Buyer beware: Govt bond market lacks investor protection

The Auditor General’s report to Parliament for 2022 raised an audit query about the fact that the Primary Market dealer Banks, which facilitate investment in the government bond market, were not licensed. Hon. Nabeta Nathan earlier raised this issue through a motion he tabled to amend the Capital Markets Authority Act, which received overwhelming support during the 8th sitting of Parliament on 16 November 2022. I have been part of his legal team in an attempt to bring order to the chaos in the government market.

The audit query might have revealed a licensing issue on the surface; however, it exposed much bigger systemic problems in the government bond market that have not been discussed. There are no investor protections in the government market. The set-up of Bank of Uganda’s Over-The-Counter (OTC) ‘Treasury Bond’ market heavily disadvantages investors. This market has unlicensed dealers facilitating the electronic submission of orders directly by investors, while others may submit orders via email to the banks, which then place orders on the BoU environment. The orders are matched at BoU. 

This entire arrangement is opaque and operates outside regulation. The investor can’t hold the dealer bank to specific standards without a license. No wonder banks are exploiting investors with abnormal spreads. The Treasury bond market needs reform.

As a rule of thumb, securities issuers (or sellers) never oversee the safekeeping of whatever they issue. During a popular morning TV show, I once compared this to going to the market to purchase bananas and leaving them with the vendor without agreed rules on safekeeping. BoU shouldn’t keep what it sells. Adding to this confusion, the National Payments Systems Act 2019 (NPSA) wrongly classifies this depository, which does the safekeeping of treasury bonds (investor assets), as a payments system. Depositories are custody and settlement systems. So, for the law to provide for depositories as payment systems is wrong and further weakens investor protections.

As if it is not bad enough for BoU to operate securities infrastructure, it now acquires some powers in the NPSA to regulate depository activity. 

BoU cannot become a securities regulator unless the Constitution is amended and the CMA is mainstreamed into the Financial Markets Department at BoU. One of the sad developments in the bond market is that the Bank of Uganda is the seller (fiscal agent) of government securities; it regulates itself as both a seller and a custodian of what it sells. Bonds are assets that belong to the investor and should be kept in transparent custody systems regulated by the Capital Markets Authority.

Investors in Uganda Government bonds should start to question the sheltering of the treasury market from regulation, operated by the central bank, without the necessary operating or regulatory powers. This is a disadvantage to those purchasing government bonds, as there are no legally enforceable investor protections. 

Government bonds are indeed safe investments, but there are other risks you will find in the bond market, such as “settlement risk” and “market risk” that require regulator risk mitigation. This is why the Securities and Exchange Commission regulates the treasury market even in the U.S. As of December 2023, rules were adopted to improve risk management in clearance and settlement to facilitate additional Central Clearing for the U.S. Treasury Market.

The Capital Markets Authority Act recognizes treasuries as securities, but the CMA does not oversee any treasury market activity. The trading is conducted by unlicensed dealers appointed by BoU without the backing of any law. As a result, investors in the treasury market are not served and exposed due to a regulator's absence to protect their interests.

Furthermore, the CMA law provides market reporting, returns, and investor information, but more information needs to be available in the bond market under BoU. The enforceable instrument is under securities law, which CMA administers that the treasury market is shielded from. Need I say more? Much needs to change.

Mr Louis N. Kizto is a lawyer at Pentagon Advocates