The 15 Year Bond. Will the Anchor Hold?

At the beginning of April this year, the Government of Ghana seemingly took a giant stride in its ongoing efforts to deepen the country’s capital market and substantially expand its constricted fiscal space with the introduction of 15 year cedi-denominated treasury bonds. Prior to the issuance, the longest tenured bonds issued on the domestic market by government had been 10 year bonds.

The international financial portfolio investment community had apparently reacted to this with enthusiasm. The Ministry of Finance gleefully announced that Investors offered to buy GHc3.427 billion worth of the bonds, although government actually took a slightly lower amount of GHc3.422 million.

But it has since emerged that most of the bonds – about 95% – were bought by a single American fund management firm.

This predominant off-take by Franklin Templeton has generated an unsettling controversy, initiated by the main opposition party, the National Democratic Congress, which claims that the bond sales process was rigged by Finance Minister Ken Ofori-Atta, who has a conflict of interest between his ministerial position and his relationship with Trevor Tregarme, who is both on the Board of Franklin Templeton and is Chairman of Ghana’s Enterprise Insurance Group, a company in which Ofori-Atta’s wife, Dr Angela Ofori Atta also serves on the Board.

Originally widely regarded as simply politicking by the NDC to discredit what was being seen as a monumental feat by the new government, the issue has not gone away quietly; rather it continues to escalate with the NDC taking the matter first to the Commission for Human Rights and Administrative Justice, and then to America’s Securities and Exchange Commission (SEC) where Franklin Templeton is licensed and which has indeed since appointed a case manager to look into the allegations.

To be sure, the case may turn out to be more complicated than supporters of the bond issue originally thought as the NDC, it its petition to SEC, has cleverly consolidated its array of earlier allegations into the one that America’s capital market regulator takes most seriously – insider trading.

Indeed, the NDC argues that only minimal efforts were made to inform local investors in particular about the issue and further points out that the bonds were only open to subscription by investors for one day, whereas similar issuances done in the past using the same process were open for subscription for three days. This, the NDC argues, proves that the issue was arranged for a particular investor – Franklin Templeton.

However, embattled Ofori-Atta has consistently maintained that “no breach of integrity” occurred prior to or during the bond issuance process. He insists that: “All prospective bidders bid through their primary dealers who in turn submitted the investors’ bids through the Central Securities Depository platform. The transaction advisors then used these bids to build up a book on which the bonds were issued.”

Indeed the three book runners – Barclays Bank, Stanbic Bank and Strategic African Securities – all of which were actually appointed by the very NDC government officials who are now effectively accusing them of collaborating with Ofori-Atta to manipulate the bond issuance process, insist that they did nothing out of the ordinary and neither did the Finance Minister pressurize them to do so. They insist that they contacted all the usual investors who are interested in buying Ghana’s cedi denominated debt securities prior to the issue but closed the issue earlier than usual because the entire issue had secured investors at yields within the price guidance given them, so there was simply no need to keep the issue open any further.

Actually here appears to lie the truth about what really happened – Ofori Atta, an accomplished investment banker with extensive contacts on Wall Street, the New York located global financial markets capital, had already convinced Franklin Templeton to buy up most of the issue before the book opened, leveraging their long standing trust in Ghana’s sovereign bond issues (the company has in the past bought up to 85% of certain medium term bond issues done when the NDC was in power and was the largest single holder of Ghana’s cedi-denominated medium and long term debt even prior to the controversial recent issue); and adding to this the trust they have in Ofori-Atta personally. Indeed it is most instructive that when defending the issuance before Parliament last week Ofori-Atta actually alluded to this indirectly when he assured that he and his team would continue to use their international connections to attract investments that would improve Ghana’s financial standing, undeterred by the ongoing allegations and consequent controversy.

Some financial and economic analysts, realizing what apparently really happened suggest that government should have openly done the issuance as a private placement which would have avoided the accusations of insider trading. However this would have required a new approval from Parliament, separate from the approval given earlier for this type of structured public issue of bonds and government seems to have not wanted to waste any time in issuing bonds that would both elongate the maturity profile of the public debt and shore up Ghana’s international reserves and thus improve the fortunes of the cedi which had suffered steep renewed depreciation over the previous six months.

Indeed, the NDC further has alleged that since the bonds were subscribed mainly by foreign investors who converted foreign currencies to invest in the cedi denominated bonds – and whom will thus be entitled to convert their cedi investment proceeds back to forex upon maturity or secondary market sales or early exit by discounting – the bonds actually amount to a foreign loan and therefore should have been subject to Parliamentary approval prior to their issuance.

