Capital Markets and Securities Regulations Law

LLM 2010/2011 (UON)

Seminar Question Week Seven

“A robust and facilitative regulatory environment is critical for the maintenance of investor confidence as well as investor protection”

In light of the foregoing:

a) Discuss the salient advantages and challenges of self regulation in securities marketsb) To what extent does you country’s securities laws promote self regulation of

securities markets

Seminar Paper Presented and Submitted By:

Joash Ratemo- G62/78813/2009Course Instructor:Dr. Jacob Gakeri

Presented and submitted on: 11 August 2011

Table of Contents

1. INTRODUCTION..............................................................................................................................3

2. BACKGROUND................................................................................................................................3

3. REGULATION OF SECURITIES MARKETS........................................................................................3

3.1. WHAT IS SELF REGULATION?.........................................................................................................4

PART A ADVANTAGES AND CHALLENGES OF SELF REGULATION..............................................................5

3.2. ADVANTAGES OF SELF REGULATION IN SECURITIES MARKETS...................................................5

3.3. CHALLENGES FACING SELF-REGULATION IN SECURITIES MARKETS............................................6

PART B: TO WHAT EXTENT DO THE SECURITIES LAWS IN KENYA PROMOTING SELF REGULATION OF THE

SECURITIES MARKET.....................................................................................................................................7

3.4. COMPANIES ACT............................................................................................................................7

3.5. THE CAPITAL MARKETS ACT..........................................................................................................7

3.6. CENTRAL DEPOSITORIES ACT, 2000...............................................................................................9

3.7. NAIROBI STOCK EXCHANGE.........................................................................................................10

3.8. CASE AGAINST SELF REGULATION...............................................................................................10

4. CONCLUSION................................................................................................................................11

5. References....................................................................................................................................11

1. Introduction

This paper analyses the regulatory environment behind the securities markets. Part one of the paper contextualizes the role of the securities markets and canvasses the salient advantages and challenges facing self-regulation in securities markets. The paper also describes the conditions in which self-regulation might be an effective element of securities markets regulation in Kenya. Part two discusses whether the securities laws are sufficient in promoting self-regulation of securities markets in Kenya. In conclusion, an brief analysis of self regulatory mechanisms in securities markets is considered with an aim to provide a comparative analysis.

2. Background

Securities markets is defined as a place or places where securities trade, the facilities and people engaged in such transactions, the demand for and availability of securities to be traded, and the willingness of participants to reach agreement on sales. There are two main types of securities markets namely: Over the Counter Markets and stock exchanges. Examples of stock Exchanges include the Nairobi Stock Exchange, in Kenya; the New York Stock Exchange, the Chicago Board of Trade and the American Stock Exchange in the US among others1.

The Capital markets Act2 defines the term “securities” as an investment instrument, other than an insurance policy or fixed annuity, issued by a corporation, government, or other organization which offers evidence of debt or equity. Securities are documents that merely represent an interest or a right in something else. Government regulation of consumer goods attempts to protect consumers from dangerous articles, misleading advertising, or illegal pricing practices. Securities laws, on the other hand, attempt to ensure that investors have an informed, accurate idea of the type of interest they are purchasing and its value.

Types of securities include notes, stocks, treasury stocks, bonds, debentures, certificates of interest or participation in profit-sharing agreements, collateral-trust certificates, pre-organization certificates or subscriptions, transferable shares, investment contracts, voting-trust certificates, certificates of deposit for a security, and a fractional undivided interest in gas, oil, or other mineral rights. Some of the security classes include Equity, fixed income securities (T Bonds and Bills, Medium Term papers, floating rate agreements etc) ,Derivatives, and alternative investments (property, hedge funds, exchange traded funds etc)

The Companies Act3 defines the two forms of securities as follows: “debenture” as debenture stock, bonds and any other securities of a company whether constituting a charge on

the assets of the company. "share" means share in the share capital of a company, and includes stock except where a distinction between

stock and shares is expressed or implied.

