Capital markets as a catalyst for economic growth

Economic growth is largely influenced by factors such as capital, labour and technology. A well-functioning financial system permits an economy to fully exploit its growth potential, as it ensures that the best investment opportunities receive the necessary funding, while inferior opportunities are denied capital. 

What is the current state and depth of the Kenyan Capital markets? What are some of the key challenges affecting the development of Kenya’s capital markets and how can the same be circumvented? How can we leverage on capital markets to spur economic growth? 

Capital markets are generally categorized into primary markets where equity (ordinary and preference) and debt securities are being issued to investors for the very first time. They enable institutions such as governments and companies raise funds for expansion or financing new projects. Through primary markets, funds can be raised using methods such as Public Issues, and Initial Public Offers, and; Secondary markets where pre-existing securities that have already been issued in a primary market are traded. Here, investors buy and sell securities such as equity securities, treasury bonds, corporate bonds and derivatives. 

Kenya’s official capital market began in 1997, with the first government security issuance, while the first company to be listed on a stock exchange was Kenya Commercial Bank in 1988. 

Since then, Kenya’s capital market has experienced robust growth, currently at 65 companies listed on the Nairobi Securities Exchange. To ensure proper functioning of the markets, the Capital Markets Authority of Kenya was formed through an Act of Parliament (CAP 485A, Laws of Kenya) in December 1989, mandated to supervise, license and monitor the activities of financial market intermediaries and all other players licensed under the Capital Markets Act. The Authority licenses and supervises all capital market intermediaries, ensures proper conduct of all licensed persons and market institutions, regulates the issuance of capital market products, promotes market development through research and introduction of new products, promotes investor education and public awareness, and, protects investor interest.

To examine the depth of Kenya’s capital market, you must look at the following five key metrics:

Pools of capital – For long-term impact, capital markets require long-term capital, usually institution based, which includes from retirement benefits schemes, fund managers, and financial services companies. Compared to developed nations such as the United Kingdom with pension funds worth US$15.6trillion, equivalent to 104.5% of GDP (OECD, 2018), Kenya’s retirement benefits assets over the same period totals to US$11.5billion, equivalent to 12.9% of GDP, highlighting the low penetration rate of retirement benefits schemes. 

Corporate Activity – There has been increased corporate activity in Kenya in the recent past, with consolidation in Kenya’s financial services industry mainly being witnessed in the banking sector over the past five years with large banks acquiring relatively smaller banks, which struggled to operate in the tough operating environment. Recent deals include those of KCB Group’s acquisition of National Bank of Kenya (NBK) and Commercial Bank of Africa’s (CBA) merger with NIC Group. In the non-financial sector, Rubis Plc concluded the acquisition of Kenol Kobil in April 2019, with the merger of Telkom and Airtel currently in the pipeline. Corporate activity in terms of private equity and venture capital saw Kenya record the highest number of deals and volumes totaling to 61 between 2017 and 2018 compared to the East African countries as illustrated in below;

However, Kenya has not fully optimized the potential of its financial markets to boost the growth it envisions. For instance, while the maximum allocation of total Retirement Benefits assets in Kenya as per the RBA Investment Guidelines to private equity is 10%, assets allocated to private equity stood at 0.04% of managed assets in 2018.

New debt issuance – Here, the country’s capital market is dominated by government bonds, where during the financial year FY2018/2019, the Government issued 23 treasury bonds, including two infrastructure bond issuance and two tap sales, raising Sh444.2b. However, the capital markets have not witnessed any corporate bond issuances since 2015 from local companies, although four medium term notes issued by KenGen, HF Group, NIC Group and CIC Insurance Group are expected to mature before the year ends, with the companies opting to redeem the debt holders and not issue any additional debt.

The drought in issuances is attributable to defaults witnessed over the past five-years by issuers such as ARM Cement, Nakumatt, Chase Bank and Imperial Bank that caused losses to holders of the bonds, and notes.

In a bid to spur activity, the CMA approved the first green bond issuance by Acorn, a property developer, to finance sustainable and climate-resilient student accommodation in Kenya. Green bonds are essentially reserved for projects with environmental benefits and help align the investor’s interest with climate policies according to the Paris Agreement and at the same time, support the transition to a sustainable economy. Although the first issuance will be restricted to target investors, we laud the Authority and the NSE for the launch of the Green bond project plan which is a step towards the development of other green investment products such as green Islamic finance which will boost inclusivity

Initial Public Offers (IPOs) and Rights Issues  The Nairobi Stock Exchange currently has 65 listed companies with a market capitalization of $22.3b as at June 2019. Since 2014 to date, Kenya has only recorded two IPOs; the Nairobi Stock Exchange (NSE) and Stanlib Fahari REIT valued at $42m, and six Further Offers (FO) by Diamond Trust Bank, NIC Bank, Uchumi, HF Group, Longhorn, and KenGen raising $0.4b in capital. 

