source: Moody’s Banking Financial Metrics

Tangible Common Equity-to RWAs of rated banks, by system South African banks' capital bu�ers are stronger than in other large emerging markets

The demise of African Bank

033-34 Banking System.indd 34 16/12/2015 17:33


A FINANCIAL HUB FOR SUB-SAHARAN AFRICA

SOUTH AFRICA HAS a lot going for it as a financial hub for sub-Saharan Africa. It has deep and liquid debt and equity markets, strong institu-tions, the rule of law, transport links to most of the continent and expan-sive local companies which provide a natural client base for South Afri-can banks building a presence in the region.

But is the country taking the best possible advantage of the situation? There is a feeling in South Africa that there is more potential than is being addressed.

Perhaps the clearest evidence of South Africa as a regional financial hub can be found in one of its banks: Standard Bank, which has offices or subsidiaries in 19 countries across Africa. Along with Togo-headquar-tered Ecobank, it is the closest thing that can be found to a truly universal pan-African banking group.

Barclays, too, clearly sees the potential of a regional business hub in South Africa, having absorbed the South Africa-based group Absa in 2013; today called Barclays Africa Group and 62.3% owned by Barclays Bank, it has majority stakes in banks in 10 African nations and representa-tive offices in two more.

To varying degrees, Standard Char-tered and HSBC also use South Africa as a base to serve other markets; Ned-bank, in a different approach, has

had a strategic banking alliance with Ecobank since 2008 (it is also a 20% shareholder), giving it representation through Ecobank’s 2,000 branches across 36 countries.

“The pioneering path has already been laid,” says Goolam Ballim, chief economist and global head of research at Standard Bank. “South African financial services are glob-ally recognised as top tier in terms of robustness, quality of governance, and credibility and legitimacy as an industry.”

That’s all true, but that’s not the same as saying it has made the most of that reputation at a regional level.

“Is South Africa a true regional hub? Yes and no,” says Charles Rob-ertson, chief economist at Renais-sance Capital in London. “Yes, it is clearly seen as a hub, and the inclu-sion of South Africa into the BRIC grouping — making BRICS — was China saying that South Africa is a good hub for access into Africa.

“The ICBC investment into Stand-ard Bank, for $5.5bn in 2008, is still one of the most significant China has ever done, and it was made because of Standard Bank’s network through sub-Saharan Africa.” Infrastructure and the legal system in South Africa are excellent, he says.

“So why no? Because if you’re going to invest in Nigeria, the best way to play that is not via South African listed companies that have tended to play a small role in Nigeria,” says Rob-ertson. “15 years ago South Africans were more likely to fly over the conti-nent of Africa on the way to New York than they were to stop in sub-Saha-ran Africa. That has changed —South African companies are paying more attention — but still investors will generally get more direct exposure from investing in Nigerian or Kenyan companies.”

He points to the clashes between Nigeria and South Africa in recent

years, most recently over the tele-coms firm MTN but more generally over visa issues, as demonstrating an underlying rivalry between the two. Indeed, Nigeria is now Africa’s largest economy, and South Africa might slip to third behind Egypt before too long.

The most natural way for South Africa to be a financial hub for the region is if its companies require it to do so. “There is a lot of potential,” says Dennis Dykes, chief economist at Nedbank in Johannesburg. “The most direct way this happens is a lot of South African companies mov-ing north of the borders looking for opportunities, and they are all listed. There is already that participation and raising of capital.

“What perhaps hampers it a lit-tle bit is the fact that countries don’t want to be dominated by South Afri-ca. They naturally want their own exchanges and their own local partici-pants.”

Market of choiceNevertheless, no other exchange in Africa compares to the Johannesburg Stock Exchange or South Africa’s debt markets. The JSE is the 19th largest stock exchange in the world by mar-ket capitalisation, and the largest exchange in Africa.

The JSE describes itself as “the market of choice for local and inter-national investors looking to gain exposure to the leading capital mar-kets in South Africa and the broader African continent.”

It has been something of a pioneer in African terms throughout its his-tory: formed in 1887, a World Federa-tion of Exchanges member since 1963, electronic trading since the 1990s, demutualised and listed on its own exchange in 2005.

It has an alternative exchange, AltX, for small and mid-sized listings, launched in 2003; it has another mar-ket, Yield X, for interest rate and cur-

South Africa has strong links to the rest of the continent and a ready-made hub in Johannesburg’s business district. But is it doing enough to fulfil its potential? Chris Wright reports

Jo’burg: bags of potential, needs support

“South African financial services are globally recognised as top tier in terms

of robustness, quality of governance,

and credibility and legitimacy as an

industry”

Goolam Ballim, Standard Bank

035-36 financial centre.indd 35 16/12/2015 18:08


A FINANCIAL HUB FOR SUB-SAHARAN AFRICA

rency instruments; and it acquired the South African Futures Exchange in 2001 and the Bond Exchange of South Africa in 2009. Investors can trade in five financial markets in South Africa — equities, bonds, and three forms of derivatives (financial, commodity and interest rate) — and there is just no comparable exchange anywhere else in the continent.

