In the recent past, Kenya’s capital markets landscape has been characterised by uncertainties and periods of turbulence, with several listed firms grappling with financial distress. Several firms listed in the Nairobi Securities Exchange (NSE) have ended up being subjected to insolvency procedures, either through liquidation or receivership. This downturn has been fuelled by a combination of high debt burdens, foreign exchange fluctuations, operational inefficiencies, and weak corporate governance.

In 2023, for instance, the financial strain on non-financial NSE-listed companies became evident, with profits plunging by 58%. Rising input costs, shrinking consumer purchasing power, and supply chain disruptions created a challenging business environment. Compounding these concerns, the Growth Enterprise Market Segment (GEMS), originally designed to attract small and medium-sized enterprises (SMEs), failed to gain traction, further dampening investor confidence in the capital markets.

In response, the Capital Markets Authority (CMA) has rolled out a series of regulatory reforms aimed at stabilising the market and restoring investor confidence. These measures include enhanced corporate governance requirements, stricter financial reporting standards, and clearer disclosure rules. Among the most significant changes is the establishment of a Recovery Board, a dedicated segment within the NSE to support financially distressed firms in regaining stability.

Amendments to Rule 5.10.1 of the NSE Trading Rules

At the cornerstone of these reforms introduced by the CMA is the amendment of the NSE Trading Rules, specifically Rule 5.10.1. The changes target speculative trading in struggling companies, fostering better governance, transparency, and investor protection.

A key provision is the creation of a Recovery Board within every market segment, including the Main Investment Market Segment (MIMS) and the SME segment. Companies that experience severe financial and governance difficulties will be placed on this board, where they will have up to two years to implement recovery strategies. Failure to make sufficient progress within this period could result in delisting, subject to CMA approval.

To curb market speculation and price manipulation, the daily price fluctuation limit for stocks of distressed firms has been reduced from 10% to 5%. This measure is designed to prevent excessive volatility, which speculative traders can exploit. Additionally, stricter disclosure and compliance requirements have been imposed, ensuring that firms on the Recovery Board regularly update the market on their financial health and recovery progress.

The reforms also introduce stringent new eligibility criteria for companies seeking NSE listing. Firms must now demonstrate financial resilience, with a minimum paid-up capital of Kshs 50 million, assets exceeding Kshs 1 billion, and a senior management team with a solid governance track record. Furthermore, listed companies must show evidence of sustainable working capital and clear growth potential.

Implications for the banking sector

The changes introduced by the CMA are expected to have far-reaching effects on the country’s banking sector, particularly in risk management, lending practices, and investment strategies, as below:

• Stricter lending policies

The placement of firms on the Recovery Board signals heightened financial instability, making them riskier borrowers. Banks that provide credit to NSE-listed firms in distress may now reassess their risk exposure, potentially demanding additional collateral, imposing stricter loan conditions, or even raising interest rates to compensate for the increased risk. If a company fails to recover within the designated two-year period, banks may be forced to restructure loans or classify them as non-performing, increasing their default rates.

Additionally, under Central Bank of Kenya (CBK) regulations, banks are required to provision for bad loans when borrowers show signs of financial distress. With more companies expected to be placed on the Recovery Board, banks will likely have to set aside higher reserves to cover potential defaults. This could impact profitability, especially for institutions with high exposure to struggling sectors such as retail, manufacturing, or real estate.

• Impact on investment portfolios

Many banks invest in NSE-listed stocks as part of their treasury operations. However, the new 5% daily trading limit on distressed firms’ shares could create liquidity challenges, making it harder for banks to offload such investments. In response, banks may shift their funds toward safer asset classes, such as government bonds, fixed-income securities, or blue-chip stocks. This move could reduce overall market participation by banks, potentially affecting stock market liquidity.

Moreover, banks that are themselves listed on the NSE will now face increased scrutiny under the enhanced corporate governance and disclosure requirements. They will be required to improve transparency in areas such as capital adequacy, non-performing loans, and risk-weighted assets. While these measures are aimed at strengthening market confidence, they also introduce higher compliance costs. Banks will need to invest in better financial reporting systems, investor relations, and internal risk management frameworks to meet regulatory expectations.

• Potential risks of delisting

Perhaps the most significant risk posed by these new rules is the potential delisting of financially troubled banks. If a listed bank is placed on the Recovery Board due to financial distress, it could trigger panic among depositors, leading to liquidity pressures and possible capital flight. Additionally, other banks may reduce interbank lending to the affected institution, exacerbating its liquidity challenges. Should market confidence erode significantly, the CBK may need to intervene, either through regulatory oversight or emergency stabilisation measures.

Conclusion

While these reforms may create short-term disruptions, they are expected to bring long-term stability to the country’s capital markets. It is writ large that the CMA and NSE are keen on creating a more predictable and resilient investment environment by working to discourage speculative trading, improve corporate governance, and enhance investor confidence.

For banks, these changes signal a need for more cautious lending and investment strategies. Strengthening capital buffers, improving risk assessment frameworks, and enhancing governance practices will be critical in navigating the new regulatory landscape. While the transition may be challenging, these reforms ultimately aim to foster a stronger, more transparent, and well-regulated financial sector.