3. Regulation of Securities Markets

Securities markets in Kenya is regulated by the following legislation: Capital Markets Authority Act, Companies Act, Central Depositories Act and Nairobi Stock Exchange Regulations among others. The institutional framework for the securities markets comprises the Capital Markets Authority, Nairobi Stock Exchange, Collective Investment Schemes, Credit Rating Agencies, Ministry of Finance (Treasury), Registrar of Companies and the Central Depository and Settlement Corporation (CDSC). The Central Bank of Kenya is included in the institutional matrix because of its crucial role in the bond market and the banking sector generally. For purposes of this paper, institutional framework denotes legally established or sanctioned institutions. The current legal framework on securities markets in Kenya is traceable to 1907 when the United Kingdom Parliament promulgated an Order-in-Council declaring that the sources of law of Kenya would henceforth be the Statutes of General Application, the Common law as modified by the doctrines of equity and judicial precedent4 This transplanted United Kingdom law to Kenya and generally remains the state of affairs. For purposes of corporate law, the United Kingdom Companies Act of 1907 was adopted in 1922 and remained in force until January 1962 when the Companies Act 1948 was adopted and remains the operative statute5.

It is important to note that from their inception in the 1950s to 1989, Kenya’s securities markets operated privately with no significant government interference until 1971 when the Capital Issues Committee was established for purposes of approving listings on the Nairobi Stock Exchange. The Nairobi Stock Exchange operated as a self regulatory organization ( SRO). Companies wishing to list had to prepare prospectuses in accordance with the provisions of the Companies Act and

1 http://www.investordictionary.com/definition/securities-market2 Cap 485A Laws of Kenya3 Cap 486 Law of Kenya4 3(1) Judicature Act, Cap. 8.5 Dr. Jacob Gakeri: Maurer School Of Law, Indiana University Enhancing Securities Markets In Sub-Saharan Africa: An Overview Of The Legal And Institutional Arrangements In Kenya.

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submit copies to the Ministry of Finance and the Nairobi Stock Exchange for approval. Additionally, a copy had to be delivered to the Registrar of Companies for registration. Registration of prospectuses by the Registrar of companies is a mere formality. On listing, companies were subject to the Listing Rules of the Nairobi Stock Exchange. The self regulatory structures appear to have served the market well. However, it was characterized by inefficiencies in enforcement. The Capital Issues Committee retained its role as the principal regulatory institution for the primary market until March 1990 when the Capital Markets Authority was inaugurated.

Robust and efficient securities markets enable entrepreneurs to access financial resources necessary to commercialize innovation, expand production of goods and services, invest in capital improvement and new technologies and increase employment. In addition, these markets promote mobilization of domestic and foreign financial resources. Finally, they facilitate privatization of state enterprises. However, the question is whether Kenya securities markets has developed enough to realize the benefits that accrue from securities markets6.

3.1. What is self regulation?

Self-regulation is an important part of the regulatory structure of securities markets in many developing, as well as developed, economies. Use of self-regulation is often recommended in emerging markets as part of a broader strategy development. Recently, however, pressures on self-regulatory frameworks have increased in markets worldwide. In much of the world, the value of self-regulation is being debated anew. Forces such as commercialization of exchanges, development of stronger statutory regulatory authorities, consolidation of financial services industry regulatory bodies, and globalization of capital markets are affecting the scope and effectiveness of self-regulation and in particular the traditional role of securities in self regulation.

Self-regulation in securities markets takes a wide variety of forms around the world. No single definition of self-regulation is universally accepted. The term self-regulation may be used to refer to formal self-regulatory organizations (SROs), to standards set by financial industry associations, and to the internal supervision and compliance functions within financial firms.

In the United Kingdom (UK), there have been efforts to move away from self regulation under the Financial Services Act 1986 and the Markets Act 2000. However, the new British Government wants to go back to Self regulation next year.

When defining self-regulation, some focus on the term “Self” as referring to any collective grouping that does not include the State.7This approach relies heavily on the members of any such group acting voluntarily, but collectively, for a common purpose and to avoid outside intervention. Under the assumption that government and other industry parties agree to the concept of self-regulation, the following general definition is suggested: a system that encourages (“regulates”) certain social behaviors by a collective (the “Self”) in order to avoid direct State intervention (“regulation”). This definition assumes a bottom-up approach, through which the Self (stakeholders or participants) initiates behavior-modifying activities (as opposed to top-down government imposition) for the benefit of the regulated community,8 as well as its consumers (customers).

