M-Akiba lessons for broader local bond market reforms

In March 2017, the Kenya Government launched M-Akiba, the first mobile-based Treasury bond, designed to achieve dual objectives of encouraging savings and fulfilling the promise of financial inclusion.

According to the Treasury, the bond empowers Wanjiku to exit the market at will, if she decides to do so, and one can buy or sell the bond exclusively using the mobile phone platform.

Since its launch, the bond has raised Sh1 billion, against an offer of Sh2.15 billion (which is not a bad performance rate).

However, performance notwithstanding, the entire structure of M-Akiba serves two lessons for the domestic fixed income market as a whole.

The first is, the market is now ripe for market making, something which the M-Akiba platform has successfully deployed.

Let’s say the Treasury is looking to raise sh50 billion through a debt sale. It has two choices, it can either sell it to the wider public, consisting of both institutional and individual investors, through an auction, which is the current model.

In that case, it has to deal with hundreds, if not thousands of investors.

Or, it can deal with a handful of pre-selected institutions, say five to 10, whose core mandate is to underwrite the debt sale.

These handful institutions, commonly known as primary dealers, in turn sell to any other party, both institutions and individuals, interested in the securities thereby creating an initial (or primary) market.

They also stand ready to buy back (or sell) any of the bond (through two-way quotes), thereby playing a market-making role.

Market makers play a crucial role of providing liquidity when needed. In the M-Akiba case, if an investor wants to sell their bond, all they need to do is select the sell option through their mobile phones.

But behind the scene, a market maker, a bank in this case, undertakes to buyback the bond and in the process provides secondary market liquidity by way of a guarantee.

The growing volume of securities rediscounting strengthens the case for market-making.

In 2018, statistics from the Central Bank of Kenya (CBK) shows that a total of Sh17 billion worth of treasuries (bills and bonds) were rediscounted, a 59 percent year-on-year growth over 2017.

Rediscounting broadly refers to an arrangement where a financial institution (CBK in this case) agrees to buy back its debt securities from an investor before maturity, but at a discount (ostensibly for occasioning a liquidity inconvenience on the issuer’s part).

But because the instrument was sold at a discount in the initial market, it is then said to be rediscounted.

In most cases, an investor rediscounts due to urgent liquidity needs, and is a tool used by central banks to prop up commercial banks with liquidity challenges, making it largely a wholesale activity.

In the Kenyan case, the rising retail rediscounting is being driven by a lack of secondary market for trading bills.

Additionally, in the case of bonds, which has an active secondary market, the liquidity threshold is so high that usually trades below Sh50 million are considered odd lots.

A market maker would solve this problem.

In the second lesson, M-Akiba is the first government bond to be deposited and registered outside the CBK.

Ordinarily, the CBK is the only depository and registry for government debt securities, while the Central Depository & Settlement Corporation (CDSC) manages the stocks and corporate bonds register, creating a dual system.

In such a dual depository system, switching asset classes sometimes becomes an onerous task for investors. Suppose you wanted to sell a portfolio of stocks and buy government bonds. How is that switching process? Can it be improved?