CMA and KDIC deadlock over recourse for bondholders

The Capital Markets Authority (CMA) and the Kenya Deposit Insurance Corporation (KDIC) have failed to strike a common deal on a compensation mechanism for bondholders in the event of a bank failure ahead of next month’s budgetary proposals.

The CMA has for several months been seeking support from the KDIC and the Central Bank of Kenya (CBK) on a clear reimbursement policy for debt held under custodial arrangements such as pension schemes by collapsed banks.

The move is part of efforts to restore confidence in the limping corporate bond market, which is on the verge of collapse, routed by defaults by collapsed Chase and Imperial Bank.

The two lenders went under with a cumulative Sh6.8 billion in bonds, whose sale to the public had been cleared by CMA in 2015, leaving investors — especially fund managers who are contracted by pension schemes to manage workers’ savings — bruised.

The capital markets regulator hopes to win back and restore the confidence of fund managers with the proposed amendment to section 30 of the KDIC Act.

The proposal seeks to have funds invested by pension schemes through fund managers “ring-fenced” from other assets of a collapsed bank and paid as a priority, an arrangement KDIC and CBK are reluctant to support.

Luke Ombara, the director for regulatory policy and strategy at CMA, said discussions with KDIC and CBK were still ongoing, but hinted at a deadlock.

“Discussions are about identifying assets under custodial arrangements. For example, if you have a bond issued, there’s a bond trustee and they are held in custody on behalf of pension funds through fund managers,” Mr Ombara said in an interview with Smart Company on Wednesday last week.

“In some other jurisdictions, funds held under custodial arrangements are supposed to be segregated from deposits. They are not supposed to be dipped into.”

Under current law, depositors are given priority when it comes to compensation from funds recovered from a collapsed bank to a limit of Sh100,000 per account.

Bondholders, like other creditors, are paid what remains after insured depositors are compensated, KDIC chief executive Mohamud Mohamud has maintained.

“According to our law, those (bondholders) are creditors and so they will be catered for under the residual (cash). If you look at our law, we first pay the depositors then the creditors,” said Mr Mohamud in a past interview.

The collapse and subsequent default on bonds by Chase Bank (Sh4.8 billion) and Imperial Bank (Sh2 billion) has exposed the gaps in Kenya’s investor compensation laws and policies, leaving bondholders with no clear recourse in the event a company is liquidated.

“It is a matter of reviewing existing provisions to ensure that it’s crystal clear that in the event of a collapse, this is going to be treated as senior debt. In doing so, basically you are telling … (investors) that whatever happens, your assets are safe,” Mr Ombara said.

While the KDIC door remains shut unless depositors have been reimbursed the maximum Sh100,000 or as determined by KDIC, the bondholders cannot also be compensated through CMA’s Investor Compensation Fund which caters for stock market investors who fall victim to insolvent brokerage firms.

Equities investors in collapsed brokerage houses are compensated up to a maximum of Sh50,000.

“We haven’t quite reached an agreement because KDIC also has its own views. They have a position, but in the light (corporate) bond, which is dying, we are telling them to consider this situation,” Mr Ombara said.

“We haven’t reached a final position, but we have now involved the National Treasury as some kind of umpire. We will know the Treasury position in June.”

Trading on the corporate bond market has been limited in recent years, perhaps pointing to apathy among investors.

A paltry Sh180 million worth of corporate papers were transacted in the first quarter of this year, half the Sh370 million turnover in the previous quarter, market statistics show.

CMA data shows that last year, investors traded Sh1.17 billion worth of corporate bonds in the secondary market, the equivalent of 0.21 percent of total bond turnover, which stood at Sh557.7 billion.

Companies that invested in Chase and Imperial Bank have had to make expensive write-offs of the paper, which in turn has raised the risk that buyers are associating with company bonds, and thus the decision to desist from buying existing paper in the market.

The higher risk associated with corporate bonds means they have traditionally paid a higher interest compared to government paper, but now it seems investors are unwilling to take a risk on the corporate paper at any cost.

“To counter the challenge of an illiquid corporate bond market in Kenya, the CMA has procured a consultancy to support the introduction and implementation of the hybrid bond market model that will allow trading of bonds both on and off the exchange,” the agency said in its quarterly market soundness report for the period ended December.

NSE chief executive Geoffrey Odundo has said the exchange has started wooing companies to consider putting up a guaranteed bond, which will ease investor fears about losing money in case of problems with the issuer.

“We are now focusing on having large issuers to inspire confidence in the market. We are talking to supranationals such as AfDB to do a local currency bond, and also large corporate companies whose balance sheets can inspire confidence in the market,” Mr Odundo said mid-January.

“We are also encouraging issuers to come up with guaranteed bonds, which is where we started in the first place in the corporate bond market before we moved to partial guarantees and then to unsecured paper,” he added at the time.