Unlocking listing at the Nairobi bourse

Measures undertaken to address the low number of listings have focused mainly on tax exemptions. There are a number of underlying issues that need to be remedied to make the country’s capital market robust


The Nairobi Securities Exchange (NSE) has struggled to attract new listings, having only raised Sh4.2b in two initial public offers (IPO’s) in the last 5-years, with one each in 2014 and 2015 by NSE and Stanlib Investments, respectively.

Currently the bourse has 64 listed stocks with a total market capitalization of Sh2.16tn, of which Safaricom controls 44.0% market share.

The Capital Markets Authority (CMA) has raised concerns that Kenya has been unable to achieve its projected listings targets as articulated in its Capital Markets Master Plan, which envisions at least four listings on the NSE every year. CMA has also noted that a few large cap stocks, namely Safaricom PLC, East African Breweries Ltd, Equity group Holdings and KCB Group Ltd, hold almost 75% of the total market capitalization, making the market volatile due to the dependence on these few stocks.

To remedy the listing drought, the CMA has been engaging stakeholders, who include the National Treasury, NSE, Central Depository and Settlement Corporation (CDSC), and Fund Managers Association (FMA) among others, to come up with value propositions for listing as well propositions to reduce the tight regulations of entry into the bourse.

From the engagements, NSE disclosed their strategy, which seeks to introduce an incubator board designed to accelerate the growth and success of entrepreneurial companies, through an array of business support resources and services to nurture firms that are not ready to list but have promising prospects. This is geared towards helping in developing a pipeline of successful businesses for possible listing on the exchange.

To cover this topic, we shall address: The structure, types of listing, and requirements for listing in the different segments in the NSE; Reasons behind the low number of new listings; A case study of Egypt, and some of the key takeout’s that can be implemented locally, and; Recommendations to unlock new IPO’s in the Kenyan Capital Market.

Why low new listing in the NSE

According to PWC’s, 2017 Africa Capital Markets watch, Africa has recorded 134 IPO’s between 2013 and 2017. In 2017, the continent recorded 28 IPOs raising a total of $2.9b, up from 24 recorded in 2016 raising a total of $1.6b. Out of the 134 IPOs recorded in the last 5-years in Africa, Kenya only managed to attract two, through the NSE IPO in 2014, which raised Sh627.0m by selling 66 million new shares at a price of Sh9.5 per share, and the Income-Real Estate Investment Trust (Reit) IPO in 2015 by Stanlib Investments that grossed Sh3.6b.

IPO activity in the African region has mainly been dominated by the South African Capital Market, having raised $4.8b in the past 5 years through 44 IPO’s representing 52% of the total capital raised through IPO’s in the region.  The Egypt and Tunisia bourses have also been performing well having had 13 and 23 IPOs, raising $1.3b and $391.0m respectively.

To address the issue of low number of listings as well as slow uptake of the capital markets products in Kenya, CMA has been embarking on offering incentives to attract companies with the potential to list to the bourse, which include:

A lower corporate tax of 27% for 3-years, set to commence immediately after company’s financial year following the date of listing for a newly listed Company approved under the Capital Markets Act with at least 20% of its issued share capital listed.

A lower corporate tax of 25% for a period of 5-years, set to commence immediately after the company’s financial year following the date of listing for a newly listed company on any securities exchange approved under the Capital Markets Act with at least 30% of its issued share capital listed.

A lower corporate tax of 20%, for a period of five years commencing immediately after the year of income following the date of listing of a company which has at least 40% of its issued share capital listed.

There were amendments made to reduce listing fees by 50% i.e. from the initial 0.3% to 0.2% for offers of equity.

All the expenditure of a capital nature incurred in the financial year when the listing took place, by a person on legal costs and other incidental expenses relating to the authorization and issue of shares, debentures or similar securities offered for purchase by the public were made tax deductible expenses.

Cost of credit rating was also made tax deductible to encourage credit rating by companies, and,

A tax amnesty on past omitted income for companies that apply and are listed, provided they make a full disclosure and undertake to pay all their future due taxes.

The incentives have, however, not boosted the number of listings. We believe this is because the measures undertaken to address the low number of listings have not taken a bottoms-up approach to identify the real impediment to listing, focusing mainly on tax exemptions whilst there are a number of deep underlying issues that still need to be remedied in order to make the country’s capital market robust. Some of the key issues that we believe should be addressed in order to unlock capital in the capital markets include:

Stringent regulatory framework and disclosure requirements:  Requirements such as the debt ratios, minimum number of shareholders and capital requirements, costs associated with compliance with regulatory as well as corporate governance framework requirements have been a limiting factor for companies to list. Most non-listed companies shy away from listing as compliance to some of these requirements amounts to loss of privacy exposing the company to the public domain, which they perceive as a loss of competitive advantage. There also is a concern in the efficiency of the processes in the capital market due to the stringent regulations and approvals that normally take too long, making listing as well as de-listing a challenging, long and tedious process. For instance, the de listing of Hutchings Biemer and A. Baumann was effected 16-years and 9-years later after the two companies were suspended from trading, respectively

