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CAPITAL MARKETS AUTHORITY

Capital Markets Authority

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Page 1: Capital Markets Authority

CAPITAL MARKETS AUTHORITY

Page 2: Capital Markets Authority

INTRODUCTION

Definition

The capital market is part of the financial system that provides funds for long-term development. This is a market that brings together lenders (investors) of capital and borrowers (companies that sell securities to the public) of capital.

Establishment of the Capital Markets Authority

In the 1980s the Government of Kenya realized the need to design and implement policy reforms to foster sustainable economic development with an efficient and stable financial system. In particular, it set out to enhance the role of the private sector in the economy, reduce the demands of public enterprises on the exchequer, rationalize the operations of the public enterprise sector to broaden the base of ownership and enhance capital market development. It had become evident that the commercial banks could not support and sustain a desirable economic development because they could not offer the necessary long-term credit.

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Cont… In 1984, a study on the Development of Money and Capital Markets in Kenya was jointly

undertaken by the Central Bank of Kenya and the International Finance Corporation with the objectives of making recommendations on measures that would ensure active development and strengthening of the financial sector. This became a blueprint for structural reforms in the financial markets. The Government further re-affirmed its commitment to the creation of a regulatory body for the capital markets in the 1986 Sessional Paper on “Economic Management of Renewed Growth”.

In November 1988, the Government set up Capital Markets Development Advisory Council and charged it with the role of working out the necessary modalities including the drafting of a bill to establish the Capital Markets Authority (the Authority).In November1989, the bill was passed in parliament and subsequently received Presidential assent (The Capital Markets Authority was set up in 1989 through an Act Parliament (Cap 485A,Laws of Kenya). The Authority was eventually constituted in January 1990 and inaugurated on 7th March 1990. The Authority is a body corporate with perpetual succession and a common seal.

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ROLE OF THE CAPITAL MARKETS AUTHORITY

CMA objectives:

a) Facilitate the creation of incentives for and the removal of impediments to long-term investments in productive activities.

b) Facilitate the existence of a market in which securities can be traded in an orderly, fair and efficient manner, and ensure participation of the general public.

c) Protect investors from financial loss arising from failure of a broker or dealer to meet his contractual obligations through a guarantee embodied in the compensation fund.

d) Develop a framework through which electronic commerce may be used for the development of capital markets in Kenya.

e) Develop new financial products to diversify the market and attract investors. f) Facilitating the training and education of investors and other market

participants. g) Participate in the integration of the East African capital market. h) Develop a legal and regulatory framework for the market.

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CMA rules and regulations:Capital Markets (Licensing Requirements) (General)

Regulations, 2002 Capital Markets (Securities) (Public Offers, Listing and

Disclosure) Regulations, 2002 Capital Markets (Takeovers and Mergers) Regulations Capital Markets Authority, Foreign Investor Regulations,

2002 Capital Markets Authority Fees Structure Collective Investment Schemes Regulations, 2001 Corporate Governance Guidelines, 2002

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MEMBERS AND PARTICIPANTS IN THE CAPITAL MARKET

CMA has a board of directors consisting of: a) A chairman appointed by the President of Kenya on the

recommendation of the Minister of Finance. b) Six members appointed by the Minister of Finance to serve

for three years. These have experience and expertise in legal, financial, banking, accounting, economics or insurance matters, and are eligible for re-appointment for another three years.

c) The Permanent Secretary to the Treasury or his representative.

d) The Attorney General or his representative. e) CMA’S Chief Executive who is appointed for four years and

is eligible for a second four-year term.

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categories of participants that have been licensed:

1. A credit rating agency to assess the credit worthiness of companies wishing to be listed at NSE.

2. A stock exchange – the NSE. 3. A venture capital fund to lend money to and acquire stake in newly established

companies. 4. A central depository. • Two approved collective investment schemes. • Thirteen stockbrokers • Six investment banks – function as both dealers (buy securities on their own

behalf) and brokers. • Eight fund managers. • Eighteen investment advisers. • Four authorized depositories – all commercial banks. • Three authorized securities dealers trading in the fixed market only.