This broad definition envisions the assumption by participants in the system of the duty to create and adopt common guidelines to govern their collective behavior9. Although such a system can take many forms, including voluntary agreements, codes of conduct, charters, guidelines, and harmonized standards, self-regulation “must be consistent with Community law, represent added value for the general interest, [and] meet the criteria of transparency. . .and representation of the parties involved.” Simply put, the overarching purpose of any self-regulatory group is to keep industry interests aligned with the public interest so as to avoid government intervention and the possibility of more-restrictive regulation10.

In designing a self-regulatory system for any industry and evaluating its benefit over government intervention, policy makers must define the objectives, focus on the social policy implications, balance the costs, and weigh the risks to the public and its individuals of any failures in the system. In essence, the design for self-regulation is often self-originating and self-driven.

6 See Phillip C. Aka, Corporate Governance in South Africa: Analyzing the Dynamics of Corporate Governance Reforms in the “Rainbow Nation,” 33 N.C. J. INT‟L L. & COM. REG. 219 (2007); Rose Ngugi, Capital Markets: Financial Deepening and Economics Growth, available at http://www.csae.ox.ac.ukconference2009 EDI, (visited on May 10, 2010); Ali Adnan Ibrahim, Developing Governance and Regulation for Emerging Capital and Securities Market, 39 RUTGERS L. J. 111 at 114-115.7

Joseph A. Cannataci and Jeanne Pia Mifsud Bonnici, “Can Self-Regulation Satisfy the Transnational Requisite of Successful Internet Regulation?” 17th BILETA Annual Conference, Free University, Amsterdam (5–6 April 2002): www.bileta.ac.uk/pages/Conference%20Papers.aspx.8

This has been defined as the “possibility for economic operators, the social partners, non-governmental organization or associations to adopt amongst themselves and for themselves common guidelines.” See AnnaJassem, “An Introduction to Co-Regulation and Self-Regulation in the EU,” EPHA Briefing for Members (February 2005).9Ibid. 10 11Ibid, p. 2.

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Self-regulation can therefore be defined as an autonomy in creating, amending, repealing, and enforcing rules of conduct with respect to entities subject to self-regulating organization’s jurisdiction and to resolve disputes emanating therefrom. Self-regulation is taken to be where ‘business sets its own standards of conduct and enforces those standards without any government involvement either in drafting the standards, promoting the standards or in enforcing the standards’. ‘Pure self-regulation’ would include voluntary codes. Self-regulation is often used ‘to correct a bad public image, to forestall legislation or to give an industry a competitive advantage’. Self regulation has been influenced by the efficiency view of regulation that looks for the balance when “it is theoretically impossible to make someone better-off (in economic terms) without making someone else worse off”. According to this theory, originated by Pareto, an objective standard for deciding when and in what form regulation is needed is formulated.

PART A Advantages and challenges of self regulation

3.2. Advantages of self regulation in securities markets

Self-regulation may make the members of the securities industry more aware of the goals of regulation and their own stake in them while at the same time making the imposition of regulatory controls more palatable. The most important advantage of self-regulation, however, is its potential for establishing and enforcing what Mr. Justice Douglas for Chairman of the SEC referred to as "ethical standards beyond those any law can establish." As he stated:

“Self-regulation ... can be pervasive and subtle in its conditioning influence over business practices and business morality. By and large, government can operate satisfactorily only by proscription. That leaves untouched large areas of conduct and activity; some of it susceptible of government regulation but in fact too minute for satisfactory control; some of it lying beyond the periphery of the law in the realm of ethics and morality. Into these larger areas self-government and self-government alone, can effectively reach”

The International Organisation of Securities Commissions objectives and principles of securities regulation highlight certain principles that should be inherent in a self-regulatory regime;

a) The regime should make appropriate use of self regulatory organisations that exercise some direct oversight responsibility for their respective areas of competence and to the extent appropriate to the size and complexity of the markets.

b) Self regulatory organisations should be subject to the regulators oversight and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities.

