The Bond Exchange of South Africa (“BESA”) provides mark-to-market (“MTM”) valuations for all
products listed on the exchange on a daily basis. This document outlines the business rules that apply in
determining the daily MTM valuations.
Submitted to
Public
Prepared by
Zayd Laher / Eve Leopold-George
Date
21 November 2005
Document type
Status
Version
0.1
Confidentiality Notice
Unless otherwise indicated, the contents of this document, including any attachments hereto are proprietary to the Bond Exchange of South Africa and are
confidential, legally privileged and protected by law; and may not, without the prior written consent of the chief executive officer of the Exchange, be disclosed to
any third party, copied or distributed.
Copyright© Bond Exchange of South Africa
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2.1
The rules for the determination of a benchmark bond and its MTM valuation........................ 4
2.2
MTM valuation rules for liquid bonds ..................................................................................... 4
2.3
MTM valuation rules for bonds in respect of which the issuers are its market makers........... 5
2.4
MTM valuation rules for illiquid or companion-linked bonds................................................... 5
2.5
MTM valuation rules for zero-coupon bonds.......................................................................... 6
2.6
MTM valuation rules for short-dated commercial paper ......................................................... 7
2.7
MTM valuation rules for inflation-linked bonds....................................................................... 7
................................. 8
3.1
MTM pricing methodology of FRN’s: ..................................................................................... 8
3.2
MTM pricing of credit-linked notes (“CLN’s”) ......................................................................... 8
........................................................................................................ 9
Bond Exchange of South Africa
The Mark to Market Valuation Rules of BESA
November 2005
Page 2 of 9
The Bond Exchange of South Africa (“BESA”) provides mark-to-market (“MTM”) valuations for
all products listed on the exchange on a daily basis. This document outlines the business
rules that apply in determining the daily MTM valuations.
The rules for the valuation of the yield-traded listed instruments were initially approved by the
Bond Traders Association after consultation with the market. At that time all market
participants, including BESA members as well as members of IMASA, were invited to
contribute.
The rules for the valuation of the price-traded listed instruments (the Floating Rate Notes)
were determined in consultation with the market participants. Floating Rate notes (“FRN’s”)
are loaded onto the BESA trade capture system as “Price traded” and this is also reflected in
the listing notice.
Historically, there were not many FRN’s listed on BESA and those that were listed, were held
in portfolios to maturity and were valued at par by BESA based on the instructions from
market participants. However, with the proliferation of these instruments along with the
different indices that are used as benchmarks, a more standardised method of valuing these
instruments is being sought. The new methodology will see BESA value these instruments
from the Zero Swap curve and BESA will seek to get credit spreads from market participants
as inputs to generate the final valuation. This methodology is in the process of being
approved by the Quantitative (Quants)1 committee.
As it stands at the moment, the valuation of FRN’s are based on a mix match of sources and
processes depending on the bond. Unless market participants inform BESA of changes in
credit spreads, these instruments are usually priced at par.
1
The Quants committee is a sub-committee established by BESA to assist in the determination of any
quantitative or valuation methodologies and other ad hoc projects assumed by BESA. The committee consists of
volunteers from the asset manager and banking industries who has committed their time to BESA.
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The Mark to Market Valuation Rules of BESA
November 2005
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2.1
The rules for the determination of a benchmark bond and its MTM valuation
The benchmark bond forms the basis of the daily MTM valuation. The benchmark bond is
determined based on the criterion of which is the most liquid bond in the South African debt
market. It is important to understand that the determination of the benchmark is not a specific
event. It is rather a function of the market’s recognition of a bond becoming the most traded
bond in the market. The current benchmark is considered to be the R153.
The first step in performing the MTM daily valuation is to ascertain a closing level for the
benchmark bond, which is done at 16h30. This forms the basis of the MTM process. BESA
establishes a closing level for the R153 (benchmark bond) by evaluating all available “live”
prices on Reuters, taken from the Reuters pages of the inter-dealer brokers (IDB’s). The
methodology adhered to is as follows:
•
•
•
•
•
2.2
the best bid (the bid with the lowest yield) and the best offer (the offer with the highest
yield) in the market are noted;
the level at which the last trade executed is then used as a starting point in
determining the closing level;
if the last trade falls within the best bid / offer spread then the last trade is deemed to
be the closing level of the R153. If the last trade does not fall within the bid / offer
spread then the level is deemed to be either at the bid or offer depending on where
the last trade was executed;
if the bid on Reuters is better than the last trade, for example, if the last trade is
executed at 8.16% and a new bid appears on the system at 8.14% (i.e. anything less
than 8.16%), the R153 is closed at the bid level;
if an offer exists on Reuters which is better than the last trade, for example, if the last
trade is executed at 8.16% and a new offer appears on the system at 8.175% (i.e.
anything greater than 8.16%) then the R153 is closed at the offer level.
