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Rational for Regionalisation of Capital Markets

The capital markets of the East African Community, even when combined, remain small by comparison with other African markets.

The key objective in regionalisation of EAC capital markets is to make them more attractive both to issuers and to investors and, as a result, to expand those markets. The creation of a single EAC capital market would offer domestic investors greater choice and domestic issuers greater potential to raise larger amounts of capital from a wider range of investors, enabling the economy and employment to expand.

The development of a single efficient and reliable EAC capital market infrastructure is also expected to not only improve capacity to complete transactions for issuers and investors; but also offer improved reliability and economies of scale and thus greater cost-efficiency.

The combination of a wider and deeper market and improved transaction efficiency and reliability should also result in the ability to attract a higher level of foreign portfolio investment than has previously been the case.

There is no shortage of demand from institutions or individuals, either domestic or international, who wish to invest in East Africa. As an illustration of this, at the end of 2007, it is estimated the total funds under management by insurance and pension funds in the three original EAC Partner States was US$ 15.7 billion compared with the estimated total market value of the float1 of securities in all three markets, including government bonds, of less than US$ 10 billion.

This excludes the value of both unit trusts and other investment funds, which are developing in all three original Partner States2, and of investments by private individuals or investment clubs3. The inflows to both public and private pension funds from contributions made by members and their employers are swelling this value regularly. Clearly the value of these institutional portfolios is not all available for investment in capital markets, but there is certainly both capacity and desire to increase this.

 

Domestic Demand

Added to domestic demand, there is an awakening foreign interest in sub-Saharan Africa as a destination for investment. While this may be temporarily reduced owing to the recent climate of uncertainty in world markets generally, it will, revive when conditions become more settled.

Therefore,the greatest constraints on further development of market depth and breadth, which would be enhanced by the integration of EAC markets, lies in the availability of investments, both bonds and equities. A key objective of integration, therefore, must be to encourage more issuance of securities of all types by enhancing the ability of issuers in all Partner States to access the deeper pool of capital available in the EAC market as an integrated whole. It is noteworthy that when markets’ size and liquidity increases, the incidence of new IPOs also increases.

This would be particularly valuable to issuers in the smaller markets, notably the new members in whose countries capital markets are in their infancy. The combined market capitalisation of the three original EAC Partner States would place an integrated EAC market 4th in size in sub-Saharan Africa, ranking after only South Africa, Zimbabwe and Mauritius as opposed to 7th (Kenya), 14th (Tanzania) and 16th (Uganda) if the markets remain separate.

The EAC has set out a strategy and plan to achieve an EAC capital markets regime which permits capital to flow and participates to operate freely across EAC borders and which becomes increasingly attractive to foreign as well as regional investors.

The result of the proposed regionalisation process would be that:

  • Market intermediaries should be able to offer their services and deliver them in each of the EAC countries;
  • EAC investors should be able to invest in any security throughout the EAC through a single point of access;
  • EAC issuers should be able to seek investors in any part of the EAC ; and
  • Transfer of funds and securities across EAC borders would be quick, easy, secure and cost effective

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1 Float describes the value of securities available to be traded in the secondary market, and excludes holdings of controlling shareholders and governments.

2 Neither Rwanda nor Burundi have initiated collective investment schemes yet

3 The latter are popular in Uganda and Kenya and are being encouraged by government and the banks

Trading Bonds in East Africa

The bond markets in the EAC Partner States, Kenya, Tanzania, Uganda and Rwanda are small and thin. There are few listings in the primary market and the turnover in the secondary market is insignificant. There are several reasons behind this and many of the more significant ones are not related to the model for trading, clearing and settling of bonds, but instead related to lack of some fundamental business drivers which is the foundation of any market.

The following issues are considered to be preventing development of the bond markets:

  • Highly liquid banks creating a disincentive to issue bonds

Banks in East Africa, bearing a dominant position in the financial market, have little or no incentive to encourage corporations to issue bonds. Neither do they see any need to develop a more widely distributed investor segments. Current business with deposits from the retail segment, building over-liquidity that can be lent directly to the corporate segment is profitable. Increased competition in this segment will most likely over time force the players to increase the service level towards both issuers and investors.
 

