October 19, 2017

The Business Interview: Keith Kalyegira and the Gospel of Patient Capital

KEithKalyegiraAn intriguing question hovering over Uganda’s almost two decade old stock market is why the sizeable pool of Ugandan medium to large scale business enterprises remains indifferent to the alternative financing offered by the capital markets.  In a market where the state is a competitor for capital with the private sector, the resulting cost of money should make listing a more attractive source of funding. Yet entrepreneurs continue to slug it out with the state for bank finance, something that almost defeats logic.

Keith Kalyegira, the Chief Executive Officer of Uganda’s Capital Markets Authority sees one key differentiator between equity and debt – one is patient, the other is not – he tells 256 Business News.

The primary challenge facing capital markets development in Uganda he says is the fact that the people who need market based financing are not aware of its benefits. If they do, they cannot come to terms with the fact that they would need to give up part ownership of their businesses and open up to probity in order to raise capital from the markets.

“Many people don’t want to have outsiders looking into or be part of their affairs even if it is to have access to patient capital. Essentially Equity is like a long term loan, once I sell you my shares I have received your money but I pay you back when I have made money and I give you dividends. It is only payable through dividends; it is a permanent loan that is only repayable through dividends. If there are people who need their cash preterm for any reason, they can sell their shares to someone else. That is the whole essence of capital markets.”

That aversion to probity partly explains why the Ugandan economy’s financing structures are heavily bank based. Once a client has provided security, banks will not demand more disclosure yet for the capital markets, more disclosure is required so that investors are comfortable and know what they are buying into.

“But going public also creates more financing options, because it shows that you are subject to probity, you are upholding good corporate governance standards and practices so you should be able to attract cheaper financing,” he says.

Be that as it may, many Ugandan enterprises have matured to a point where they are already public by default but enjoy offshore connections that give them access to cheaper capital. Take MTN Uganda for example, a public investment company that should have nothing to hide because it is already listed in its mother country, South Africa. But this gives the multinational access to cheaper sources of capital and perhaps even in larger quantities. So generally, multinationals have no incentive to go public locally in their operating countries because many of them are public in their home markets.

For that reason, Kalyegira and team are looking at large to medium scale Ugandan companies that have prospects for growth, companies that are turning over annual revenues in the region of $10 million and above.

Debt Vs Equity

The challenge for him is that players in that league have access to cheaper money offshore so convincing them to switch from debt to equity is always going to be an uphill task.

“That is true because in a situation where equity investors are assuming more risk, their expectations in terms of return on investment may be higher than those of a straight forward lender. But getting equity injected into a business helps to reduce the cost of financing which boosts profitability. That is what Umeme did, they chose to go for equity, paid off expensive debt and profitability was boosted almost immediately.”

So does Uganda need a credit crisis of significant proportions before the many eligible enterprises can be driven to list?

“There has to be a major constraint to bank financing which doesn’t seem to be about to happen because private sector credit is still quite low compared to other countries in the region and other parts of the world,” Kalyegira says pointing to the fact that the state is already the major taker of bank finance.

Uganda’s stock of domestic credit is worth about Ushs 8-9 trillion per year which is roughly 50 percent of the total money supply. However, private sector credit remains minuscule because banks are more incentivised to lend to the state as opposed to the private sector through high returns on government paper which is more secure for them.

It may sound basic therefore but awareness appears to be the major challenge facing capital markets development in Uganda.

“People are simply not aware of the benefits of stock markets and I don’t think we have enough foot soldiers out there making people aware of the potential benefits. And you also have to be sure that the foot soldiers know what to say to potential issuers to make them realise that it is a plausible alternative.

“People are simply not coming forward and I don’t believe that all people who need to know already know about capital markets as a source of financing. People are so used to bank forms of credit and financing and looking at the past where banks have taken over the assets of businesses, people are quite shy to grow too fast because growing fast means mortgaging more of your business. So they try to grow within the resources generated by the business which is not really the best way if you want to grow a business because it is not fast.”

Market based financing would allow them to finance growth without being put under pressure to repay debt but many remain married bank credit despite its cost.

A secondary challenge is the high level of involvement by the state in the capital markets as it tries to raise money for development, which in turn raises the cost of financing.

Under normal circumstances however, that should be an incentive for listing because if bank financing is expensive, businesses should look for cheaper sources of capital or if not cheaper, more patient sources of capital which is what the stock markets offer.

As a regulator, Kalyegira presides over one of the most underdeveloped and shallow capital markets on the continent. That puts him in the awkward position where he must carry the whip and yet superintending over the markets development.

“That is normally a conflict in itself but not unusual,” he says. “Most third world regulators face that conflict because they are presiding over underdeveloped markets and so by default find themselves having to play a developmental role.”

In Uganda’s case, the CMA’s development mandate is written in the law because the regulator also doubles as the line minister’s immediate advisor on all matters related to the development of the capital markets. Either way, it does not remove the conflict in roles because the person who is working to attract market based financing is the one that must regulate his customers.

It works but at it leaves some discerning investors wondering whether the regulator will be impartial in enforcing regulatory action.

“We are very mindful of that conflict but it is not something we are alone face, it is faced by many regulators around the world and one thing we are doing is to make sure that increasingly, the intermediaries’ we license are empowered to play the development role,” Kalyegira explains.

Developing Uganda’s capital markets is something Kalyegira approaches with passion. The CMA has for far licensed 8 brokers but only 3 to 4 are active at any one time. A few initiate transactions but most are just traders; while the others are more specialized in corporate finance trying to initiate market based financing transactions. That is the reality he faces and stimulating more activity in the market is a continuing challenge.