Some of the advantages of self regulation include:

a) Increases overall level of regulatory resourcesMany countries rely on self-regulation because expansive resources are required to regulate securities markets effectively, especially in large and complex markets. This rationale applies in the US, for example. Government regulators often cannot obtain approval to invest in the professional staff and infrastructure that thorough regulation requires, even if the agency is “self-funding” on the basis of fees charged to market participants. Because securities dealers and exchanges benefit from self-regulation, policy makers may feel they should assume part of the burden and cost of regulation directly.

b) Uses knowledge and expertise of industry professionalsThe investment products, trading strategies, and risks involved in today’s securities markets are complex and rapidly changing. The rules and systems required to effectively control and to regulate intermediaries’ and exchanges’ activities are complicated and require a very high level of expertise to understand and supervise. Self-regulation is often seen as a way to tap the knowledge of practitioners in the markets, especially if the regulator has difficulty attracting people with specialized knowledge. Self Regulatory Organisations may offer considerable depth and expertise regarding market operations and practices.

c) Enables the regulator to focus on other priorities while relying on an SRO for front-line supervision of its members and regulated markets

SROs are often referred to as frontline regulators. Annual compliance examinations, analysis of regulatory reports, and online market surveillance are resource-intensive tasks that require teams of experienced officers. If a regulator can rely on an exchange or another SRO to carry out thorough supervision of securities dealers’ operations and market activity, the regulator is able to concentrate more resources on identifying and responding to major systemic risks, and to other priorities outside of the ambit of self-regulation.

d) Awareness: Makes members of the exchange more aware of the goals of regulation and how they stand to benefit

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e) Acceptability: Regulatory controls are made more palatable and acceptable to the members

f) Ethical guidelines: Self regulation achieves what the law cannot achieve by legislation and this is in the area of ethical standards, business practices and morality. Understandably, the law cannot legislate on every minute thing and some areas can only be covered by self- government or regulation.

g) Information: There is a lot of information available within the industry being regulated and this makes self regulation more efficient, appropriate and cost effective as compared to government regulation of the same industry.

h) Flexibility: Self regulation is more dynamic and flexible to market changes and is likely to have a more effective complaints procedures since it can respond more quickly and flexibly than the government authority

i) Setting of standards: Self regulatory organisations are bound to set realistic and attainable standards and achieve greater comprehensiveness of rules within their industry

3.3. Challenges facing Self-regulation in Securities Markets

Privatization of securities exchangesThe widespread demutualization and privatization of securities exchanges is having far-reaching effects on the role of self-regulation because securities exchanges are the only, or at least predominant, form of formal SRO that exists in the great majority of markets. The ability of for-profit exchanges to perform regulatory roles effectively, given inherent conflicts of interest with their commercial objectives, continues to be debated. (This is so even though conflicts of interest were always inherent in self-regulation.) Many exchanges are retreating to a “business approach” to their regulatory roles by focusing on core regulation functions that directly impact the quality of their services. These functions include trading surveillance, or monitoring market integrity and quality, and listings requirements, which set quality standards for listed securities. Those reforms aim to mitigate conflicts of interest, as well as enable exchanges to focus on business priorities.

Intensive competitionCompetitive forces are an important driver for changes to exchanges’ regulatory roles in many countries. Intensive domestic and cross-border competition among exchange SROs increases exchanges’ concerns about cost structures, the potential for regulatory arbitrage, and free riding by competing markets on the primary market’s regulation. Exchanges also compete with private marketplaces, such as electronic communications networks (ECNs) and ATSs, which do not perform regulatory functions. Intensive competition also exacerbates conflicts; it may create incentives to cut regulatory costs, to divert resources to commercial priorities, and to avoid regulatory actions that could damage business interests.

Questions on the effectiveness of self-regulationQuestions have been raised about how effective self-regulation really is in ensuring market integrity and protecting investors. Scandals and regulatory failures leading to reforms in self-regulation are nothing new, but the difference today is that the overall environment is less hospitable for self-regulation, leading more policy makers to question if it is still useful. Today investors’ expectations, government scrutiny, and international standards of regulation are higher than ever, which increases pressure on SROs.

