Cytonn problem is regulatory failure

Last week, investors who put money in Cytonn High Yield Solutions accused the company of defaulting after their investment matured. What followed was a shocker when the Capital Markets Authority attempted to distance itself from the problem when the crisis is largely a result of its regulatory failure.

First, the crux of the problem is that the CMA approved Cytonn High Yield Solution Fund which is regulated to run parallel to the Cytonn High Yield Solution, which is unregulated.

With the difference being the word “Fund”, the average Kenyan would not have recognised that. So, when Cytonn ran adverts about investing in their Fund stating that it’s CMA-licensed, investors couldn’t tell the difference between the regulated and unregulated one.

But interestingly, it never occurred to the CMA that Cytonn was misleading the public, or they were simply never bothered because Cytonn ran these adverts for years. In short, the CMA failed to protect consumers.

Second, the Cytonn investment model had red flags from the start. The firm promised investors the highest yields in the short term but were investing in long term assets. Even though banks do the same in the mortgage market, they diversify portfolio to reduce risks.

But in the case of Cytonn, it promised high returns while investing in one asset category, meaning the firm would have very high refinancing risks.

The CMA can’t argue that the product was out of their control and couldn’t intervene. Analysing any emerging risks in the industry is the cup of tea of any regulator, and with Finance being an attractive field for fraudsters and shysters, the CMA can’t say its hands are tied to intervene.

In fact, Cytonn was using the capital markets infrastructure and any proactive regulator would have foreseen the risk of default from its investment model and worked on managing the risks.

Third, it is correct that the CMA shouldn’t license every product that comes into the capital markets because this will inhibit product innovation. But it failed to take note of the fact that Cytonn running both an unregulated and regulated fund when possessing high refinancing risk meant even the regulated fund was not safe.

The chances of the firm using the regulated fund to refinance the unregulated fund was very high, placing both products at risk. So, for the CMA to distance itself saying the regulated product is safe is unacceptable.

Fourth, whether the product is regulated or not, for Cytonn to collect Sh10 billion from the public, a pool of funds estimated to be 12.5 percent of assets under management, means that the CMA risk analysis is either asleep or dead.

For the CMA to remain unbothered when a single unregulated product has pooled Sh10 billion says a lot about the kind of regulator it is.

Surprisingly, even the Central Bank of Kenya that also conducts risk assessment of sectors also failed to see this risk. It has been more bothered with digital lenders who take the risk of lending own money uncollateralised but failed to see the risk of one firm collecting Sh10 billion from the public through an unregulated product holding more than the deposits of tier-III banks.

So, what is happening at Cytonn is regulatory failure; the CMA is only catching up with it.

The whole Collective Investment Scheme industry is now facing a systemic risk.

Industry players are facing reputational risk from Kenyans who can differentiate between regulated and unregulated products.

Also, the confidence of the public in investing in Collective Investment Schemes stands damaged and the industry faces capital flight back to traditional investments like land buying.

It’s incumbent upon the CMA to address the Cytonn issue whether the product is regulated or not.

The better option is to prevail upon Cytonn to liquidate their assets even if it means taking a haircut and pay investors.