Capital Markets in South Africa

01 March 2007

Megan McDonald – Director, Securitisation, Standard Bank of South Africa Limited

South Africa was denied access to international financial markets during the 1970s and 1980s as a result of sanctions being progressively imposed on the country. At the time, the government carried large budget deficits as a result of imprudent fiscal policies. It had no choice but to fund its growing budget deficit, and thus the development of the domestic bond market, with government debt dominating issuance. The government therefore played a key role in developing the domestic capital market. However, in recent years the private sector has started to play a more active role and the growth in corporate bond issuance over the last 5 years has outstripped that of government bonds. In 1996, government bonds accounted for over 80 per cent of the total debt listed on the Bond Exchange of South Africa. This ratio declined to just over 60 per cent by the end of December 2006. 

The last five years has been a period of rapid growth and development for the capital markets in South Africa with the volume of transactions in both the corporate bond market and the asset backed securities or securitisation market growing significantly. In addition the level of sophistication has increased with the introduction of new asset classes and more complex structures including hybrid instruments such as convertible bonds. The growth in the capital markets in South Africa has been mainly attributable to the increase in issuance by the banking sector and increased activity in the securitisation market, which has become the fastest growing segment of the capital markets. Corporate bond issuance was ZAR25.9bn and ZAR38.5bn in 2005 and 2006, respectively. Securitisation issuance showed spectacular growth of 197.4 per cent year on year in 2005 and was followed by another strong performance of 51 per cent year on year in 2006. The growth in supply has been driven by positive macroeconomic conditions with a stable inflation environment and historically low interest rates enhancing growth prospects for South African financial institutions and corporates. These economic conditions have also fuelled consumer demand and household debt as a percentage of disposable income rose to a historical high of 70 per cent in 2006.

As a result, total loans and advances by South African banks grew to ZAR1.708bn at the end of November 2006 from ZAR1.328bn in November 2005. This prompted the banks to securitise their assets to fund the growth in their burgeoning loans and advances book. Securitisation in South Africa therefore increased by 44 per cent to ZAR31.7 bn in 2006 with ZAR13.4bn of this comprising residential mortgage backed securities. Commercial mortgage backed securitisations also showed positive growth with issuance volumes more than doubling to ZAR4bn from ZAR1.6bn in 2005. Asset backed commercial paper grew 51 per cent to ZAR52.2bn from ZAR34.5bn in 2005, largely driven by continued appetite for investing in term securitisations and, to a lesser extent, corporate issuance. As a result of increased consumer spending, inflationary pressures started to appear in the South African economy during latter half of 2006. This saw the Reserve Bank increase its repo rate by a cumulative 2 percentage points to 9 per cent in 2006 as it sought to tame rampant consumer spending. Despite this tightening of monetary policy, issuance volumes in both the corporate bond and securitisation market are expected to surpass the levels achieved in previous years as banks continue to see securitisation as a viable funding and capital management tool. The introduction of Basel II in South Africa in 2008 will also see banks looking to the securitisation market to obtain capital relief especially in respect of capital intensive asset classes such as credit cards. In addition the 2010 soccer World Cup in South Africa has necessitated large amounts of development in transport, airports, stadiums and utilities such as water and electricity. Key projects will be the expansion of Durban, Cape Town and Johannesburg (OR Tambo) international airports: the Airports Company of South Africa has already announced that it will borrow ZAR2bn from the capital markets in 2007. Transnet, the transport parastatal, has also announced plans to issue bonds and raise debt over the next 3 years to fund the upgrade of its ports and railways. The building of new soccer stadiums as well as upgrades to existing stadiums are in the pipeline and the capital markets will provide a significant amount of funding for these and other infrastructure projects related to the FIFA World Cup in 2010. 

The growth in the capital markets in South Africa has been facilitated by a robust legal and regulatory framework as well established principles of company, banking and finance law. The legal and regulatory framework can, however, pose significant challenges when executing new and complex transactions and the choice of legal counsel is a key decision which can have a significant impact on the success or failure of the transaction. When choosing a lawyer a number of factors are important and it goes without saying that a thorough knowledge of all the relevant rules and regulations is the best starting point. Having a lawyer on the team who is an expert in the particular field allows the bank to concentrate on the financial issues in the transaction without having to spend precious time trying to understand complex legal concepts. 

Legal counsel should also be seen as partners in the transaction who display a passion for ensuring the success of the transaction rather than merely acting as disinterested service providers. This keen interest in the outcome of the deal should not, however, be at the expense of their professional independence but rather a willingness to work with their clients in order to find solutions to ensure a successful and legally robust transaction. The best value-add lies not in telling a client that a particular structure is not legally sound but rather in being creative and suggesting alternative structures, which are acceptable to the lawyers and which meet their clients’ financial objectives. 

For some transactions, the lawyer’s previous work experience in the relevant field will be a big factor in their appointment. Working with someone who has done it all before provides significant benefits in terms of both cost and time savings. This is of particular importance in an emerging economy such as South Africa where local banks and financial institutions do not have access to as large a pool of highly experienced capital markets lawyers as their European or American counterparts. Furthermore, the regulatory framework in an emerging economy, whilst legally robust, may not be as sophisticated as the regulatory framework in more developed economies. Often the regulations may be silent on a particular issue and a lawyer with a keen understanding of what the regulatory environment aims to achieve will be able to assist the client by developing solutions which comply with the spirit of the law. 

Capital markets transactions by their nature (and most particularly securitisations) involve lengthy legal documentation and a lawyer who is able to grasp the key financial and commercial concepts of the deal and translate them into legal documents which are well drafted and easy to read will go a long way towards ensuring a smooth and successful transaction. An ability to draft legal agreements in clear and understandable English is a vital attribute which not only ensures that all parties understand the legal consequences of the transaction but also avoids unnecessary disputes later on when difficulties arise in the interpretation of the legal agreements. Relationships are also key and with the increased emphasis on good corporate practices as well as compliance with an increasingly complex regulatory and legal environment it is crucial to have established relationships with individuals which one trusts. This should enable any conflicts of interest to be identified and managed to everyone’s satisfaction early in the transaction. 

In conclusion, capital markets transactions tend to involve large amounts of money and as such pose material risks to banks if they are not managed and executed properly from a legal perspective. The choice of legal counsel is an important one for banks in today’s highly competitive banking environment. The participation of legal counsel who are highly skilled and experienced in capital markets transactions not only provides the bank with a competitive advantage but is also vital for the continued growth and development of the capital markets.

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