Growth of the Debt Markets Globally
The debt markets create an ecosystem that allows corporations to grow, and governments to finance themselves efficiently while investors gain returns for their investments. The globalization of the largest banks, asset managers, hedge funds, and corporations has driven the growth of a market that allows money to flow to those who need it from those willing to lend it. Fixed-income securities constitute the most prevalent means of raising capital globally based on total market value. The United States (US) fixed-income markets are the largest in the world, comprising 41.3% of the $122.6 trillion of securities outstanding across the globe as of 2022. This is 2.2 times the next largest market, the European Union (EU), with the US market share averaging 38.9% over the last 10 years.
The growth of the U.S. capital market, especially the debt market has been supported by various key stakeholders among them being credit rating agencies (CRAs). Credit ratings are an important component of the capital markets and have functioned effectively for more than a century in the United States. The role of credit ratings is also growing and flourishing in many countries including emerging markets with the development of global capital markets. The Nigerian debt market is one of the emerging economies where the debt market growth has steadily been supported by credit ratings. The Nigerian debt market provides access to a range of fixed-income securities from local and international issuers, through the Nigerian Exchange Limited (NGX) and the FMDQ Securities Exchange Limited. As at the end of FY 2022, the value of the NGX and FMDQ fixed-income markets stood at ₦23.2 trillion ($27.9 billion) and ₦21.8" trillion ($26.3 billion), respectively, with a cumulative value of ₦45 trillion ($54.2 billion). Figure 1 below illustrates the size of the Nigeria, Kenya and South Africa fixed income markets which form part of the emerging economies:
Figure 1: Fixed Income Securities Market in Kenya, Nigeria and South Africa
Source: Nairobi Securities Exchange, Nigerian Exchange Group, FMDQ Securities Exchange Limited, Johannesburg Stock Exchange
South Africa and Nigeria are among the leading debt markets in Africa, where credit ratings have continued to support the market to effectively and efficiently evaluate and assess credit risk, price debt securities, benchmark issues and create a robust secondary market for those issues. Good ratings are majorly supported by robust financial performance, strong corporate governance on the part of the entities and transparency among other factors. Credit ratings involve measuring the credit risk of an issuer (of a debt instrument) or an obligor (in a debt obligation), providing a means of comparison and providing a generally accepted benchmark. In an issuer or entity rating, the focus is on the issuer's capacity to meet all financial commitments as they fall due whereas for an issue or debt rating, the emphasis is on the obligor's ability to meet its obligations promptly on that particular instrument.
It is essential that a rating is carried out in every debt issuance, to ascertain if the company can effectively utilize that magnitude of debt, given that a good credit rating for an entity does not necessarily qualify the company to issue a large debt instrument.
Furthermore, investors must grasp the distinction between a credit rating and an equity opinion, as the former does not evaluate a company's capacity to create value for its shareholders. It is also not an audit of financial statements, as it is merely an objective assessment of an obligor's financial condition and ability to meet obligations as and when due. However, it is imperative to acknowledge that effectively implemented credit ratings can serve as a valuable tool in identifying vulnerabilities and obstacles that demand the attention of astute investors, prompting them to adopt requisite measures of precaution.
Kenya's Credit Rating Regulatory Landscape
In accordance with the provisions outlined in Kenya's Capital Markets Act of 2022, it is mandated that asset-backed securities undergo a rating process before their issuance in the market. Although other capital market instruments in Kenya are not mandated to obtain ratings, having a rating is considered a 'good to have' when raising capital. Due to the corporate failures that the Kenya capital market has experienced in the past, we believe that credit ratings would help to inform investor decisions going into the future. Several firms were put under receivership at a time of perceived improvement, which was after efforts at raising capital from the public via rights issues or bond issues. These instances of corporate failure caused significant concern among investors, leading to discussions regarding the sufficiency of corporate disclosures and the effectiveness of regulatory oversight in protecting investor interests during capital-raising endeavours. To address investor concerns, we believe that well-crafted regulations and oversight over listed companies' corporate governance and presentation of accurate and quality financial statements will be essential.
Furthermore, the integration of suitable regulations for credit rating agencies in the capital markets holds the potential to significantly bolster the quality and integrity of credit assessments through consistent application of practical and flexible standards coupled with appropriate regulatory supervision. Such regulations would aim to foster analytically robust, independent and unbiased credit ratings, which would strengthen investor confidence. In 2022, the Capital Markets Authority (CMA) initiated a review of the credit rating agencies' guidelines to improve the standards for assessing sovereign and company ratings in Kenya. The new guidelines will include information on the licencing and recognition of credit rating agencies, the rating process, and monitoring, as well as the disclosure of rating definitions and rationales. We anticipate that these regulations will enhance investor protection and increase the regulator's direct oversight of credit rating agencies.
Role of Credit Ratings in Shaping Investor Sentiments
Credit ratings are primarily driven by meticulous research and an adequate understanding of industries, alongside the associated risks. Without such contextual knowledge of industry-specific risks and the prevailing macroeconomic landscape, rating agencies would encounter significant challenges in dissecting the performance of an entity. Given the existing information asymmetry, industry and tailored research is critical to ensuring that investors have access to credible information. In our view, there exists a gap in the Kenyan market in terms of independent research and expert opinion regarding the performance and potential risks associated with key industries. We believe that to effectively guide investor decisionmaking amidst the volatilities in the macroeconomic landscape, it is imperative to undertake advanced and innovative research initiatives, coupled with sophisticated data analysis methodologies. As a result, enhancing the content of research reports to provide vital insights into the condition of the industry, risk position, difficulties, and possibilities will be critical in dealing with investor information asymmetry challenges. Furthermore, the Nairobi Securities Exchange's (NSE) investor education initiatives, which include seminars, webinars, and educational materials accessible to both retail and institutional investors, will serve to equip investors with the knowledge and skills required to make informed decisions.
The implementation of these solutions is expected to effectively address the crisis of investor confidence in the market - particularly the debt market -, which has arisen due to previous corporate failures. We have seen renewed investor confidence in the public corporate bond market over the past three years, with recently issued bonds being oversubscribed. The Kenya Mortgage Refinance Company's (KMRC) inaugural Kshs 1.4 billion corporate bond issued in February 2022 attracted a 480% oversubscription and a total performance rate of 579.6%, demonstrating the increasing appetite for corporate bonds coupled with the attractive interest rate premium. In addition, we believe that the KMRC bond's investment-grade national credit rating, along with its stable outlook, has impacted investor confidence positively.
Conclusion
Moving forward, in light of our projections for substantial expansion in the bond market due to rising issuer and investor confidence, it is our firm belief that credit ratings will play a pivotal role in bolstering market confidence. Furthermore, credit ratings will be an important component of the market structures that must be put in place to unlock growth in the debt market. Credit ratings allow entities to borrow on their capacity and reduce reliance on banks, thus enabling entities to access a variety of funding sources while also contributing to the uniform pricing of debt instruments based on credit risk. In light of the emerging macroeconomic difficulties that are impacting the business environment, ratings based on thorough research can serve as a valuable tool for alerting investors who have grown apprehensive about the shifting economic landscape resulting from inflationary pressures and currency depreciation.
Consequently, investors must obtain independent opinions from CRAs before making investment decisions, which bear significant exposure to macroeconomic risks. Failure to diligently monitor said risks may potentially undermine market confidence.