Traders during the NSE in the past: Equity turnover ratio at the Nairobi Securities Exchange remained below one percent throughout 2021. FILE PHOTO | NMG
Kenya ranked eighth overall in the just released Absa Africa financial markets index (AFMI) 2022, an improvement from position 10 in 2021. However, Kenya lost some ground in the Pillar One of the index, scoring 43 out of a maximum score of 100, compared to a score of 46 in 2021.
Broadly, there are six pillars in the index. Pillar One evaluates the size and liquidity of domestic capital markets, along with the diversity of listed asset classes and the existence of standard features that enhance market depth. This low score speaks to two factors. First is liquidity, as measured by the turnover ratio. This essentially compares the volume of shares traded to the number of shares outstanding.
If there is a high level of share turnover, this indicates that investors have an easier time buying and selling their shares. This is a significant measurement for investors to be aware of, for a low share turnover rate indicates that it may take time to sell off a share holding.
Statistics from the Capital Markets Authority show that equity turnover ratio at the Nairobi Securities Exchange (NSE) remained below one percent throughout 2021, which is quite thin.
Indeed, the equity market has traded on thin liquidity and improving turnover levels in the long run requires more listings as well as increased investments by both institutional and retail investors. Additionally, recent product innovations such securities lending and borrowing should help drive up activity (and hence liquidity).
The second factor is a lack of primary dealer system. In any financial markets, primary dealers underwrite any primary sale of securities, whether equities or bonds, which they in turn re-sell to other market participants in the secondary market. By doing this, they perform two functions: providing market making and price discovery. Market making in the sense that they provide a ready market for any investor looking to sell a security.
Price discovery, on the other hand, is achieved through two-way quotes; which basically means that if I can sell it to you at a certain price, then I also show you my buy-back price. In the Kenyan context, this has been a missing link and continues to contribute to the low score.
The lack of primary dealer system in the equity market also (partly) explains the initial public offer (IPO) drought at the NSE.
Think about it. Currently, any entity wishing to raise equity capital through the IPO route will have to content with pitching to hundreds of potential investors without any guarantee of securing funding. They would have to undertake a domestic and cross-border roadshow, depending on the offer size.
The roadshows and the pitches can be such a lot of work. It would be much easier if such an entity would only meet three or four investment banks in a meeting room and obtain an undertaking to fully underwrite the equity raise (after which the investment banks will sell down in the secondary market).
The same concept applies to the fixed income market, both corporate and sovereign. And in the case of government bond market, the central bank, being the government’s fiscal agent, approves a list of primary dealers (using its own criteria for selection). The absence of primary dealer system in the public markets has given more energy to the private equity market.
Merger and acquisitions data from the East Africa Venture Capital Association shows that the value of reported and disclosed transactions between 2018 and 2021 stood at $3.1 billion, when there was no single equity capital raise at the NSE. Essentially, there is a more activity in the private market compared to the public market, and it’s all down to (lack of) primary dealership.
It is noteworthy that neighbouring Uganda, which operates a primary dealer system in its government bond market, scored higher than Kenya.
Ultimately, the insights from the Absa Africa financial markets index presents some sort of wake-up call to reform the structure of the domestic capital markets.
The writer is an investment analyst. @GeorgeBodo
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