Prepared by Tata Toria
A bond, like a share, is a major and important type of securities. It is a long-term loan obligation and confirms its owner’s right to receive profit with the agreed periodicity and to return the bond’s nominal value by the specified date.
If a shareholder is considered as an enterprise’s owner, a bondholder is only an enterprise’s creditor. Bond holders have no right to vote and, correspondingly, they cannot take part in enterprise management. However, bondholders have the rights that shareholders do not have. In particular, an issuer is obliged to pay interest on bonds while in case of shares, even the privileged ones, there is no such obligation. In case of an enterprise’s liquidation, bondholders have more rights than shareholders. Proceeding from this, bonds are securities of a higher class.
Most bonds are ensured by an enterprise’s immovable property, other tangible property and other securities possessed by it. In case of bankruptcy of the issuing enterprise, bondholders can lay a claim to a share of its property. There are also bonds without provision, the owners of which cannot lay a claim to a company’s share, but they have preferred rights in case of liquidation of the issuing enterprise. This kind of obligations are less reliable than the ensured ones and for this reason the interest rate on them is higher. Bonds without provision are often convertible, which gives investors a possibility to exchange them for ordinary and privileged shares of the issuing enterprise during the whole period of the bond’s validity.
There is a difference between public and corporate bonds. A public bond is a coupon medium-term public security denominated in the national currency and issued in a non-material form. The state issues public bonds in order to cover the budget deficit and finance state projects. As a rule, they are distinguished by high liquidity and purchasing of them is related to a less number of risks.
As for corporate bonds, they are issued by corporations, banks or other financial institutions. As a rule, interest rates on corporate bonds are higher than on public bonds. Their issuance is related to a more number of risks and is a much more profitable investment.
Bonds circulate on the primary and secondary securities markets. On the primary market newly-issued securities are sold, i.e. their initial offering is carried out. On the secondary market (stock exchange) investors, finance and credit institutions, insurance companies and intermediaries trade in securities that have already been sold once.
As we have already pointed out, the only official market for securities’ circulation is the Stock Exchange. It was set up in 1999. With the assistance of USAID, a normal legal base was elaborated, a regulatory body – Commission for Securities was created, the stock market’s infrastructure was formed – the Stock Exchange, the Central Depository of Securities, brokerage companies, securities’ registrar, i.e. the whole system that was necessary for the development of the Stock Exchange, though it has not developed all the same. According to the Chairman of the Supervisory Board of the Stock Exchange – Mr. Gogi Loladze, in 2002, when all structures of the Exchange were enabled it resembled a new supermarket with modern equipment and counters, in which neither buyers nor sellers were seen. The main reason why the Stock Exchange has not developed was the lack of attractive instruments in which investors could place their funds. This was conditioned on objective factors. In particular, the process of privatization of state enterprises carried out in a distorted form in 1990s created the atmosphere of distrust. In spite of the fact that the mentioned enterprises were turned into joint-stock companies, they have not undergone a principal transformation. They still remained organizations that were less oriented for profit. That is why the shares brought by them to the market were not attractive for investors. Added to this was the fact that shares were brought to the market without any information. It is a necessary condition that when a joint-stock company offers a financial instrument to investors it should give the potential buyer as complete information about the issuer as possible. Usually, during the public offering there should be the issuance booklet containing complete information about the enterprise, its activities, future plans and financial indicators. An investor will place his funds in profitable assets only on the basis of reliable information. Besides, no education work had been carried out in this direction and added to that was a difficult political and economic background that shaped in the country. The mentioned factors considerably impeded the Stock Exchange’s development rates. True, there was a significant progress in 1999-2000, in particular, the legal base and regulatory structures were created, but the market was not developing all the same. As Mr. Gogi Loladze pointed out, more agitation and taking of concrete steps by the state was necessary in order to change the existing distrust background among the population.
Along with the shares issued by the mentioned companies, state Treasury obligations issued by the Ministry of Finance were circulating on the market. Their purpose was financing of the budget deficit.
State Treasury obligations are a standard instrument widespread all over the world, mastering of which by our state started from 1997 and this market has been gradually developing, but, unfortunately, according to Mr. Loladze, this process has taken a wrong direction as well. On the one hand, privatization was carried out in a distorted form, on the other hand imperfections of Treasury obligations entailed abnormal discount rates, which sometimes reached 100% and more. It had a ruinous effect both on the budget and the country’s image. Not a single country had this kind of interest rates. As usual, the interest rate on the state Treasury obligations is the lowest. In America it makes up 1,5%, while in Europe it ranges from 1% to 3%.
