AN ADDRESS BY EDWARD ODUNDO, CHIEF EXECUTIVE, RETIREMENT BENEFITS AUTHORITY, KENYA, TO THE 3RD PUBLIC PENSION FUND MANAGEMENT CONFERENCE WORLD BANK, WASHINGTON, D.C., SEP 2004 OVERVIEW AND EVOLUTION OF INVESTMENT INSTRUMENTS IN SUB-SAHARAN AFRICA WITH SPECIAL REFENCE TO KENYA Mr. Chairman Distinguished Guest Ladies and Gentlemen It gives me great honour and pleasure to address this third conference on Public Pension Fund Management. Mr. Chairman, I note that this gathering has attracted a wide and distinguished representation of pension administrators and key resource persons from the world’s financial industry. I would therefore like to thank the organizers for giving me this opportunity to speak on the overview and evolution of investment instruments in Sub-Saharan Africa. I propose to do so with a special reference to my country Kenya. A typical financial market comprises of several institutions including banks, insurance companies, mutual funds, mortgage firms, finance companies and stock markets. The development of domestic financial markets provides opportunity for greater funds mobilization, improved efficiency in resource allocation and provision of relevant signals for investment appraisal. Cognizance to this fact, a number of African countries are making conscious efforts to develop these markets. While writing about the development of Stock markets in sub-Saharan Africa in 1997, Emenuga noted that in sub-Saharan Africa banks have historically dominated long term financial intermediation. In recent years, however, a more holistic approach has gradually shifted emphasis away from development of banks to the development of security markets and other financial instruments. The strength of securities markets that make them focal points of emphasis in sub-Saharan Africa are their ability to mobilize long term savings for financing long term ventures, to provide risk capital, encourage broader ownership of firms and improve efficiency of resource allocation through competitive pricing mechanism. This new emphasis is, however, of recent origin. Compared to developed ones, African markets have fewer market participants, and less sophisticated and less skilled investment analysts. The earliest Security Markets to be established in sub-Saharan Africa include the South Africa’s JSE in 1887, Egypt’s Cairo-Alexandria in 1888 and 1903, Zimbabwe Stock Exchange in 1946 and Kenya’s Nairobi Stock Exchange in 1954. The number of these markets is still on the increase with new markets being established in East and central Africa. These markets include that of Malawi in 1994, Tanzania in 1995 and Uganda in 1997 among others. Some of the biggest markets by market capitalization include JSE, Cairo Alexandria and Nigeria stock exchange. The Nairobi Stock Exchange (NSE) is a fairly average security market with a capitalization of about US$ 4 billion at the end of 2003. It is instructive to note that the capitalization of JSE is way above that of the other security markets in Africa combined. This serves to expose the emerging nature of most of these markets. A key ingredient toward enhancing their capacity and therefore their efficiency has been identified as integration, automation, innovation and openness to international investors via the internet. Turning to the Kenyan scenario, the Kenyan financial sector is manifest in a bank sector of US$ 6.4 billion (Dec 2003) an equity market with a capitalization of US$ 4 billion (Dec 2003) and a bonds market with an outstanding value of US$ 2.4 billion (Dec 2003). The key (traditional) instruments remain equity securities and debt securities. The market is however now looking forward to the introduction of other instruments like mutual funds, real estate investment trusts, asset backed securities among others. Kenya is also in the processes of embracing the Over The Counter (OTC) market as a halfway home toward listing for firms. This is especially important given that the market has recently witnessed stagnation in activity with regard to new listings. The evolution of the traditional investment instrument in Kenya is a short one by international standards. The growth has however been tremendous. Dealing in shares and stocks started in the 1920's when the country was still a British colony. In 1951, Francis Drummond, an estate agent established the first professional stock broking firm. He also approached the then Kenyan Finance Minister, Sir Ernest Vasey and impressed upon him the idea of setting up a stock exchange in East Africa. Further consultation thereafter resulted in the constitution of the Nairobi Stock Exchange as a voluntary association of stockbrokers registered under the Societies Act. The business of dealing in shares was then confined to the resident European community. In 1984 a study by IFC and the Central Bank of Kenya on the "Development of Money and Capital Markets in Kenya" was adopted as a blueprint for structural reforms in the financial markets culminating in the formation of a regulatory body; the Capital Markets Authority (CMA), in 1989, to assist in the creation of a conducive environment for the growth and development of the country's investment markets in Kenya. While the Nairobi Stock Exchange is still classified as emerging in terms of size, efficiency and market level of complexity, coupled with market