This is the oldest financial instrument in the Kenyan Market. Equity refers to the ownership of interest in a company and carries limited liability. Offers of equity securities to the public are governed by the Capital Markets (Securities, Public Offers, Listing and Disclosures) Regulations, 2002. Potential investors can invest in this product through the primary market; an Initial Public Offer (IPO) a Rights Issue or through the secondary market on the Nairobi Securities Exchange. As of November 2022, there were Sixty-Six (66) listed companies at NSE.
A bond is a loan between a borrower and a lender. The borrower promises to pay the lender some interest quarterly or semi-annually at some date in the future. The borrower also promised to repay the initial money invested by the lender. The lender lends and expects to make a profit. The profit from a bond is gained in the form of an interest. At the moment some bonds in the market have an interest rate of 14%, 12%, 10%,8% depending on the type of bond it is, and when it was issued. There are two main categories of bonds issued in the Kenyan Market namely: -
2.1 Treasury Bonds
Treasury bonds are a secure, medium- to long-term investment that typically offer you interest payments every six months throughout the bond’s maturity. The Central Bank auctions Treasury bonds on a monthly basis, but offers a variety of bonds throughout the year. However, treasury bonds can also be purchased in the secondary market (through the Nairobi Securities Exchange). An investor needs at least Kshs. 50,000 to purchase Treasury bonds in Kenya.
Most Treasury bonds in Kenya are fixed rate, meaning that the interest rate determined at auction is locked in for the entire life of the bond. This makes Treasury bonds a predictable, long-term source of income. CBK also occasionally issues tax-exempt infrastructure bonds, a very attractive investment.
Individuals and corporate bodies can invest in Treasury bonds as a nominee of a commercial bank or investment bank in Kenya, but if you hold a bank account with a local commercial bank you can also invest directly through the Central Bank and avoid additional fees.
2.1.1 Corporate Bonds
These are long-term (at least one year and above) debt instruments issued by private and public institutions. The prescribed minimum lot as per the public offers regulations is Ksh 100,000/=. This implies that this product is available to an investor who is willing to invest a minimum amount of Kshs 100,000/=. As of September 2022, there were six outstanding corporate bonds which are yet to mature.
2.1.2 Green Bonds
Green Bonds are fixed income instruments whose proceeds are earmarked exclusively for projects with environmental benefits, mostly related to climate change mitigation or adaptation but also to natural resources depletion, loss of bio-diversity, and air, water or soil pollution. Green bonds deliver several benefits to both issuers and investors; Green Bonds can be issued by corporates or and governments. Acorn issued the first green bond in Kenya in 2019, the bond is listed at NSE and cross listed at LSE.
2.1.3 M-Akiba Bond
A government of Kenya mobile-based retail bond that sought to enhance financial inclusion for economic development. It was launched into the Kenyan market on March 23rd, 2017 by the National Treasury aimed at mobilizing funds for infrastructural development projects, both new and existing.
CMA approved the listing of the Special Limited Offer bond valued at Kshs One Hundred and Fifty Million (Kshs 150,000,000/=) on the Fixed Income Securities Market Segment of the Nairobi Securities Exchange. Following the success of the Limited Offer, a subsequent offer, M-Akiba 2, was made on June 30, 2017. The 3-year mobile phone-based bond modelled as an infrastructure bond allowed buyers an initial investment minimum amount of Kshs. 3,000/= exclusively via mobile phones. The M-Akiba bond was tax-free and the interest rate of the bond was 10% per annum payable semi-annually.
Final payout of principal amount and final interest to both M-Akiba 1 and M-Akiba 2 had been made to investors on April 7, 2020 and September 7, 2020 respectively following maturity of the bonds. As at the time of publishing the Handbook, the Government of Kenya had not issued other M-Akiba bonds. However, given the success of the first two bonds, it is expected that the Government will from time to time be issuing the bond as and when need arises.
3.0 Commercial Papers
These are short-term debt instruments issued by companies to raise funds for a time period. Commercial papers are not transferable or to be listed at a securities exchange.
4.0 Loan Stocks & Preference Shares
These are less frequently used Financial Instruments in the Kenyan Market and have characteristics of both equity and debt. Despite priority in payment from the balance sheet of loan stockholders over equity holders, yields on these securities are relatively low.
4.1 Preference shares
These are shares of a company’s stock with dividends that are paid out to shareholders before common stock dividends are issued. If the company enters bankruptcy, the shareholders with preferred stock are entitled to be paid from company assets first.
4.2 Loan stocks
Loan stock is shares in a business that have been pledged as collateral for a loan. This type of collateral is most valuable for a lender when the shares are publicly traded on a securities exchange and are unrestricted, so that the shares can be easily sold for cash.
