OF AN OVER-THE-COUNTER (OTC) VAS CONSULTANTS LTD

Transcription

1 STUDY ON THE VIABILITY AND FORM OF AN OVER-THE-COUNTER (OTC) MARKET IN KENYA DRAFT REPORT PRESENTED TO STAKEHOLDERS BY VAS CONSULTANTS LTD 1

2 FORMAT OF PRESENTATION Introduction Methodology Summary of findings Synthesis of findings Recommendations 2

3 INTRODUCTION Background As part of the Vision 2030, the country expects to increase stock market capitalization from about 50% to 90% of GDP. The CMA is supposed to play a key role in the attainment of the above target in line with its mandate. Further, various stakeholders have continued to advocate for the establishment t of a formal Over- The-Counter (OTC) market in Kenya. The CMA commissioned i a study to inform policy direction on a formal OTC market. 3

4 INTRODUCTION Objective and TORs To assess the viability of the OTC market in Kenya and recommend the form and appropriate policy and regulatory framework. The terms of reference of the study were to: Review operations of informal OTC market in Kenya; Assess the viability of the OTC market in Kenya; and Recommend suitable policies, regulations, form and structure of a formal OTC markets if found viable. 4

5 INTRODUCTION Definition of an OTC market For the purposes of this study, the operational definition of The term OTC market includes: A market segment of a fully fledged exchange that targets securities of small and medium enterprises. An association of security brokers and dealers for purposes of facilitating issuance, buying or selling of securities. A formal exchange that focuses on securities of small and medium enterprises 5

6 METHODOLOGY Population The population consisted of all stakeholders in the capital market in Kenya, stratified into: Policy makers Market facilitators (stockbrokers, investment banks and investment advisors) Listed companies Potential OTC companies Institutional investors Individual investors. Sample A sample of 88 entities was selected (see Table 1) 6

7 Table 1: Sample and number of respondents Respondents Listed companies No. of firms/individuals in the sample No. of respondents Individual id investors Institutional 13 5 investors Market facilitators Potential OTC companies Policy makers 9 4 Combined

8 METHODOLOGY Data collection Both secondary and primary data was used. Secondary data was obtained through a review of documents on the Kenyan and other jurisdictions securities markets. Primary data was collected through interviews and questionnaires. Data analysis Data was analysed using descriptive statistics, including frequencies, proportions, percentages and cross-tabulation. Qualitative data was analysed using content analysis. 8

9 1. Informal OTC market 1.1 Existence 72% of the respondents were aware of the existence of the informal OTC market (see Table 2). Examples of firms that have participated include commercial banks, agricultural companies, a retail company, an investment bank, tea processing factories and high level co-operatives societies. SUMMARY OF FINDINGS Table 2: Awareness of existence of an informal OTC market Respondents Degree of awareness (%) Listed companies 64 Institutional 100 investors Individual investors 63 Market facilitators 93 Potential OTC 67 companies Policy makers 50 Combined 72 9

10 1.2 Operations Informal OTC trading is taking place mainly in shares. Prices are fixed through negotiations between the buyers and sellers. Transactions in the same securities could take place at different prices on the same day. Matching of buyers and sellers is by the respective parties themselves. However, in some cases company employees and some market intermediaries in the NSE assist in matching the parties. 10

11 2. Viability of a formal OTC market 2.1 Respondents indication of need for a formal OTC market There was an overwhelming (90%) support for the need of a formal OTC market in Kenya. (See Table 3) Table 3: Need for a formal OTC market Respondents Degree of support (%) Listed companies 90.9 Institutional investors 80.0 Individual investors 89.5 Market facilitators 100 Potential OTC companies Policy makers 100 Combined 90 11

12 2.2. Reasons for the support of formal OTC market Shortcomings in the informal OTC market: Lengthy and tedious procedures Risk of dealing with share certificates High costs of transactions Lack of liquidity in the market. Raise capital for investment. Diversification for owners of closely held companies. Price discovery mechanism. Enhance easy transferability of securities. Nursing environment for small companies to prepare for listing in the main market. Reduces cost and delays in search for suitable counter parties. 12