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Nairobi Stock Exchange

The Nairobi Stock Exchange is therefore a market, which deals in the exchange of shares of publicly quoted companies, and government, corporate and municipal bonds among other instruments for money.

The development of the Nairobi stock exchange is growing in importance because of the important role they play in facilitating the following:

higher savings rate of the working population; offering of a variety of securities to as many people as possible; flow of foreign direct investment into long-established or recently introduced

companies; distribution on capital in the most productive sectors of the economy redistribution of wealth in the economy improved corporate governance through increased transparency and access;  

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PRODUCTS

The products that are available for investments in the Kenya Capital markets are: Equity Venture Capital FundsVenture capital is capital invested in a project where there is a substantial element of

risk, especially money in a new venture or an expanding business in exchange for shares in the business. It is not a loan. There are currently one authorized venture capital funds in Kenya registered by the Capital Markets Authority (Kenya) i.e.  Areous Fund, largely due to the absence of comprehensive regulations.

Asset Backed SecuritiesAsset-backed securities are securities which are based on pools of underlying assets such

as credit card receivables, mortgage loans, and automobile loans. Share and bondsShares are financial instrument where one acquires ownership stakes of a company

rather than an IOU. Returns are neither fixed nor guaranteed one acquires voting rights and benefits from exceptional performance. Bonds on the other hand are financial instruments that serve as an IOU; an investor loans an issuer, and returns are fixed and guaranteed, no voting rights and no benefits from exceptional performance by a company. One can acquire shares or bonds in the primary market (when the company is issuing them) or in the secondary market (which is more common) –by buying from an investor who has bought them.

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FINDINGSFour failed players in four years may sound like a simple statistic to the majority

of a public that is all too familiar with news of corporate failures; but behind these numbers are thousands of innocent investors and families’ dreams that have been shattered by the negligence, acts of commission or omission of a few.

It is clear that although the market is growing too fast and too big, many big brokerage firms do not have the institutional capacity to handle the kind of money coming their way.

The brokerages are under capitalized,

badly managed and

poorly supervised by the securities regulator, the Capital Markets Authority (CMA).

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Cont…The collapse of four players in quick succession can

therefore only be taken to be evidence of a horrible institutional and regulatory failure.

The Kenya government has had to pay out some $4 million to investors who lost money when Nyaga Stockbrokers collapsed. Another firm, Francis Thuo and Partners, was closed down in 2007 for selling shares without clients' authorization, and the NSE and CMA took over management of a third, Discount Securities, in 2008.

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Factors that lead to the collapse of stock brokering firms

Lack of institutional capacity to handle the kind of money coming their way The brokerages are under capitalized badly managed and poorly supervised by the securities regulator, the Capital

Markets Authority (CMA)e.g Francis Thuo and Nyaga stock brokers inability to meet its financial obligations e.g Ngenye Kariuki Stock brokers who failed

to meet financial obligations of upto Sh 227m Insolvent Corporate Governance practices of Listed Companies

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Examples of Investment firms that have become Insolvent are:

Ngenye Kariuki Stock brokersFrancis ThuoDiscount SecuritiesNyaga Stock brokers

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The Capital market Authority is to blame for the collapse?

The CMA’s primary mandate is to obviate such failures and protect investors who surrender their hard earned money to brokers and other capital markets licensees.

Ngenye Kariuki has been found not to be in compliance with the legal and regulatory provisions as outlined in the Capital Markets Authority Act

The collapse of four players in quick succession can therefore only be taken to be evidence of a horrible institutional and regulatory failure.

Yet the red flags were always clear to warn those who cared to see about the systemic weaknesses that have seen brokers give way at the slightest push.

Share application and allocation reconciliations for the KenGen IPO were at best a sham, but the CMA decided to look the other way as thousands of investors complained that some brokers had cashed what was supposed to be their refund cheques from the power company’s IPO.