  • Corporations not prepared to meet information disclosure requirements

The number of corporations with the financial and organisational procedures in place to disclose appropriate and required information to the market on a regular basis is limited. The situation is better in Kenya but coming from a barter economy, the steps to fulfil the requirements set up by professional investors and executed through legislation and rules by market organisers are many. The ease with which funding can be raised through bank borrowing does not create the incentives to go to the market.

 

  • Investor concentration, lacking institutional inventors (pension funds/mutual funds)

The institutional investor segment needs to be developed in especially Tanzania and Uganda where there also is a potential to further develop the pension system. Without a diversified investor segment, with diverting risk and placement preferences, all participants in the market will apply a “follow the herd” behaviour. The prevailing investor behaviour among professional investors is to buy and hold the security which is creating a vicious circle for the secondary market of any security.

 

  • Understanding of fixed income markets

The knowledge of fixed income instrument and markets are limited and fragmented among market participants, which is hampering the development. The banks, trading government securities have an advantage over the brokerage firms. However some brokers in Kenya have chosen to take a special interest in fixed income markets and by that achieved a position in the segment. Similar initiatives would be beneficial for the development of the bonds markets in Uganda and Tanzania as well.

Regional Banking - An Overview

The overall objective of the EAC Financial Sector Development and Regionalization Project (FSDRP) is the establishment of a single market in financial services. In this regard, the main objective of the EAC policies regarding the banking sector is to attain a single market in banking services as a means to promote sustainable economic growth in the Partner States and higher levels of financial inclusion.

 

Banking Sector

The banking sector is playing a major role in propelling regional financial integration in the EAC region by adopting a regional business model motivated by a range of factors including client-demand and opportunities perceived along the regional trade corridors.

 

Commercial Banking

The commercial banking industry in Kenya is the fourth largest in Sub Saharan Africa after South Africa, Nigeria and Mauritius with 43 commercial banks and 2 mortgage finance institutions. The Tanzania Banking system has 26 commercial banks whereas there are 21 commercial banks in Uganda. The Rwanda banking system has 8 commercial banks, 1 development bank and 1 mortgage bank. The Burundi banking industry is comprised of 7 commercial banks, 1 development bank and 1 housing fund.

 

Cross-Border Expansion

Cross-border expansion of banking in the region started in the 2000’s with Kenyan banks setting up in other EAC Partner States. As at the end of 2012, Kenyan banks had set up a substantial branch network with 251 branches in the EAC (and also 31 branches in South Sudan). A total of 11 multinational and Kenyan owned banks are performing with cross-border banking business in the EAC.

Five (5) Kenyan banks with branches within the region include Kenya Commercial Bank (KCB), Equity Bank, Fina Bank, Commercial Bank of Africa. Interest from banks domiciled in other EAC Partner States in cross border expansion is increasing with CRDB Tanzania setting up a branch in Burundi in 2012.

 

Bankers’ Associations

In all EAC countries, the commercial banks established national umbrella bodies, known as Bankers’ Associations to promote member banks’ interests and endeavour a reputable and professional banking sector.

From the perspective of EAC regionalization, an efficient and stable banking sector is a prerequisite for achieving sustainable growth in EAC countries where the majority of financial intermediation takes place through commercial banks.

With this regard, moving towards legal and regulatory harmonisation against the international standards known as the Basel Core Principles (BCPs) is critical to achieve an effective functioning of a single market in banking services.

EAC Financial Sector Development and Regionalization Project

Following the signature and ratification of the Common Market Protocol, the East African Community (EAC) Secretariat in collaboration with the World Bank and other development partners established the EAC Financial Sector Development and Regionalization Project (EAC - FSDRP) I.

The Project Development Objective is to establish the foundation for financial sector integration among EAC Partner States.

The higher-level objective of the program is to support the broadening and deepening of the financial sector through the establishment of a single market in financial services among EAC Partner States, with a view to making a wide range of financial products and services available to all, at competitive prices.

