It is expected to reduce the risk of settlement failure in the event an investor unexpectedly runs short of a stock.
Kenya and Uganda have agreed on a plan to allow investors to loan out shares and bonds to brokers as part of efforts to boost activity on their stockmarkets.
The plan has been adopted by the countries’ capital markets regulators and will allow shareholders of listed companies to benefit from both dividends and fees levied on the loaned shares.
It is also expected to reduce the risk of settlement failure in the event an investor unexpectedly runs short of a stock.
Under the proposed arrangement, a broker will borrow shares or bonds from an investor and sell them only when there is demand for a particular stock but there are no willing sellers.
The broker then buys back the stock from the market when prices fall and returns it to the investor and in the process makes a profit through a process that is referred to as short selling.
Short sellers are people who sell shares they don’t yet own, with hopes of buying them back cheaply from the market.
It is argued that such dealers make stock markets more efficient by improving liquidity, reducing overpricing and speeding up price discovery by factoring new information into share prices.
However, there are concerns that short sellers drive down prices of company stocks — since they bet on the share price dropping — to make money.
The European Union introduced short selling regulations in 2012 after capital markets regulators raised concerns that such practices were damaging to the markets and were possibly being abused.
These included suspending short selling on a stock when a suspiciously sharp drop in a share’s price was noticed.
The practice was banned in the UK, France and the US to deal with malpractice such as spreading of negative information to manipulate market prices.
“Dealers will need the ability to borrow stock from time to time to meet their obligations. Therefore, a securities lending and borrowing arrangement needs to be put in place.
“Such a service can also be used by other market participants to meet unexpected delivery shortfalls or short selling operations,” said Kenya’s Capital Markets Authority.
In Uganda, there is no legal framework or infrastructure yet for short selling in bonds but the Bank of Uganda is considering introducing securities lending in the wake of strong market demand for short selling.
Sell buybacks are being “considered,” according to the Uganda Capital Markets Authority.
Uganda is also seeking to increase the number of listings on the Uganda Securities Exchange, which currently stand at 16, of which eight are primary domestic and eight others are cross-listed from the Nairobi Securities Exchange.
Its recommendations on how to bring more companies to list include removing tax disincentives and granting an amnesty on companies identified as tax defaulters but which are willing to get listed.
Other East African stock exchanges are also finding it difficult to attract companies to list.
For instance, the NSE and Dar es Salaam Stock Exchange have only listed five firms since the launch of the SME trading platforms in 2013.
The Rwanda Stock Exchange has not attracted any.