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Deepening local bond markets in the WAEMU through securitization

25.03.2013Anna Selejan

Securitization is a financial engineering technique that enables a private or public entity to raise cash by selling its cash-flow producing assets or its future revenues. These assets are sold to a Special Purpose Vehicle (SPV) which, in order to raise the needed cash, issues fixed income securities on the local capital market.

Although widely used in developed countries and in some parts of Africa (Morocco, Tunisia, South Africa and Nigeria), securitization is a new concept in most Sub-Saharan countries. In the WAEMU, asset securitization has been possible since 2010 when the regional regulator (the CREPMF) issued the relevant texts. The law allows for a very large spectrum of FCFA-denominated assets to be securitized: besides traditional mortgages, it is possible to securitize any kind of existing assets and even future cash flows. Moreover, there is no restriction on entities that can sell their assets: they can be financial and non-financial companies, as well as public sector entities. However, no securitization transaction has occurred yet in this part of Africa. This article explores how securitization can contribute to the development of the local bond markets.

The public debt market in the WAEMU presents numerous challenges to both potential issuers and investors. Issuing costs are high relative to other forms of debt financing and almost all corporate issuers need to have their bonds partially or fully guaranteed by a Development Financial Institution (DFI) or a guarantee fund, which further increases costs. Sovereign or quasi-sovereign issues dominate the bond market, and there is little credit discrimination among these bonds and the guaranteed corporate ones, they have more or less the same risk/reward profile. Maturities are concentrated in the 5-year segment with only a couple of bonds issued at 7 or 10 years. In a nutshell, the fixed income universe in the WAEMU is quite homogeneous, offering investors little choice in risk, yield and maturities.

The CREPMF has recently introduced the possibility of substituting a guarantee with a financial rating given by one of the 2 licensed rating agencies. This action would allow for more credit discrimination among securities, since interest rates would reflect the real credit risk of each issuer. However, the first bond without guarantor and with a credit rating is yet to be issued.

Asset securitization can be the solution for private and public sector entities looking to raise cash, as well as for investors keen on diversifying their portfolios, while substantially increasing the depth of the local bond markets. Through securitization, companies can monetize part of their good-quality assets or future revenues by selling them to a Special Purpose Vehicle (SPV), thus raising cash without having themselves direct recourse to capital markets. If the securitized assets are worth more off-balance sheet (translating into lower borrowing costs against the specific assets than against the company’s entire balance sheet), raising cash through securitization is much more cost-efficient than issuing company debt. With the advent of financial rating, securitization can help curb financing costs for companies that are considered risky and thus have a lower credit rating than part of their assets would.

For example, the first securitization transaction in Morocco that took place in 2002 involved a mortgage pool securitization for Crédit Immobilier et Hôtelier (CIH), a bank who wished to restructure its balance sheet. Through the true sale of a quality mortgage portfolio, CIH was able to raise DH500M (approximately $45M) through the indirect issuance of two senior and one junior tranche. The longest (16-year) senior tranche was issued with a 7.32% annual coupon, only slightly above the 7.1% coupon offered on a 15-year Moroccan government bond issued some months earlier. Had the CIH issued under its own signature, its borrowing costs would have been much higher.

Governments could also resort to securitization of existing assets or future flows, in order to reduce budget deficits, as well as to finance future investments. The Italian and Belgian governments in the late 90s both securitized outstanding social security receivables, thus putting them off-balance sheet in order to reduce their budget deficits to comply more easily with the Maastricht criteria. In 2004, the Government of Hong Kong SAR decided to securitize the future toll revenues from state-owned tunnels and bridges, thus raising a total amount of HK$6 bn (approximately $800M). The state government of West Bengal (India) raised Rs.15 bn (approximately $300M) through the securitization of future taxes levied on several fuel products. Apart from instant cash inflow in an alternative way, these kinds of transactions allow public authorities to have a better asset-liability management, by matching public asset cash flows to the repayment of the asset-backed securities, and a more efficient cost-benefit analysis and hence management of public assets, by clearly earmarking revenues to be used to fund them, instead of relying on general tax-backed funding. Moreover, future flow securitizations involve a thorough assessment of the sovereign originator’s legal and institutional environment, notably recovery processes and claim enforcement rules, which can foster necessary institutional reforms. This in turn can have a positive spill over effect on general investor confidence.

Securitized assets are carefully selected and their future behaviour (future cash-flows) is thoroughly modelled. The future cash-flows (and the risk of non-payment associated with them) are then structured into fixed income securities (tranches) of different risk-return profiles. Thus the same asset pool will serve as a funding source for senior (low-risk, low-return) and junior (higher risk, higher return) securities. The basic idea is to spread the risk unevenly among tranches and reward investors according to the amount of risk taken. For example, the above cited Moroccan mortgage-backed securities were issued in 3 different tranches, all offering different risk exposure, maturity and remuneration.

