The Development of Securities Market in Kenya

The stock exchange market is important for development of the economy of every country. It provides facilities for trading of securities and other financial derivatives. The securities exchange markets have significantly progressed over years in developing countries due to introduction of technological platforms, which enable access to information to enhance the efficiency market (Nyasha & Odhiambo, 2014). Kenya, being one of the developing countries, has also experienced significant transformations in its securities exchange market since its establishment in 1954.Therefore, this study explores the securities market microstructure in Kenya by analyzing the historical growth of the market, the market`s regulatory structure, trading systems and automation, information disclosure, market liquidity, trading cost, market makers, price discovery, and future development perspectives.

Historical Growth of the Market

The securities market was established in Kenya in 1954 by stockbrokers, who formed the association by registering it under the societies act and named is the Nairobi Stock Exchange Market. The securities market was established for regulation of trading activities and further development in Kenya. The Capital Markets Authority (CMA) was established in 1990 to control and manage the securities market in the country. The functions of the CMA entail fostering and facilitating the growth of efficient stock exchange markets in Kenya (Nairobi Securities Exchange, 2017). The CMA was established as the main regulator of the securities market and stock brokers, making Kenya’s securities market one of the best performing markets by the International Finance Corporation (IFC) in 1994 (Nairobi Securities Exchange, 2017). It enabled the securities market to set up a computerized delivery and settlement system and increase the number of stock brokers in the market.

Members of the NSE formed an Association of Kenya Stock brokers (AKS) in 1997 with the purpose of setting up a code of conduct, enhancing professionalism, and establishing examinable courses for members of the securities market (Nairobi Securities Exchange, 2017). The capital markets authority also suggested new disclosure requirements to promote good corporate governance practices and enhance disclosure standards, as well as reporting obligations of the listed companies. The NSE launched an automated live trading systems to facilitate the trading of equities in the market. The NSE also introduced a wide area network in 2007 to facilitate remote trading for stock brokers and investment organization (Nairobi Securities Exchange, 2017). The Stock Exchange market changed its name to Nairobi Securities Exchange in 2011, when it became a sustainable market for trading securities and financial derivatives in the market.

Market and Regulatory Structure

The establishment of a regulatory framework is important for the development of securities market. Kenya’s securities market enabled protection of investors, reduction of systematic risks, and ensured that the securities market was fair, transparent, and efficient. Its main components include the NSE, CMA, and the Central Depository and Settlement Corporation (CDSC). The capital markets authority was established by the central government to issue guidelines and approve licenses of companies that meet the requirements for trading on the stock exchange market in Kenya. The main purpose of their introduction was providing guidelines and approving the securities traded on the stock exchange market. The role of CMA entailed regulating, licensing, and monitoring the issuance of securities in the stock market. Therefore, the capital markets authority is the main regulator of the securities market in Kenya.

Other established regulators of the stock exchange market in Kenya are the CDSC and the NSE. The latter obtains its trading license from the capital markets authority. NSE provides a platform for trading securities and financial derivatives, and acts an oversight institution for securities market. Its functions include reviewing and monitoring the operations of the listed companies, managing and controlling the securities market, announcing information related to trading of securities on the market, and approving companies that seek to be listed on the stock exchange market (Nairobi Securities Exchange, 2017). The CDSC regulates the functioning of market participants, such as brokers and investment banks. It also facilitates the clearance, delivery, and settlement of securities, which are tradable in the stock exchange market.

Market Structure and Design

The stock exchange market provides a platform for trading equity and debt securities, as well financial derivative securities, such as futures contract on the stock market. According to Nairobi Securities Exchange (2017), the stock exchange market has twenty trading participants and twenty-three nominated advisors. The NSE provides a platform for trading securities, whereas the CMA approves organizations that seeks to be listed on the stock exchange market. The CDSC facilitates clearance, delivery, and settlement tradable securities on the stock exchange market. The stock market uses the automated trading system that was established to facilitate trading of securities. The securities exchange market has several trading costs, which range from statutory fees to bid-ask spreads.

Basically, the NSE market structure is designed for the benefit of all market participants and investors, and allows for increase in capital of the companies and higher returns. The NSE market is divided into four segments, which are essential for trading securities and derivatives (Nairobi Securities Exchange, 2017). The futures and options segment enables the market participants to minimize various risks in the market. The fixed securities segment provides trading of such items as bonds and preference shares. The alternative investment segment enables small and medium enterprise companies with an increased growth potential to raise their capital. The main investments market segment enables organizations to trade their shares on the stock market by meeting the set guidelines and regulations (Nairobi Securities Exchange, 2017). Therefore, the organization of NSE market was carefully elaborated to meet the basic needs of the man participants.