Still he remains optimistic. The Uganda Securities Exchange has just got a new Ceo who doing is a lot to try and grow the market. The USE went electronic opening to a future of instant settlement.

Kalyegira’s refuses to allow the domestic situation to cloud his vision of the future of capital markets development in Uganda.

“If am looking at the domestic market, I am seeing a limited market but looking further afield in the context of regional integration, you see firms that will want to grow output to supply a larger base. If you are a company that is trying to grow rapidly, you need patient capital more than those that have reached a certain stage of growth and just need working capital.  If you are looking at capital for expanding capacity and sometimes you are not sure when your expansion is going to transition into revenue, patient capital will make more sense.”

A question that is less explored is the role divestiture could have played in stimulating activity on the USE. During the nineties to the early 2000’s, the state divested from many enterprises and a number of them continue to do robust business today. Apart from Stanbic Bank and Bank of Baroda which listed part of the public stake on the local bourse, others have not been forthcoming. In some cases, the private partners invoked preemptive rights to push the state into ceding the public stake to the other shareholder.

The state divested from Barclays, Tororo Cement and Kakira Sugar on condition they were supposed to list in 5 years time but this has not happened. While Kalyegira believes the government needs to push for these listings to take place he does not see it as the solution.

“We missed the privatization boat but fundamentally, you cannot hope to rely on government induced listings to grow the market; the private sector needs to see the benefits. The government has led and capitalized the markets up to this point but the private sector needs to take over.”

Amidst the clamour for more local content in privatized enterprises, Kalyegira sees a possible compromise. The National Social Security Fund could acquire stakes in those companies such as Tororo Cement, Barclays Bank and Standard Chartered Bank where the state still has a stake. Ugandans would then have a stake through such intermediaries.

That would bring some relief to NSSF too because the challenge for the provident fund right now is that savings are growing faster than investment products. That means if nothing changes, you will have money seating idle in bank accounts.

So under such circumstances, what was the rationale for licensing a second exchange ALTX, when the USE is still groping for a hold?

“On the face of it the prospects for a second exchange in a small market might appear bleak but usually the private sector sees what we in the public sector sometimes don’t see. So they saw an opportunity, they want to take advantage of technology, some of their shareholders are people who have started and sold exchanges before, and I think they have got a pan African vision. They are looking beyond Uganda although it is the starting point where they want to be coming with alternative products such as depository receipts and other traditional products like equity and debt if they can get hold of them.”

An East African Stock Exchange?

As East African economic integration deepens, the regions institutions have been trying to keep pace, visualizing operational scenarios in a border-less economy. For the start, work has been ongoing to harmonise the rules that will govern the capital markets in the new economic space.

“That process has been going on for some time and it is progressing well. To a large extent most of our regulations are similar and what we have been going through is a process of developing directives that should inform any future changes in our legal frameworks. As and when we get to a point where we have one stock exchange and one regulator, remains the ultimate destination but in the meantime we work very well together.”

Currently there is an ongoing project to try to link the securities central depositories of the exchanges. “The major remaining challenge is currency conversion across borders because even if you trade you have got to settle in different currencies. And the spread between different currencies’ can cause a potential loss of anywhere between four and eight percent at conversion. That is kind of a deterrent unless you are a medium to long term investor.”

Kalyegira believes the East African Monetary Union, anticipated from 2024, will resolve that dilemma and it will be possible to have similar trades across the region. That should also generate a lot more activity compared to today where the eight cross-listed companies hardly trade because of the incompatibility of the Security Central Depositories that are for now not talking to each other, leaving cross border processing  to be a mere expression of intent.

It is envisaged that when the EAC stock exchange finally gets into place, the existing stock markets will become shareholders in a single regional bourse. Depending on where it is headquartered, Kigali, Kampala, Dar or Nairobi for that matter, will be there as satellite boards of one exchange. That means that rather than marketing 8 cross-listed stocks, the market will have upwards of 85 -90 stocks across the region.

“It will be a much better proposition because you will be looking at a regional pool of savings for institutional investors. It will be good for investors, especially foreign investors who will be looking at East Africa as an asset class as opposed to the different countries.”

Current boundaries not withstanding, Kalyegira says inward investors have been the most active players in the Ugandan market and there was a year when foreign investors dominated trading on the USE especially on counters such as power distributor UMEME.

“Foreign investors see value in our market because they are looking for yields which they can’t find anywhere else. Our market is also attractive because we have an open current account. Tanzania recently opened up and you can see a pick-up in turnover and liquidity, so it is a good thing and we shall be doing everything as a country to ensure that that remains the case from a macroeconomic and political perspective.”

Unit Trusts

Despite the fact that a Collective Investment Schemes law has been in place since 2003, that stream remains earthbound. The regulator is still trying to understand why Collective Investment Schemes have not taken off with the few companies that started unit trusts subsequently closing shop.

Kalyegira thinks the failure has more to do with how unit trusts are sold to retail and institutional investors.

“There are only 3000 Securities Central Depository accounts in Uganda and yet quite a pile of money is held in savings accounts. If people were aware more would be investing in government securities,” he says pointing to the consistently high returns on the USE.

“About four counters have consistently given a return of more than 16 percent annually since they were listed. For some, the return has been as high as 28 to30 percent annually. Inevitably, there are some counters that are struggling but unit trusts are about diversification so that should not be much of an issue.”

So what are the short to medium term prospects of Uganda’s capital markets? Kalyegira is optimistic. He sees market capitalisation as a proportion of GDP reaching 20 percent from the current six percent.

“We hope to see a greater number of competent licensed intermediaries who are participating in the stock market and an easier and more flexible regulatory framework including a more flexible Collective Investment Schemes  law to facilitate savings; and more awareness generally about the benefits of the capital markets.”

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