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Cont..Ngenye Kariuki joined a surging graveyard that has seen Francis

Thuo and Partners, Nyaga Stockbrokers and Discount Securities Ltd imperil investor funds. None of the firms put in statutory management has survived, by the latest case may much depend on where investor accounts are intact.

The firm has been one of the last stand-alone firms at the NSE with Most of its peer’s burdened by the weight of financial obligations and heavy losses have sold operations to commercial banks.

The major consequence of the collapse is that thousands of Investors have lost money that the CMA has to compensate them for.

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challengesLack of Public awareness Generally, there is lack of awareness and information on the role,

functions and operations of the stock exchange and the CMA among potential investors and business entities

Economic and political conditions Kenya experienced poor output performance with an average GDP

growth of about 1.8% between 2003 and 2009. Listed companies experienced losses or low profits and individuals faced low income thereby resulting in low demand for equities.

Market Infrastructure The current manual trading system is slow, costly and limits the range

of products that can be provided. It has also hindered international integration of the market

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Cont…Bond Market Government bonds have dominated the debt market in the NSE. Until

2002, there was little trading in the bond market partly because institutional investors exhibited a “buy and hold” strategy.

Insurance Industry The insurance industry has played a relatively smaller role in the capital

markets than it is capable of doing because it is dominated by non-life companies whose liabilities are short-term and not suitable for investment in capital markets.

Market Rules and regulationsIneffective application of existing market rules and regulations for the

woes at the brokerage firm adding that the complications arising from the Safaricom IPO could have dealt the company, a death blow.

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RECOMMENDATIONS

Generally, the effective functioning of capital markets requires the following:

a) Existence of an exchange, clearing and settlement system. b) Existence of a legal system to enforce contracts. c) Availability of information on financial soundness and future

prospects of companies. The following recommendations will ensure that existing

shareholders are strengthened, the general market share of all brokers is grown by 30% in the next 2 years and will enable the CMA strengthens its regulatory capacity to a point where it is able to identify weak brokers and mitigate possible collapse before it actually happens.

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Cont…REFORMING OF THE FINANCIAL SYSTEMThe country should work towards reforming and deepening its financial systems,

through the expansion of the capital market in order to improve its ability to mobilize resources and efficiently allocate it to the most productive sector of the economy.

ACTING ON THE STRINGENT LAWS AND GUIDELINESSections 11(3) and 12 of the Capital Markets Authority Act (the Act) empower the

Capital Markets Authority to make rules and regulations to govern capital markets in Kenya.

The main issues that the Authority should investigate are:• Compliance issues involving listed companies. • Investor complaints on market manipulation. • Complaints on mismanagement of listed companies. • Violation of regulations.

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Cont..CORPORATE GOVERNANCEFor purposes of the guidelines, the Capital market Authority should

define corporate governance to be seen as a process and structure used to direct and manage business affairs of the company to enhance prosperity and corporate accounting with the ultimate objective of realizing the shareholders long-term value and taking into account the interests of other stakeholders.

Board of Directors: Every stock brokering company should be headed by a board of directors made up of both executive and non-executive directors with a specific requirement that at least one third of the directors should be independent and non-executive.

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Cont… An independent director should be defined by the Authority as one who: a) has not been employed by the company or affiliate of the company in an executive capacity within the last

five years prior to appointment. b) is not associated to or is a member of the immediate family of an adviser, consultant, senior management,

significant customer or supplier of the company or with a non-profit entity that receives significant contributions from the company.

c) has not had a business relationship with the company within the last five years for which the company has been required to make disclosure.

d) has no personal service contract with the company or a member of the company’s senior management. e) is not employed by a public listed company at which an executive officer of the company serves as a director. The procedure for appointment to the board should be formal and transparent, and prospective directors

should be required to disclose potential areas of conflict that may undermine their position as director.

Chairman and Chief Executive Officer: The guidelines should prescribe a clear separation of the role and responsibilities of the chairman and chief executive officer (CEO) to ensure a balance of power of authority and to provide for checks and balances so that no individual has unfettered powers of decision-making.

