The Senate approved $1bn Eurobond sale last week, as investors “fret” over oil production and currency.Much earlier, the Minister of Finance, Kemi Adeosun,had promised to bring out “$300m Diaspora bond out in March”. The media, in turn, reported on: “Deals that will shape capital market in 2017”, and “oil marketers raise the alarm over $1bn banks’ debt”. These policy announcements as well as news flashes covering the movement of capital in and out of the economy are seldom of interest to the vast majority of citizens in this country. Financial news tends to be dry, somewhat esoteric and appealing only to the professional in the field until one sits down and pauses a little to ask some basic questions: Why is government always harping on bonds, and their issuance? Why is the capital market so central to company development and the macro-economy? Why then, given the importance of capital in the economy, do we learn of shady deals that bring banks and company down every so often? I have to say, it is difficult enough to get even the most educated in my family into a discussion of the ebb and flow of capital and the daily gyration of markets, let alone bring the topic down to the level of a mass audience. This is what this column attempts to achieve with this piece this week and next week. So, let us take a stroll through the capital markets. If you think there is an eerie, casino feel, to all the money talk; gains and losses, you are not alone.
The reader will have immediately noticed that I have written market(s) instead of market just above. In most advanced economies and in international capital markets, it is written in plural because it is a series of linked markets specialising in different types of instruments. It is in singular in smaller economies where only money and financial instruments are traded. What most people associate with financial markets in this country is the stock exchange, where stocks and shares are bought and sold. This is simply a coincidence of history. Government debt used to be issued as stocks or bonds, while companies issued shares. Although the Nigerian Stock Exchange still lists government debt in stocks and bonds, but the vast majority of what stock exchanges do nowadays is deal in company shares. Over time, “stocks” and “shares” have become synonyms. More about that later, but first, there are two types of capital: equity and debt. Flowing from which we can also identify two types of debts: loans and bonds. Companies do raise money through bank loans, of course. But big companies sometimes issue bonds of their own. It is one of the advantages of being a public liability company (PLC). What then is a “bond”? A bond is a guarantee on a piece of paper; a sort of “IOU”. When government issues one, it is called “sovereign bond”, because it is cast-iron guaranteed.
Bonds are debt instruments involving a humungous amount of money; billions and trillions of naira at a time. For instance, company “A” issues a bond for $100m and promises to pay the holder an interest of five per cent a year until maturity, which could stretch to 10, 15, 20 and even 30 years. The holder keeps the coupon (IOU), collects interest of five per cent every year and also gets the principal back at the end of the agreed period. Simple enough? Yes, but there is more. The whole of the bond will not be provided by one person; it is too much money. Several individuals and fund managers will take pieces of it so, the totality of the holders can eventually run into hundreds and even thousands. The company or government that issued the bond does not know exactly who is holding what quantity; it does not matter. Bond holders need not hang on to the coupon until maturity either. Since a bond is a tradeable instrument, the holder can decide to sell it on to someone else. This is why they are also referred to as “securities”. Unlike a bank loan, where the bank manager remains in touch with the borrower until redemption, a bond issuer never knows who is holding its bond. It is a lot cheaper for companies to raise money this way. Some large companies may prefer to issue debentures, which are domestic bonds in local currency, but they are also listed on the stock exchange. Debentures are, nonetheless, secured over the company’s assets, and are registered in favour of an individual or groups of individuals. This is otherwise known as “security”, not to be confused for “securities” mentioned earlier. Debentures market is domestic and relatively small, whereas, bonds market is international and huge. The “IOU”, on a bond coupon, used to refer to the “bearer”. This means that it is acknowledged regardless of who was holding it, but nowadays it has been “dematerialised”. This means that it is no longer written on paper; it has been digitalised. Bond holding now only exists as electronic entries.
As stated earlier, when government issues a bond, it is referred to as “sovereign”, because it is guaranteed by the state on behalf of its citizens. What about, in this country, situations of state governments issuing bonds to the public? Is it not possible for the states suffering from financial hardship (more than 20 in fact) to simply issue bonds then, spend, spend, spend? In theory, yes, but in practice no. Bonds are usually issued to finance major capital projects and deductions on them are taken from source. That means the bondholders do not have to lobby the state government for interest payment; the interests are directly deductible from the federal allocation. No ifs and buts, no quibbles. So, while not being “sovereign” as such, state bonds have the characteristics of sovereign bonds. Money going directly to building infrastructure in a state is a good thing, but the terms of the bonds can stretch over 20 years or more. The question then is, is it right to tie the hands of future political leaders in a state by forcing them to pay debts they have not sanctioned? Would it not be politically expedient for an unpopular governor of a state to saddle his likely successor with huge debts he will have no choice but to repay perhaps throughout his own entire period in office?
To be concluded next week
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