13 Reasons for the support of formal OTC market cont Provide exit route for investors. Increases reliability of information available to various parties. Bring in competition in the market thus enhancing efficiency. Guarantee settlement of trades. Removes conflicts of interest that employees might face as a result of being officers of the company and transacting in its own shares. To introduce market discipline in financial reporting, disclosure and corporate governance in the small and medium size companies. 88% of respondents were of the view that benefits of operating a formal OTC market would outweigh the costs. 13

14 3. Respondents views on form and structure of a formal OTC market Shares are the most recommended (92%). However, other securities also received some support. Corporate bonds/commercial paper (46%), Treasury bonds (46%) Derivatives (38%) 65% of the respondents proposed the use of automated trading system (ATS). Most (78%) respondents indicated professional valuation as the preferred method for determination of initial security prices. Book building was supported by 17% of the respondents. 14

15 Respondents views. The respondents were somewhat indifferent as to who should own the formal OTC market. They proposed with almost equal support ownership by securities dealers/brokers, NSE and other stakeholders. Listing eligibility factors Minimum i asset base of Ksh 20 million; Minimum paid up capital of between Ksh 5 million and Ksh 10 million; Availability and reliability of financial i records; Competence and suitability of directors and management; Solvency and adequacy of working capital; and Profitability of the firm. 15

16 Respondents views. Disclosure requirements Annual audited accounts; Appointment/resignation of Chief Executive Officer; Information relating to significant changes in the company assets; Issue of additional shares; and Acquisition, takeover or merger decisions. 16

17 Respondents views. Organizational arrangements The formal OTC market be centralised New market intermediaries be licensed to work together with those already operating at the NSE. Payment, clearing and settlement cycle of the transactions be regulated. Fees charged by the intermediaries i be regulated. The CMA to regulate the market. 17

18 4. Lessons from other countries Securities markets of 10 countries (Egypt, India, Japan, Malaysia, Mauritius, Pakistan, Rwanda, South Africa, UK and USA) were reviewed. The following are the main characteristics of formal OTC markets in other countries: Designed to attract young and fast growing businesses mostly SMEs. Main purpose p of the markets is raising capital. Operate as separate entities either under the main securities exchanges such as Nilex (Egypt), Alt X (South Africa), DEM (Mauritius), OTC (Pakistan), MESDAQ (Malaysia) and AIM (UK) or are operated and supervised by associations of securities dealers such as NASD (USA) and JASDA (Japan). The regulatory framework is less stringent than in the main markets and is designed to suit smaller companies but at the same time provide investors with the certainty and transparency they need to make informed decisions. 18

19 Lessons from other countries cont The market provides a nursing environment where SMEs can prepare for listing on the main exchanges. The market make use of a combination of two trading methods: the auction method and the market maker method. Sponsors/advisors assist the company to comply with the requirements of the OTC market. Require directors of listed companies to attend an induction programme. Have led to increased competition with the formal exchanges thus enhancing overall efficiency in the capital markets. Make use of automated trading systems (ATS). 19

20 SYNTHESIS OF FINDINGS 1. Options From the analysis of the findings three OTC market options are discerned: I. OTC as a segment of the NSE. II. III. OTC market as an association of stockbrokers and dealers. OTC market as a public limited company. 20

21 Option I: A segment of the NSE The OTC market be established as a segment of the NSE. Listing requirements for the OTC segment be less stringent than those of the main market. Establishment t of the OTC segment would be faster and less expensive because the infrastructure is already existing. Companies listed in the OTC segment may be perceived as weaker than those in other segments thus making it less attractive. 21

22 Option I: A segment of the NSE cont There could be inadequate attention to the OTC market segment as the NSE may focus more on the large companies. There is the risk of negative impact on the NSE if firms in the OTC segment fail. The already perceived impediments on the NSE may hinder listing and investment in the segment. 22

23 Option II: Association of securities dealers/brokers The OTC market be established and licensed as an association of securities dealers/brokers to facilitate buying and selling of securities in the market. The main objective of this form of OTC market is to provide a secondary share trading facility rather than a platform to raise capital. The market will be self-regulating which may be a cheaper regulatory mechanism. 23

24 Option II: Association of securities dealers/brokers cont Raising of capital by SMEs from the public, which is an important objective e of a formal OTC market especially in a developing country, might be incompatible with this structure. There is a risk of conflict of interest between operating a business and self-regulating at the same time. The SRO may be less objective in dealing with the members than a government regulator. 24