In the structure used, this is untrue – Parliament had given approval for this type of issuance to be classified as domestic debt, since it is cedi-denominated, several years ago and indeed every administration starting from the Kufuor administration has used such approval accordingly. However, the incumbent government carelessly gave the NDC ammunition for this allegation by continually quoting the proceeds of the bond issue in the dollars which they received rather than the cedis in which the issue is actually denominated.

Furthermore, the Finance Ministry failed to include the controversial new issue in its debt calendar for the first half of 2017 – ostensibly because at the time the calendar was being devised, the agreement with Franklin Templeton to invest in 15 year bonds had not been reached – and the NDC is standing on this crucial omission as evidence of irregular conduct.

Finally, the NDC argues that the pricing of the bonds was too high – ostensibly to reward the favoured majority investor – and that the issuance makes Ghana’s forex exposure on its public debt inordinately high.

With regards to the first part of this allegation – that the interest rate agreed was too high – Cassiel Ato Forson, Member of Parliament for Ajumako-Enyan- Essiam constituency who was a Deputy Finance Minister in the Mahama administration and currently is ranking member of Parliament’s Finance Committee, argues that by replacing 91 day and 182 day treasury bill debt, currently yielding 16.35% and 16.70% respectively, with 15 year bonds at 19.75%, government will pay an extra GHc330 million a year, this translating to GHc4.95 billion over the next 15 years.

Conversely though, Ofori-Atta argues that the bonds issuance will save Ghana GHc600 million in costs associated with the continuous refinancing of short term debt.

Here, Ato Forson’s computations are, to some extent, incorrect. The fact is that interest accrues on a portfolio investment whenever it matures and over a 15 year period, a 91 day investment would mature about 60 times while interest on a 15 year bond is usually paid every six months. This means that if the 91 day investor keeps rolling over the investment, interest inclusive, over 15 years he or she would earn more than the 15 year investor. However at current interest rates, the 182 day investment would be cheaper to service, just as Ato Forson asserts.

Nevertheless, Ofori-Atta is right in arguing that substantial refinancing costs would be saved by cutting the inevitable costs involved in re-issuing short term debt securities every 91 or 182 days.

Unsurprisingly, the Ministry of Finance has quickly responded to the allegations of conflict of interest.

Actually, the relationship between Ken Ofori-Atta and Trevor Tregarme is tenuous at best. Neither Tregarme nor Dr Ofori-Atta hold executive positions in Franklin Templeton or Enterprise Group respectively. However, the allegations have got tongues wagging on the grounds that Dr Ofori-Atta’s is the largest single individual shareholder in the Enterprise Group and there are suspicions, albeit completely without any concrete evidence of any sort, that she is holding those shares on behalf of Ken Ofori-Atta himself. This speculation is intensified by the fact that Ofori Atta’s long standing business partner, Keli Gadzekpo, with whom he co-founded and nurtured Databank, the investment bank which they own together, is the CEO of the Enterprise Group, having left his position as CEO of Databank itself to take up his current appointment.

However, as both the Ministry of Finance and the three institutional book runners that actually conducted the recent bond sale – Barclays Bank, Stanbic Bank and Strategic African Securities – point out, the structure of the latest bond issuance is exactly the same as that for all the medium and long term bonds issued by every successive administration since the Kufuor administration opened the door to foreign investors in 2006.

To be sure, the three book-runners were actually appointed by the NDC’s Mahama administration when it opted to change over from the erstwhile Bank of Ghana auction system of medium and long term bond issuance to the current book building system in November 2015. Instructively, the Ministry of Finance, under that NDC administration, over the following 13 months, loudly lauded the performance of those same book runners that it is now accusing of being part of the incumbent Finance Minister’s conspiracy to favour a particular foreign investor.

Just as instructively, Franklin Templeton has been a regular, large scale, buyer of Government of Ghana bonds over the past decade, including those issued when the NDC was in office.

The new bonds were issued at a yield of 19.75% which was within the initial price guidance range of 18.15% to 19.85% announced prior to the issuance by government’s three book runners. The NDC argues that this coupon rate is much higher than the coupon rates on any of the Eurobond issues it did while in office, the highest indeed being 10.25%.

However bond market analysts point out that this is like comparing apples with oranges, in that with Eurobond issues, government incurs the foreign exchange rate risk, which is appreciable considering that the cedi continually depreciates against the US dollar in which Eurobonds are denominated; whereas in cedi denominated bonds the investors themselves incur this risk and so it has to be compensated for in the coupon rate. Indeed, in criticizing the coupon rate on the new bond issue as too high, the NDC failed to remember that over the past four years all its medium and long term cedi denominated bond issues have been done at significantly higher rates – most at over 24% – even though their tenors have invariably been shorter.