In Georgia securities, their issuance, registration and mechanisms of secondary circulation have many imperfections. This, in its turn, impeded the development of the securities market. Both instruments – share and state securities had an imperfect form.
It is interesting why other companies did not issue the product attractive for investors. According to Mr. Loladze, there were several reasons for that: “First of all, the share of the shadow economy in the country often reached the level of 70%. A complete transparency on the issuer’s part is necessary so that an investor should make investments in an enterprise’s securities. It is clear that when on the market a purchaser is offered tens of thousands of bonds and shares, the issuer should use all mechanisms in order to become the most transparent one. But in the country with such a high level of shadow economy an issuing enterprise was unable to become transparent for everyone. True, they had a wish to work in a transparent way, but there were such tax conditions in the country that they just could not do it. That is why a part of their business was a shadow one. However, Mr. Loladze points out that even in transparency conditions it would be difficult for them to occupy solid positions on the capital market, since the state artificially limited the functioning of the organized secondary market. Growing of the interest rate on Treasury obligations ruled out any possibility of appearance of private companies on the market. Of course, private company’s bonds could not meet competition with the state that offered annual 100% to potential buyers. Besides that, there was another impeding factor – the demand on the market was impaired because of abnormal demand for money of the part of the state. The market was also undergoing deformation from the viewpoint of supply. Georgian companies received investments from international organizations that were trying to invest their funds in the most successful Georgian enterprises. Proceeding from that, these companies they had no demand for money and they were deforming the market from the viewpoint of supply. The market was deformed from both sides. The aforementioned factors were impeding a normal development of the securities market.”
It is interesting what is the current situation on the market and whether the impeding problems still persist on the market. According to Mr. Loladze, the conditions for eradication of the problems can be observed. Namely, the level of the shadow economy in the country has decreased. It is true that it has not yet reached the desirable minimal level, but positive trends can be observed. There appeared companies that can work in a practically transparent way.
Treasury obligations. It is natural that one of the most important instruments of the financial market – treasury obligations are in the centre of attention. There are two reasons for that, the first one is old fantastic stories related to the 80% income and the agiotage around it, and the second one the issue carried out this year, which was quite popular among the participants of the market. It is clear how solid and profitable this market is, but are ordinary Georgian citizens or investors interested in this sphere?
Gogi Loladze – “As for the problems related to Treasury obligations, taking into account the recommendations proposed by the Stock Exchange to then the Chairman of the Finance and Budget Committee and now the President of the National Bank – Mr. Roman Gotsiridze has had some effect. In particular, if the process of auctions’ announcement used to take place with total violations, now these shortcomings have been put right, auctions are held in an electronic form, which can be only welcomed. At the same time, the interest on Treasury obligations has been reduced. Last year the mentioned indicator dropped to 12-13%, though its growing again took place at a certain stage. It rose to 20%. Then the National Bank decided to reconsider the mechanisms related to circulation of the state obligations. For this purpose in 2005 it ceased the obligations’ issuance. It was supposed to stop the issuance of the obligations for one month, but then, on the basis of the situation’s analysis, the government decided not to issue the obligations at all. It is interesting why the issuance of obligations was stopped in 2005, though they had been issued since 1997. The government points out to the budget proficiency as the reason for that. The government had no need to take additional loans. There was a certain logic in this argument, but it should be also taken into account that the budget will not always be a proficient one. It is true that in 2005 high incomes were received from privatization and “other sources”, but that is a single income and it is impossible to fill the budget this way all the time. That is why a market of state obligations should exist so that, in case of need, the state could use it in a purposeful way. The World Bank and the International Monetary Fund also believe that existence of the loan obligations’ market, even a small one, is necessary, i.e. the market’s functioning ought to be continued for the existence of the reference point for the interest rate and ensuring of the market’s continuity. Besides, it would be an important instrument of the monetary and credit policy, which could be used in case of need.”
Issuance of Treasury obligations was really discontinued in 2005. This year the state decided to securitize the debt that it owes to the National Bank. The mentioned debt makes up 840 million GEL and its covering will take place by stages, i.e. each year 48 million GEL will be transferred into securities – Mr. Loladze said.
Proceeding from the aforementioned, it becomes clear that this market is very small and its serious growth in 2007 is not planned, though it will be attractive for investors. Activity of the population and physical persons is also important, since they can receive more profits here than in some other sphere.
Interesting are the macroeconomic aspects of issuance of this type of securities. For years the Georgian government resorted to such method of covering the budget deficit as borrowing money from the national Bank. Now it is prohibited by the law and they cannot resort to this tool of covering the budget deficit. However, the old debt has remained, which has become the reason for introduction of the novelty on the financial market.
