Commentary (by Nation Editorial team) - Reform capital markets before it is too late

Ref: http://www.nationmedia.com/dailynation/nmgcontententry.asp?category_id=24&newsid=118594

Publication Date: 3/9/2008

Crowds of small investors were lining up in downtown Nairobi this week, which is not an unusual sight in a country where investment — in shares, pyramid schemes, plots and all manner of other things — is all the rage. But this time they were not bringing their their hard-earned savings, they were there to salvage their money — and business — from a stock brokerage that had gone bust.

Ordinary Kenyans cannot understand how a brokerage could go bankrupt. It is a commission-based business: You order shares, the broker buys them for you and gets his cut whether you made a wise investment decision or not. So long as there are customers, and Nyaga Stock Brokers has them in the thousands, they should be making money hand over fist, shouldn’t they?

In last Thursday’s Business Daily, a publication of the Nation Media Group, was very sobering reading for the investing public. It suggested that unauthorised trading — trading in client’s shares without their consent — as well as other forms of fiddling with transactions may have been rife at the bourse and could account for the financial problems facing brokers.

The actions taken by the Nairobi Stock Exchange and the inaction by the Capital Markets Authority, especially with regard to the financial stability of brokerages, suggests that the overriding concern of NSE and CMA is to secure the reputation of the capital markets and the confidence of the investing public — possibly at whatever cost.

This would explain why the CMA took no strong measures despite knowing that the brokerage had been in financial trouble for close to a year, according to press reports.

It would also explain why the NSE made available Sh100 million to the broker in an apparent effort to keep a lid on an embarrassing issue as probably other efforts were made to get Nyaga to put its house in order.

These efforts to give the capital markets a stable and reputable face are laudable and desirable. But they are not enough. Every investor in this country by now knows that there has been some fiddling with transactions at the NSE.

Clearly, the crooks will not be swept under the carpet.

The fact of the matter is that the capital market in Kenya has come of age; nearly a million Kenyans have share accounts at the NSE. But the capital market is trying to grow within the constraints of the old structures: a largely ineffectual regulator and a market in the grip of a tight circle of 18 brokers.

The brokers own the NSE, and they are not known for their enthusiasm to invite new entrants into the market. CMA itself is extremely slow to register new brokers, even though it is quite clear that the expansion of the market requires new institutions and more competition.

What does it say about the capital market when it is reported in the press that corporate governance is so wanting that few, if any, of the brokers have filed their quarterly financial reports with the CMA?

In the absence of this, and given the collapse of a firm controlling a quarter of the share accounts, how is the investing public to know whom to trust with their investment?

The investment sector is too big to be managed like a club, where every transaction becomes a deal between buddies. That may have been the case in 1975; today it is no longer so.

If the stakeholders want their business to grow and if the regulatory authorities want to cement the public’s confidence in the capital market and secure its growth, then the sector is due for comprehensive and total reform.

The NSE should be a publicly traded company in which outsiders are allowed to own substantial stakes. There should be greater competition with more brokers registered and admitted to the trading floor. The trading rules should be reviewed to ensure that brokers do not trade in their client’s shares without their consent. Stronger regulation to stamp out fiddling with such things as across-the- book deals is also urgently needed, as is serious thought on allowing brokers to trade on their own account.

Finally, the capital market in Kenya should learn the value of full disclosure in creating confidence and protecting reputations. You can not create stability by hiding information.

Quite obviously many brokerages are honest and in good financial health and will help Kenyans make their money work for them. The few who are not should be exposed and disciplined.