Harmonizing tax incentives between Bank Funding and Capital Market Funding: Currently, other non-bank funding entities and capital markets products such as unit trust funds and private investment do not enjoy similar tax incentives available to banks e.g. the 15% final withholding tax that bank depositors enjoy. These entities are however, essential to the economy in mobilizing savings, which improves efficiency, liquidity and volume of investments in the capital markets and in effect, enhance economic growth and development. The government needs to harmonize tax incentives so that other non-bank funding entities and capital markets products become more attractive to investors,

Costs associated with listing: Issuing of shares in the stock exchange usually involves some direct costs perceived to be high especially for smaller firms because the companies have to pay annual listing fees. Kenya’s economy has dominance of small and medium sized enterprises, which are mainly reliant on bank loans. According to a study by the CMA, the percentage cost of floating securities in the capitals market is relatively lower than bank lending rates. IPO costs, the study says, have ranged from 1.9% to 10.6% from 2012-2016, compared to bank lending rates ranging at 13.0%-16.0%, with the highest being the floatation of Eveready at 10.6% and the lowest being Deacons in 2016 at 1.9%. Compared to bank loans, which are annual costs over the tenure of the relevant loans, the cost of floatation is a one-off. Despite raising capital through the capital markets being cheaper than loans, lack of awareness by companies with the capacity to list has been established as one of the major issue in emerging markets, as companies do not fully understand the benefits accrued to them from floating their shares,

Size of companies: Kenya’s economy has a dominance of small and medium scale enterprises mainly reliant on bank loans and other informal sources of financing. Quoting Chemmanur (2005), “only large old public firms with adequate cash flows and private limited firms that have accumulated a track record of successful performance find it optimal to go public by issuing IPO”. This has made small companies shy away from listing for fear of having failed IPOs. IPOs are described as great indicators that a firm has matured. With this in mind, the low number of listings in our country maybe an indication of a deeper underlying issue that start-up companies in the country are not growing big enough thus the reason the informal sector still dominates the economy,

Market infrastructure:  In November 2004, the automated central clearing settlement and depository system (CDS) was commissioned. This essentially facilitated the electronic trading of shares. In September 2006, there was the introduction of live trading through the automated trading systems (ATS) which matches bids and asks orders automatically as well as execution of the orders on a first come first served basis by the stockbrokers. The bourse has continued to be more diverse, with the latest development in the offing being the licensing to set up a derivatives exchange, which has seen the NSE continue to work with stakeholders to ensure the institutions and infrastructure necessary are in place. However, to attract more capital including foreign investors, there is need to implement liquidity-enhancing mechanisms, such as securities lending and short selling, derivatives like commodity contracts, stock and currency futures. The implementation of this is however reliant on proper infrastructure and platforms for execution. On this front, the NSE has been testing its derivatives trading platform, which is set to go live next year,

Loss of control: Many firms especially family owned or closely held companies are reluctant to list due to fears of dilution of ownership and lose of voting control. The companies tend to rely on bank finance as well as a proven network of family and friends to raise additional capital when required. Companies also avoid listing due to constant pressure to increase earnings that come with it as public shareholders unlike the original owners, usually take a short-term view mainly interested in seeing constant rises in the stock’s price so they can sell their shares for a profit and less emphasis on the values and core ideologies of the company. To remedy this, we believe that the NSE and the government, through amendments to the Company Act, should come up with alternative policies to address the concerns of loss of control by major investors for example by allowing companies to have a shareholders structure that ensures the initial owners do not lose control. As in the case of Facebook, which has a dual class stock structure consisting of Class A and Class B shares. Facebook’s founder Mark Zuckerberg and a small group of insiders have about 18% of the shares. Despite this, Zuckerberg and the small group of insiders owns the majority voting rights. This is because, as per their shareholding structure, they hold a class of shares of the company, which carry 10 votes per share as compared to what is held by the public shareholders, that carry only one vote per share,

Shallow market: A shallow market is one with few instruments and relatively low liquidity, leaving firms with minimal financing options. The strength of securities markets that make them essential in an economy is the ability to mobilize long term savings for financing long term ventures, to improve efficiency of resource allocation through competitive pricing mechanisms, to provide capital, and encourage broader ownership of firms. A robust stock market assists in the rational and efficient allocation of capital. The NSE is characterized by intermittent trading of relatively few stocks, often held by a relatively small group of investors making it inefficient. The NSE also lags behind in the number of listed stocks as compared to countries such as South Africa with a total of 165 listed companies. To enhance the level of activity, improve liquidity and attract more capital in the bourse, foreign ownership limits were lifted effective July 2015 allowing foreigners to hold over 75% of the listed companies in the NSE. Despite this, the market still lags behind being heavily reliant on a few stocks thus limiting liquidity in the market and in effect discouraging listing as companies with the potential to list shy away for fear of having failed IPOs,