InternationalizationGlobalization of securities markets and major securities dealers makes it more difficult for exchanges and member associations to effectively regulate markets because they have a local, and usually a market-specific, focus. In developed markets, a significant amount of trading has a cross-market, OTC market, or cross-border aspect. As the number of products and strategies proliferates, the capability of exchanges focused on specific trading systems and products to effectively regulate overall market activity is increasingly questioned. Major dealers do business globally and are far less tied to affiliations with local exchanges and regulators than they were decades ago. Many SROs have taken steps to address this issue through bilateral and multilateral agreements to cooperate on regulatory matters and supervising cross-border trading. For example, the Intermarket Surveillance Group (ISG) 11now comprises over 35 exchanges around the world.

Strengthening of government regulatorsPartly because of the preceding four points, governments are vesting greater authority in public regulatory bodies. The effect is to diminish, and in some cases virtually eliminate, the role of self-regulation. Globalization of the markets translates into a growing emphasis on meeting international standards and, therefore, to strengthening the powers, resources, and independence of statutory regulators. Market scandals have been another catalyst to strengthening government regulators, in response to pressure to increase standards of conduct in the markets. Government bodies have much broader jurisdiction and powers than SROs, and they are seen as stronger, more effective regulators.

11 www.isgportal.org

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Trend to consolidation of financial regulatorsA global trend toward consolidation of financial regulators is another factor in reducing reliance on self-regulation. Some governments believe that regulation is more efficient if fewer government agencies, rather than multiple public and private agencies, carry it out on a centralized basis. Others argue that the system benefits from the checks and balances inherent in the involvement of SROs, exchanges, the industry, and the regulators in response to the issues, which improves the content of new initiatives.

Pressure to increase efficiency and lower costs Governments want to improve regulatory efficiency to make their markets more competitive with regional and global competitors. Controlling regulatory costs is an important factor in the efficiency and competitiveness of a capital market. At the same time, the securities industry is concerned about the ever increasing costs of regulation at all levels. The industry is seeking more efficient and streamlined regulation. This concern lies behind pressures to consolidate SROs in countries with multiple SROs, such as Canada and the US. Regulation services agreements that enable an exchange to outsource certain regulatory functions to another SRO and other types of outsourcing arrangements are other ways of increasing efficiencies.

Investor confidenceThe question is whether declines in investor confidence (because of real or perceived conflicts of interest) threaten the continued vibrancy of the financial market

Summary

In summary, in many countries, the role of self-regulation has been diminished or virtually eliminated, while in a smaller number of countries, self-regulation is stronger and more professional than ever. In other countries, where capital markets developed only recently, policy decisions were made not to rely extensively on self-regulation. Such decisions may be based on concerns about the efficiency of regulation, and the likely credibility of self-regulation in a market with no history of the concept. The central question is whether the general trend toward reduced reliance on SROs in global securities markets will continue, or if fresh interest in self-regulation will arise from ongoing reforms and pressures to continually raise standards of conduct and the quality of supervision.

PART B: To what extent do the securities laws in Kenya promoting self regulation of the securities market

There are various provisions in our laws that seem to promote self regulation of the securities market. Some of the provisions include:

3.4. Companies Act

The companies Act provide for a framework for registration of companies, regulation and winding up of companies and other associations. It provides rules on company membership. Section 28 of the Act provides that a person can become a member of a company by subscribing the memorandum of the company, or by agreeing to become a member, the entry of his name in the company's register of members ( by allotment etc), transfer and transmission by death. The Act provides rules on Share capital, Public company, prospectuses, Listing of shares among others. Although the Companies Act was the oldest Act to make reference to securities markets, its provisions are too imprecise to make any substantial impact on regulation of the securities markets.