MTM valuation rules for liquid bonds
The liquid bonds are those bonds that trade frequently and currently consists of the most
liquid government issues (namely the R152, R157, R194, R201, R206, R203, R204, R186
and R207). The closing levels of these bonds are determined with the assistance of the
primary dealers.
As soon as BESA determines the closing level of the R153 benchmark bond, it is supplied to
all 9 Primary Dealer Banks (namely Citibank, Standard Bank, ABSA, RMB, Investec,
Deutsche Bank, Nedbank, JP Morgan and Barclays) who in turn use this level to determine
the closing levels of the liquid bonds. The primary dealers derive the closing levels by setting
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The Mark to Market Valuation Rules of BESA
November 2005
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a spread against the R153, and using spreads between the liquid issues. The two highest
and lowest levels for each liquid bond are discarded and the remaining 5 levels are then
averaged to determine the MTM value of the relevant issues. This level is then rounded to
the nearest half basis point.
2.3
MTM valuation rules for bonds in respect of which the issuers are its market makers
Certain organisations act as market makers in their own issues. These organisations provide
daily closing levels on their issues to BESA which is then recorded as their MTM valuations.
Eskom, Land Bank and Transnet are market makers in all their own bonds and supply closing
levels on the following listed bonds:
Eskom bonds
E153
E154
E155
E157
E159
E160
2.4
Land Bank bonds
LB01
LB107
Transnet bonds
T004
T011
T017
T018
MTM valuation rules for illiquid or companion-linked bonds
An illiquid bond is a bond that is scarcely traded. Due to the illiquidity of many bonds it is
essential to devise a methodology to account for the limited information and provide the
market with accurate valuations. The methodology for valuating illiquid bonds is detailed
below:
•
upon issue, the bond is linked to a liquid government issue (a companion bond). The
companion is chosen so as to best fit the characteristics of the issue, with time to
maturity being the most important factor. The spread is determined after liaising with
the issuer as well as the market maker in that particular security. This spread is then
verified by taking the yield at issue and comparing it to the companion bond’s yield at
the time of issue.
•
BESA receives bid / offer spread information from market participants and interdealer broker pages (Reuter’s pages). This information is used to revalue any
existing spreads. The spread is adjusted if there is a better bid / offer in the market,
for example, if a bid appears which is better than the current MTM level, say if the
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The Mark to Market Valuation Rules of BESA
November 2005
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current MTM is at a 25 point spread above its companion and a new bid appears on
the system at 24 points above the companion (i.e. anything less than 25 points), the
market is deemed to have moved. Likewise if an offer appears which is better than
the current MTM level, say if the current MTM level is 25 points above its companion
and a new offer appears on the system at 26 points above its companion (i.e.
anything greater than 25 points), the market is deemed to have moved. Only bids /
offers in nominal value equal to or more than ZAR 5 million but not exceeding ZAR 50
million will be considered. This is due to the inherent discounts associated with large
trades as well as the premium charged for odd-lot trades.
•
any trade that is reported through BESA within certain parameters is also used to
revalue spreads. Trades are analyzed using the BESA trade capture system. The
procedure is carried out daily at 16h00. Only spot trades i.e. for settlement (T+3), will
be taken into consideration for the day in question. BESA does not consider REPOs,
FOV2, SD3 and OX4 trades. Only trades in nominal value equal to or more than ZAR
5 million but not exceeding ZAR 50 million will be considered. This is due to the
inherent discounts associated with large trades as well as the premium charged for
odd-lot trades. Internal book-overs are not considered when evaluating spreads.
As markets are dynamic and constantly changing, BESA will respond to any suggestion for a
change in either spread or companion bond. These requests come form internal (staff of
BESA) or external (market participants) sources. These requests are communicated to no
less than 4 market participants. If all the parties agree that the pricing methodology or current
value of a particular instrument needs to be altered, then the change is executed by the
exchange. Upon reaching a decision to alter the pricing methodology or valuation of an
instrument, an information notice will be sent to the market regarding the proposed change.
2.5
MTM valuation rules for zero-coupon bonds
The BEASSA Bond Perfect Fit Zero Curve is used to value zero coupon-long dated bonds.
The curve is generated using the closing levels of the bonds that constitute the GOVI Index.
