Is it possible for a country to move beyond the limitations of being small sized to create a diversified capital market? With the recent Market Maker Pilot project, Albania is testing the feasibility of deepening its domestic markets. A first in World Bank history, the Pilot aims to facilitate a secondary market trading in selected government securities by introducing a tailored approach for developing the Albanian capital markets.
A country of 2.9 million in the Balkans, Albania has grown from being the poorest nation in Europe in the early 1990s and rising to middle-income status in 2008. However, economic growth slowed down tremendously in 2013 due to the economic crisis experienced with its main trading partners, leading to a surge in public debt and to accumulation of budgetary arrears. Moreover, a high amount of non-performing loans placed additional stress on the banking system. As a result, the Albanian government adopted a broad-based reform program to address the structural weaknesses in the economy resulting in growth picking up with reduced risks.
With 66% Debt/GDP ratio and 53% of the debt stock in local currency, Albania relies heavily on the domestic market. However, this comes at a cost and poses a risk as the secondary market for the government bonds is not deep enough to allow pricing of securities to meet its market value. Enabling true price discovery in the capital markets can help Albania promote efficiency and drive competition in the financial system to support the government raise long-term resources at lower costs.
Making the development of the domestic market for government securities a priority
Since 2014, the Albanian authorities and the World Bank have been working on strengthening the government bond market and related public debt management, under the Financial Sector Reform and Strengthening Initiative (FIRST). When, Albania joined the Government Debt and Risk Management (GDRM) program, a World Bank Treasury initiative sponsored by the Swiss State Secretariat for Economic Affairs (SECO), in 2017, development of the domestic market for government securities continued to be a priority. The authorities wanted to continue its implementation and raise the involvement of market participants in the domestic market development more actively.
Before committing to a full-scale transformation of the system, the World Bank and the major stakeholders (the Ministry of Finance and Economy - MoFE, the central bank - BoA and the Albanian Association of Banks - AAB) agreed that it would be safer to run a pilot first. Once the Pilot project was successful, it would be easier to extend to rest of the market; otherwise, it could be an indicator of the significant obstacles.
The Market Maker Pilot design
The Benchmark: MoFE picked the 5-year fixed coupon bond to build a benchmark security. Within the scope of a few months, by issuing the same bond frequently, the Pilot aimed to increase its volume so that it would foster increased trading, making it a liquid bond eventually. The target size of 12 to13 billion Albanian lek (ALL) would be built over a period of six months. Access to the auctions was granted to market makers, who signed a contract with the MoFE.
The Market maker: Five banks agreed to participate in the Pilot to act as market makers. Committing to purchasing a minimum of three percent of the total issuance in six months, the banks made sure to have enough bonds for secondary market making. Additionally, they agreed to quote prices for the bond on a best effort basis, participate in the daily fixing by quoting executable prices for a certain period (30 minutes per day) at a predefined time, and report aggregate trading volumes to the BoA/MoFE on a weekly/daily basis.
The Auction: The joint team took advantage of the Pilot to implement some long-standing World Bank recommendations, by redesigning the auction rules. The bids were submitted electronically, and the auctions were set as multiple-price auctions with no limitation on the number of bids. The system limited maximum allocation to one participant and significantly reduced the share of non-competitive bids. All the investors could submit bids via the primary dealers, and there were consecutive auctions until the bond reached the benchmark target size.
The Securities Lending Facility: MoFE established the facility to support the Market Makers that would need securities to honor their daily quoting obligations, should there be a secondary market trading request.
The Communication: A key element in the Pilot was the communication component to raise awareness of the importance of making relevant information widely available. The communication with the market started beforehand about the planned issuance, and the results were communicated right after the auction. Moreover, the team had regular meetings with all the stakeholders to discuss the progress of the Pilot.
Results of the Pilot
Albania has launched the Pilot project on July 17, 2018. In the period of July 17 to December 14, 2018, there were ALL2.5 Billion of bonds traded in the secondary market where buyers were from banks, investment funds and pension funds managers, etc.
More importantly, this project helped all the major stake holders. It enabled the MoFE to streamline its benchmark issuance program; it facilitated the communication between the BoA and the MoFE due to daily communication and reporting; it helped the market makers bring their bidding procedures in line with standard auction bidding practices, develop reporting tools and improve their communication with their investors. Local country management unit’s (CMU) support was critical for the success of the Market Maker Pilot, collaborating closely with the authorities they facilitated the implementation of the program.
The project is starting to produce other positive effects in the market. It is helping lessen the supervisory liquidity concerns, due to lack of active secondary market, for the local investment funds which are overwhelmingly investment in government bonds. The Albanian Financial Supervisory Authority has imposed strong liquidity buffer requirements on the investment funds. And the creation of an active liquidity market is directly benefiting the investment funds that are currently buying into benchmark securities, or prospectively as part of the Market Maker arrangement. Another positive impact is the increased trading in other government securities with remaining maturities similar to the 5-year benchmark bond. This shows the positive impact the project is having in the market by providing an avenue for market players for a true market-based opportunity on price discovery.
The Albanian stakeholders and the World Bank, assessed the results of the Pilot in mid-December 2018. Given the successful pilot stage, there was a consensus to bring in additional benchmark securities, investors, banks. “Albania is taking the right steps in developing their domestic market”, said Cigdem Aslan, Lead Financial Officer from the World Bank Treasury. “The deeper the domestic market, the less cost of borrowing for the government, and less risk, due to expanding maturities.” The potential benefits for the Albanian citizens are multiple. “In the future, if corporates want to borrow from domestic markets in local currency, they could use the government benchmark securities as a reference for their pricing”, said Zsolt Bango, Senior Financial Sector Specialist from the Finance, Competitiveness & Innovation Global Practice, World Bank. The local CMU shares the same view. “The project has the potential to reduce the foreign currency exposure for the corporates, support the development of local capital market and the mobilization of domestic savings”, concluded Keler Gjika, Financial Sector Specialist and co-leader in the Tirana office.