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Cont… Shareholders: The main requirement for the shareholders is that shareholders of the stock brokering company should

participate in major decisions of the company and that they have a right to information relating to restructuring and annual reports of the companies.

Auditors: The Capital market Authority should also ensure that auditors of the stock brokering companies are members of the Institute of Certified Public Accountants and are complying with the International Auditing Standards. Independent auditors should be appointed by the shareholders at each annual general meeting.

Chief Financial Officers: The chief financial officers and persons heading the accounting department of a listed company should be members of the Institute of Certified Public Accountants.

Disclosure: The board should be required to disclose in its annual report, its policies, incentives, quantum and components of remuneration for directors as well as the share options and other forms of executive compensation that have been made or are to be made during the financial year. Other forms of disclosure should be the aggregate loans held by directors and any management or business agreements entered into by the company and its related companies that may result in a conflict of interest.

EDUCATIONAL ROLES Clients need to know beforehand what to expect from an agent or whoever they are dealing with, in order to make it

clear what they offer, and avoid unnecessary delays and misunderstandings.

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AMENDMENTS TO CAPITAL MARKETS AUTHORITY TO INVESTORS COMPENSATON FUND

COMPREHENSIVE REFORM AND REGULATORY FRAMEWORK-The Government should undertake a comprehensive reform program to put in place a robust supervisory and regulatory framework in the capital markets that conforms to international best practice

IMPLEMENTATION OF A RISK-BASED SUPERVISION PROGRAM This program will help in re-engineering of Capital Market Authority business processes. The Government

should also work with the Capital Markets Authority and the Nairobi Stock Exchange to demutualize the Stock Exchange.

STRONG JUDICIARY SYSTEM The effective application of the rules is likely to be a challenge for the capital market regulators because of

limited resources and weak judiciary .FUNDING FOR THE CAPITAL MARKET AUTHORITY Definitely, CMA needs more and independent funding from the Treasury to boost its capacity for

investigation and dealing with white-collar crimes, particularly securities fraud related crimes.TAMPER -PROOF SYSTEM While commercial banks face problems of ATM thefts, insurance firms have to deal with fraudulent claims

as fraud hit the entire financial sector, Unfortunately, the systems that have been put in place to detect fraudsters are not fully tamper proof,

especially those with access to administrator codes within the brokerage firms.

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ConclusionsCapital markets can ensure the efficient and sustainable

funding of governments, corporations and banks for large-scale or long-term projects. In this regard, any country should work towards reforming and deepening financial systems, through the expansion of capital markets in order to improve their ability to mobilize resources and efficiently allocate them to the most productive sectors of the economy.

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ReferencesWebsites http://wbln0018.worldbank.org/html/FinancialSectorWeb.nsf/generaldescription/1Capital+Markets?opendocument

. http://www.africacncl.org/downloads/AssessCapMkt-Benimadhu.ppt http://www.nse.co.ke/AboutNSE.htm http://www.nse.co.ke/AboutNSE.htm. http://publications.worldbank.org/ecommerce/catalog/product http://wbln0018.worldbank.org/html/FinancialSectorWeb.nsf/generaldescription/1Capital+Markets?opendocumentDiscussion papers Sam Q. Ziorklui, “Capital Market Development and Growth in Sub-Saharan Africa: The Case of Tanzania.” African

Economic Policy Discussion Paper 79. (2001). Asea, Patrick.“Promoting Regional Financial Market Integration.” Presentation at the African Capital Markets

Development Program in Johannesburg, South Africa, October 2003. Benimadhu, Sunil. Assessing African Equity Capital Markets: The Mauritius Stock Market. Presentation at Corporate Council on Africa (New York, February 26, 2004). Accessed April 13, 2005.

Available at Capital Markets Authority Act, Chapter 485A Laws of Kenya. Capital Markets Authority Act, Corporate Governance Guidelines, 2002. Capital Markets (Licencing Requirements) (General) Regulations, 2002. Carmichael, Jeffrey. Michael Pomerleano. “Development and Regulation of Non-Bank.