“Generally if you want to raise capital, whether it be bank finance or project finance or equity capital, this is really the only deep market you have available,” says Dykes. “In a lot of African countries, the tradi-tion is mostly to invest in government bonds: you don’t have those deep cap-ital markets which have developed over a number of years.”

Additionally, many of the compa-nies listed on it are themselves mul-tinational and strongly present in numerous African markets, among them British American Tobacco, SAB-Miller, Glencore and BHP Billiton.

Other countries in the region seek to make use of South Africa’s markets from time to time. In 2012, for exam-ple, the Namibian government float-ed an R850m 10 year bond, the first tranche of an R3bn programme.

On the equity side, a 2011 change in the listing rules to allow foreign domiciled companies to be treated as domestic listings was clearly intend-ed to attract foreign companies to consider the South African market as a listing venue. Before that, for-eign companies had been subject to foreign exchange rules, limiting the amount of equity that local investors could hold. Before 2004, foreign com-panies couldn’t list at all.

Africa’s New YorkIf there’s something missing, it’s the sense of the state really pushing South Africa as a financial hub.

“I would have thought there was very high potential given our finan-cial markets are broad, deep and there is a lot of experience, with world class market infrastructure and insti-tutions,” says Peter Worthington, sen-ior economist at Barclays in Johan-nesburg. “But I don’t know if the government has really got its head around the idea that this is a desirable thing, to be aggressively promoted.”

That might be a question of prior-ity. “The government is very fixated on manufacturing as the saviour sec-

tor, and perhaps other sectors like tourism and financial services aren’t pushed as much as they could be,” says Worthington. “But the govern-ment has been proactive in the sense that if you want to invest in Africa, capital controls have been lifted com-pletely. So there is an African agenda at the South African government, and all activity is favoured.”

There are some practical further steps the government could take to bolster the country’s ambitions as a regional hub, bankers say. One is to make it easier for an internation-al workforce to set up there. “If they want South Africa to be a financial and commercial hub for Africa, the government needs to make it easy for companies to operate, for example by a more accommodating attitude to work visas for skilled foreigners,” says Worthington.

Curiously, earlier this year a Chi-nese property developer, Shanghai Zendai, announced that it planned to develop a chunk of Johannesburg into a financial hub, in what was assumed to be an attempt to cen-tralise China’s trade relations with various African countries. Shanghai Zendai calls it “Africa’s New York”.

There is some sense in this. Chi-nese trade with Africa hit $201.1bn in the first 11 months of 2014, according to the ministry of commerce of the People’s Republic of China (Mofcom) 2014 Business Review, and total Chi-nese investment in Africa to date is believed to have topped $40bn, chief-ly in mining and infrastructure.

The ICBC/Standard Bank deal is a signal that China wanted finan-cial services capability to go with all that investment, and so building a hub for it is not with-out merit. Shang-hai Zendai has acquired 4,000 acres, paying $100m to buy it from a South Afri-can chemical man-ufacturer, but does not appear to have done much since.

Johannesburg would argue that it already has a financial hub — the Sandton district, where the stock

exchange is housed along with most of the major local and international banks — and that the Chinese might sensibly just hub their operations from there.

Johannesburg itself is unarguably the city that should be seen as a hub. According to the City of Johannes-burg itself, it generates 16% of South Africa’s wealth, employs 12% of the national workforce, and 74% of South African companies have their head-quarters there. The city’s internation-al airport serves 2.5m international passengers a year, and its City Deep freight terminal handles 30% of South Africa’s exports. It also hosts South Africa’s highest court, the Constitu-tional Court.

There’s no doubt that the financial services industry, one of the strong-est sectors in South Africa, is central to the country’s health and so rep-resents one of its best prospects for expansion.

“It is amazing what share of our corporate income tax receipts, our personal income tax receipts and our VAT tax receipts are generated by the financial sector, and only the finan-cial sector,” Worthington says. “It’s a goose that is laying a fiscal golden egg. The sector should be supported and promoted.”

And the positive view is that it also helps Africa in general, making it eas-ier to fund infrastructure, grow pri-vate capital and just do new things.

“The deepening of Africa’s finan-cial services is well in train,” says Ballim, “and we [as lenders] are arguably the most significant sweep-ing force that can change lives on the continent.” s

0

100000

200000

300000

400000

500000

600000

700000

800000

Bourse de Casablanca

Egyptian Exchange

Johannesburg Stock Exchange

Nigerian Stock Exchange

Stock Exchange of Mauritius

$million

African stock markets compared Source: World Federation of Exchanges

035-36 financial centre.indd 36 16/12/2015 18:08

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