The FSDRP I is structured into the following six components:

  • Component 1 – Financial Inclusion and Strengthening Market Participants
  • 
Component 2 – Harmonization of Financial Laws and Regulations

  • Component 3 – Mutual Recognition of Supervisory Agencies

  • Component 4 – Integration of Financial Market Infrastructure

  • Component 5 – Development of the Regional Bond Market
  • Component 6 – Capacity Building 


 

Component 1 - Financial Inclusion and Strengthening Market Participants:



The main objective of the component is to leverage the establishment of a single market and the benefits of scale associated with regionalization to make a broader range of formal financial services/products available to a more diversified client profile, including those that are currently unserved. The Component also provides capacity building programs to the market participants.

The main areas of focus are:

  • 

Cross-regional mobile banking in EAC;


  • Demand and supply study on barriers to provision of and participation by unbanked in non-bank services (pensions, insurance, capital markets, housing/mortgage);


  • Retail payments infrastructure and how it can better support access to finance;


  • Financial education issues in EAC states and establishment of  regional/national strategies on the same; and


  • EAC Certification on Banking, Securities, Insurance, Pension, and Microfinance.






Component 2 – Harmonization of Financial Laws and Regulations:

The objective of the component is to move towards legal and regulatory harmonization in banking, securities markets, insurance, pensions, micro finance, investment funds critical to achieve an effective functioning of a single market in financial services via EAC Laws, Regulations and Directives.

The main areas of focus are:

  • Establishment of technical working groups at the EAC Secretariat to formulate legal and regulatory EAC Bills on microfinance, SACCOs, branchless banking, banking, securities markets, insurance, pensions, payment systems and investment funds; and
  • Production of EAC Bills, Regulations and Directives on microfinance, SACCOS, branchless banking and accounting, securities markets, insurance, pensions, payments systems, investment funds for submission to the Council of Ministers.






Component 3 – Mutual Recognition of Supervisory Agencies:

The objective of the component is to support the establishment of a regional pass porting system and mutual recognition of supervisory authorities. Under this system, a financial institution and market intermediaries licensed by the supervisory authority in one Partner State will be allowed to operate in all Partner States upon simple notification to the supervisory authority of the host State.

The main areas of focus are:

  • 

Support to task force at the EAC Secretariat for compliance with international principles in banking (BCP), pension (IOPS), insurance (IAIS);


  • Assessment of compliance with international principles in banking, pension, and insurance;


  • Elaboration of a multi-year action plans to comply with international principles in banking, pension and insurance;


  • Assessment of compliance with international principles in securities markets (IOSCO) and development of post IOSCO assessment action plans for Rwanda and Burundi; and


  • Implementation of a multi-year action plan to comply with IOSCO Principles and support for the peer reviewer process for Kenya, Tanzania, Rwanda, and Uganda.






Component 4 – Integration of Financial Market Infrastructure:

The objective of this component is to support the establishment of an efficient market infrastructure, compatible at the regional level.

The main areas of focus are:

  • Integrating and linking the EAC markets through implementation of a Capital Market Infrastructure for trading and settlement systems;


  • Support the demutualization of the stock exchanges in the EAC; and


  • Support to establish capital markets in Burundi and automate the Rwanda stock exchange trading system towards an integrated EAC capital markets.






Component 5 – Development of the Regional Bond Market:



The objective of the component is to support the development of the government bond market in each Partner States, to ensure bond issuers in individual EAC Partner States having access to a deeper pool of liquidity in a single market.

The main areas of focus are:

  • Support to elaboration and implementation of government bond market development strategy in each Partner State as needed;


  • Development of primary market for non-government bond market; and


  • Development of secondary market for non-government bond market.






Component 6 – Capacity Building:

The objective of the component is:

  1. To Strengthen the Department of Financial Regionalization and create capacity for regional policy formulation and coordination at the EAC Secretariat;
  2. To strengthen financial sector supervisory capacity in the Partner States in addition to the support provided by national-level projects through:
  • Capacity building for financial sector regulators and


  • Financial literacy education of the East African citizenry.

Financial

Co-operation in monetary and fiscal matters in order to establish monetary stability within the Community, aimed at facilitating economic integration efforts and the attainment of sustainable economic development of the Community.

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East African Community
EAC Close
Afrika Mashariki Road
P.O. Box 1096
Arusha
United Republic of Tanzania

Tel: +255 (0)27 216 2100
Fax: +255 (0)27 216 2190
Email: eac@eachq.org