Kenya’s stock exchange has played a vital role in the expansion of the nation’s economy for six decades. In terms of market capitalisation, it is the leading bourse in the East African region. As well as being a founding member of the African Securities Exchanges Association and the East African Securities Exchanges Association (EASEA), the bourse was promoted from affiliate to full member of the World Federation of Exchanges (WFE) in February 2018. This came after a number of important developments in 2017, most notably the launch of the first exchange-traded fund (ETF) and the introduction of short selling.
More generally, the market entered 2018 on the back of strong performance the previous year, in which the main index followed a broadly positive trajectory that continued into the first quarter. Though the markets saw some fluctuation over the following months, continuing legislative support and positive sector developments suggest a resilience going forward.
History
The Nairobi Stock Exchange was formed in 1954 as a voluntary association of stockbrokers, and was given the responsibility of developing and regulating the nascent securities market. By 1968 it had become a regional market for East Africa, with nearly half of the 66 public sector companies belonging to the Kenyan government, and 23% and 11% owned by the Tanzanian and Ugandan governments, respectively. In the 1970s changing circumstances resulted in the delisting of these foreign components, a process which was completed with the collapse of the EAC in 1975.
In 1990 a new phase of growth for the exchange began with the inauguration of the Capital Markets Authority (CMA), which was charged with the development of an orderly and efficient capital market in the country — a mandate which it retains to this day. The following year saw the unveiling of a formal trading floor, which used the pit-trading system and was based at the IPS Building on Nairobi’s Kimathi Street. In 1994 the exchange moved to new premises at the Nation Centre, and introduced a computerised delivery and settlement system. The following years saw a number of institutional advances, such as the establishment of an Investor Compensation Fund, as well as several significant flotations, one of the most notable being the 1996 privatisation of Kenya Airways.
In 2001 the exchange underwent a further reform which divided the market into three segments: the main board, an alternative market and a fixed-income segment. Three years later the central depository system was commissioned, allowing for the automation of clearing and settlement functions. Equities transactions and all listed government bonds were transferred to an automated trading system in 2004 and 2009, respectively. In 2011 the exchange was rebranded as the Nairobi Securities Exchange (NSE), a move which signalled intentions to develop into a full-service securities arena, offering equities, debt, derivatives and other advanced instruments. In 2014 the NSE demutualised, listing on the exchange’s main board, as a part of this development strategy.
Joining the WFE in 2018, following a rigorous evaluation process and on-site inspection the previous year, has brought a number of practical benefits, such as an ability to participate in global debates on policy and regulatory matters, and access to research covering exchange instruments and processes.
Given the profitable foundation it has built, the exchange remains a vital platform in East Africa. Paul Murithi Muthaura, Chief Executive of the CMA, told OBG, “Not only is Kenya in a prime position to serve as a competitive destination for investment by domestic and international players, it also seeks to help entities leverage the increasing diversity of capital-raising products available in the local market to catalyse their own business growth in the region.”
Diverse Field
As of September 2018 there were 65 companies listed on the NSE, the vast majority of them within the Main Investment Market Segment, the nation’s principal quotation market. The country’s diverse and rapidly developing economy is reflected in the variety of listed firms, which are divided into 13 classifications for indexing purposes: agriculture, automobiles and accessories, banking, commerce, construction and allied, energy and petroleum, insurance, investment, investment services, manufacturing and allied, telecommunications and technology, real estate investment trusts (REITs) and exchange-traded funds. A much smaller number of listed companies are categorised as members of the Alternative Investment Market Segment, which is designed to assist medium-sized companies that require access to capital and a public platform to continue growth. The capital requirements, reporting demands and listing fees for this segment are less onerous than those applied to companies on the main market. Since 2013 the NSE has also operated a Growth and Enterprise Market Segment for small and medium-sized enterprises (SMEs), with no minimum asset requirement. By 2016 the enterprise market had attracted five listings, ranging from a Kenyan shoe vendor to a sharia-compliant investment firm.
On the debt side, the Fixed-Income Securities Market Segment comprises government- and quasi-government listings with maturities of between five and 30 years. Given the importance of the debt market for firms requiring finance for projects, expansions and working capital, its advancement is widely viewed as central to the country’s economic growth.
Debt Developments
Over recent years the authorities have worked hard to liberalise a bureaucratic and relatively illiquid government bond market. Until 2015 state bond purchases were largely the reserve of institutional investors such as commercial banks, with retail investors accounting for about 2% of the annual total. This was due in part to prohibitive aspects of the process, such as requirements to apply for a central depository system account, submit physical forms at the central bank and use a broker. Moreover, the minimum subscription was KSh50,000 ($489) — beyond the reach of many individual investors.
