Jaindi Kisero
14 October 2008
opinion
Nairobi — It is not surprising that the Capital Markets Authority, the regulatory policeman of financial markets, has decided to be economical with information about the financial health of the troubled Discount Securities Ltd.
These are very scary times in financial markets. Once fear grips small investors, they panic and adopt a herd mentality.
Hardly hours after the statement was put out, queues of panic-stricken clients immediately formed outside the headquarters offices of the troubled stockbroker to demand their deposits.
As a regulator, and in an environment of widespread panic, you must watch what you say because if you disclose too much information, you run the risk of adding fuel to the fear that is prevalent in the markets right now.
Today, we have a situation where analysts are competing over who will come up with the most apocalyptic scenarios for the financial markets.
In brief, this is what the CMA said in the statement which was endorsed by the Nairobi Stock Exchange:
First, that it had discovered during routine inspection that Discount Securities Ltd was facing "corporate governance challenges".
Secondly, that it had, therefore, decided to appoint an independent chief executive to run the company's affairs. Third, that the doors of the firm will remain open and it will be allowed to continue trading on the Bourse.
For purely tactical reasons, the CMA decided that it was not the time for full disclosure. It decided to explain everything away in generalities.
But as the panicky behaviour by members of the public who formed queues in front of the firm's offices demonstrated, very few investors believed what the CMA was saying. They voted with their feet.
The lesson, therefore, is as follows. When doubt and uncertainty grips financial markets, the last person the investors will want to believe is the regulator. It does not matter how hard the regulator tries to mask the blemishes.
In the prevailing cynical mood in the market, "corporate governance problems" was going to be interpreted by investors as no more than code words for deep-seated financial problems - insider dealings, poor capitalisation, a high insolvency margin, and a huge hole in the books.
Corporate governance problems mean "front-running" clients, dodgy across-the-book transactions and speculating in clients' money - all those gimmicks which stockbrokers employ to take advantage of investors.
The irony is that, unlike commercial banks, stockbrokers are not supposed to accept or hold deposits from the public. They are basically supposed to function as middlemen between those who want to buy shares and those who own them.
You take your man to broker, he buys you the shares and takes a commission. But in this country, unscrupulous brokers will take your money, and hold it for weeks on end pretending that they have not found buyers.
So when a regulator tells you that a broker is experiencing "corporate governance problems" it will in most cases be because they have taken clients' money without authority and invested it recklessly.
Whether it is Nyaga Stockbrokers or Francis Thuo and Partners, it is clear that brokers fall into problems for very similar reasons. The only difference is the size of the hole in their books. And, they are good at employing accounting gimmicks to disguise indebtedness.
One other major factor is at play in the predicament which Discount Securities Ltd has found itself. Believing that big is better, its shareholders forgot that the best way to acquire size is by increasing capital and reserves.
The company was growing too fast, establishing one branch after another. Yet the truth is that these are very lean times for stockbrokers.
There was a time when the daily turnover at the Nairobi Stock Exchange was more than a billion shillings. Today, daily volumes have dipped to below Sh200 million.
Divide this amount between 20 licensed brokers and you appreciate how much of a financial tightrope brokers are walking right now. Is the money small investors have at Discount Securities at risk and is the problem big enough to cause system-wide distress?
Until the CMA tells us more, it is not possible right now to know the size of the net insolvency.
But my gut feeling is that the problem is not insurmountable. CMA deserves praise for acting promptly and bringing in managers. Depending on size the net insolvency amount, and if the current shareholders cannot plug the hole, CMA should allow the new manager to quickly bring in a suitor.
Fortunately, the demand for brokerages is very high right now. Commercial banks are likely to fall over one another, rushing for the firm.
In the medium term, Parliament should move fast and enact the Bill requiring brokers to increase minimum capital to Sh50 million.
Regulation should also target corporate governance. We have too many owner-occupier brokerages where decision-making is concentrated on family members.
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