Kenya: Safaricom IPO Brings out Flaws in Regulation and Supervision
Friday, 27 June 2008
It is not just the proposals on banks and stockbrokers in Finance Minister Amos Kimunya’s 2008/2009 budget that indicate that all may not be well in the capital markets. Before analysing the proposed changes, Deepak Dave takes a look at the flaws that have become obvious during an IPO the size of Safaricom. Praises were sung, pictures were taken and bells rung as the largest IPO in East African history was launched onto a world looking for positive news “Out of Africa”. Safaricom shares soared on debut. Michael Joseph was lionised in The Economist and the financial press breathlessly talked of yet another chapter in Africa’s, and Kenya’s, renaissance. The mutual admiration society that is Kenya’s financial sector gave each other pats on the back while fondling bulging wallets.

However, it is not just the proposals on banks and stockbrokers in Finance Minister Amos Kimunya’s 2008/2009 budget that indicate that all may not be well. Regulation in any industry ultimately hinges on encouraging good activity while circumscribing illicit or criminal actions that distort price mechanisms. Before analysing the regulations, it is worth looking at the flaws that have become obvious during an IPO the size of Safaricom. The murky waters of high finance often hide flotsam that can cripple the ship of commerce. A strong tide is needed to throw the debris onto the beach. Once that tide recedes, we have better idea of what lay beneath the murky waters. Safaricom’s IPO was such a tide.

In an ideal world, most of us who invest in capital markets will want the same thing: To be able to buy or sell shares freely, get our money in a timely manner net of a fair commission and know that our trades and securities are safely stored and held and will not be open to fraud, theft or misallocation. When such a process flow is disrupted through poor account opening, unsafe networks or poor service, questions need to be raised.

Reports that there was a failure of the security network governing the online account opening and Safaricom IPO share tendering should be enough to set alarm bells ringing loudly. Brokerages in Kenya need to be able to use the IT backbone to run their share trading network and their client accounts. Failures of this sort will only disrupt the growth of the market: Consider that insecure networks are likely to hamper the growth of retail investing and the development of online brokerage, both of which are necessary to increase liquidity and prime the pricing function, and one sees why this particular problem should be investigated minutely.

Another flaw I found was in the process of requiring institutional investors to submit bank guarantees for the shares they bid for. Ostensibly, the reason was to prevent liquidity being sucked into a small sub-set of depository firms leading to poor liquidity allocation. Right intention, wrong solution.

In most countries, a qualified institutional investor (QII) could not be formed without having passed strict regulatory muster. Once licensed, a QII should be able to draw in capital other than its investors, and indeed be considered a reliable investor. A large investor should not have to deposit cash to back their share purchase. Should they need to, why can’t central depository accounts accept the funds and then act as a single clearing house, negating the liquidity pooling problem? I have not been able to find a single regulator, broker or banker who explained this properly. The only people who benefited were the large banks who could underwrite the guarantees and take a huge fee off the top. The process was a loser.

Investors have come out badly from this too. This desire to generate monetized value for shares that had not been allocated or priced yet leads directly to the failure to return monies to investors who did not get their full allocation. The lackadaisical approach taken towards the return of these funds is going to have severe repercussions for the monetary system over the next 12 months. Yet CMA and CBK who ought to have been digging the money out appear to be tuning their fiddles.

The single most appalling failure has been that of investors taking out loans to buy shares they either did or did not get. I was surprised enough when I first received bank marketing materials suggesting I take out loans to buy shares. I was flabbergasted when ads started appearing in quality newspapers and despaired when senior regulators either encouraged or ignored the practice. Incidentally, every paper that ran the ads is now writing stories about how on earth the loans are meant to be repaid. Surely a bit late!

Let’s be clear about this. In a country with a poor savings rate, low incomes, high poverty and severe lack of savings channels, the stock market is till the last resort. Much as my friends in the international business press are always delighted to run the story of someone who sold their chicken/bicycle/sweater to buy an IPO share in Africa, this is a very high risk practise. To add insult to that injury and expect people to borrow to buy those shares is a dreadful mistake.

Shares, by definition, confer ownership and the risks that go with that. I have great faith in the alchemy of Michael Joseph but this issue is bigger than his management skill. No company can guarantee value or dividends on its shares. Borrowing to purchase these shares means a debt that MUST be repaid irrespective of the shares performance. The loans charge interest monthly, with deductions for interest AND principal. Shares pay dividends twice, sometimes thrice a year. Principal is recouped through sale of the share. Which stops the dividend, leaving the investor to make up the rest.

I have been at a number of conferences in the last year where Africa’s resilience in the face of the West’s credit crunch due to poor quality lending were crowed about. We certainly will not be affected by western credit problems   not when we’re doing a super job of creating our own.

A number of instances have come up of wanainchi being unhappy with the low share allocation their segment got. Everybody should be thanking their lucky stars that no more shares were allocated. It would have ultimately been an even bigger problem. It is pointless blaming the banks or brokers. To generate business, their incentive is to get the maximum number of investors, the most amount of money and the highest number of trades. The failure, and the remedy, are regulatory.

 About the Author

Deepak Dave is a former Director of Risk Management for Renaissance
Capital Africa and previously served as Credit Director for Investment
Banking at Barclays Africa & Middle East. He has worked for a number
of banks, investment funds and NGOs on foreign investment in the
African market.

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