In April 2017 a large step forward in improving this was taken, when the Treasury launched M-Akiba, an investment framework that uses mobile phone technology to increase access to the debt market, allowing millions of citizens to forego the application process and purchase bonds instantly via a number of network operators. To incentivise participation, the minimum subscription level was reduced to just KSh3000 ($29.39), which was welcomed as an advance in the area of financial inclusion. Importantly, M-Akiba is expected to enhance the saving culture of citizens over the long term. In 2017 gross savings stood at approximately 10% of GDP, compared to 20% and 13% in Uganda and Rwanda, respectively.
A further development that may affect the public bond market is increased participation by local political entities. “Government debt in hands of the banks is a situation that appears to be persistent, but a slight shift might be under way,” Sam Omukoko, group managing director at Metropol, told OBG. “Counties, empowered to borrow independently for infrastructure projects, might change the overall public debt profile,” he said.
An additional change came in November 2017, when the NSE signed a memorandum of understanding with Nasdaq Dubai aimed at facilitating the creation of a sukuk (Islamic bond) market in Kenya. Speaking at the time, Geoffrey Odundo, CEO of the NSE, outlined the exchange’s ambition with regard to the Islamic bonds, stating hopes that it would promote issuance and attract local and international investors, while providing funding for national development and strengthening relationships with foreign nations.
Money Measures
Just as the NSE has grown in depth and complexity over recent decades, so have the tools by which investors are able to view it. The oldest of the market indices is the NSE 20, established in 1964 to measure the performance of 20 blue-chip companies, such as Barclays of Kenya and Safaricom. Its focus on companies with strong fundamentals makes it popular with investors, but as a price-weighted index, it is heavily biased towards higher-priced equities. The NSE 20’s selection criteria, which take into account price as well as factors such as turnover, has also resulted in a bias towards banking and manufacturing.
Since 2008 investors have also had recourse to the NSE All Share Index (NASI), which is formulated according to market capitalisation and consists of all stocks listed on the NSE. The NSE 25 Index, meanwhile, was launched in 2015 to provide opportunities for the development of structured products. The market capitalisation-focused measure tracks 25 securities with a minimum market cap of KSh1bn ($9.8m).
Investors willing to pay higher annual subscription fees are also able to refer to two third-party tracking tools: the FTSE Kenya 15 and the FTSE Kenya 25, market capitalisation-weighted indices launched in 2011 by the NSE in conjunction with the FTSE Group. Third-party providers have stepped in to fill what was a long-standing gap in coverage of the market. The FTSE NSE Kenyan Shilling Government Bond Index and the Standard & Poor’s Kenya Sovereign Bond Index are independently calculated benchmark indices which have made it possible for investors to obtain a useful overview of the yield curve for government debt.
Performance Snapshot
After a muted performance in 2015 and 2016, the NSE staged a sustained recovery in the first six months of 2017. The NSE 20 Index stayed almost level, sitting at 3607 in June of that year, compared to 3640 in the first half of 2016. The NASI, meanwhile, showed a 9% gain, reaching 152.92 at the end of the first half of 2017.
The exchange demonstrated its usefulness as a capital-raising platform, with total market capitalisation growing by 10% year-on-year (y-o-y) in the first six months of 2017, to reach KSh2.2trn ($21.6bn). Market activity also remained vibrant, with the number of shares traded rising by 38% y-o-y to 3.8bn in June 2017, compared to 2.7bn during the same period in 2016. Much of the bullish performance was attributed to lower yields on government debt, which encouraged investors to channel funds towards equities, and attractive valuations in the banking sector due to the anticipated capping of interest rates.
In the second half of 2017 the performance of the NSE was under particular scrutiny due to the general election scheduled for August, as political changes have led to social turbulence and rising tensions in the past. The 2017 ballot was further complicated when the results were annulled by the Supreme Court and new elections called for in October. However, market disruption was minimal, with the NASI and NSE 20 indices falling by 4.3% and 6.4%, respectively, over a two-day period, before returning to positive trends. From the 152.92 posted in the first half of 2017, the NASI continued its upward trajectory to reach 171.20 by the end of the year. During the same period, the NSE 20 Index rose to 3711 points.
While the market experienced a rally in the first quarter of 2018, driven by a bull run in March, it declined steadily over the following months. In September 2018 regional media reported investor losses of KSh568bn ($5.6bn) in paper wealth over the previous five months. By that time, market capitalisation had eased to KSh2.3trn ($22.5bn), down from an all-time high of KSh2.9trn ($28.4bn) on April 5, 2018, marking a decline of 19.6% over this period. Meanwhile, the NASI fell from 179.5 points to 157.5 and the NSE 20 declined from 3735 to 2962. Stakeholders have stated that the fall was driven by poor corporate performance that resulted in losses as well as foreign investors exiting market.
Regulation
While the performance of the NSE is linked to the wider economic growth, the actions of the authorities play an important role in attracting liquidity to the market. Since July 2016 the NSE has operated as a self regulatory organisation (SRO), which establishes the exchange as the front-line regulator of market activity. As with other markets which have adopted the SRO model, this means that the exchange authorities are able to set higher standards for members than those required by legislation where they deem necessary, as well as address complex areas of regulation with the aid of industry professionals who are close to the market. The NSE is currently implementing its Strategic Agenda 2016-19, comprising three areas of focus: revenue boosting through product development and new technologies; brand enhancement through global best practices, roadshows and striking new partnerships; and organisational strengthening, with a focus on creating a deeper talent pool within the NSE.