25 Option III: Independent market under a public limited company The OTC market be established as an independent market from the current exchange. The OTC market be a public limited company. The market to cater primarily for the needs of SMEs. Institutional independence may ensure implementation of policies that specifically target the OTC companies. 25

26 Option III: Independent market under a public limited company cont Provide competition which may enhance efficiency in the capital markets in Kenya. Promotion of growth and development of SMEs which would lead to increased GDP thus helping towards the attainment of Vision There is a move towards demutualization of securities exchanges globally. 26

27 SYNTHESIS OF FINDINGS 2. Theoretical perspective p A categorization of firms targeted by the NSE and those that would be targeted by the formal OTC market. 27

28 SYNTHESIS OF FINDINGS Number of potential listees in formal OTC market is expected to be fairly large. Average size of the companies in the OTC market is also expected to be relatively lower than in the NSE. The large number of companies, though each with a low market value, may imply a high total market capitalization. The shareholding of these companies is expected to be widely held and may translate into significant market liquidity. These factors, combined with efficient operations of the OTC company may translate to it being sustainable. 28

29 SYNTHESIS OF FINDINGS The risk-return trade-off pattern 29

30 SYNTHESIS OF FINDINGS Due to the need for equity capital, Tier II could attract t many more firms than in Tier I (who are the more attractive companies to the commercial banks). Tier II would also be a good hunting ground for venture capitalists and other institutional i i investors with a higher h appetite for risk. 30

31 RECOMMENDATIONS 1. Establishment of a formal OTC market The survey findings indicated that an informal OTC market for shares exists in Kenya 90% of the respondents advocated d for the establishment of a formal OTC market in Kenya. Formal OTC markets have been successful in other countries: ti Malaysia - MESDAQ, which in 2005, recorded 46 new listings, surpassing both Main and Second Boards of Bursa, which collectively recorded 33 new listings. Japan - JASDAQ with its market size surpassing that of the second segment of the Tokyo Stock Exchange. Mauritius - DEM has outperformed the official market in terms of listed companies with 50 companies against 41 in the official market 31

32 RECOMMENDATIONS 1. Establishment of a formal OTC market cont.. A formal OTC market for shares be introduced in Kenya. Dealing in corporate bonds, commercial paper p and derivatives be considered at a later stage as the market develops. Establishment of a formal OTC market will: Enable small and medium size companies raise capital; Provide a breeding gground for small companies to list in the main securities exchange; Enhance efficient transfer of securities; Facilitate unlocking of investments in closely held companies such as family businesses; Avail investors with additional investment avenues; Enhance market discipline in financial reporting, disclosure and corporate governance in SMEs. 32

33 RECOMMENDATIONS 2. Trading in government securities The current processes and procedures hinder transactions efficiency. A review of the processes and procedures relating to trading of government securities be undertaken with a view of enhancing efficiency in their trading. Efficient transactions will among other things avail financial institutions an opportunity to use government bills and bonds for liquidity management. 33

34 RECOMMENDATIONS 3. Form and structure of the formal OTC market About 62% of the respondents were of the view that the formal OTC market should be a public limited company. In most countries, where the OTC markets are operated as separate markets under the main securities exchange, the exchanges are public companies, for example: JSE (South Africa) - AltX, LSE (UK) - AIM, Bursa Malaysia (Malaysia) - MESDAQ NASDAQ (USA) OTCBB. 34

35 RECOMMENDATIONS 3. Form and structure cont 3.1 The formal OTC market be a separate market from the NSE. 3.2 The OTC market be a public limited company with its ownership widely distributed ib t d with the NSE being a key shareholder. 3.3 The market be licensed and regulated by the CMA. 35

36 RECOMMENDATIONS 3. Form and structure cont Establishment of an OTC market as a separate market from the NSE will: Enhance institutional independence which will ensure implementation of strategies that specifically target the OTC market players. Provide competition to the existing market which can enhance efficiency in the capital markets in Kenya. Other potential ti shareholders h of the OTC market may include the CDSC, commercial banks, insurance companies and other institutional investors. 36

37 RECOMMENDATIONS 4. Potential users 83% of the interviewed potential OTC companies indicated that they would participate in the market. Potential users of the OTC market could be SMEs engaged in various economic activities such as: manufacturing, information technology, finance, land buying, investment clubs etc. In addition investment companies owned by SACCOs would be eligible. National association of co-operatives such as the Co-operative Insurance Company limited and Co-operative Bank of Kenya could also be eligible. However, the CMA may need to consider waiving the requirement of free share transferability in order to enable them to be listed. 37

