Brokers rattled as banks take over the bond market

The licensing of commercial banks as securities traders has unsettled stockbrokers who stand to lose a substantial share of their revenue, particularly in the wake of falling turnover and volatile trading at the stock market.

The Capital Markets Authority (CMA) two weeks ago licensed Chase Bank to start trading bonds directly – without going through the Nairobi Securities Exchange (NSE) – formally repealing a law that required all secondary trading of the treasuries to be channelled through stockbrokers.

This means that banks, which control 56 per cent of the total treasury papers worth Sh790 billion as at the end of June, can now trade the securities between themselves by circumventing the brokers and relying on the central bank’s Central Depository System.

Trading bonds outside the market means stockbrokers will miss out on billions of shillings in commissions that come with transacting in the fixed-income securities.

“Allowing commercial banks to buy and sell the securities without any intermediaries will definitely deprive us of business. But the market will also be denied the ability to get the best prices for the securities on the basis of supply and demand,” said Faida Investment Bank managing director Bob Karina.

The challenge of a shrinking market is compounded by the fact that turnover in the secondary bonds market has been falling after five years of stellar performance.

New data compiled by Kestrel Capital shows that turnover in the secondary bonds market had shrank by two-thirds to Sh12.2 billion at the end of June, down from Sh36.9 billion in January.

READ: Chase Bank becomes first bank to deal in treasury bonds

The market traded an average of Sh45 billion worth of bonds in the past five years, meaning turnover has more than halved.

Mr Karina said the market will be worse off with price discovery based on agreements between one buyer and one seller without the benefit of bidding and negotiations among multiple buyers and sellers.

The CMA said its decision to license banks as intermediaries in the bonds market is meant to create a hybrid system in which stockbrokers can trade bonds on the NSE even as banks trade on their own.

Some brokers who previously took advantage of market inefficiencies to earn huge commissions are also expected to lose income.

Former CMA chairman Kung’u Gatabaki said the markets regulator had tightened the reporting of back-office operations of various intermediaries to end the practice of using clients’ cash to buy own shares before returning the money to the clients’ accounts post-trading.

Mr Gatabaki said brokers engaging in this activity had been earning huge commissions. The practice also helped the stock brokerage firms to raise their incomes especially in times of poor performance at the stock market and in the absence of mega deals such as initial public offerings and rights issues.

Misuse of clients’ money has been documented in the CMA’s annual reports and some of the brokerage companies have been punished for it.
Mr Gatabaki said the loopholes – in the back office and selling clients’ shares – had been closed and could no longer be used to swell the incomes of brokers.

Stockbrokers have been rattled by the CMA’s recent decision to license Chase Bank as the first authorised securities dealer (ASD) – opening a window for the bank to trade bonds without the involvement of other intermediaries.

The ASDs can buy and sell on their own account, underwrite and originate securities without having to go through any other intermediary.

The license effectively makes the bank a member of the securities exchange with powers to make deals without involving other members of the bourse.

For years, commercial banks have been piling pressure on the CMA to allow them into the bonds trading market without going through brokers.

This allows them not only to save on the 0.035 per cent charge as turnover commission but also ensures quicker settlement or payment for transactions.

Transactions

Bankers became particularly keen on doing own transactions as the secondary bond market grew steadily to become a multibillion-shilling business.

Bond market turnover quadrupled in 2010 to Sh483.1 billion from just Sh110.6 billion in 2009, the year in which the NSE introduced automated trading of the instruments.

As a result, the CMA in 2010 gazetted rules allowing the banks to trade directly in bonds. Three lenders are understood to have applied to be ASDs but stockbrokers lobbied heavily against the move forcing the CMA to temporarily abandon it.

“The brokers have done a lot of lobbying to stop some of the things we wanted to introduce in order to streamline the market, including improving corporate governance. That is how banks were not able to get into selling bonds as dealers. I’m happy to see what the new CMA chairman [James Ndegwa] is doing about letting new members deal in bonds,” said Mr Gatabaki.

Job Kihumba, an executive director at the Standard Investment Bank, however, reckoned that trading of the bonds outside the bourse is not efficient.

“There has been debate globally as to whether trading securities outside an exchange is the most efficient way to move the instruments. The conclusion has been that it is not. Allowing banks to trade is more or less like setting up an over-the-counter market, which though practiced elsewhere, is not what we should have here in Kenya,” he said.

Mr Kihumba, who once served as the chief executive of the NSE, said that there was a tendency for prices struck outside the bourse not to reflect what would normally be achieved in the open market.

“There is lack of transparency when you have two people locked somewhere negotiating without the benefit of the open market. The exchange promotes transparency and also ensures liquidity because it is easier to find a buyer when you expose the security to many people at the same time.”

Mr Kihumba said five banks had applied to be ASDs some five years ago but they were never given the go-ahead to operate.

Paul Mwai, the chief executive of brokerage house AIB Capital, said brokers would still get their earnings from trading in securities that are not held by the lenders, even if more commercial banks are licensed to do the business.

Mr Mwai said the licensing of Chase Bank looked like the starting point of licensing other banks as ASDs.

“I see this as the first of many other banks being allowed to be authorised securities dealers. But brokers will continue to have their role in the market,” he said.

The brokerage pie for each player has also been shrinking on account of the number of licensed market intermediaries having risen from the original 18 just a few years ago to the current 23.