The rise of Private Equity firms providing easily accessible capital: Kenya’s private equity space has been vibrant. Raising capital through private equity firms has been on the rise, filling much of the void left by the drought in IPOs. The attractiveness of private equity funding as opposed to public listing is mainly because private equity funding gives companies the opportunity to continue financing their growth while remaining privately held which allows companies to preserve decision-making control which that usually lost when companies list, and,

False Market Perception that Capital Markets Should Play a Second Fiddle to Banking Industry: In developed economies, capital markets funding is larger than bank funding, at 60% compared to banks, which only provide 40% of the funding in the market. Whereas in Kenya it is the opposite with the capital markets providing 5% of the funding in the market and banks providing 95%. Beyond the numbers, there is somehow acceptance that banks control the economic agenda, rather than them being equal to capital markets. For example, we had a case of an innovative product, Cash Management Solutions, CMS, which was phased out of the market, just because banks did not like it. In more developed markets, the capital markets industry and the regulator would have pushed back on the banking industry. Capital markets ought to view itself just as important as the banking industry.

How to remedy the low number of listings:

The following should be done to facilitate growth in the number of new listings as well as development of products in the NSE:

Privatize of some of the state corporations through listing: Over the years, the NSE has played an increasingly important role in the Kenyan economy, especially in the privatization of state-owned enterprises. The privatization process started in 1988 when the government floated 7.5m shares equivalent to 20% equity of the Kenya Commercial Bank (KCB) that was over- subscribed by 2.3-times. Since then the government has had subsequent issues, which have also been popular, recording subscription rates of as high as 400%. A study by CMA shows that successful IPOs by State Owned Enterprises have generated significant interest in the market, attracting a good number of private companies to list immediately after. KCB’s 327% over-subscription in 1988 immediately attracted the listing of Total Oil Company, Standard Chartered Bank and Nation Printers. The 303% oversubscription of Housing Finance Corporation of Kenya in 1992 also attracted new companies like Crown Berger, East African oxygen (BOC), NIC, Firestone, Rea Vipingo and East African Portland Cement to the stock market. Government should embark on privatization of some of the state corporations through listing in a bid to bolster investment in order to revive the economy. Privatization would also lead to additional revenue, which would also effectively reduce the fiscal deficit as well as reduce a portion of the recurrent expenditure in running them. This strategy has been replicated in various economies such as Brazil, which earmarked 57 companies in 2017 to be privatized as well as Egypt, which named 23 companies in March 2018 that the government is planning to privatize through listing. Privatization also has a positive impact on the financial performance of poorly managed state companies that are usually insulated from the same discipline requirements as private companies.

Harmonizing tax incentives: Tax incentives available to banks should also be made available to non-bank funding entities and capital markets products such as unit trust funds and private investment funds. For example, providing alternative and capital markets funding organizations with the same withholding tax incentives that banking deposits enjoy, of a 15% final withholding tax so that investors don’t feel that they have to go to a bank to enjoy the 15% tax. Alternatively, normalize the tax on interest for all players at 30% to level the playing field,

Review of rules and regulations: The CMA should continuously review, identify and amend restrictive provisions in the capital markets and related laws that are unattractive to capital raising and listing to ensure the rules in place facilitate rather than deter active participation in the markets. This includes rules such as the restrictive regulation inhibiting participation of investors. For example, the minimum amount an investor can put in a DREIT at Sh5m, which is prohibitive.

Engaging with private equity firms to consider exiting through the capital markets: The size of the private equity market space in Africa and more so in Kenya, largely involved in financing businesses showing great potential in the market has grown significantly in the recent past. The Capital market Authority ought to engage with private equity firms to consider exit mechanisms through the capital markets to take advantage of the vibrancy in the PE space to compliment the capital markets activities. For this to happen however, the issue of the shallow market in the NSE needs to be addressed in order to make exiting through IPO’s feasible.

Awareness programs aimed at enhancing literacy on capital markets: One of the major impediments to the number of listings as well as uptake in the products listed in the NSE remains to be the level of awareness and knowledge by the companies with listing potential as well as the local investors who are important in driving IPOs. In order to rectify this, the CMA as well as other market stakeholders should embark on a comprehensive awareness programme targeted at enhancing literacy on the capital markets and the various opportunity accrued to its participants.

In conclusion, regulators should focus on making the process of listing appealing to companies while still maintaining investor protection and not sacrificing minimum requirements for disclosure. They should also sensitize companies on the importance of listing as well as focus on liquidity-enhancing mechanisms, such as securities lending and short selling, derivatives like commodity contracts, stock and currency futures to deepen the capital markets and provide a range of options to investors. The government should also stimulate the Capital markets through the privatization of state- owned enterprises through the NSE.