38 RECOMMENDATIONS 4. Potential users cont Potential OTC companies would: Access funds for investment and development of their business. Improve image amongst suppliers, customers and other stakeholders. Investors in the formal OTC market (both individual and institutional) would be the same as those in the NSE but with a higher appetite for risk. Investors in the OTC market will: Realize value through an effective pricing mechanism. Have an opportunity to diversify their share portfolios. Have increased confidence due to the knowledge that the OTC market is regulated by the CMA, which provides investor protection. 38

39 RECOMMENDATIONS 5. Market intermediaries 67% of the respondents recommended that new market intermediaries be licensed for the OTC market. However, in other countries the OTC markets use the same intermediaries i as those licensed to operate in the main securities exchanges provided they obtain rights to operate in the OTC markets. The formal OTC market to use the same intermediaries operating at the NSE including: Stockbrokers/dealers. Investment banks. Investment advisors. The Central Depository and Settlement Corporation. Note: Licenses for brokerage/dealer firms and investment banks will be issued by the CMA after the intermediary has been granted rights to operate in the formal OTC market. 39

40 RECOMMENDATIONS 5. Market intermediaries cont Use of the existing market intermediaries will optimize the use of the existing securities market infrastructure, reduce set up costs and reduce implementation time line. OTC markets in some of the other countries rely on specialised financial i advisors for the listed OTC companies. Special advisors be licensed to support companies applying to be listed in the OTC market. Special advisors will help ensure that OTC companies have access to high quality advice and this may safeguard the market. 40

41 6. Trading mechanism RECOMMENDATIONS 65% of the respondents recommended the use of the automated trading system (ATS). 70% of the respondents recommended a centralized market. OTC markets in other countries use both electronic order-driven method for the most actively traded securities and a market making method for the less liquid securities. The use of centralized electronic order-driven method for the most liquid shares. 41

42 RECOMMENDATIONS 6. Trading mechanism cont The benefits of an automated trading system include: Providing market transparency and efficient matching of orders; and Enhancing the variety and quality of market data and information provided to the market. The use of a manual trading system for less liquid shares which may require negotiation. The negotiated trading process will increase the possibility of illiquid shares being transacted. A study be undertaken to determine the viability of the use of market making in Kenya. The study will inform the need or otherwise of the introduction of market making in Kenya securities market. 42

43 RECOMMENDATIONS 7. Clearing and settlement mechanism Most capital markets around the world use one central depository and settlement system for the various securities exchanges within the market. Further, the Central Depository and Settlement Corporation (CDSC) has enough capacity to handle the additional securities to be traded in the OTC market. The securities traded in the formal OTC market be cleared through the central depository and settlement system operated by the CDSC. The use of the existing clearing and settlement t system will eliminate the cost of establishing another system and will enhance overall market efficiency and reduce duplication of resources 43

44 RECOMMENDATIONS 8. Listing i eligibility ibili requirements The respondents overwhelmingly supported the need for eligibility criteria for companies to be listed in the formal OTC market. In most countries, the listing requirements for the OTC market were less stringent than those of the main market. For example, the minimum paid-up capital requirements were generally lower ranging from a ratio of 0 to 1. UK there is no requirement for minimum paid-up capital for AIM, Mauritius the minimum paid-up capital for DEM is lower than that of the main market by 20%, Pakistan by 90% India the amount is equal for the OTCEI and the NSEI. 44

45 RECOMMENDATIONS 8. Listing eligibility requirements cont Listing eligibility criteria be established for the formal OTC market. Proposed listing eligibility criteria i. A public company registered under the Companies Act. ii. Minimum paid-up capital of Ksh 10 million. iii. Audited financial statements for the year preceding application. iv. Directors to undergo an induction programme prior to or immediately after listing. v. The company be a going concern. vi. At least 25% of equity shares be owned by not less than 10 shareholders excluding employees or family members of the controlling shareholders. 45

