REVIEW

Second Spring

The BSE is slowly transforming itself into a strong vehicle for government and corporate debt placement, though its development is being taken in careful steps.

The nascent capital markets in Azerbaijan may have been well sheltered from the global financial crisis, but even in their safe harbor a lull of activity was experienced following the highs of 2008. Over 2009-2010, market activity abated, as investors sought more liquid and reliable investments, and issuers shied away from registering shares or launching bonds. However, since the start of 2011, market activity has picked up strongly, with turnover on the Baku Stock Exchange (BSE) in the first half of the year up 4.4 fold on that recorded for the same period in 2010, and representing a strong 167.3% of the turnover for full-year 2010. Still, the BSE has a way to go before it reaches the pre-crisis high of AZN9.52 billion visited briefly in 2008.

HISTORY & DEVELOPMENT

The BSE has a relatively short history, with the idea first being floated in late 1999. In July 2000, the State Committee for Securities, the newly born market regulator, issued an exchange license to the BSE, and the first government bonds were traded in September of that year. In its first five years of operation, the BSE mostly operated as an outlet for the Ministry of Finance’s short-term bonds, though things were soon to change. Since then, the BSE has slowly but surely added new instruments to its list of offerings, with the first repo hitting the exchange in November of 2001, and the Central Bank of Azerbaijan listing its first notes in September of 2004. However, it hasn’t all been a government-linked story, with the first corporate bonds getting a showing at the start of 2004, while the first equity trade was conducted in April of the same year.

MARKET, INTERRUPTED

From 2004, activity on the BSE picked up sharply, with volumes moving from a low AZN94 million to AZN518 million in 2005, before later
hitting their high-water mark of AZN9.52 billion by 2008. However, as quickly as it had risen, the BSE experienced the chill winds blowing across the globe. Trading volumes slumped to AZN3.32 billion in 2009, and fell further still to AZN2.22 billion in 2010. Clearly, something, or someone, was missing from the equation.

Prior to the global economic crisis, up to 54% of the bond market was dominated by foreign investors, eager to cash in on the keen spreads offered by Azerbaijani state medium- and short-term debt. However, come 2008 that figure had fallen to 40%, and then fell to zero by 2009, according to the BSE. Local banks and investors stepped in to fill the role of the absent foreign investors, thus accounting for the massive drop in volumes seen in the post-crisis environment.

As the economy began to heat up strongly again, the government realized it had to step in the revitalize the nation’s capital markets and improve trading and liquidity levels. In March 2009 the first placement of medium-term government bonds was offered, while in June the Azerbaijan Mortgage Fund came to market, and has been a strong issuer ever since. By seeking to improve the range of instruments on offer, the government hoped to both help grow the local capital markets, and provide attractive issues for investors. It has also used bond placements as a useful monetary policy tool, both in determining rates and controlling available liquidity levels in the banking system.

Over the crisis period, corporate securities began to make inroads into the previous dominance of government-linked notes, growing to AZN706 million in annual turnover, well up on the AZN353 million recorded over 2010. By comparison, government securities slowed from AZN2.69 billion in 2009 to AZN1.52 billion in 2010, or some 68.26% of annual BSE turnover, well down on the 98% figure from 2008. However, this slowdown was not to last.

FINIDNG ITS WAY

In the first half of 2011, government-linked securities have once again stormed the market in terms of volumes, with 91.76% of volumes being devoted to them (AZN3.42 billion), while the corporate securities side recorded a respectable AZN307 million, well able to reach in numerical terms the strong showing from 2010 when government issues were in retreat. The release of new government securities in 2011 may well have much to do with keeping the level of money supply in the banking system under control, reigning in excessive economic growth in rent-oriented sectors of the economy, and maintaining a steady inflation track.

The corporate side has remained active in terms of equities, with some 20 share placements or listings over the first six months of 2011. The corporate sector remains dominated by financials, such as banks, insurance companies, and even the newly established leasing sector. Bucking the dominance of financials, the largest new share issuance for 1H 2011 was for ordinary book-entry shares in Azerenerji, being valued at AZN824 million and underwritten by Chelsea Kapital. Other notable issuances more in the AZN10 million range were those for Teknikabank and the Bank of Azerbaijan. Although the equities side remains weak, in terms of market development the BSE still has some way to go before it can spread its wings. Only in October 2010 did the BSE hold seminars in the technicalities of IPO listings for brokers, meaning that the road to a fully fledged, highly liquid securities market is still under development.

However, the corporate bond side shows some promise. In March 2011, the BSE recorded a first, with Unibank issuing $25 million in unsecured convertible bonds. The nominal bond amount, of $10,000, could be converted into 4,053 ordinary shares in the company should certain conditions be met, and the issue was picked up by two investors. The coupon rate for the bond was 8% plus the prevailing interbank rate over a five-year tenor.

This new development in Azerbaijan’s corporate debt sector marks a marked turn away from the traditional sources of financing resorted to by the local banking sector, and could well see new opportunities for other local banks to tap the domestic market for medium-term funding.