Getting exposure to a specified pool of assets and having the possibility to select the desired risk-return investment profile are clearly two important steps forward in the development of the local bond markets. While until now, investors could basically subscribe to two kinds of risks (sovereign and quasi-sovereign), with relatively low risk profiles, with the introduction of asset-backed securities, investors will not only be able to get exposure to a new risk classes, but they will also be able to select how much of it they want to hold (by choosing either the senior or more junior tranches). The asset-backed securities also introduce the notion of real credit risk: that of not being able to get back 100% of their initial investment or all coupons, based on the underlying asset pool’s overall performance.

Are institutional investors ready for the big change? Definitely. Are companies and national treasuries ready to add securitization to their list of financing options? Not quite so. Securitization, and financial engineering in general, are quite unknown concepts for the majority of companies in the WAEMU. The subprime crisis has not helped much either in popularizing the concepts in a positive sense. Since companies have traditionally raised cash through banks or DFI loans, a large part (if not all) of their asset base is pledged as guarantee, so there is little room left for alternative asset-based financing. Securitization offers a different perspective on assets: they are no longer considered as an end, but rather as a means to optimize a company’s financing. Realizing this concept may take some time and may need a more innovative state of mind.

We believe that education is key to the success of any financial innovation and that applies in the WAEMU as well. Once public and private sector decision-makers thoroughly understand the concept and philosophy of securitization, it will no longer appear as a mystical, complex and ultimately risky alternative. Bonds issued in this fashion will tap into huge reserves of regional savings (through asset managers and insurance companies) and thus further enhance the efficiency of local capital markets.  

Anna Selejan has been the Managing Director of ALC Titrisation, the first privately owned securitization SPV management company in the WAEMU, based in Abidjan, Côte d’Ivoire. Prior to setting up ALC Titrisation, she worked as Vice President – Investment Management with IC Securities, a Ghanaian asset management company and as Fixed Income and SRI (Socially Responsible Investment) portfolio manager with Allianz Global Investors in Paris (France) for several years. She holds a Master’s degree in Economics from the Budapest Corvinus University, Hungary and a Master’s degree in Portfolio Management from Université Paris XII, France.

Making macroprudential supervision work for Africa

04.06.2012Miquel Dijkman

Although the concept of macroprudential supervision dates back to the seventies, it has staged a remarkable comeback since the global financial crisis. There is now by and large consensus that pre-crisis approaches to regulation and supervision lacked a proper “macro” dimension, focusing exclusively on risk within individual financial institutions and insufficiently on assessing and controlling systemic risk. Macroprudential supervision is meant to fill this gap. It requires a holistic perspective on the financial sector, that pays due consideration to the interconnections between financial institutions, markets and infrastructure and the real economy. Operationalizing macroprudential supervision requires progress on several fronts: monitoring risk build-up and detecting when risks have materialized (i.e. macroprudential surveillance), and applying tools to curb the accumulation of risks (i.e. macroprudential policymaking).  

Macroprudential surveillance should thus contribute to more informed choices with regard to macroprudential policymaking. Macroprudential supervision should be comprehensive, capturing the time-series and the cross-sectional dimension of systemic risk. The former refers to the tendency for financial firms, nonfinancial corporates and households, to overexpose themselves to risk in the upswing of a credit cycle, and to become overly risk-averse in a downswing, while the latter refers to the linkages within the financial system that can function as contagion channels in times of distress, potentially creating self-amplifying spirals and severe contagion effects.  

Policymakers worldwide have enthusiastically embraced the rationale for macroprudential supervision. African policymakers are no exemption to the rule, as illustrated at a recent seminar in Douala on the topic where central bankers across the continent exchanged experiences. They strongly endorsed the rationale for macroprudential supervision, but also highlighted the difficulties in putting macroprudential supervision to actual practice. To some extent, this is a challenge that policymakers worldwide are struggling with. A satisfactory operational framework for macroprudential supervision is still lacking and the measurement of systemic risk is still “fuzzy”. In the case of Africa, these measurement issues are often exacerbated by concerns over data availability, reliability and comparability, and capacity constraints. 

Participants of the seminar echoed these concerns, reiterating that the need for additional guidance for the practitioner. This includes a clarification of the scope of macroprudential supervision, its relation to existing microprudential supervisory frameworks, and the nexus between macroprudential surveillance and macroprudential policymakers. Policymakers in emerging market economies would also benefit from a systematic appraisal of the suitability of the various instruments (such as forward-looking provisioning requirements and countercyclical capital buffers) in light of the overall stage of economic and financial development: financial regulation is not without costs and there are concerns that measures to smooth the credit cycle can delay financial development.

Another important set of questions relates to the relevance of macroprudential supervision for African policymakers. Its relevance depends on many factors, especially the stage of economic and financial development. As a general rule, macroprudential supervision gains in importance as financial systems mature and deepen. The process of financial deepening is often accompanied by a changing composition of the financial system, with an increasing share of new financial instruments, greater leverage and the emergence of financial intermediation outside the realm of the deposit-taking banking system. Also, increasing cross-industry and cross-border integration contribute to greater interconnectedness of financial systems, both nationally and internationally while financial innovation leads to a more complex financial system, in terms of the intricacy of financial instruments, activities, and risks, as some countries in the region have already experienced.