Contrary to the Capital Markets Master Plan, which had a target of at least four listings per year on the Nairobi Stock Exchange, Kenya has failed to attract any IPOs since 2016. South Africa, on the other hand, raised capital worth $5.8b through 33 IPOs between 2014 and 2018, while Nigeria raised $0.6b through 3 IPOs. 

To remedy this, the Nairobi Stock Exchange launched the NSE Ibuka Platform early this year to help Small, Medium and Large Enterprises who wish to list or raise funds on the bourse, build strong structures before listing or access various financing options available in capital markets. According to the program’s weekly report as at August 2 2019, 16 companies were under the Ibuka program, at different stages of the induction, acceleration and incubation processes. During the week, NSE announced that it plans to list at least one firm from the program on the Main Investment Market segment by the end of the first quarter of 2020, which in our view will be an optimistic step towards increasing market activity. 

Product diversity – Kenya’s capital market has increasingly developed new products for investors and issuers over the years as the market grows. Kenya has well-developed equity and debt market, and early this year NSE launched the Derivatives market that facilitates the trading of Equity Indices and Single Stock futures contracts and is set to launch Intraday Trading within the year, which we expect will further deepen Kenya’s financial markets. Other products such as Real Estate Investment Trusts (REITs) are gaining traction, as the past year has witnessed potential issuers engaging with the CMA. The REIT Market Cap to GDP for Kenya compared to other countries shows significant opportunity of REITs, which is currently 0.06% of GDP in Kenya compared to 6.9% in South Africa, indicating room for growth for Real Estate listings in the capital market hence making real estate an investible security. 

South Africa

According to the first report published in 2017 and the subsequent report in 2018, South Africa ranked first in both occasions as the most developed financial market in Africa. 

According to the Africa Financial Markets Index 2018, by Absa Group, while most capital markets in African countries are relatively underdeveloped, those countries which introduced reforms that are geared towards the development of capital markets have been able to grow at relatively higher and sustainable rates. The Africa Financial Markets Index tracks progress on financial market developments of selected African countries annually across a range of indicators. These indicators are: Market depth, access to foreign exchange, tax and regulatory environment, market transparency, capacity of local investors, macroeconomic opportunity and legality and enforceability of standard financial markets master agreements.

A summary of rankings from the ABSA report is highlighted in the table below, where the higher the score, the more developed the capital markets are based on the indicators above:

The South African capital markets consist of: Equities; The Johannesburg Stock Exchange (JSE) is the largest exchange in Africa with over 400 listed firms and a market capitalization of $13.7trillion, which is 236.2% of GDP: Bonds: The South African-listed bond market is estimated to be ZAR 2.7trillion ($186.4billion). It is largely dominated by bonds issued by the National Treasury, which account for 68.4% of the outstanding debt, followed by bonds issued by the financial sector (16.0%) and state-owned entities [parastatals] (11.2%). In terms of turnover, the monthly average amount traded on the JSE is ZAR 2.3trillion ($158.8billion),

Others include derivatives, which  are traded in exchanges under the umbrella of the JSE, and over-the-counter (OTC). Exchange-traded products are standardized and free of counterparty risk. The JSE permits trading in equity, commodity (mainly agricultural), currency, and interest rate derivatives, and; Real Estate,which has the largest and most established REITs market in Africa. The South African listed property sector had a market capitalization of approximately ZAR 380.0billion ($26.2 billion) at the end of 2016, which is 6.4% of GDP.


To get here, South Africa took serious steps towards regulatory reforms as well as the restructuring of the financial system including introduction in the Johannesburg Electronic Trading (JET) system of electronic screen trading, corporate and non-resident participation, and provision for negotiated commissions and principal, versus broking trade by members of the Exchange; removal of exchange controls, leading its foreign exchange market to become more competitive and active. The JSE in 1996 introduced the Johannesburg Electronic Trading (JET) system, which greatly improved the efficiency of the trading platform, which in turn improved market activity and liquidity, and; improved transparency and investor confidence. JSE introduced the real-time Stock Exchange News Service (SENS) in 1997, which required listed companies to disclose any corporate news and price-sensitive information through the service before releasing the information to the media.