Trading Systems and Automation

Automated trading systems are computerized programs, which create orders and submit them to an exchange market automatically. These systems are used during execution of repetitive tasks, which allows for data procession faster than human being can do. Trading securities using computerized systems is faster and cost effective. NSE launched its first live trading using the automated trading systems in 2006 (Nairobi Securities Exchange, 2017). The introduction of an automated system facilitates functioning of the market and enhances the liquidity of trading securities. The automated trading system links the stock exchange market to the brokers, the central bank, and the central depository agents in the stock market, and stores all securities and derivatives data in electronic accounts.

The stock market`s automated trading system facilitates the trading of securities electronically, thereby enhancing the security of the stock exchange market and enabling prospective investors to access and use the system easily. The linking of automated trading system to the central bank facilitates the trading of treasury bonds. The introduction of automated trading systems at the NSE market has enabled the extension of the trading duration by an hour and enabled the trading of rights, as well as equities. The establishment of the automated trading system ensures transparency in the securities market and increases the liquidity market (Nairobi Securities Exchange, 2017). It is indicated by the increase in the turnover of the bond market after the introduction of automation in the system. In addition, the automated trading system is able to strengthen market surveillance, thereby reducing insider trading significantly (Nairobi Securities Exchange, 2017). Therefore, the automation and establishment trading system has increased the effectiveness of the stock exchange market.

Information Disclosure

Information disclosure is fundamental pillar in regulation of securities since it is a vital component of effectiveness in the operation of securities market. Investors require information about the securities and the issuer, because the issuer needs capital to run the organization, and it makes emphasis on the importance of information disclosure. The stock market regulators play a critical role in managing the securities market. The regulators’ main objective is safeguarding the interest investors by ensuring that companies, which are listed on the stock exchange market, adhere to the information disclosure requirements to enable prospective investors to make sound decisions based on the provided information about securities (Gakeri, 2014). The information disclosure requirement on the issuer and securities enable the potential investors to evaluate the associated risks. Information disclosure enhances the management of organizations by increasing transparency and integrity, thereby strengthening the confidence of the potential investors in the securities market (Gakeri, 2014). Therefore, information disclosure reduces information asymmetry in the securities market, thereby enabling prospective investors to access the required information for making sound investment decisions.

Information disclosure regulations in Kenya’s securities market is provided in the companies and capital markets statutes. The provisions in the capital markets act lack substantive regulations on information disclosure, whereas the companies act contain detailed regulations on information disclosure requirements of registered companies in Kenya. The companies act requires organizations to disclose the identity of the directors, senior management, auditors, and legal advisors of the company. The statute also requires companies to disclose their operational and financial information, major shareholders of the company, and describe the business that is undertaken by the companies and its prospects (Nairobi Securities Exchange, 2017). For instance, the statutes require registered companies in Kenya to prepare their financial statements according to the internationally recognized standards and file annual returns with the respective authorities. Therefore, regulatory bodies in Kenya`s securities market have established effective regulations and guidelines for ensuring all companies listed at stock exchange market comply with the information disclosure requirements to reinforce transparency in the securities market, which enable investors to make informed decisions.

Market Liquidity

Market liquidity refers to the ability of securities market to allow for the purchase or sale of securities without drastic price changes. Liquidity assets can be sold rapidly at all trading hours in the securities market without losing their value. The main determinants of the market`s liquidity are speculators and market makers. A market’s liquidity influences the prices and expected returns of securities. It can be determined by evaluating the bid-ask spread of securities. Liquid markets enable trading the high volumes of securities without the drastic changes in the prices of the securities (Nyasha & Odhiambo, 2014). Therefore, it is an important parameter, which regulates the functioning of the market significantly.

Market liquidity is important for the growth of the stock exchange market in Kenya. According to Nyasha and Odhiambo (2014), although some improvement in the liquidity level of securities market in Kenya has been experienced, the market still has significantly lower liquidity levels compared to other international securities markets. The NSE market has already experienced lack of liquidity on securities for a number of reasons. The introduction of electronic limit order book has significantly increased the liquidity of the stock exchange market (Nyasha & Odhiambo, 2014). It is due to its ability to allow for the investors executing orders against the best securities available on the securities market. Therefore, the NSE market needs to develop strategies for further increase in its market liquidity to enhance the operational efficiency of the securities market.

Trading Cost

Trading costs refers to the expenses that are incurred, when trading securities on stock exchange markets. They include the commissions, the bid-ask spreads, and the market impact costs. The bid-ask spread is the difference between the buying and selling price of securities in securities exchange market. In other words, it is the profit obtained by the brokers, as well as a hidden cost that is incurred, when trading securities on the stock exchange market. The bid-ask spread is determined by the liquidity, as well as the supply and demand of the particular securities. The associated costs can significantly be reduced by the use of limit orders to eliminate liquidity charges, evaluation of spread percentages, and trading securities with narrow bid-ask spreads (Nairobi Securities Exchange, 2017). It would contribute to higher efficiency of the NSE and attract more investors.

