Kenya ranked eighth overall in the just-released Absa Africa Financial Markets Index (AFMI) 2022, an improvement from position 10 in 2021. However, Kenya has lost ground in the first pillar of the index, scoring 43 out of a maximum score of 100, up from a score of 46 in 2021.
Basically, there are six pillars in the index. The first pillar assesses the size and liquidity of national capital markets, as well as the diversity of listed asset classes and the existence of standard features that enhance market depth. This low score can be explained by two factors. First, liquidity, measured by turnover rate. This basically compares the volume of shares traded to the number of shares outstanding.
If there is a high level of stock turnover, it indicates that investors are finding it easier to buy and sell their stocks. This is an important metric that investors should be aware of, as a low stock turnover rate indicates that selling a stake may take time.
Statistics from the Capital Markets Authority show that the share turnover rate on the Nairobi Stock Exchange (NSE) has remained below 1% throughout 2021, which is quite low.
Indeed, the equity market has been trading on low liquidity and improving long-term turnover levels require more listings as well as increased investment from institutional and retail investors. In addition, recent product innovations, such as securities lending and borrowing, should help boost activity (and hence liquidity).
The second factor is the lack of a primary trader system. In all financial markets, primary dealers underwrite any primary sale of securities, be it stocks or bonds, which they in turn sell to other market participants in the secondary market. In doing so, they fulfill two functions: providing market creation and price discovery. Market making in the sense that they provide a ready market for any investor looking to sell a security.
Price discovery, on the other hand, is accomplished through two-way quotes; which basically means that if I can sell it to you for a certain price, I also show you my buyout price. In the Kenyan context, this has been a missing link and continues to contribute to the low score.
The absence of a primary trader system in the equity market also (partly) explains the dryness of the initial public offering (IPO) at the NSE.
Think about it. Currently, any entity wishing to raise equity through the IPO will have to content itself with pitching to hundreds of potential investors with no guarantee of obtaining funding. They should undertake a national and cross-border roadshow, depending on the size of the offer.
Roadshows and pitches can be a lot of work. It would be much easier if such an entity met only three or four investment banks in a meeting room and obtained a commitment to fully subscribe to the capital increase (after which the investment banks would sell on the secondary market ).
The same concept applies to the bond market, whether corporate or sovereign. And in the case of the government bond market, the central bank, as the government’s fiscal agent, approves a list of primary dealers (using its own selection criteria). The lack of a primary trader system in public markets has given more energy to the private equity market.
Mergers and acquisitions data from the East Africa Venture Capital Association shows that the value of reported and disclosed deals between 2018 and 2021 was $3.1 billion, while there was no increase in capital to the NSE. Essentially, there is more activity in the private market than in the public market, and it’s all due to the (lack of) main dealer.
It should be noted that neighboring Uganda, which operates a principal dealer system in its government bond market, scored higher than Kenya.
Ultimately, the information from the Absa Africa Financial Markets Index presents a kind of wake-up call to reform the structure of domestic capital markets.
The author is an investment analyst. @GeorgeBodo