According to the head of the Currency and Money-and-Credit Operations Department of the National Bank of Georgia – Mr. Giorgi Laliashvili, the debt that was entered to the balance of the National bank was not a circulating one. Now that it has been turned into securities, it has acquired a concrete function – it helps the bank in the implementation of the money and credit policy. The National Bank is regulating the circulation of the money aggregates by putting obligations up for auction. In the concrete situation it started to withdraw money aggregates from circulation with the purpose of reduction of the inflation rate. According to Mr. Laliashvili, by issuing securities the National Bank will, to a certain extent, contribute to the development of the financial market.
In Mr. Laliashvili’s opinion, attention should be drawn to the fact that the state is formally the issuer of securities. Their initial offering on the market is provided for by the National Bank. From the technical point of view, it is a secondary sale, but as from the beginning the National Bank possessed 100% of the bonds, the public sale is a primary one, i.e. when 48 million GEL worth of securities turned out to be in the National Bank’s portfolio, it was decided that the bonds would be put up for auction. The auction was held on December 8 of the current year. The nominal cost of the public bonds was equal to 1000 GEL and the number of bonds in the purchase application submitted by the bank should not have been less than 50. The deadline for covering of the securities is 15 December 2007. For the present moment 30 million GEL worth of securities have been sold. Their owners are commercial banks. At the auction the bond’s maximal interest rate made up 13%. In the near future the National Bank is planning to put up for auction 18 million GEL worth of securities.
As we have already mentioned, commercial banks have become the bonds’ owners. For the time being they are the only persons admitted to the auction. As Mr. Laliashvili points out, it is necessary the brokerage companies should be admitted to the primary market along with commercial banks, since thousands of investors will be able to take part in the auction with their assistance and, correspondingly, public obligations will have a more effective circulation.
According to Mr. Laliashvili, the National Bank, along with commercial banks, has nothing against brokers’ admittance to the auction. Moreover, they cooperate with these companies, from time to time hold meetings with brokers and soon we should expect the National Bank’s concrete decisions in this direction.
As for the secondary market, it is working with all types of securities, except for public securities. Mr. Loladze points out that the secondary market remains sluggish to the most attractive securities. It is true that the National Bank does not deny its necessity, but for some reason the mechanisms that would contribute to a better circulation of public obligations on the secondary market are not enabled.
The second important phenomenon on the financial market is the issuance of corporate bonds. It is noteworthy that on December 5 of the current year the micro-finance organization “Georgian Credit” implemented the issue of bonds, however, it was not a public offering. According to the Director of “Georgian Credit” – Mr. Evgeni Gigineishvili, the decision on the issue of bonds was taken after the preliminary offering of a certain circle of clients. The volume of the bonds’ issue made up 400 000 GEL. In all, 80 bonds were issued. The nominal cost of one bond is 5000 GEL. It is an interest bearing or a coupon bond and the annual interest rate makes up 17%. The bond’s form is non-documentary, form of distribution – closed. The organization’s payment agent is “Basisbank”. The bond is ensured by the issuer’s assets. The authorized capital of “Georgian Credit” makes up 250 000 GEL.
The bonds’ distribution period is 15 working days (October 5-26), though, as Mr. Gigineishvili points out, if the rate of the bonds’ sale is retained, all bonds will find their owners before the appointed time. It is the first case of issuance of bonds by micro-financial organizations. As for other organizations, “ProCredit Bank” and “Bank of Georgia” issued bonds as early as in 2005. The mentioned issues turned out to be quite successful. “Bank of Georgia” issued a 2-year bond whose annual interest rate made up 11%. The bond issued by “ProCreditbank” was a one-year, annual interest rate – 14%.
According to Mr. Loladze, the bonds issued by the mentioned banks were public securities. Proceeding from that, they were admitted to the exchange and there existed a certain circulation of them. As for “Georgian Credit”, the bonds issued by it were not admitted to the exchange since they were distributed in a closed way, i.e. they have 80 owners. It is not a public security and, correspondingly, it cannot circulate in public channels. Its circulation will take place only by means of direct negotiations. But if it becomes a public one, the issue booklet and everything that is necessary for public offering should be prepared in advance, i.e., as Mr. Loladze points out, on the one hand it is good that the bond was issued, but on the other hand it is not interesting since it will not be in wide circulation. A bond’s attractiveness consists in the fact that its recurring sale should be possible. For this purpose it is necessary to create an effective secondary market, which, in its turn, will make the bond more attractive for investors. This fact is another evidence of the fact that the functioning of the securities market in Georgia has serious problems.