5.0 Collective Investment Schemes (CISs)
Collective investment schemes are pools of funds that are managed on behalf of investors by a professional fund manager. These are arrangements made or offered under which the contributions, or payments made by the investors, are pooled and utilized with a view to receiving profits, income, produce or property, and is managed on behalf of investors according to specific shared investment objectives that have been established for the scheme. Collective investment funds groups assets from individuals and organizations to develop a larger, diversified portfolio.
In return for putting money into these funds, the investor receives units that represent his/her pro-rata share of the pool of fund assets. The performance of the fund is is dependent on the market value of the instruments in which the pool of money is invested, therefore it it fluctuates. The yield for money market funds and the price for the other funds is calculated daily.
Collective Investment Schemes may take the form of:
- Equity funds
- Bond/fixed income funds
- Balanced funds
- Money market funds
- Special funds
As at September 2022, there were 34 fund managers and 32 collective investment schemes licensed by the Capital Markets Authority.
6.0 Real Estate Investment Trusts (REITs)
Real Estate Investment Trusts are designed to enable the investing public to benefit from investments in large-scale real estate enterprises. They invest in real estate through property or mortgages and often trades on the securities exchange like a stock. REITs provide investors with an extremely liquid stake in real estate and mortgage properties. There are two main types of REITs in Kenya namely:
In Kenya, the two main types of REITs are:
6.1 Income Real Estate Investment Trusts (I-REITs)
This is a real estate investment trust that primarily derives its revenue from property rentals. It owns and manages income generating real estate for the benefit of its investors. Distributions to investors are underpinned by commercial leases. I-REITs provide an instrument for investing in the real estate market which offers both liquidity and a stable income stream.
Kenya’s first Real Estate Investment Trust, the Stanlib Fahari Income REIT got listed through an Initial Public Offer process in the Real Estate Investment Segment of the NSE in October 2015. The REIT raised KES3.6 billion to be invested in identified real estate projects.
6.2 Development Real Estate Investment Trust (D-REIT)
This is a real estate investment scheme where the proceeds of the REIT go towards development and construction of property for sale and/or rental. The returns from D-REITs come from capital gains from the project when the company completes development and exits by either sale to the open market, or to an I-REIT.
As at September, 2022, there were 10 REIT Managers, 3 REIT Trustees and 3 Authorized REITS (1 D-REIT and 2 I-REITs) – Ilam I-REIT and Acorn REITS (I-REIT & D-REIT) approved by the Capital Markets Authority.
7.0 Asset Backed Securities
Asset-backed securities (ABS) are created by buying and bundling loans or payables – such as residential mortgage loans, commercial loans or student loans – and creating securities backed by those assets, which are then sold to investors. Often, a bundle of loans is divided into separate securities with different levels of risk and returns. Payments on the loans are distributed to the holders of the lower-risk, lower-interest securities first, and then to the holders of the higher-risk securities. For investors, asset-backed securities are an alternative to investing in corporate debt. They are mainly used to finance roads, power, energy, ports, railways and many other projects. Asset-backed securities constitute a growing segment of the global capital markets. In recent years the ABS market has enabled companies and banks to finance a wide range of assets in the public debt market and has attracted a variety of fixed-income investors.
Companies use securitization as borrowing instruments through the creation of Special Purpose Vehicles (SPV). An SPV is a subsidiary of an originating company whose books are run independently from those of the parent company. The parent company then transfers assets to the Special Purpose Vehicle which issues securities that are collateralized by the assets with the proceeds transferred back to the parent company.
8.0 Derivative Instruments
A derivative is a financial instrument whose value is based on the performance of one or more underlying asset(s). They generally take the form of (legal) contracts under which the parties agree to payments between them based upon the value of an underlying asset or other data at a point in time. The main use of derivatives is to transfer risk. Derivatives can be based on different types of assets such as commodities, equities (stocks), bonds, interest rates, exchange rates, or indices (such as a stock market index, consumer price index (CPI) or even an index of weather conditions, or other derivatives) offering the potential for a high return (at increased risk) to another.
Derivatives can either be traded Over the Counter (OTC) or on an exchange. An OTC transaction involves trades done directly between two parties without any supervision of an exchange as opposed to trading on an exchange characterized with rules upon which parties can engage.
There are four most common types of derivative instruments.
i. Forward Contract
A forward contract is a non-standardized agreement between two parties – a buyer and a seller – to purchase or sell an asset later at a price agreed upon at the time of signing the contract. It is thus traded over the counter.
ii. Futures Contract
This is a highly standardized agreement between two parties – a buyer and a seller – to buy or sell an asset at a future date. Prices are determined by the forces of demand and supply as the contracts are traded on an organized exchange.
iii. Options Contract
An option bestows upon the holder of the contract the right, but not the obligation, to buy or sell the asset underlying the option at a pre-determined price during or at the end of a specified period.
These are private agreements between two parties to exchange one financial instrument for another between parties concerned in the future according to a prearranged formula. The exchange takes place at a predetermined time as specified in the contract. They can be regarded as portfolios of forward contracts. The two commonly used swaps are interest rate swaps and currency swaps.
