Kenya’s financial landscape is witnessing a unique power struggle, a tug-of-war between the Treasury and the Central Bank of Kenya (CBK) over the future of bond trading.

At the heart of this conflict lies the emerging East African Bond Exchange (EABX), introducing an “over-the-counter” (OTC) market for bond trading.

What exactly does this mean? Essentially, an OTC market provides an alternative to traditional exchanges like the Nairobi Securities Exchange (NSE).

Instead of trades happening through a centralised platform, they occur directly between buyers and sellers. Think of it as a more personalised, negotiated approach.

All trades are thoroughly recorded electronically, ensuring transparency despite the direct interaction between the parties. This bilateral negotiation model offers a different dynamic compared to the established, more structured environment of a formal exchange.

The introduction of an OTC market for bonds in Kenya holds several potential benefits:

• Increased Accessibility: OTC markets can sometimes be more accessible to a wider range of investors, including smaller players who might find the requirements of a formal exchange more challenging.
• Greater Flexibility: The negotiated nature of OTC trades can offer more flexibility in terms of pricing and deal structuring, potentially catering to specific investor needs.
• Enhanced Liquidity: By providing an alternative trading venue, the EABX could boost liquidity in the bond market, making it easier for investors to buy and sell securities.
• Market Development: The presence of an OTC market can contribute to the overall development and sophistication of the Kenyan capital markets.

Behind this exciting new OTC initiative is EABX PLC, primarily sponsored by the Kenya Bankers Association (KBA) and FSD Africa.

The KBA, with its 47 member financial institutions, acts as the anchor shareholder, bringing its deep understanding of the Kenyan financial sector to the table.

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This move is a big step forward for Kenya’s capital markets. It essentially mirrors the successful model seen in Nigeria, where the Nigeria Stock Exchange operates alongside the FMDQ Group, an OTC bond trading platform established in 2012.

This dual structure has proven beneficial, offering investors and traders more options and potentially increasing market liquidity.

The EABX, having secured its operating license from the Capital Markets Authority in February 2023, promises to offer an alternative to the Nairobi Securities Exchange (NSE) for bond trading.

There are other factors at play in this development. The Treasury has thrown its weight firmly behind the EABX, citing a 2009 agreement among industry stakeholders.

This agreement envisioned the creation of a self-regulating organisation for the fixed income market, with the goals of increased transparency and efficiency. The Treasury’s support suggests a desire to modernise and potentially boost this crucial segment of the market.

The CBK, on the other hand, is slowly dragging and essentially preventing the EABX launch by denying it electronic access to the central securities depository.

The central bank’s primary concern revolves around the potential for market distortion. They argue that the existence of two competing platforms could lead to dual pricing of bonds, creating confusion and potentially destabilising the market.

The CBK also worries about the complications this could introduce to the yield curve, a critical indicator of market sentiment. Their resistance highlights their mandate to maintain market stability and prevent any disruptions that could jeopardise investor confidence.

This disagreement isn’t just about a new trading platform. It reflects a deeper tension surrounding the structure and control of Kenya’s debt market.

Proposed legislative changes that would transfer government securities issuance from the CBK to the Treasury’s Public Debt Management Office (PDMO) are only making the power struggle worse.

This proposed change represents a significant power shift, further blurring the lines of responsibility and potentially altering the delicate balance of power between these two key institutions.

The promoters of the EABX, which include commercial banks, anticipate that the new platform will inject much-needed liquidity into the bond market.

They also envision a more direct interaction between traders, potentially fostering greater price discovery and efficiency. These are valid arguments, and the potential benefits of a more dynamic bond market are undeniable.

But the CBK’s concerns cannot be easily dismissed. The potential for dual pricing and yield curve complications is a real risk. A fragmented market could lead to confusion and trade-off opportunities, potentially harming smaller investors and undermining market integrity.

The CBK’s cautious approach is understandable, given its responsibility for maintaining financial stability.

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This development comes at a time when secondary bond market turnover, while showing impressive year-on-year growth, has experienced recent quarterly dips.

Capital Markets Authority data reveals that bond turnover more than doubled year-on-year in the second quarter, reaching a substantial 323.6 billion shillings ($2.51 billion).

However, a 29% decrease from the previous quarter highlights the need for more consistent activity and improved market depth. The introduction of an OTC market aims to address this very issue.

This isn’t the only significant change shaking up Kenya’s bond market. Just recently, President William Ruto launched DhowCSD, a new online bond trading platform, on September 11, 2023.

This digital platform, along with the upcoming OTC market, represents a powerful approach to modernising and stimulating bond trading in the country.

The critical question is whether this push for a parallel bond market will ultimately benefit investors or create unforeseen risks. Will the increased competition lead to better prices and greater access for investors?

Or will it create a fragmented and volatile market, undermining investor confidence? The answers to these questions will depend on how this power struggle plays out and whether a compromise can be reached that addresses the legitimate concerns of both sides.