integration to the economy, it indeed witnessed incredible growth following the legislation to bring in the regulator CMA. NSE was registered under the Companies Act in 1991, the same year it phased out the "Call Over" trading system in favour of the floor based Open Outcry System which is still in place today. Four years later in 1995 the Kenyan Government relaxed restrictions on foreign ownership in locally controlled companies subject to an aggregate limit of 20% and an individual limit of 2.5%. These were doubled to 40% and 5% respectively in 1995 to help encourage foreign portfolio investments and further relaxed in 2002 to provide for a 25% minimum reserve of the issued share capital for locals while the balance of the 75% becomes a free float for all classes of investors. The impending automation is therefore expected to unlock the investment potential provided by this window to the international community. The environment of Kenyan investment opportunities has evolved too. From a regime bent of restrictive legislation, today the financial sector showcases a number of incentives for investments, including; free repatriation of capital and returns, sufficient brokerage and investment banking services, up to date market information, a good financial infrastructure, absence of capital gains tax, and a government committed to market reforms. The sector also allows tax concession of 5.0% for newly listed companies for 5 years after listing, provided the firm lists a minimum of 30% of its fully issued and authorized share capital on the NSE. At the same time Employee share ownership plans (ESOPS) enjoy tax concessions on income. Essentially ESOPS enjoy the same treatment as Collective Investment Schemes, if they are registered as such with the Capital Markets Authority. The market also provides a number of incentives for investors with withholding tax on dividends for Kenyan residents at 5% and 7.5% for foreigners compared to 15% on interest received from deposits, government debt securities or corporate debt securities. New and expanded share capital by listed companies or those seeking listing is exempt from stamp duty as are transfers of assets to a special purpose vehicle for the purposes of issuing asset backed securities. Further, expenses incurred by companies in having their financial instruments rated by an independent rating agency are tax deductible and there is a 10-year tax holiday for registered and approved venture capital funds. The reform of the 1990s heralded an era during which the NSE would experience substantial growth in annual turnover, market capitalization and price index. This is not withstanding, the fact that the levels of these performance indicators still remained low when compared internationally. In 1990, the turnover was US$ 3 million. This rose to a level of US$ 39.4 million in 1994 registering a whooping 1239% increase on the 1990 level, it further increased to high of US$ 78.8 million in 1997. This however was followed by a decline of 26% in 1998 and by a further marginal increase of 12% in 1999. Last year the market however established an all time high of US$ 194.8 million. Similarly, market capitalization registered a significant increase since 1990 when it stood at US $ 139.7 million rising to US$ 1.7 billion by 1994. It however fell in the subsequent years to stand at US$ 1.29 billion in 2000 but rose again to US$ 4 billion at the end of 2003. The Nairobi stock exchange 20-share price index, which is regarded as the leading stock market performance indicator, rose by a significant 175% between 1990 and 1993. This trend continued into 1994 with the index reaching a peak high of 5137.08 in February. The index has however dropped significantly after 1994 to close at 2303 in 1999, only to rise to 2737.59 at the end of 2003. It is note worthy that in 1994 the NSE was indeed rated by the International Finance Corporation as the best performing emerging market in the world with a return of 179% in dollar terms. The market has also been used by the Kenyan government in its programme of privatization of state corporations while at the same time a number of companies have been able to raise capital through it. On the other hand, in the debt market, the Kenyan government total public debt stood at US$ 9.12 billion or 70% of the GDP at the end of 2003. Of this, US$ 4 billions which is 29% of the GDP and 42% of the total public debt is financed from the domestic financial markets. The key instruments for domestic borrowing by the government have been treasury bonds and treasury bills. Recently there has been a deliberate shift of emphasis from short term borrowing in form of bills to medium and long term borrowing in bonds. The upsurge in the bonds market is a very recent phenomenon given that the government listed its first bond in the market in 1996. This has by and large been made possible by the reforms within the pensions industry. As a result, the treasury bills rates are currently very low falling below 2% for much of 2004. This contrasts with 11% at the beginning of 2002 and above 80% at some point in the early 1990s. It would then follow that the Kenyan debt market has over the years been dominated by government securities with the first corporate bond being issued in 1996. Perhaps this could be explained by the crowding out effect