Member Article

With so much banking regulation coming down the pipeline, and driving up the cost of borrowing, corporates are likely to look with greater interest at alternative sources of capital such as the bond market.

In the years since the 2007/2008 global financial crises, regulators around the world have analysed the causes of the global financial crisis (“GFC”) and, as regulators tend to do, produced a slew of legislation and regulation aimed at shoring up the global markets, increasing the regulatory capital required to be held by various types of financial institutions and agitating for heightened levels of transparency and disclosure in relation to financial markets and financial products.

Some of the legislation produced has been developed in response to very specific, local concerns and circumstances. A significant portion of the legislation arises out of global or regional initiatives, built in response to a view that systemic risk in the financial markets is best managed in a coordinated and consistent manner. An example of this type of legislation is the current initiative to implement regulations to give effect to the Basel III requirements (designed to improve the liquidity and capital position of banking institutions) in all G20 jurisdictions, including the Republic of South Africa (“South Africa”). It is debatable whether or not these initiatives will in fact result in safer, more stable global financial markets, but it is undisputable that these stringent regulations add to the complexity and the cost of doing business.

South African regulators have been eager to propose regulatory steps aimed at ensuring that the South African financial markets will be regulated in a manner closely aligned with the type of regulatory environment that is developing in the United States of America, Europe and elsewhere, in order to facilitate and encourage investment and trade in accordance with international best practice. Notwithstanding that South Africa as a country, and its financial institutions generally, emerged from the GFC relatively unscathed, there appears to be a general assumption that South Africa needs to be kept in line with so-called international developments in relation to the regulation of its financial markets. Accordingly, South Africa has introduced or is in the process of introducing, legislation that will increase the capital adequacy requirements of local financial institutions, in particular South African banks.

Legislation will also change the manner in which banks are regulated with the introduction of the so-called “twin-peaks” approach which will separate the oversight of the capital and regulatory compliance of a bank from the regulation of the bank’s interactions with its customers and clients. The Basel III regulatory capital requirements are in the process of being introduced and the Financial Markets Act, 2012 which deals with the regulation of financial products and institutions as well as with products such as over-the-counter derivatives has recently come into force and effect.

One of the results of this heap of new legislation is that it may become more difficult for corporates to obtain funding directly from banks in South Africa. While the new legislation is being developed and refined, some banks may adopt a wait-and-see approach so that they can better understand the impact of the legislative developments on the bank’s capital requirements and its cost of funding. In addition, the increase in regulation, including increased reporting and due diligence requirements, as well as more onerous requirements to hold expensive capital against certain types of funding is likely to see banks being required to charge higher interest rates on the money that they lend to clients as they seek to recover the increased costs of doing business. As banks are required by regulators to undertake increased due diligence and reporting in relation to transactions, the lead-time for obtaining a loan from a bank is also likely to increase and due to being highly-regulated, banks may not be permitted to lend the required cash to corporates wishing to raise hefty sums.

In these circumstances certain corporates may start to examine alternative ways in which funds can be raised. To this end, the South African debt capital markets is a well-regulated, sophisticated and highly regarded emerging market[1] that covers all types of debt instruments, from conventional listed and unlisted corporate bonds to complex asset-backed securities and securitisations.

It is often cheaper for corporates to raise capital by accessing the bond market than by financing through traditional bank loans, debt or equity financing, due to liquidity of securities. Bond market documentation is often covenant and reporting lite when compared with traditional bi-lateral loan documentation. Furthermore, the bond market provides access to a global pool of institutional investors looking for opportunities to get real returns on investments and earn high yields. The bond market allows corporates to borrow for a longer period at a lower rate than may be possible through traditional bank loans. In addition, they offer stability and predictability of returns, which is appealing to a wide range of institutional investors. In this way corporates, by diversifying their sources of funding, are able to increase their investor base.

Corporates wishing to list programmes and raise finance by way of the bond market must be generally acceptable to the JSE Limited (“JSE”) and meet certain minimum requirements. Ultimately the JSE retains a discretionary power to approve or reject listings of applicant issuers, regardless of whether or not they are compliant with the JSE Debt Listings Requirements, if it is of the opinion that the listing will or will not be in the interests of the investing public. Issuers are required to make specific disclosures in their placing documents, report to the JSE on an ongoing basis and update placing documents within 6 (six) months after financial year-end if any information therein has become materially outdated.

The Banks Act, 1990 (“Banks Act”) prohibits entities other than registered banks from accepting deposits from the general public. As a result of the broad definition of "deposit" in the Banks Act, which extends to cover the issuance of notes and debentures to the general public, the Commercial Paper Regulations to the Banks Act, dated 14 December 1994 and the Securitisation Regulations to the Banks Act, dated 1 January 2008 have been enacted to allow non-bank entities to issue commercial paper and implement securitisation structures. The Commercial Paper Regulations prescribe the disclosures that must be made in an issuer's placing document, and set further conditions for the issue of commercial paper. The most important of these are that commercial paper may only be issued in minimum denominations of R1 million ($94,000) unless (among others) it is listed on a recognised exchange, endorsed by a bank or issued for a period in excess of 5 (five) years; and that commercial paper may only be issued for the acquisition of operating capital by the ultimate borrower (the issuer, its subsidiary or holding company or a juristic person in a similar relationship to the issuer, or a juristic person controlled by the issuer), and not for the granting of money loans or credit to the general public.

The Securitisation Regulations strictly regulate (i) the corporate status, ownership and control of the issuer of commercial paper (which must be an insolvency-remote special-purpose vehicle independent of an institution acting in a "primary role" as originator, remote originator, sponsor or repackager); (ii) the transfer of assets from the originator to the issuer by requiring a total divestiture of rights, obligations and risks in and control over the assets (a true sale); (iii) the provision of credit enhancement and liquidity facilities; and (iv) the disclosures that must be made in the issuer's placing document.

The South African debt capital market has become an appealing place for foreign investors to list commercial paper, given that the relative yields are high by international standards. The documentation used and the process followed to access the capital markets in South Africa is broadly similar to that of the Euromarkets and this makes it relatively easy for offshore parties to enter the South African market.

The attractive returns coupled with the lower cost structures and the recognition of the potential opportunities in well-regulated emerging markets, make the South African debt capital markets a viable alternative source of funding for corporates looking to raise finance.

by Clinton van Loggerenberg, a director in the banking and finance department at ENSafrica

[1] In the 2013/2014 World Economic Forum's Global Competitiveness Report, South Africa ranked first out of 148 countries for the regulation of its securities exchanges. The JSE Limited has scored highly in international rankings for its regulation.