46 8. Proposed listing eligibility criteria cont vii. RECOMMENDATIONS Appoint a special adviser to: Appraise the company for the purpose of seeking listing of the company under the OTC market regulations and certify/confirm to the OTC market that these have been met; Facilitate (where necessary) communication between the issuer, the OTC market and the Capital Markets Authority; Ensure that the issuer is guided and advised on the application of the listing requirements and continuing disclosures prescribed by the rules of the OTC market; Present the application for admission to OTC market; and Attend board meetings in an advisory capacity. The less stringent listing eligibility criteria will attract small and medium companies which do not meet the requirements of the NSE 46

47 RECOMMENDATIONS 9. Disclosure requirements There was overwhelming support by the respondents of the need for continued disclosure requirements by the companies listed in the formal OTC market. In other countries, most of the disclosure requirements in the main market are maintained i for the OTC markets. Continuing disclosure requirements be established for the formal OTC market. 47

48 RECOMMENDATIONS Proposed continuing disclosure requirements i. Notification of new developments concerning changes in: Financial i condition Sphere of activity Business performance or expectations ii. The terms of material transactions with related parties iii. Annual financial information iv. Changes in capital structure v. Compliance with the guidelines on corporate governance 48

49 RECOMMENDATIONS Proposed continuing disclosure requirements v. Initiation of acquisition, takeover or merger vi. discussions. Information regarding: The resignation, dismissal or appointment of any director giving the date of such occurrences; Change in accounting date; Change in the registered office; The resignation, dismissal or appointment of the special advisor. Continuing disclosures enhances fairness and investor protection in the securities market. 49

50 RECOMMENDATIONS 10. Fees and commissions The respondents were of the view that the listing fees charged in the current market are rather high. In other countries, the OTC markets generally charge lower fees as compared to the main markets. The listing fees be lower than those charged in the current securities market. Lower listing fees will attract SMEs in the formal OTC market 50

51 RECOMMENDATIONS Proposed levels of fees To OTC market Listing application fees 0.03% of the market value of the shares to be listed subject to a minimum of Ksh 50,000 and maximum of Ksh 500,000. Listing fees for additional shares 0.015% of the market value of the additional securities subject to a minimum of Ksh 25,000 and a maximum of Ksh 250,000. Annual registration fees 0.03% of the market capitalization at the end of each year. To the regulator 0.015% of the value of securities issued 0.005% of the market capitalization as annual market development fees. 51

52 RECOMMENDATIONS Commissions In other countries the costs of transactions are similar for both the main stock exchanges and the OTC markets However, commissions charged in the current market are high as compared to those of most markets. For example: Mauritius - the maximum total commission in is 1.25% of the value of transaction. Malaysia - is 0.70%. In other countries like USA, UK and Pakistan the brokerage fees are negotiable. A study be carried out to determine the appropriate level of commissions in the entire capital market. The study will establish appropriate level of transaction commissions i 52

53 RECOMMENDATIONS 11. Market incentives Companies listed at the current securities market enjoy certain incentives. The respondents also expressed the need for incentives as a way of attracting SMEs to the formal OTC market. Market incentives be provided to companies listing in the formal OTC market Market incentives will encourage potential issuers to list in the OTC market and institutional investors to invest in the market. 53

54 RECOMMENDATIONS Proposed market incentives: The cost of listing be made tax deductible. The companies listed in the OTC market to enjoy a tax incentive of a lower corporation tax rate of say 20%. The companies to be exempt from stamp duty for the shares listed in the OTC market. Companies listed in the OTC market be granted a conditional tax amnesty on past non-disclosed income. Transfer of formal OTC market listed securities be exempt from stamp duty and value added tax. Incentives to the OTC market The CMA to consider defraying part of the initial set-up and operational costs for the formal OTC market. 54

55 Other comments To prepare the general public for the implementation of a formal OTC market there is need for investor awareness creation by the CMA on the characteristics of the market especially the risk-return relationship. A steering committee be formed to establish modalities for setting up the formal OTC market and oversee the implementation of the recommendations. The committee to include the CMA, key stakeholders and experts in capital markets. 55

56 Formal OTC market implementation plan Activity Timeline April 2008 May June July Aug Sept Oct Nov Dec Jan 2009 Adoption of the report Establishment of a steering committee Preparation of the budget for implementation ti Establishing the legal and operational requirements Mobilizing the requisite resources Formation of the company and setting up operational systems Marketing to the potential listees Approving applications from the potential listees Commencement of operations of the formal OTC market CMA public awareness creation 56

57 Thank you 57