3.5. The Capital Markets Act

The Capital Markets Authority (CMA) was set up in December 1989 through an Act of Parliament Capital Market Act12 as the regulator and supervisor of capital markets for the purpose of promoting, regulating and facilitating the development of an orderly, fair and efficient capital market in Kenya with the view to promoting market integrity and investor confidence. The Ugandan and Tanzanian statutes on securities markets have identical preambular provisions. Implicitly, the focus of the statute was the Authority not the securities markets13. In summary, the objectives of CMA are:

1. Facilitate development of capital market products and Services2. Enhance market Infrastructure, Capacity and Institutional arrangements3. Establishment of a robust, facilitative, legal and regulatory framework that conforms to International Best Practice4. Promote Investor Education and Public Awareness5. Strengthen the Institutional Capacity

The CMA, which is a body corporate with perpetual succession and a common seal, was constituted and inaugurated in 1990. However, the CMA has limited capacity, and lacks operational mechanism; Rules are opaque, compliance is low and

12 Ibid note 213 Jacob Gakeri: Maurer School Of Law, Indiana University Enhancing Securities Markets In Sub-Saharan Africa: An Overview Of The Legal And Institutional Arrangements In Kenya.

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enforcement is weak. The NSE, a self-regulatory organization (SRO) under the supervision of the CMA was formed in 1954 as a voluntary organization of stockbrokers and is now one of the most active markets in Africa.

Section 102 of the CMA Act14 empowers CMA to make regulations prescribing any matter required or permitted by the Statute to be prescribed for carrying out or giving effect to the Statute. To date rules and regulations have been promulgated covering prospectus requirements, establishment of Stock Exchanges, conduct of business, advertisements the maintenance of registers of interests in securities, accounting and financial requirements, and licensing of market operators. Guidelines for the issuance of Corporate Bonds and Commercial Paper have also been published. In addition documents covering procedures for companies going public and an investor’s guide to shares and public flotation have been issued.

The CMA Act provides that a public company wishing to offer its securities to the public or a section of the public for subscription or sale must prepare an information memorandum and file a copy with the Authority . The Authority may approve or reject the proposed issue or sale.

An Investor Compensation Fund for the purpose of granting compensation to investors who suffer pecuniary loss resulting from the failure of a licensed broker or dealer to meet his contractual obligations has also been established by the CMA as under Section 18(1) of the CMA Act. Annual contributions to the fund are made out of the Authority budget and from market practitioners. The aim of the fund is to enhance investor confidence in the newly created markets. The CMA Act also provides rules on frauds like insider dealing or trading and other offences relation to capital markets.

The Authority, led by the Board of Directors and supported by the Chief Executive together with the management, carries outIts mandate of regulating and developing the Kenyan capital markets through a regulatory framework that is deliberately designed to meet this objective.

The capital markets industry operates within a certain regulatory framework which the players in this industry must adhere to in the course of offering their services. Since inception, the Authority has strived to deepen and broaden the capital markets by developing a regulatory framework that facilitates the development of new financial products and institutions through research and ensuring fairness and orderliness in the capital markets industry.

The regulatory framework of the Authority is comprised of the Capital Markets Act and the Central Depositories Act, 2000. Section 12(1) of the Capital Markets Act confer upon the Authority power to formulate rules, regulations and guidelines as may be required for the purpose of carrying out its objectives. In exercise of its expansive legislative mandate, the Capital Markets Authority has promulgated a number of regulations and guidelines on various aspects of the securities markets. In several cases, the regulations or guidelines were promulgated in anticipation. Adoption of some of the regulations appears to have been motivated by the anxiety to keep pace with global developments as opposed to demands by local constituencies. The paragraph below provides a snapshot of the Regulations and Guidelines promulgated by the Capital Markets Authority. The objective of the summaries is to underscore the specific aspects of the securities markets in respect of which legislative intervention has been made. The regulations include: The Capital Markets (Collective Investment Schemes) Regulations, 2001 The Capital Markets (Securities) (Public Offers, Listing and Disclosures) Regulations, 2002 The Capital Markets (Licensing Requirements) (General) Regulations, 2002 The Capital Markets (Takeovers and Mergers) Regulations, 2002 The Capital Markets (Foreign Investors) Regulations, 2002 The Capital Markets Tribunal Rules, 2002 The Capital Markets Asset Backed Securities Regulations 2007 The Capital Markets (Registered Venture Capital Companies) Regulations 2007. Guidelines on Corporate Governance Practices by Public Listed Companies Guidelines on the Approval and Registration of Credit Rating Agencies

In addition, the CMA licenses Securities Exchange (Nairobi Stock Exchange), Central Depository (The Central Depository and Settlement Corporation Ltd.), Investment Banks, Stockbrokers, Dealers, Investment Advisers, Fund Managers, Authorized Securities Dealers, Authorized Depositories (Custodians), Credit Rating Agencies and Venture Capital Companies among others.

