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The shape of capital markets 3 years since launch of master plan

Nairobi Securities Exchange CEO Geoffrey Odundo with Kenya Association of Manufacturers CEO Phyllis Wakiaga during the signing of the Code of Ethics for Business in Kenya report last year. PHOTO | DIANA NGILA | NMG
Nairobi Securities Exchange CEO Geoffrey Odundo with Kenya Association of Manufacturers CEO Phyllis Wakiaga during the signing of the Code of Ethics for Business in Kenya report last year. PHOTO | DIANA NGILA | NMG 

The Capital Markets Master Plan (CMMP), one the two flagship projects under the financial services theme of a phase of Vision 2030, charts the direction of the Kenyan capital markets over a 10-year period ending in 2023.

It positions Kenyan capital markets as the continental gateway to African capital market investment.

The plan positions the capital market to take up a key role in the next stage of development due to the growing pressure on the traditional sources of revenue as the government implements programmes under Devolution.

Indeed, it sets up the capital market to drive national growth needs and aspirations as envisioned under Vision 2030 while responding to new risks such as regionalisation and globalisation of financial services.

The CMMP is anchored in three pillars: Supporting development and economic transformation with a focus on the role of capital markets; the infrastructure of the markets keen on a secure and efficient marketplace meeting international standards; and, legal and regulatory environment to strengthen and streamline the legal and regulatory environments to accommodate the requirements placed upon them, as well as the overall competitiveness of the capital markets among its peers.

The Capital Markets Authority’s (CMA’s) strategic direction is properly aligned to the plan whose development is a a result of broad consultation, including international benchmarking with jurisdictions that have implemented financial sector reform strategies, attained International Financial Centre (IFC) or Gateway status or developed diversified and sophisticated capital market products and services.

In Kenya, consultative meetings with stakeholders, ministries, industry licensees and market participants produced the CMMP launched in November 2014.

The capital market is one of the identified key catalysts to the establishment of Nairobi as an International Financial Centre (NIFC).

The master plan is intended to support this development on many fronts, including the improvements to legislation and regulation governing capital markets.

This should create an attractive institutional environment for users of the Kenyan marketplace and the International Financial Centre in particular.

To support the free flow of capital into the economy, the CMMP implementation team has worked with the National Treasury to remove the capping of foreign ownership in listed companies of 75 per cent.

This will pave the way for the externalisation of the Kenyan financial sector.

The Government further removed the provision in the Companies Act, 2015 on capping of foreign ownership at 70 per cent and the requirement for the local boards of directors for locally registered branches of foreign entities.

These achievements are expected to ensure that the Kenyan capital markets further progress to achieving the Morgan Stanley Capital International (MSCI) Emerging Markets ranking, hence raising further the profile of Nairobi as an International Financial Centre.

With the thriving Kenyan agricultural sector and emerging mining, minerals and extracting sector, the Master Plan targets a fully functional, developed and regulated spot and derivative market organised with an efficient price discovery mechanism to help realise the full potential and value of the historical agro- and emerging economic sectors.

The Nairobi Securities Exchange has so far been licensed to set up a derivatives exchange, and is working with stakeholders to ensure the institutions and infrastructure necessary are in place.

A work stream running parallel to the establishment of the derivatives exchange is the Warehousing Receipt Bill. The Bill aims at putting in place a legal framework through which market players can build and operate warehousing receipt systems (WRS).

A warehouse receipt system enables farmers or other commodity owners to deposit storable goods (such as grains, coffee, minerals) in exchange for a warehouse receipt, a tradable document issued by warehouse operators as evidence that specified commodities have been deposited at a particular location. The depositor can defer selling until prices pick up.

It is, therefore, evident that full roll-out of the derivatives markets and establishment of a commodities exchange will play a critical role in stabilising commodity prices especially for agricultural products.

Experience from other jurisdictions indicates that other than price discovery and stability, a vibrant derivatives and commodity exchange enhance distribution of food and other produce.

The capital markets in Kenya are also expected to support the development of housing in the country. Some of the products CMA has rolled out to support this goal are Real Estate Investment Trusts (Reits) and Asset-Backed Securities (ABS).

There is an elaborate policy and legal framework to facilitate their roll-out.

The market has witnessed the issuance of a income Reit at the NSE.