Despite the exchange’s ability to develop the regulatory structure upon which Kenya’s capital market rests, ultimate control over regulatory issues lies with the CMA, an independent public agency under the Ministry of Finance. The authority has the primary responsibility of supervising, licensing and monitoring the activities of the NSE, the Central Depository and Settlement Corporation, and all other entities licensed under the Capital Markets Act. In April 2017 the Cabinet approved the draft Financial Services Authority (FSA) Bill 2016, legislation which will merge the functions of four regulatory bodies: the CMA, the Insurance Regulatory Authority, the Retirement Benefits Authority and the SACCOS Societies Regulatory Authority. However, in May 2018 the Financial Markets Conduct Bill was developed, replacing the FSA Bill. The new bill will allow the Financial Markets Conduct Authority to regulate and supervise financial services and products for its retail customers, with the potential to protect people making financial investments or managing financial risk. The merging of regulatory functions is intended to eliminate supervisory overlaps and opportunities for arbitrage, thereby reducing systemic risk and increasing protection for consumers. Regulatory convergence of this kind has become a more salient trend in markets since the global credit crisis of 2008, replacing the earlier trend of multilateral rule convergence by which separate regulatory entities sought to harmonise their rules with their counterparts in other industries.
New Products
Working together, the NSE regulators and the CMA have overseen several important developments in recent years. In October 2015 the NSE became the third on the continent to introduce real estate investment trusts, a collective investment vehicle that allows the pooling of capital into property portfolios. The first REIT to launch on the market was the STANLIB Fahari I-REIT, which was offered to both retail and institutional investors with a minimum subscription of KSh20,000 ($195), or 1000 units. As well as bringing fresh liquidity to the exchange, the instrument offers investors a new asset class and an attractive route to diversified portfolios and stable cash inflows.
In March 2017 Barclays Bank launched its NewGold ETF on the NSE. The instrument is the largest gold ETF in Africa, and a cross listing of the $1.4bn fund of the same name that first listed on the Johannesburg Stock Exchange in 2004. It is now the seventh-largest gold ETF in the world, and allows investors to purchase individual securities equivalent to approximately 0.001 oz of the precious metal, which are held in a secure depository on their behalf (see analysis).
The NSE’s most recent liquidity-boosting measure came in January 2018, when it implemented the Capital Markets (Securities Lending, Borrowing and Short Selling) Regulations 2017. The introduction of short selling, a fundamental capability, by which investors sell borrowed shares with the intention of later repurchasing them at a lower price, provides a much-needed hedging tool for market participants.
Regional Cooperation
All of these advances have taken place against a backdrop of regional cooperation which is adding further impetus to the NSE’s development efforts. Under the aegis of the EASEA, the exchange authorities from Tanzania, Rwanda, Kenya and Uganda have joined forces to develop several long-term initiatives aimed at boosting the capacity of their markets. A meeting of EASEA members in August 2016 resulted in the publication of four objectives which will inform its implementation of a five-year strategic plan, the principal goals of which are to increase the array of products in each market, build the capacity of market intermediaries, provide continuous public education and awareness campaigns, and to integrate market infrastructure, such as trading platforms and depository operations. The longer-term ambition of the member nations is to implement the EAC Common Market Protocol, which provides for free movement of capital throughout the region.
While this objective remains in place, the NSE and Kenyan authorities have adopted a cautious approach to some aspects of its implementation. For example, Kenya will not be a participant in the Capital Market Infrastructure Project (CMIP), due to be fully rolled out in 2018. The initiative is centred on the Smart Order Routing System, an IT platform which links the clearing and settlements systems for securities trading among EAC member states, allowing trade in shares using a single broker and reducing the time it takes to trade in cross-listed shares from more than 30 days to three. Kenya’s concerns included the quality of the software, and its compatibility with the NSE’s clearing and settlement system. Whether or not Kenya joins Burundi, Rwanda, Tanzania and Uganda in the CMIP system remains to be seen, but the wider question of regional market integration is a salient factor going forward.
Outlook
While the end of 2017 and into 2018 saw some fluctuation in NSE performance, over the long term a positive trend in the overall economy will likely result in increased investment. In April 2018 the IMF estimated that the Kenyan economy, after a 4.8% expansion in 2017, would grow by 5.5% over 2018. The Ministry of Finance, for its part, anticipates 5.8% growth, though it cautions that pressure to reduce fiscal debt may result in the slower rollout of large infrastructure developments (see Economy chapter).
At the same time, continuing regulatory support and a project pipeline that includes the continued launch of financial derivatives for equities, bonds and currencies, as well as the expansion of commodity derivatives, ensure the market will remain a driver in the region.
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