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Lessons for Kenya from financial markets reforms in West

By Justice Gatuyu | Published Tue, January 9th 2018 at 00:00, Updated January 8th 2018 at 23:56 GMT +3
[Photo: Courtesy]

The second European Union Markets in Financial Instruments Directive (MiFID II), which  will restructure financial markets worldwide, came into force in January 2018. Kenyan financial markets regulators should pay close attention and learn.

When the sub-prime mortgage-triggered financial crisis of 07/08 struck, Western countries moved to revamp their financial markets laws to ensure such an eventuality does not happen again, unlike Kenya where a bank called Charterhouse will collapse on account of insider looting. We will neither learn nor do anything, until Dubai collapses, for the same reason. We will do nothing until Imperial bank collapses.

The United States reacted to the financial crisis by revamping her financial market laws through the voluminous Dodi-Frank. Late 2017, Secretary Mnuchin submitted a detailed report on reforms necessary in the banking sectors and financial markets. It is such constant reforms that make America great.

But it is in the EU where reforms to the financial laws were more ambitious. After the financial crisis, they issued the first Markets in Financial Instruments Directive (MiFID). This was an overarching directive that reviewed the trade in all the financial instruments, these being shares, bonds, units in collective investment schemes and derivatives.

Review urgency

But still, this initial directive focused more on equities and general trading. It has been so since, till there was an overwhelming urge for review, resulting in a revolutionary MiFID I1 that offers another comprehensive review of the financial markets law and practice.

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It streamlines the markets and offers more clarity for customers. It has been introduced at an opportune time, when investor confidence in the markets is dwindling, ostensibly to ensure never again will there be market-caused financial crisis.

As anticipated, the directive has fulfilled its revolutionary hype. First is the aspect of market research. Fund managers will henceforth be required to pay for research received from investment analysts. Free market analysis is no longer allowed.

If Cytton, a Kenyan investment firm was, for instance, operating in Europe as a financial market intermediary, they would be required to charge separately for the Sunday night newsletter they circulate with research on market analysis.

So the research costs will need to be unbundled and segregated from execution cost.The second issue is the directive that gags the so-called dark pools, or as they are more commonly known, the dark pools of liquidity.

In public markets such as the Nairobi Securities Exchange, dark pools are deemed to be private placements that allow investors to buy and sell large blocks of shares directly to one another without necessarily revealing beforehand the size of the orders, or the price they paid to the general public.

At the NSE, dark pools and their equivalents are not common, for one cannot execute them without an approval of the regulator. And our capital markets regulator is a snail. It will take eternity to offer an approval of even a minor application. But in advanced markets they are common.

Calming effect

It is true that dark pools serve an important market function. They prevent panic disposal of securities or ecstatic purchases, ensuring there are no market failures. They can also be the bane. They can create market asymmetry.

Despite the trade being off the market, sophisticated high-frequency traders, who ordinarily use advanced algorithms, can always spot block orders and almost instantly trade against them. This distorts market trading and makes the general investors to feel duped.

Above the financial markets, the directive may have some impact on taxation, even though it was not incentivized by tax issues. For instance, with a requirement that research costs be unbundled and treated separately, these costs may be deemed to be a supply of services on their own. Thus, there will be VAT implications, unless the VAT laws specifically exempt them.

The directive applies in Europe, but its impacts will be felt worldwide. But there are lacunas. There has arisen a trade in crypto currencies such as Bitcoin. Even regulated exchanges are unable to keep off. The directive is mum. It does not even classify them as financial assets or otherwise.  Probably they did not have a solution. Have they ceded their regulatory powers to Blockchain, a distributed ledger?

Now, more than ever, we should be like Europe. Our financial markets laws are medieval and rudimentary. They have failed to keep pace with the evolving world. A huge bundle of the Kenyan capital markets regulations is for the year 2002, save for token amendments. This was before the financial crisis, pre-social media era. We need to keep pace. We need to move fast. To have our own MiFIDs'.

 Mr Gatuyu is an advocate of the High Court of Kenya