The above Acts, Regulations as well as the Guidelines are what the Authority uses to supervise and regulate the market intermediaries. The regulatory framework is crafted in such a way that it encourages self regulation to the maximum practical extent.The legislative framework makes no provision or regulations on professional standards of market intermediaries and recognition of self regulatory organizations in the securities markets.

14 Ibid note 2

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Some of the shortcomings of the CMA include: The statute is silent on investor education and yet investor education is an important public policy issues. The Act does not consolidate all the laws relating to securities markets but rather just lays the institutional

framework. Some of the laws not harmonised include; disclosure, prospectuses and investor remedies which are important in the regulation of the securities markets.

The CMA consists of eleven members and quorum to transact business is six members. This has been argued to be a big number of persons to assemble regularly and deliberate constructively and arrive at a consensus. A lower number like 5 would have been advisable since the enlarged membership undermines efficiency. The Monetary Authority of Singapore (MAS) which oversees the entire financial services sector has ten members. In Malasya, the Securities Commission has eight members.

The Act does not establish an objective criterion of licensing stock brokers and other market intermediaries. The number of stock brokers has oscillated between 18 and 26 since 1995.

The CMA does not confer a private right of action on investors for violations of securities laws for example non disclosure, misrepresentation and insider dealing.

Overall, the CMA still stands short of promoting a proper self regulatory legal environment for the securities markets.

3.6. Central Depositories Act, 2000

The Central Depositories Act, 2000 is an Act of Parliament to facilitate the establishment, operation and regulation of central depositories, to provide for the immobilization and eventual dematerialisation of, and dealings in, securities deposited therewith in Kenya, and for connected purposes

CDS stands for the Central Depository System. This is a computer system that facilitates holding of securities in electronic accounts and facilitate faster and easier processing of transactions for NSE securities (shares and bonds)

A simple example best demonstrates how a CDS operates. Company X issues some shares, which are subscribed by party A and party B. Rather than the shares being delivered to A and B, Company X delivers the shares to the CDS, who holds those shares in safe custody for A and B. If A decides to sell to B, then in non-CDS environment, A would deliver the shares to B in exchange for payments via a broker. A manual registration process would then follow this. However, with the CDS, the shares would remain in safe custody with a book entry debit to A’s account and a credit to B’s account. Simultaneously, B will pay A. Thus the CDS plays an important role in bringing together issuers (e.g. corporates), investors (e.g. institutions), intermediaries (e.g. brokers) and interested third parties (e.g. regulators).

The CDS is a separate legal entity to be incorporated and is licensed in Kenya to provide central clearing, settlement and depository services for securities held in electronic form. It is licensed under a law defining all the powers, duties and responsibilities of the company.

The typical functions of a CDS are:

Immobilization of securities: This means the storage of securities’ certificates in a vault in order to eliminate physical movement. The objective is to minimize physical movement of securities where complete elimination of physical movements is not achievable.

Dematerialised Securities – which means the elimination of physical certificates or documents of title, so that those securities exist only as computer records.

Providing book entry accounts: this means an accounting system for securities and cash, which electronically facilitates the exchange of ownership of securities and the movement of cash. Thus, the securities move between parties without the need for movement of physical documents. The cash moves with aid of cash clearing mechanisms.

Delivery Versus Payment (DVP) or Effective DVP: this means that the exchange of securities and cash payment between counter parties in a transaction occurs simultaneously. In an environment where DVP is possible, cash settlement and beneficial ownership can be transferred intra-day. This requires an electronic link between the CDS and the national central payment system. In Kenya, it is likely that settlement will be on an effective DVP basis. This is whereby the cash settlement element is transferred into the Kenyan banking system.