Ironically, it is the aspect of the bond issuance that the NDC emphasized the least that actually represents the greatest problem for the Ghanaian economy going forward: the inevitable foreign exchange exposure that comes with taking what is effectively a foreign loan even though it is classified as a domestic loan. Again though, even where the NDC did mention this it failed to mention that it is just as guilty as the NPP government that has succeeded it.

It is instructive that the Kufuor administration opened up medium term bonds fo foreign investors in the first place because it needed investors willing to buy bonds of longer tenors than local investors are willing to, at lower coupon rates and perhaps most importantly, who would invest in cedi denominated bonds by converting their foreign exchange. This means foreign investors provide the forex Ghana so direly needs and take up the exchange rate risk themselves, rather than put it on government as in the case of direct foreign loans.

But government still incurs the forex exposure created through issuance of bonds to foreigners, since it has to guarantee that foreign investors can convert their cedi investment proceeds back into the foreign currencies they converted in the first place, whenever they exit from their investment. To this extent NDC is right in claiming that cedi bonds sold to foreigners are in truth actually foreign loans. Curiously though, the NDC itself has been classifying them as domestic loans for the past eight years while it has regularly been issuing them.

The danger is that each time the cedi depreciates, foreign bond holders are tempted to sell their investments on the secondary market or through bond discounting to forestall their exchange losses and their consequent demand for forex to finalize their dis-investment process puts immense pressure on the local forex market, thereby worsening the situation.

Currently, about one-third of Ghana’s public debt that is classified as domestic debt is in reality foreign debt. However, because Ghana needs more and more forex – including that needed to meet forex obligations on maturing (or discounted) bonds held by foreigners – government continues to issue more of them rather than less. It is instructive that each successive administration since Kufuor’s has issued larger volumes than the previous one and the early signs are that the Akufo-Addo administration will be no different.

However, while the current government is proving as guilty of this as its predecessors, its critics are generally at a loss as to how the latest bond issue gives more rewards to the investors who bought into it than those reaped from previous issues. The most sensible theory so far is that the novel callable feature in the issuance, which allows government to call in the bonds at any time by amortizing them early, enables the Finance Minister to effectively turn the 15 year bonds into an issuance of much shorter tenor, even as the investor enjoys a coupon rate based on the full 15 year tenor. Only time will tell whether there is any truth to such speculation.

On the other hand though, supporters of the issuance point out that the NDC has succeeded in its aim of simply muddying the waters, by turning what was supposed to be a crowning achievement by the new government into one that is now widely regarded as suspicious by many people just because they do not understand the technicalities nor the history of domestic bond issuance to foreign investors.

Ultimately, despite the accusations of conflict of interest and insider trading with a view to favouring a particular investor, it appears that the real beneficiary of the controversial bond issuance is actually the Ghanaian economy itself. The bond issuance, in shoring up the country’s gross foreign reserves substantially, has restored confidence to the foreign exchange market and thus has stemmed the cedi’s recently renewed, sharp depreciation. Just as importantly, the long term bond issuance has enabled government to significantly reduce its short term treasury bills and notes issuance, which are the debt instruments that local investors, rather than foreign ones, tend to invest in.

This has resulted in a sharp fall in short term treasury bill rates, to between 12% and 13%, and a consequent significant fall in bank lending rates as their cost of funds falls. Similarly, smaller treasury bill volumes being issued are forcing banks and other financial intermediaries to return to giving their funds to private sector borrowers rather than government itself, resulting in significantly increasing credit to the private sector. Franklin Templeton on the other hand has locked itself into 15year bond investment, which, although offering a relatively handsome yield in a dispensation of falling interest rates, nevertheless carries huge risks of foreign exchange losses over the tenor of the bonds. If government itself does not exercise the callable feature and amortize those bonds early, Franklin Templeton would have to exit its investment to avoid rising foreign exchange translation losses, only at a stiff discount.

For most knowledgeable, but politically neutral observers then the verdict is that Ofori-Atta did combine his current position as finance minister with his relationship with Franklin Templeton, but did so for the benefit of Ghana rather than the American fund management firm.

The success of the newly introduced long term bonds had been widely seen as a vote of confidence by the international investment community in the President Akufo-Addo administration’s ability to improve Ghana’s economic fortunes, especially with regards to debt sustainability and the stability of the cedi. Unfortunately, now it has simply divided the country along political lines.

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