An increasing body of academic research indicates that financial development can propel economic growth, but it also raises the economic costs of disruptions in the financial system, usually in the form of an erosion of economic activity and significant budgetary outlays to support troubled financial institutions. As financial systems mature, it thus becomes increasingly important that policymakers adopt a more holistic perspective on the financial sector and take timely measures aimed at curbing emerging risks to financial stability through macroprudential supervision.

The capacity of the authorities to credibly deliver on a macroprudential also matters. The lead agency responsible for macroprudential supervision, typically the central bank and the supervisory agency, need to be adequately resourced for the new task. Many central banks have established financial stability units responsible for periodic financial stability reports. To be effective, they need a critical mass of qualified staff, and access to information - including key prudential indicators from the supervisory agency. Ideally, the central bank should also be provided with an explicit mandate for financial stability. Since macroprudential supervision is essentially an add-on to microprudential supervision, a robust basic microprudential framework should be in place before branching out into this new territory. Lastly, the authorities responsible for macroprudential policies need to have sufficient gravitas and independence to overcome industry and political pressures, so that the outcomes of macroprudential analysis can be credibly translated into macroprudential policymaking. Scaling up macroprudential supervision can thus be a worthy objective, provided that these preconditions are met.

Miquel Dijkman is a senior financial sector specialist at the Financial and Private Sector Development Vice Presidency of the World Bank.

Financial Services Regulations – Nigeria vs USA

12.11.2010Vincent Nwani

There is a wide gap between the US and Nigeria’s level of financial development. Yet, they share many puzzling features, including regulatory trends, structural transformation and response to shocks. For instance, the banking industry in Nigeria has experienced marked changes over recent years, characterized by a decline in the number of banks, growing concentration and increasingly international focus. Like many of their American counterparts, the largest banks transformed into full-service financial firms offer diversified range of products and services to retail and corporate clients.

Growth of non-interest revenue is a noticeable trend; technology is also transforming banking business (among other things) in the decline in paper-based payments, and the emergence of very large financial service firms has continued to mirror the developmental  trend of US financial services. Regulators have had to face challenges in adapting to this new domestic environment by paying attention to domestic credit market, potential shocks from securities and insurance business.

We here analyze the commonalities and the co-movement between the US and Nigerian’s financial service regulations.

  • Regulatory Trends: Recent events in the Nigerian financial services landscape suggest that the Nigerian financial services regulators usually mirror the domestic financial services supervisory frameworks after the American example (viz: a broad range of elements of Sarbanes–Oxley entering Nigeria’s Corporate Governance tenets, introduction of “Universal Banking” in 2000, following the repeal of the US Glass-Steagall Act in 1999, and, a decade later, the ongoing scrapping of the Universal Banking following the introduction of the “Volker Rule”, aimed at limiting the banks' trading and investment capabilities, by President Obama in January this year). Also, the extant delineation of commercial bank’s margin lending limits echoes similar restrictions in the US jurisdiction.

  • New Capital Requirements: They are hard-coded into regulation, with references to US$50billion-asset financial firms (investment or commercial banks) described as being “systematically important” to the US financial services industry. Similarly, the new capitalisation requirements for international, regional and merchant banking delineate the level of scrutiny that they will attract in Nigeria. For example, the systemic dangers of banks may raise differing red-flags at differing times unlike the experience of the “rescued banks” in August 2009.

  • Financial Stability Oversight Council: The US council is mandated to specifically scrutinise emergent risks to the whole financial system. Indeed a specific “Vice Chairman for Bank Regulation” has been established to report to the US Congress. Similar responsibility is echoed in the ongoing resuscitation of Nigeria’s Financial Services Regulation Coordinating Committee (FSRCC), promulgation of Asset Management Corporation of Nigeria (AMCON) Act, and support for CBN’s financial services reforms.

  • Stress Tests: Like the US Supervisory Capital Assessment Programs (sensitivity, scenario-tests to forecast capital adequacy), stress tests will soon become regular occurrences instead of dramatic one-offs. They will be more akin to stop-checks and will be an expansion of the type of special examinations of (historic) books that the Central of Nigeria (CBN) carried out in mid-2009.

  • “Living Wills”, as coined by Bloomberg Markets journal: Like an expanded, more elaborate (and more structured) form of Nigeria’s exercises, and as being practiced in the US, systematically important banks may find themselves subject to detailed distressed-sale measures which would reduce the risk and financial burden on trading partners in case of untoward market movements or developments.

As outlined above, and in many other respects, the Nigerian financial services regulation appears to follow similar trend with the US financial services regulation. While leveraging on other jurisdictions’ regulations is not a new phenomenon, adaptability of such regulations to local political and socio-economic realities is critical for success. This is in addition to regulators’ involvement of other stakeholders in the debate on such adaptability. Nigeria appears to have recognised this as demonstrated in the process that led to the banks’ new prudential guideline and AMCON Act.

 

Vincent Nwani is Head of Research at First Bank of Nigeria. The article has been co-authored with Tunji Inaolaji, Research Associate at First Bank.
   

 

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