2
FOV - A free of value trade is a trade whereby the scrip is settled electronically through the CD, however the
cash is settled offshore.
3
SD - A structured deal (SD) is a trade whereby the normal vanilla bond pricing formula does not apply. This
trade is simply settled on the UNEXcor system.
4
OX - An Option Exercise trade (OX) represents a trade that results from an option that has been
exercised. These trades are deliberately flagged on the system as the strike is usually out of the daily
trading range.
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The Mark to Market Valuation Rules of BESA
November 2005
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The methodology of the curve is clearly outlined in the BEASSA Zero Coupon Curves booklet
(available for review from the Bond Exchange of South Africa).
2.6
MTM valuation rules for short-dated commercial paper
These issues are privately placed and trade infrequently or not at all. Upon issue the issue
price is divided by the nominal issued and then multiplied by 100 in order to determine the
price / R100 nominal. We quote this level until maturity.
2.7
MTM valuation rules for inflation-linked bonds
Inflation-linked bonds (“ILBs”) are valued using trades as well as live prices available in the
market (obtained from IDB Reuters screens). The procedure is as follows:
•
At 16h00 trades in ILBs are analyzed using the BESA trade capture system. Only spot
trades i.e. for settlement (T+3), will be taken into consideration for the day in question. BESA
does not consider REPOs, FOV, SD and OX trades. Only trades in nominal value equal to
or more than ZAR 5 million but not exceeding ZAR 50 million will be considered. Internal
book-overs are not considered when evaluating spreads. The level will be adjusted to the
level of the last trade should it meet the criterion mentioned above.
•
At 16h25 the best bid (the bid with the lowest yield) and the best offer (the offer with the
highest yield) in the market are noted. The level at which the last trade executed is then
used as a starting point in determining the closing level. If the last trade falls within the best
bid / offer spread then the last trade is deemed to be the closing level. If the last trade does
not fall within the bid / offer spread then the level is deemed to be either at the bid or offer
depending on where the last trade was executed. If the bid on Reuters is better than the last
trade, for example, if the last trade is executed at 2.8% and a new bid appears on the system
at 2.78% (i.e. anything less than 2.8%), the market is closed at the bid level. If an offer
exists on Reuters which is better than the last trade, for example, if the last trade is at 2.8%
and a new offer appears on the system at 2.82% (i.e. anything greater than 2.8%) then the
market is closed at the offer level.
•
In the event that there are no trades reported in an instrument on a particular day, the
previous day’s close is used as a starting point (or last trade).
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November 2005
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3.1
MTM pricing methodology of FRN’s:
A FRN is a security that resets coupons against a floating benchmark rate (usually on a
quarterly basis). This means that at any period, the only cash flows that are known are those
that are paid at the next interest date. Because of this, the pricing \ valuation of FRN’s is
usually considered to be more complex.
The instrument is generally issued at a margin above the benchmark rate (initial margin).
Over the life of the security this margin may or may not change based on credit
characteristics of the issuer or the industry, prevailing interest rates, etc. as it nears maturity.
This is referred to as the trading margin.
There are bonds that have similar features to FRNs in that they pay quarterly coupons or that
they are amortizing which means that both principal and interest is paid on the coupon dates
as one payment. While such bonds will are not priced like FRNs, their special features
require adaptations to the methodologies and the valuation rules around that will be dealt with
separately herein. These calculators are made available to BESA for valuations either by the
issuer or lead underwriter \ debt originator.
Thus currently FRN’s and other special feature bonds similar in nature to FRN’s are priced
either by BESA or externally by lead underwriters or the debt originators. The pricing
formulas that are used for the MTM valuations of the various price-traded bonds are available
on request from BESA.
3.2
MTM pricing of credit-linked notes (“CLN’s”)
BESA currently prices some CLN’s as FRN’s but this is also under review by the Quants
committee. CLN’s are based on an underlying security which could be a share or a bond so
they are effectively derivative instruments. Their prices are supposed to move in tandem with
the underlying instrument which means that the risk changes daily. This, and the fact that
BESA is not aware of who the underlying credit is, poses difficulties in the pricing.
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The Mark to Market Valuation Rules of BESA
November 2005
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Should you have any queries regarding the MTM valuation rules or would like to have access
to any pricing formulas, please contact either of the following BESA staff per e-mail (to enable
us to keep a record of all MTM queries):
•
Zayd Laher
E-mail: zaydl@bondexchange.co.za
OR
•
Eve Leopold-George
E-mail: evel@bondexchange.co.za
Bond Exchange of South Africa
The Mark to Market Valuation Rules of BESA
November 2005
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