NSE New Criteria of Generating Yield Curve

The Nairobi Securities Exchange (NSE) has been generating a yield curve based on a weekly basis. The Curve is aimed at providing market participants including but not limited to Fund Managers, Commercial Banks, Custodians, and Investment Banks with a credible tool to mark to market bond portfolios.

Current yield curve Generation Criteria

The Curve is based on yields traded at the Exchange on a weekly basis. This means that the NSE factors the trades across the maturities whose trades are above Kes fifty million. The trades are then volume-weighted to determine the yield curve reference point for the traded bonds.

Due to the liquidity challenges where not all bonds trade within a week, the NSE calls for quotes from the trading participants. The NSE aggregates all the quotes received and averages all the bid ask quotes per firm and then factors a simple average for all quotes received per issue per trading participant to derive the yield curve and indicative yield for bonds.

To accommodate the bonds that have not traded within a week and where quotes were not received from the trading participants, the Log-linear (logarithmic) interpolation method is used to fill in the gaps.

The yield curve and the prices of all bonds inform of an implied yields report is published every Friday and end of every month where the latter does not fall on a Friday.

Key Points of Noting

NSE Factors traded yields of trades above Kes.50 million traded within the week.
NSE Factors Primary Auction activity within the week to determine the rates at the short end of the curve (Below 364 days).
NSE calls for firm quotes from trading participants which are factored where a bond has not traded within the week.

Challenges Being Experienced in Generating the Curve

The Exchange has been generating the curve on a best effort basis with an aim to ensure that the curve is reflective of market trends. The Exchange is however experiencing the following challenges in its efforts to achieve a reflective curve.

Yields Distortions Arising from Buy/Sell Back Transactions

Buy/Sell Back transactions are transactions consisting of simultaneously concluded transactions for buying and selling the same amount of financial instruments with different

settlements dates and at different prices. Given that the said transactions as witnessed are not concluded within the market rates, their inclusion in the generation of the yield curve has

resulted to distortion on the curve.

Trading Rules are silent with regard to price movements in the ATS

Under the current provisions, there is no price cap that governs trading of bonds at the secondary market. The rationale for not capping the price movement for bonds was that the

pricing of bonds is based on interest rate movement which the market may have no control over, and prices are assumed to adjust accordingly based on this fundamental fact.

Lack of Market Makers

The bonds market does not have market makers. As such the quotes received from the market are not from licensees who have an obligation to make the market. market.

Proposed Intervention to Enhance the NSE Yield Curve

The NSE proposes to put in place the following measures to address the above challenges.

Quotations Board

The Exchange proposes to introduce a Quotations Board where licenced entities will be providing two-way indicative yields on a daily basis. The yields shall be based on 100 basis

points from the previous yield curve and shall be within a reasonable spread of within 100 basis points. This proposal has been enacted in the proposed trading Rules for the CMA's consideration

The NSE has enhanced the current trading system to allow for a special Board where buyback transactions are concluded. The trades executed on this Board will be reported as buy/sell back transactions and will not be considered in the generation of the yield curve.
The NSE proposes for the licensed trading participants to be obligated to provide the two-way indicative quotes as part of secondary market making obligation. The NSE propose an incentive for this service that could be issued by the issuer though its fiscal agent the Central Bank of Kenya.

Conclusion

The Authority is requested to note the above enhanced proposals which have been factored in the revised Trading Rules. The third proposed policy direction above will be championed through the National Treasury lead round table. The NSE shall issue a circular once guidance is received from the Authority.

Source: NSE