Published: October 06, 2014
Diversification of funding sources is an important pillar of liquidity risk management and a sustainable funding profile. As the South African banks move towards Basel III implementation they are required to hold even higher levels of liquid assets and reduce their reliance on short-term institutional funding. This can be a challenge in the South African environment of low net household savings.
Banks are continuously seeking to optimise their funding, and improve risk adjusted pricing. In a low savings environment the ability to tap into a new and broader investor base with differing mandates while raising long term funding efficiently is of great value. Those banks which are able to get the most efficient mix of funding are able to provide more competitive products and pricing to their clients and it is not surprising that this is currently a focus across all the South African banks.
Following the theme of innovation and alternative funding sources, Rand Merchant Bank recently arranged a KrugerRand denominated bond raising R2bn in the initial offering. This product, a first for the domestic market, is a five-year interest bearing, KrugerRand denominated note issued by FirstRand Bank Limited and listed on the Main Board of the JSE. The bond is unique in that it is the first to be denominated in KrugerRands rather than ZAR (each note initially represents 10 1oz KrugerRand coins and will trade in 10 1oz increments) and bears a fixed rate of 50bps interest in gold ounces. It therefore gives investors an opportunity to invest in gold while simultaneously earning a positive interest rate. It also represents the only listed gold product available where there is no profit erosion originating from management fees or insurance and storage costs.
To participate, investors subscribe to the bond in 1oz KrugerRand coins, which are made available by Rand Merchant Bank’s (RMB) gold desk. On maturity, investors receive their principle amount and accrued interest in 1oz KrugerRand coins or smaller denominations thereof (if required). Should the investors not wish to hold the physical KrugerRand coins, the issuer undertakes to purchase the KrugerRand coins on the maturity date, effectively enabling investors to receive settlement in KrugerRand coins or cash.[[[PAGE]]]
The structure takes advantage of the fact that KrugerRands are classified as legal tender domestically and can, therefore, be viewed as a standalone currency. As such, investors participating in the bond can view it as a domestic asset and will not need to utilise their foreign investment allowance.
The product has been marketed to both institutional investors and high net worth individuals, targeting those who have a positive view on gold. As interest continues to grow, further tap issues may be arranged.
Investors subscribe for the bond in KrugerRands. The price of the KrugerRand coins is determined by the prevailing gold price, USD/ZAR exchange rate and the numismatic premium, where the numismatic premium is the premium attributable to the gold being in bullion coin format and historically ranges between 3%-10%. In order to eliminate the impact of the numismatic premium, it has been set at 4% throughout the life of the bond.
In an environment where banks are exposed to increasing competition and rising funding costs, the bond provides the issuer with a new and innovative source of funding by broadening its investor base and supplementing traditional wholesale funding methods, including senior unsecured bonds and securitizations, with a new product.
The monies raised can be used to fund gold assets directly. Historically this has been funded via the traditional capital markets either in ZAR or USD resulting in a funding mismatch between the source and usage of funds thereby requiring the gold desk to hedge exposures, a costly and inefficient process. As the bond is denominated in KrugerRands and directly linked to the gold price, the funding raised via the bond is matched, thereby improving funding efficiencies.
Further, as the note has a five-year tenor and locks in a fixed rate of interest, it provides the issuer with the opportunity to access longer-dated funding which can be applied to longer-dated gold assets.
Whilst the idea of a KrugerRand denominated bond originated from a funding need for the gold desk, the product also provides an innovative and new opportunity for investors who wish to gain exposure to the gold market. Gold has often been used as a store of value, an inflation hedge or a diversification of risk. Historically, gold has been viewed as a ‘safe haven’ asset as, due to its negative correlation with other assets, it has generally been held as a hedge against economic and financial stress.
Prior to the launch of the bond, if an investor wished to obtain gold exposure, the options were limited to gold futures, gold exchange traded funds (ETFs) or holding physical gold in the form of KrugerRand coins or jewellery. While providing the desired exposure, all of these products come at a cost.
Futures provide exposure to the underlying asset but are typically highly leveraged products, exposing investors to potentially large margin calls. ETFs and physical KrugerRand coins are not typically leveraged products and are more comparable to the bond.
There are currently two gold ETFs which are JSE-traded namely NewGold and AfricaGold. Both are physically backed and provide investors with direct exposure to the gold price in rand. Investors are charged a management fee of 0.40% and 0.35% respectively, per annum, which is recouped via reducing the gold holdings annually by the equivalent fee amount. The effect on an investor is that the overall gold exposure is eroded each year.
An investor can also purchase physical KrugerRand coins. The costs associated with holding the coins include storage, insurance and potentially large numismatic premium spreads.
In contrast, the bond allows investors to obtain the required exposure but eliminates the costs associated with comparable gold products currently in the market. Due to the nature of a fixed income product, an investor will actually receive an enhancement on the return as 50bps interest is earned on the bond, in gold ounces. Thus, an investor’s gold exposure and holdings will increase over time.
The benefits to investors include:
Liquidity and ease of access
The bond will list and trade on the main board of the JSE thus assisting liquidity in secondary market trading. Settlement will take place via Strate. RMB, via the gold desk, will act as market facilitator on the notes and ensure that a competitive bid/offer spread is shown.
Direct gold exposure
The bond provides investors with direct exposure to the gold price and USD/ZAR exchange rate. Furthermore, on maturity, investors can be settled in bullion if desired (i.e., KrugerRand coins)
Interest return
50bps interest, in ounces, will be earned in addition to the gold exposure. This enhances an investor’s exposure to gold and increases the overall return.
Zero cost
There are no management, administration, storage and insurance fees associated with the bonds. The only costs include the normal broker and JSE trading fees which are accompanied with any exchange traded product.
Mandate friendly
KrugerRands are classified as legal tender in South Africa. This implies that since the bond is denominated in KrugerRands, it is deemed as a domestic asset (as the underlying currency of the bond is the KrugerRand). The bond also meets investor mandate requirements.
The KrugerRand denominated bond is a unique product for the South African market and benefits both the issuer and investors. For the first time, South African investors are able to access the gold lending side of the market whereby they gain gold exposure and simultaneously earn interest on their coins, whilst the issuer benefits from the direct gold funding raised which can potentially be used to develop its gold related business activities.
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