The provisions of the Central Depositories Act vest substantial power in the Capital Markets Authority giving it overwhelming control over the CDSC, Central Depository Agents and by implication the Nairobi Stock Exchange. Whether the control of the Authority is good for the securities markets remains uncertain.

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3.7. Nairobi Stock Exchange

The NSE is one of the most active capital markets in Africa with more than 50 listed companies. It is a market that deals in the exchange of securities issued by public quoted companies and the government. Overally the industry is regulated by the CMA and subsidiary regulations made therein.

The NSE is a private company limited by guarantee. The guarantees are held by the members of the NSE who also are stockbrokers/investment banks. It is licensed by the CMA to carry out the business of a securities exchange.In many respects the NSE is self-regulatory. In terms of the CMA licensing requirements for a securities exchange, the exchange is required to have;

a) Procedures and appropriate systems of exercising self regulation over its membersb) A code of conduct for its membersc) Adequate trading surveillance and compliance capacityd) Procedures for dispute resolutione) A system of self regulation with respect to its full and associate members and ensure that the day to day management of trading, settlement, delivery and all other activities of its full and associate members. Such system shall be in accordance with the memo and articles of associate and rules of the securities exchange which have been approved by the authority. The formulation of all these rules by the NSE is an indication that it possesses the capacity to regulate its affairs. In doing so it also acts as a self-regulatory organization by having in place rules and regulation to regulate the practice and conduct of its members.

The NSE has put into place the following rules and regulations to regulate its business;a) The listing manual 2002b) The automated trading system rules 2006c) The management and membership rulesd) The disciplinary rulese) In addition to the above, the NSE is also mandated to carry out additional regulatory roles by virtue of provisions made in the CMA rules and regulations. The above points demonstrate the extent to which the NSE is self regulatory.

3.8. Case against self regulation

(i) Self regulation does tend to insulate an industry group from effective regulation by creating an illusory facade that consumer interests are well catered for. In Kenya capital markets for example we have seen collapse of a few brokerages that have gone down with substantial investor funds

(ii) Self regulation has been criticized as more expensive than direct regulation(iii) Absence of checks and balances of government may permit abuse of rights of members, protectionism and anti-

competition tendencies(iv) Self regulated organizations might not be sufficiently dedicated to their regulatory tasks. It has been argued that

self regulators are generally considered and understandably motivated by self interest to lean towards the lesser degree of regulation

(v) There are concerns of equity and market abuse that are evident where there are self regulatory schemes(vi) Self regulatory models have been found to lack transparency, openness, accountability and acceptability to the

public and consumers of the services

4. Conclusion

Securities markets cannot operate without trust. Investors can trust exchanges to regulate because of their powerful incentive to maximize trading volume. The many choices that investors have today remind exchanges that investor protection is a crucial part of their business. Investors will leave markets that fail to protect investors to find markets that will. Government regulation, by contrast, is unlikely to be as responsive to the needs of the securities markets and risks burdening investors with the cost of unnecessary regulation. Notwithstanding the advantages of exchange, government must play a role even in a largely self-regulatory scheme. Government must provide exchanges with sufficient authority to regulate and provide criminal enforcement of exchange rules when necessary. In addition, government has an important role to play in auditing the exchanges to ensure that they enforce their rules as written. As President Ronald Reagan put it in another context: “Trust, but verify.” Investors need to be able to verify the quality of self-regulation when allocating their capital among different markets. Indeed, an efficient and robust securities markets are dependent on institutional building blocks and the mainstream institution is the legal architecture15.

5. References

15 See Troy Paredes, The Importance of Corporate Law: Some Thoughts on Developing Equity Markets in Developing Countries, 19 PAC. MCGEORGE GLOBAL BUS. & DEV. L. J. 401 (2007).

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1. Alastair Hudson: Securities Law (1st ed., London, Sweet & Maxwell, 2008)2. James A. Klimek: A Brief History of Securities Law accessed at http://klimek-law.com/Brief%20History.shtml on 13th

July, 20113. Stuart Banner: Anglo-American Securities Regulation Cultural and Political Roots, 1690–1860, (Cambridge,

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