The Sunday Leader

Bond Scam – Who’s Scamming Whom?

The Budget deficit of Sri Lanka is funded through Commercial and Non-Commercial borrowing. Non-Commercial Borrowing is concessional funding from international donor agencies and countries.

The Government of Sri Lanka uses Treasury Bills and Treasury Bonds to fund a significant portion of the Commercial borrowing used to fund the budget deficit. Until 1995, the total Commercial borrowing to fund the budget deficit was through Treasury Bills and Rupee Loans. Treasury Bills were distributed to the market through weekly competitive auctions of accredited primary dealers.

Rupee Loans were sold at a price determined by the Central Bank to captive sources such as the EPF, ETF, and Government owned Insurance Companies, and other Government controlled provident funds. These were generally at fixed rates, which had no price transparency.

In order to bring in transparency, Treasury Bonds were introduced through an amendment to existing legislature in 1995. The guide lines decreed that a majority of Treasury Bonds had to be issued through an auction process similar to the issuance process for Treasury Bills. There was also a provision for the issuance of private placements of government securities through primary dealers.

Along with the introduction of Treasury Bonds, Rupee Loans were gradually phased out. The competitive auction process was followed for many years until 2008. The biggest beneficiaries of the change in process since 1997 till 2008 were the EPF and the ETF, and thereby the employees of the country as the competitive auction process ensured that they received market rates for their savings. In Year 2008, Central bank decided to change the system to favour the direct placements of bonds over the auction process.

In the last few years, 2014 and the preceding five years approximately 80%-95% of all Treasury Bond issuance was done on a private placement basis with no transparent bidding process.

This created a situation where the larger Government controlled funds such as the EPF and ETF etc, had no choice, but to buy long term bonds at sub optimal rates. This finally affects the pension and retirement pool available to provide a post retirement livelihood for many million of employees in the country.

 

Yield curves

The yield curve of a country reflects the additional premium, which needs to be paid for the Government to issue longer tenor instruments verse shorter tenor instruments. For example on February 27, the US 3 months TB was trading at 0.02% vs the 30 year bond at 2.6%, a difference of 130 times. This denotes the additional premium demanded by investors, and the market to invest in longer tenor government securities.

 

Current Situation

In the recent 30 year bond issue, the EPF has put in 3 bids totallingRs two billion (Rs 500 million at 10.75%, 1 billion at 11% and 500 millon at 11.25%). Providing a weighted average bidding rate of 11%. If the entire initially offered size for the issue of one billion was taken from the EPF alone, the weighted average rate for the Government would be 10.875%. The weighted average for the entire Rs 10 billion was 11.73%.The market has both active and passive investors. The EPF can be considered a passive investor. They therefore do not demand a premium for investment in securities as they hold to maturity and do no trade securities in the secondary market. Many of the primary dealers have an institutionalized market making obligation. Therefore they have to offer two way prices and create liquidity for bonds. Therefore they tend to require a higher price premium for issuances. 30 Year issuances are rare, and due to the long tenor carry a very large price sensitivity to movements in market rates. This can result in very large Mark to Market losses or gains based on movement of interest rates in the future. Therefore premium of 11.73 to the EPF weighted average rate of 11% can reflect the premium required by a market makers to trade a security which is has a long term maturity. The final price of the auction was decided based on the 26 bids received and accepted of the issuance. The bids are reflective of the perceived rates for the issuance by market participants.

 

Conclusion

Given the above it does not seem that the weighted average rate of 11.73% is exceptionally high for a 30 year issuance of Rs 10 billion given that the EPF, which is a Government controlled entity, which has no market marking obligation bid at a weighted average rate of 11%.There are however insider dealing allegations which have been levelled at stakeholders to the above issue. These allegations have to be thoroughly investigated and the involved parties if proved guilty should be punished to the full extent of the law.

(Mangala Boyagoda is the Chief Executive Officer Wealth Lanka Management (Pvt) Ltd and former CEO of Standard Charted Bank of Sri Lanka, who posses extensive experience and expertise in the field of financial service and corporate strategic management, both in the national and international arenas, in careers that have spanned over three decades. He formed Wealth Lanka Management (Pvt) Ltd in 2006 and specializes in treasury and capital market advisory services, asset management and related financial service activities, including the structure of debt and equity capital as well as diagnostic studies, corporate restructuring and formulating strategies to assist corporate bodies to enhance shareholders wealth.)

 

3 Comments for “Bond Scam – Who’s Scamming Whom?”

  1. Pachcha Sirra

    This is no question that this was insider trading. Its a shame for the Supreme Court to have cleared the Governor the primary culprit for this financial scam.

  2. H.L. van Straten

    I understand that Mr. Mangala Boyagoda advises the government to undertake an investigation into allegations of possible recent past insider dealing of certain treasury and capital market stakeholders.

    Perhaps he can also give us his views on the country’s overall financial situation. I read that the present state debt amounts to 7400 billion rupees. Is it still growing? What sort of economic performance in terms of its GNP must the country show in the coming years to get rid of this debt and how many years would that take?

    I suppose that this huge debt has a vital influence on the level of interest rates that are asked for new loans to the government from financial institutions and private lenders. What happens if the government is unable to pay off its loans at some time in the future?

  3. KAUTILYA

    Dear President & Rev. Maduluwawe Sobhitha,

    Please take the initiative to FIRE GCB Mahendran. Insider trading can be proved with the evidence of the employees of the Central Bank. YOU do not need experts beyond that. The Disaster has taken place. NO EVIDENCE IS NECESSARY. NOW USE Circumstantial Evidence. Dr Ranjith Cabral and Attorney Shiral Lakthilaka will confirm the fraud as they have been vocal about it. We have no TRUST in the SC until its cleansed. No SC in any country is ALL KNOWLEDGEABLE.READ THE COPE REPORT. APPOINT A COMPREHENSIVE COMMISSION.ASK MAHENDRAN TO STEP DOWN SEND HIM, SON_IN _LAW AND ANY OTHERS TO JAIL AND ASK THEM TO PAY THE LOSSES TO OUR POOR COUNTRY.
    THE change of government and National Government become a FRAUD when it starts with a FRAUD like this.

    THINK OF WHAT PEOPLE WOULD SAY WHEN YOU ARE OUT OF POWER. OUR VILLAGES SAY “RAJJURUWANGE PUTHA HELUWEN YANAKOTA KIYANNA KISIWEK NAHA.” This situation is like that.

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