Unlocking Liquidity in Local Credit Markets

In the South African credit market, year-to-date (YTD) daily traded volumes in local government bonds average R49 billion a day (1.2% of outstanding bonds: R3.8 trillion), while traded volumes on the credit side can average R346 million a day (0.03% of outstanding bonds: R1.1 trillion). Meanwhile, equities’ daily traded volumes YTD average R21 billion (0.1% of market cap: R19 trillion).

Structured notes account for roughly ZAR263 billion of total issuance, while floating and fixed-rate notes total ZAR 839 billion. Of the vanilla corporate bonds, only 8% (ZAR66 billion) had traded between January and the end of October. The top 10 traded entities account for 71% of those year-to-date volumes. Overall, liquidity is poor.

The credit market has shown a robust performance over the past four years, as demonstrated by the tightening in credit spreads. Asset demand is high, defaults are low and returns are strong. What, then, accounts for the low liquidity? It stems from multiple factors, including investor behaviour, a buy-and-hold strategy, limited supply, narrow spreads and insufficient transparency concerning the asset’s true market value.

Many of these issues might not have immediate solutions. Changing investor behaviour cannot be achieved overnight, and increasing supply is more about factors like enhancing macroeconomic conditions, stimulating economic growth and reducing interest rates.

Improving transparency in the market in terms of both pricing and trading activity represents a significant opportunity. Having a centralised platform where all buyers and sellers can meet and trade credit would do much to enhance trading activity.

Currently, trading activity for the local corporate bonds is influenced by supply and demand factors; however, it is also affected by the lack of information. We examine the market setup across different asset classes within global markets.

Equities have a centralised platform where stock prices are broadcasted, ensuring that all market participants are aware of the price. This levels the playing field for all participants, as no single player has an advantage over others. The equities platform helps aggregate bids and offers and enables more focused and larger flows into the asset class due to increased visibility. It becomes easier to participate in an asset class when there is clarity regarding market conditions. Furthermore, a trading platform allows the superior price-finding mechanism, known as the invisible hand, to function effectively. Transparency in pricing reduces the premium to fair value and potentially brings it in line with fundamentals, macroeconomic conditions and overall liquidity.

An electronic trading platform (ETP) for trading South African government bonds was introduced in 2014. The aim of introducing the ETP was to enhance the transparency within the South African Bond Market and to enable National Treasury to more accurately monitor the activities of the primary dealers (PDs).

Bloomberg ALLQ is a trading platform for fixed income products was designed to improve market efficiency. The Eurobond market responds rapidly to news and exhibits highly elastic pricing. As such, the ALLQ platform is a reliable source for price discovery for Eurobonds. However, confidence in ALLQ for ZAR corporate bonds is limited and may therefore not achieve the desired level of transparency for this market. Other trading platforms include MarketAxess, which is the market leader in the electronic trading of US corporate bonds, where about 20% of corporate credit is traded.

In the South African corporate bond market, banks send their bids and offers to clients and investors on a daily basis, with each bank showing different spreads for the same bond. The JSE also provides a mark-to-market (MTM) file, but it’s up to the buyer to decide at which level to purchase the bond. Some opt to buy at the MTM price, even if it’s six months old (as they consider it to be the market level). Brokers typically add their fee to the quoted price, resulting in investors paying a premium without knowing the true market price of the bond. Unlike equities, there’s no specific price displayed on a screen for that bond. This lack of transparency, in our opinion, restricts trading activity. If there were a visible ‘price’ that everyone could see, with sell-side participants being just 1 or 2 basis points apart, it could boost trading activity. Implementing platforms or systems that provide such transparency would be highly beneficial.

Two platforms tackling this issue are Intengo Market and Addendum Marketplace. Intengo offers analytics on primary market activities, helping issuers gain crucial insights when entering debt capital markets, thus benefiting both issuers and investors. During an auction, issuers and arranging banks can access real-time data, monitor investor bids and keep records for future analysis, with the platform’s analytics being impressive. Intengo has reviewed all listed bonds in the market and developed tools around them, showing spread evolution over time, which is beneficial in a tightening spread environment. Although additional work is needed (and underway) to achieve a more precise ‘modelled spread’, especially concerning the liquidity premium, Intengo still provides valuable information that can improve liquidity.

While Intengo provides market analytics and is working on a solution for the secondary market, Addendum already supports secondary market trading activity. Addendum Marketplace is an electronic trading platform enabling debt capital market participants to connect, negotiate pricing and trade credit. Users – both buyers and sellers – employ the platform to find assets and trade with other market participants.

Despite this, platform usage is limited, with only two banks (including Absa) actively participating. Currently, roughly 20% of trading occurs on Addendum, making derived information limited. Increased user adoption could yield invaluable market price information in real time.

Both platforms – Intengo and Addendum – are continually improved to enhance market efficiency, but without greater user engagement and volume, their value-add remains untapped.

South Africa’s corporate bond market may not be large enough to sustain multiple trading platforms and we could well see consolidation in the future. Requiring investors to navigate multiple platforms can hinder transparency and efficiency. But if all sell-side participants posted their bids and offers on a single platform, market efficiency could improve through more accurate price discovery, reflecting up-to-date prices rather than stale data.

Trading on outdated MTM prices would cease, as the latest market prices would be universally available. These platforms could also allow for an accurate evaluation of the liquidity risk premium, which is often absent in current spreads, empowering market participants to make well-informed portfolio choices.

Despite widespread digitalisation, much of the credit market trading activity still takes place via email, Bloomberg chats and calls. While there are platforms designed to streamline credit trading, they remain underutilised, limiting their potential influence on the credit market. Increased use of these platforms could significantly enhance and transform the sector.

There are other initiatives that aim to improve transparency and liquidity, including the S&P Global spread consensus service, which was promulgated via the Banking Association of South Africa (BASA), involving Absa and the other big South African banks. Incorporating this into the platforms mentioned above could further enhance their functionality and effectiveness in aiding the market to the correct prices.

Equity markets have had trading platforms for many years, which has increased efficiency rather than harm by making trading more streamlined. The credit markets space will quickly learn that a more efficient and transparent market translates into a more vibrant one.