Since the launch of the CMMP in 2014, the government has supported the Reit and ABS through implementation of tax neutrality by waiving stamp duty and Value Added Tax (VAT) on transfer of assets from the originator into the Reit/ABS.

As well as through the full implementation of Reits/ABS in a tax neutral environment, it is expected that the two products will be instrumental in supporting housing development in the country.

One of the key first milestones that was realised as part of the implementation of the CMMP was the rebranding, demutualisation and subsequent self-listing of the Nairobi Securities Exchange (NSE).

The demutualisation and self-listing of the NSE helped achieve part of the government’s policies to enhance governance standards and facilitate access to markets by a wider community of investors.

Following the demutualisation, the exchange reduced admission fees ten folds from Sh250 million to Sh25 million hence facilitating access by more trading participants.

On the other hand, the public offering of its shares provided an opportunity for Kenyans to become shareholders hence transitioning from a mutual company to a public listed one.

Additionally, the exchange has also achieved Self-Regulatory Organisation status, which has enhanced innovation in their offerings to create more value for its shareholders through venturing into the derivatives space.

Stability of the financial system has been a focus of many jurisdictions particularly in the post-global financial crisis era.

The Kenyan financial regulators have prioritised stability as key to ensuring that the sector mobilises savings sustainably.

In light of this need to have stable and resilient capital markets in the country, the CMMP recommends a shift in capital markets regulatory approach from prescriptive to a risk-based approach.

Under the prescriptive approach, the regulator defines a series of safety requirements that the licensee must demonstrate are met.

Experiences from other jurisdictions have proved that prescriptive regulatory approach is best suited for nascent markets.

For incrementally more developed markets like Kenya, however, prescriptive approach poses challenges that include inflexibility which limits initiative in the licensee to strive for better performance; the approach is linked to generic industrial experience and is not easy to modify or replace; and, is normally not very helpful in developing and promoting safety culture.

Following the CMMP’s recommendation, the CMA has adopted and incrementally implemented a risk-based regulatory approach which is a more proactive approach that focuses on the risk profile of each licencee.

Such a risk-based approach is preferred for markets such as Kenya as it does not only promote innovation but instils a sense of self responsibility to the licencees.

The fact that risks are identified well in advance makes it possible for the regulator to ensure timely mitigation before they cristalise.

Full implementation of risk-based regulatory approach is expected to buttress the ongoing national efforts to make the Kenyan financial system stable and resilient.

An additional key recommendation of the CMMP which is related to risk-based approach is the gradual shift from rules-based regulation to principles based regulation.

The shift is in line with one of the thematic areas within the Vision 2030 of easy access to financial services. Principles-based regulatory approaches use a broad set of tools set out by the financial services regulator.

The principles are then left to regulated parties to decide how to most appropriately implement them.

Rule-based regulation on the other hand leaves less to the regulated parties to decide and requires the regulator to set out a more specific rule book.
It cannot be gainsaid that principles based regulatory framework promotes innovations and hence allows regulated entities to explore different options to maximise their returns.

On bringing new products to the market, a principles-based regime will normally expect the innovator to present his/her concept as well as the proposed associated risk management framework.

The players are, therefore, allowed to roll out their products even if there is no existing regulatory framework.

The spirit is to develop a regulatory framework based on tested experiences. The Authority has adopted the option of developing broad guidelines to facilitate preparation of new products.

It is against the foregoing that the Kenyan capital markets has witnessed the issuance of Exchange Traded Funds (ETF) Policy Guidance Notes (PGN).

The PGN is a faster and more flexible instrument used to bring a product to the market.

This approach has allowed the first ever ETF product in Kenya— Gold Bullion Debentures — to be approved and listed on the NSE in March 2017.

Other key deliverables in the pipeline, all of which show strong industry commitment is evidenced as well as policy support include development of a warehouse receipting system, establishment of a commodities exchange, operationalisation of an effective hybrid bond market, and consolidation of financial sector regulation.

The implementation of liquidity-enhancing mechanisms such as securities lending and shortselling, introduction of Global Depositary Receipts and Notes, launch of Islamic capital markets products and development of a robust clearing house infrastructure for all securities also make the list.

Jairus Muaka is Assistant manager, Strategy & Policy, Capital Markets Authority.

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