occasioned by excess public borrowing. At the end of 2003 the outstanding value of bond was US$ 2.3 billion and US$ 98 million for government bonds and corporate bonds respectively this was an increase from respective values of US$ 105 million and US$ 10.5 million recorded in 1996. Currently there are only four companies that have bond listed on the market. Its is instructive that the trend in the growth of the professionally managed pension assets has had an impact on the growth of outstanding bond holding by pension schemes and indeed the outstanding value of long-term debt securities in Kenya, especially with regard to the public sector. Between 2001 and 2003, professionally managed assets within the pension industry rose from US$ 572million to US$ 1.1 billion. At the same time government security holding by professionally managed pension funds rose from US$ 285 million to US$ 505 million while the government bonds stock rose from US$ 1.2 billion to US$ 2.4 billion. With regard to the future outlook, there is a deliberate effort to enhance the diversity of investment instrument in Kenya. This is informed by theory and experiences else where. Accordingly, emphasis is now being placed in a number of new developments within the financial sector fraternity which include but are not limited to the following. To begin with, the Capital Market Authority gazetted regulations for collective investment vehicles in 2001. Initially the rules were perceived to be too stringent for an upcoming market. This not withstanding, the market is slowly accepting the concept of a mutual funds and unit trusts. Currently there are three operational mutual funds within the meaning of the Capital Markets Authority. There is also an additional company listed in the market that operates as a mutual fund. This new way of investing is evolving very fast. Indeed there are ongoing consultations to ensure that an enabling environment is enhanced for collective investment vehicles to thrive. Secondly, the Nairobi Stock exchange has hitherto remained as one of the oldest stock market in Africa that is yet to automate. Its is however currently implementing an automation exercise intend to creare a robust clearing and settlement environment. The technology path in line with the overall market automation strategy is manifest in four sub projects, namely; central depository system – CDS, Automated trading system – ATS, broker back and front office system – BFO, and real time information dissemination. Thirdly, as an answer to the problem of over concentration in property concerns by investors in Kenya, coupled with the need to develop the property market, the financial market is now embracing the concept of asset backed securities and that of Real Estate Investment Trusts. The use of Special Purpose Vehicle (SPV) has therefore now been allowed some tax concessions to enhance its employment as a securitization tool. Fourthly, the concept of OTC markets has been used the world over as a half way home for private companies that propose to go public. In Kenya this market is now evolving as one that will provide an arrangement for transferring shares that are not listed on the stock exchange. The key ingredient will be liquidity and as a result better price discovery. While it is desirable to have shares traded on a formal stock exchange for the most effective pricing mechanism to be effected, an OTC market will act as the next best alternative by ensuring transferability. The incubation effect is expected to impact on corporate governance principles, improve share ownership value, inculcate a culture of commercialism and eventually result in listing on the main market. Fifthly, the nation state is increasingly being discredited as an economic unit. The Kenyan financial sector does not wish to be left behind in acknowledging this fact. It is in this vein that the governments of the Eastern African region are pursuing regional integration with a view to coming up with a centralized regional market. The idea is to increase the pool of investment instrument and the pool of investors both in complexity, size and in numbers. To Kenya an amalgamation of theses markets will result in an instant increase in the number of listed companies and bonds by 17.3 % and 25.0% respectively to 61 listed companies and 85 bonds. Lastly, there has been intense duplication and overlap of regulation in Kenya leading to heavy costs of compliance and increased opportunities for regulatory arbitrage. In bid to mitigate this stakeholders are looking at ways of inculcating the required harmony. Kenya is therefore debating about whether to integrate totally at once, or whether to initially pursue a half way home in the name of a coordinating body for all the regulatory. In conclusion, given the diverse nature of the representations here I would like to emphasize the importance of foreign capital inflow to Kenya and to Africa in general. It would be very discouraging for the African countries to create the necessary environment and still fail to attract interest from the industrialized countries, whether in terms of investment funds, technology transfer, or knowledge and skills transfer. What Africa is actually looking for is a regular flow of investment from our partners. Thank you.
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