9.0 Venture Capital Funds
Venture capital is capital invested in a project where there is a substantial element of risk, especially money in a new venture or an expanding business in exchange for shares in the business. It is not a loan. Venture capital Funds are emerging as critical in addressing the funding needs of entrepreneurial companies that generally do not have the size, assets, and operating histories necessary to obtain capital from more traditional sources, such as public markets and banks. In Kenya, the number of venture firms has increased significantly over the years given that Nairobi is considered an investment hub within the East African region from external investors.
10.0 Private Equity Funds
Private equity (PE) funds invest and acquire equity ownership in private companies, typically those in high-growth stages. These PE funds purchase shares of private companies or those of public companies that go private and become delisted from the public securities exchange.
There are various types of private equity firms, and depending on strategy, the firm may take on either a passive or active role in the portfolio company. Passive involvement is common with mature companies with proven business models that need capital to expand or restructure their operations, enter new markets, or finance an acquisition. Active involvement does not mean the PE firm runs the company on a day-to-day basis, it does mean that the firm plays a direct role in restructuring the company, reshuffling the senior management, and provides advice, support, and introductions.
While venture capital is a subset of private equity, there are differences between the two. The most notable difference is that venture capital funds raise capital from investors to specifically invest in startups and small- and medium-size private companies with strong growth potential.
11.0 Exchange-Traded Funds (ETFs)
An exchange traded fund (ETF) is a pooled investment vehicle with shares that can be bought or sold throughout the day on a securities exchange at a market-determined price. Like a mutual fund, an ETF offers investors a proportionate share in a pool of stocks, bonds and other assets. Generally, the price at which an ETF trades on a securities exchange is a close approximation to the market value of the underlying securities that it holds in its portfolio. An ETF can be managed either passively or actively. Constituents of a passive ETF follow underlying indices or sectoral securities and are not at the discretion of a fund manager, whereas for active ETFs the fund manager would continuously make portfolio adjustments so as to maximize the returns. In Kenya, there is one commodity ETF issued by Absa Group called Absa Gold Backed ETF listed in 2016 at NSE.
12.0 Depository Receipts (DRs)
Depositary Receipts (DRs) are a means for investors to hold and trade foreign securities as if they were local securities. A DR is an instrument issued in one country representing an interest in an underlying security issued in another country.
The underlying securities are held by a Depositary Bank, which is responsible for creating and issuing the DRs and for passing through any entitlements, such as dividends, to the holders of the DRs. The Depositary Bank either creates or cancels DRs as securities are moved into or out of this form. DRs have also been used by developing markets as a means both of raising capital and familiarizing international investors with local companies. This typically takes the form of a Global Depositary Receipt (GDR) program. Global Depository Receipts are transferable/negotiable certificates that represent an ownership interest in the ordinary share of the stock of a company.
In Kenya, there is a
13.0 Islamic Finance
Islamic Finance refers to a type of financing mechanism that requires stakeholders to comply with the principles of Islamic Law (Sharia). The concept can also refer to the investments that are permissible under Sharia.
Islamic finance is based on principles that demarcate boundaries within which financial transactions should be conducted, highlighting the permissible and prohibited activities, products and/or services. The main principles are as below:
- Prohibition of interest or Riba.
- Prohibition of any transaction that involves uncertainty (or Gharrar)
- Sharing of profits and losses as Muslims are considered partners in a business, and should therefore bear the risk of loss and profit sharing in equal measure.
14.0 Online Foreign Exchange Trading
This is the internet-based trading of foreign exchange and includes trading in contracts for difference based on an underlying foreign asset. Online Foreign Exchange brokers are firms that provide currency traders with access to a trading platform and a method to make online currency exchanges. Some brokers offer the service for free, and others will require a payment for the services, either as a portion of the spread or as a set fee.
Money Managers are also key players in the online foreign exchange trading. They are entities licensed by the Authority to engage in the business of managing the online foreign exchange portfolio of an individual or institutional investor in return for a fee based on a percentage of assets under management.
There are two types of Online Foreign Exchange brokers:
a. Non-dealing online foreign exchange broker
Refers to an entity licensed by the Authority that acts as a link between the foreign exchange market and a client in return for a commission or mark-up in spreads and does not engage in market making activities.
b. Dealing online foreign exchange broker
Refers to an entity licensed by the Authority to engage in the business of online foreign exchange trading as principal and market maker.
As at March 31, 2021, the Authority had licensed four (4) Non-Dealing Online Foreign Exchange Brokers and one (1) Online Foreign Exchange Money Manager.
15.0 Spot Commodity Contracts
A contract for the supply of a commodity traded on a spot market which is promptly delivered when the transaction is settled. A spot commodity market is a centralized market in which commodities are sold for cash and promptly delivered when the transaction is settled.