Other reforms included the replacement of the Securities Services Act with the Financial Markets Act in 2012, designed to modernize the sector and have supervision up to date with international standards. As a member of the G20, South Africa continually reforms its offerings, such as the Over-the-Counter Derivatives market to be in line with G20 proposals and recommendations from IMF and World Bank, and; a high level of institutional funds as compared to their economic output, with some of these funds being directed into their capital markets. 

South Africa continues to emerge top in Africa in terms of capital markets activity on the back of better supervision and strengthened regulatory frameworks. The Johannesburg Stock Exchange continues to lead in equity and debt market capital activity, over the years recording the highest number in Africa, in terms of value. Despite the slowing economic growth, South Africa continues to instill investor confidence as one of the most popular investment destinations, with the most developed derivatives and bond markets in the region. A lot can be borrowed from South Africa in terms of regulation and supervision in order to make our capital markets accessible to international investors, local institutional investors as well as issuers of equity and debt instruments. 

How to improve and leverage capital markets for economic growth

Innovative financial products and services – In order to drive investor participation in the capital markets, it is imperative that more sophisticated products and value adding services are created such as Shariah compliant products. Capital markets development should also be driven by advancements in technology, accompanied by the necessary regulatory policies and structures to support their growth.

Development of structured products – These products have been a welcome alternative to banks for businesses seeking capital for growth. In developing markets such as Kenya, capital markets remain under developed, hence businesses are forced to source up to 95% of funding from banks, while only 5% from capital markets, compared to developed markets where banks provide only 40% of credit in the economy. As such, real estate development and investment is not being provided with adequate access to this source of capital, which if provided at competitive rates can increase the development of affordable housing.

Improve market access and efficiency – In order to achieve efficiency, there is need for high quality and timely information, which is derived from better disclosures by listed companies. Borrowing from South Africa, we recommend that the NSE develop policies which will require listed firms to disclose corporate news and price sensitive information to the bourse before going to the media,

Tax amendments to level the playing field – Structured Products and non-bank funding need to be given favorable tax treatment as other funding methods, which will provide an incentive to capital providers to invest in capital markets. This is expected to spur development of alternative sources of funding at competitive rates available for business development,

Investors and issuers education– In order to transform the culture of saving and investment, and build trust, it is important that capital markets regulators invest in investor education. The lack of investor education for retail investors is another factor affecting the development of capital markets. It is important to educate retail investors on investment products and the benefits of saving, in order to channel savings to the capital markets,

Shift reliance away from bank Loans – Banks are the primary source of business funding in the country, providing 95% of funding, with other alternative sources such as the capital markets providing a combined 5%, compared to developed markets where banks provide only 40% of the credit in the economy. Several SMEs have a poor understanding of the capital markets and are unaware of ways in which they can use them to raise funds. The first step towards achieving this would be investor education/ awareness campaigns in order to educate SMEs on how they can use the stock exchange better and build their confidence in the financial system of the capital markets,

Reduce minimum amount investable in all REITs – In order to attract capital into capital market vehicles such as Real Estate Investment Trusts for real estate development, the minimum investment amount needs to be amended. The current regulations, which define the minimum subscription amount per investor at Sh5m for a Development REIT (D-REIT) is too high to attract significant interest from investors. An amount of Sh1m ensures the investor is sophisticated while also allowing a larger pool of investors to participate,

Expand tax relief for regular savings towards home purchase – Savings into Collective Investment Schemes regulated by the Capital Markets Authority (CMA) should qualify as HOSP (Home Ownership Savings Plan). Savings in CMA approved products, such as Money Market Funds currently don’t qualify as HOSP. Therefore, savers only have the option of banks, which pay low interest. There is need to expand the meaning of “approved institution” that hold deposits intended for the Home Ownership Savings Plan (HOSP) to include Fund Managers, thus enabling the potential homeowners making savings through the CIS to enjoy the tax relief provided under HOSP, and,

HOSP guidelines only recognize investment guidelines per CBK. If Fund Managers were included, the guidelines would be as per CMA, so that an investor has a choice whether to save through a bank or an investment savings product. To include investment guidelines provided by the CMA regulations, in addition to the prudential guidelines issued by CBK to regulate investment of deposits under a registered HOSP.  

Cytonn Investment

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