New rules to spur Exchange Traded Funds liquidity

Money Markets

Nairobi Securities Exchange chief executive Geoffrey Odundo. PHOTO | SALATON NJAU 

By JOHN GACHERU, jgachiri@ke.nationmedia.com

Exchange Traded Funds (ETFs), a form of investment vehicle where investors pool their cash, will have to guarantee ability of seller to find a buyer by appointing market makers before listing on the Nairobi Securities Exchange.

According to a new policy guideline from the Capital Markets Authority (CMA) the market makers will provide both selling and buying prices to ensure that an investor actually buys or sells the units they seek to at a specified price at any time.

It will be the first time that market makers are introduced to the NSE — after a similar effort failed in 2001 — since the other securities currently listed there do not have any guarantees for liquidity.

A seller is not guaranteed to find a buyer on any particular day, nor is a potential buyer necessarily in a position to get a willing seller.

The market maker is typically a well-capitalised broker-dealer or investment bank capable of buying the securities in the event that they do not find a buyer and putting them in their books until they find a buyer. They can also borrow securities for a willing buyer who cannot find a seller immediately on the market.

“The work of the market maker is to ensure that there is liquidity in the trade of ETFs. In case where no buyer is found then the market makers book the sales in their books,” said Nairobi-based Standard Investment Bank head of research Francis Mwangi.

The ETFs are subdivided into units similar to shares for sale to investors. The portions, like those of units trusts, of an ETF trade like a single share, but the fund may be composed of a number of different stocks in the same sector such as those of banks or insurance firms or the entire NSE 20 Share Index.

Mid this year, NSE chief executive Geoffrey Odundo said there have always been challenges of finding a buyer of shares on the exchange whenever an investor wants to sell.

“From my broking experience, I know it is very difficult to find a buyer or seller for exactly the same value, in the same company, at exactly the same time as you are. This is where a market maker comes in,” said Mr Odundo.

The NSE chief said “the firms meet stringent capital and operational requirements, which are obligated to provide a two-way price in certain securities in order to ensure that there is always a certain amount of liquidity in these stocks.”

The ETFs must also sell and list a minimum of 25 per cent of their value that is freely tradable, which is the same requirement for other share securities currently listed on the NSE.

READ: All firms listing on NSE to enjoy income tax break

Companies on the Growth and Enterprise Market Segment, intended for small companies that are not necessarily profitable, only need to list 15 per cent of their shares as free float.

The setting of the minimum amount of free float is intended to ensure that the ownership of the ETFs is not closely held by a certain group of shareholders to the point of being illiquid or remaining untraded for long.

Acting CMA chief executive Paul Muthaura said the regulator introduced the guideline to fast track the introduction of ETFs in the absence of laws for the new securities.