The Kenya’s stock Exchange market has several trading costs, which include capital gain tax and statutory fees, such as the NSE fees and contributions to the Investor Protection Fund. The capital gain tax was introduced by the Kenyan government in 2015 to tax the profit gains obtained from securities trading at NSE market (Nairobi Securities Exchange, 2017). The market trading fees are set above the exchange fees within bands instead of being charged at fixed rate to enhance the efficiency and competitiveness of the market. The fees charged at the NSE are a quotient of the trade values to encourage the differentiation of securities that are traded on the market (Nairobi Securities Exchange, 2017). Therefore, trading costs in Kenya’s securities market are high.

Market Makers

Market makers consist of intermediaries, such as banks and brokerage firms, that buy and hold large volumes securities to sell them to potential investors. Market makers in securities market charge the cost for bearing the price risk of the security to prospective investors. They obtain their returns from the bid-ask spread on securities by setting prices above the bid value. Market makers ensure that securities for trading are available on the stock exchange market during all trading hours (CMA, 2016). The NSE market has partnered with several stakeholders for the development of regulations and a comprehensive framework for market makers to operate effectively in the securities market in Kenya. Therefore, market makers are important in the development of liquidity in the securities market, thereby enhancing the efficiency of the securities markets.

The basic responsibilities of market makers in the NSE is maintaining ordered and fair markets for the successful operation of the securities market in Kenya. However, the NSE market has not established an operational framework for increasing the efficiency of its market makers (CMA, 2016). It can be explained by the fact that the NSE market is still developing and therefore, market makers the required capacity to ensure a continuous trading during trading hours. In addition, market makers are required to regulate short selling and their efficient operations. Therefore, the NSE market should establish an effective framework for lending and borrowing securities that will enable its market makers to maintain sufficient volumes of tradable securities at all times, as well as enhance the overall efficiency of Kenya’s securities market.

Price Discovery

Price discovery is the determination of security prices, using the supply and demand factors. The accuracy of this procedure can be evaluated using price volatility for a short period of time. According to Alan and Schwartz (2013), price volatility is influenced by the securities market microstructure factors, such as the bid-ask spreads, market impact, and price discovery noise. The bid-ask prices are determined using the information that has been disclosed by the issuer, thereby resulting in price volatility due to investors’ decisions. The bid-ask spreads are usually wider, when dealing with informed investors. It means that movement in prices of securities for informed customers is lower compared to the shifts in securities for the less informed customers (Alan & Schwartz, 2013). Therefore, market dealers and investors analyze the relevant information to establish stable prices for securities in the exchange markets.

Price discovery is beneficial in the securities market, since it enables prospective investors to access information and to make reasonable investment decisions. This phenomenon is characterized by shifts in prices upon the arrival of new information in the securities market. It is provided by prospective investors’ demand changes, which are caused by trading costs, such as commissions and bid-ask spreads, and due to the effects of other trading frictions in the securities exchange markets. The price discovery mechanism is influenced by various factors, such the number of market participants, the current bid and ask prices, the cost of trading securities, and the availability of pricing information. Price discovery mechanism is the most effective in speculative securities exchange markets (Alan & Schwartz, 2013). Therefore, the introduction of an automated trading system in NSE market will significantly contribute to price discovery in securities market in Kenya by mitigating the volatility of prices, reducing the bid-ask spreads, unlocking the selection problems in the securities market, and substantially reducing transaction costs for all market participants.

Future Development

Although Kenya has one of the best securities market in Africa, it still requires further developments to enhance its competitiveness. Respective regulatory bodies can implement effective strategies in the securities market to increase its efficiency and competitiveness. According to the Capital Markets Authority (2016), the stock exchange market can be developed further by creating sufficient infrastructural system to enhance the securities market and stimulate the growth of the derivatives markets. The implementation of effective strategic plans by regulators of securities market in Kenya will ensure an increase of market liquidity, and the resulting improvements in the listing and performance of new products. Therefore, the CMA in partnership with other stakeholders has established a strategic plan, which will increase the number of products and trading activities on the stock exchange market, and attract more international investors by developing effective infrastructural system that reinforces the security.

The Capital Markets Authority has come up with strategic action plans that should be implemented to increase the securities market liquidity and its efficiency. The future development plan for securities market in Kenya involves facilitating the entry of new market makers. It can be achieved by partnering with NSE to introduce market making for all securities that are traded on NSE by developing guidelines and regulations for market makers. The CMA should develop a legal framework, that will introduce securities lending and borrowing, as well as short selling in Kenya, to increase the securities market liquidity. Moreover, the Capital Markets authority should establish new regulations, that will eliminate the current requirements for pre-funding, and introduce new guidelines, that will foster block trading of securities (CMA, 2016). In addition, the CMA should also introduce a computerized trading system for bond trading in the NSE market to increase its liquidity. The relevant authorities can also allow margin trading, remove artificial barriers for entry of new participants, address the laws, which inhibit foreign investment and improve them for the promotion of growth. It will enhance the development of financial derivatives and securities market in Kenya.