The Capital Market as an Investment Opportunity in Uganda Finance Essay

Abstract

The purpose of the study was to examine how the share market has developed in Uganda from inception of the Capital Markets Authority in 1998 to the current date, 2010. A qualitative study using a descriptive method was used. Key stakeholders were identified as African Alliance, a broker, Stanbic Bank an issuer, the Uganda Securities Exchange (USE) as the Exchange Market trading platform and the Shareholders. Primary Data was collected by using structured interviews that were held with the key stakeholders mentioned in the previous paragraph and Secondary data from various books and the Internet. The findings from the data collected are presented in form of graphs and tables. The study revealed that Uganda is at the stage of developing its Stock Exchange Market and is still far from the standards of most International Stock Exchanges. This is mainly because there are a few stocks available in the country as compared to the growing economy, the confidence of Ugandans to buy stock is still low due to the exposure that Stock Exchange over the last few years has had in the country and the companies that are still family based private institutions. 

INTRODUCTION

With the advent of financial liberalization, a wider choice of business investment opportunities has been created as a measure of economic development. Today, one way of determining a country's developing economy can be through its stock exchange. Growing activity and increased investment in the stock exchange indicates a developing economy in the business world [1] . The stock market has proved to be a vital source for companies to raise money other than the traditional bank loans and it improves a company's valuation through the price discovery mechanism. It also creates a platform for savings for investors who wish to participate as Shareholders in these companies. Uganda being a developing country, the introduction of financial instruments and the establishment of the Uganda Securities Exchange has deepened the financial sector encouraging local and foreign investors. USE as a stock governing body was created because of Uganda Government's privatization policy where state owned companies were disposed.

The Government would sell a percentage of small number of its shares to the public and retain a percentage for a core investor. This was aimed at promoting wide spread ownership by involving the people of Uganda in the buying of shares of these privatized companies. The basic function of USE is to provide a facility for raising funds for investment in long term assets. Being a developing country with difficulties in accessing finance for new and small companies, the stock market provides a good platform for raising capital and mobilizing savings for investment opportunities. The USE was established in 1997 and the first security, the EADB bond was listed in 1998. Currently, there are 14 listed equities, six corporate bonds and over forty government bonds fairly representing a growing securities market. However compared to the neighboring Kenya stock market with 49 companies, there is still potential for growth. These companies were majorly *Parastatals, which were wholly or partially owned by government. According to Stuart R. Cohen the best source of capital is public investment through the purchase of shares [2] .

In spite of there being 14 listed companies on the Ugandan stock market, development has been unpredictable (refer to Table 1). Based on these facts and from my observation as a Stanbic Bank shareholder, the slow development could be attributed to the shallow financial sector, lack of confidence in the stock market, insufficient knowledge poor governance practices and lack of incentives or interest for companies to list on the stock market. Therefore the purpose of this study is to examine the development of the share market from inception to 2010 with specific reference to Stanbic bank as the biggest issuer and African Alliance as a significant broker. The findings from this study will be able to assist USE to formulate specific solutions to identified problems, stimulate others to research further into the areas identified and benefit myself to acquire techniques required to do my research when I join University.

In reviewing the period between inception and the current situation of the share market, Uganda Securities Exchange were looked at in general. The USE is the Ugandan stock market governing body; it was formed in May 1997 after receiving a license form the Capital Markets Authority (CMA). It is a private company with a board of directors and articles of association, the exchange regulates the trading of shares. The Uganda securities exchange in Uganda is so far the only licensed stock exchange body that has controlled all stock activity in the country since 1997. Its main function is to provide a facility for raising funds for investment in long term assets in the country. It also mobilizes savings for investment, creates liquidity and helps in the growth of the related financial services sector. To date, there are fourteen (14) companies listed in the security exchange In examining the existing secondary literature, the aim was to broaden the understanding of identified themes highlighted in the introduction above.

THE STOCK MARKET AND ITS OPERATIONS

On a simplistic view, a capital market is just like a normal market where people go to buy and sell or trade goods. Specifically a capital market deals with the entire range of activities that relate to buying and selling of financial instruments which include government treasury bills, bonds, company shares of stock. [3] AA stock exchange or stock marketA is known as a secondary market where securities which are already in circulation are formally bought and sold through brokers. [4] The purpose of a stock exchange is to monitor the exchange of securities between buyers and sellers of stock. These exchanges provide real time trading information on the values of stock for different companies. This process of selling new shares by an issuer to securities dealers is known as underwriting or a Primary Market. When companies sell new shares, it's known as an Initial Public Offering (IPO) a process which Stanbic bank Uganda had to go through. [5] The stocks sold by an Issuer are listed and traded on Stock Exchanges.

Following an IPO the shares are then listed on the stock exchange and traded through the Secondary markets. Share prices are based on demand and supply of the shares, company performance, speculation of future performance, or perception. If there are more shares being offered for sale than purchasers are willing to buy, the price of shares will drop in order to reflect the excess supply. On the other hand, if fewer shares are being offered than there are buyers; the price will rise as an indication of excess demand. Participants in the stock market can range from Small Retail Investors to largeA Institutional Investors, Brokers, dealers and fund managers. Some exchanges of stock are at Physical locations where transactions are carried out on a trading floor, through theA open outcry system, the method currently used in the Ugandan Stock Exchange (2010).

This method involves calling out of bids and offers by the floor traders. When the bid and ask prices match a sale is considered to have taken place. This is based on a best price first come basis. Trading is started and ended with the ringing of a bell. [6] The fact that the trading place is located at only the premises of USE in the city center, very few people are likely to know what has taken place at the trading place unless one is physically present. This limits the number of buyers The other type of stock exchange is a virtual kind, composed of a network of computers where trades are made electronically via traders. In Uganda this system of the stock market has not yet been established, Over-the-Counter (OTC) trading of securities although is not allowed. [7] The exchange disseminates information to the public through the media or its website which shows share price movement, corporate announcements and market activity. How they do this is mentioned later in the essay.

THE UGANDAN CAPITAL MARKETS INDUSTRY

 

The advent of Capital Market in Uganda started with the establishment of the Capital Markets Authority (CMA) in 1996 with the purpose of regulating the Capital markets industry. The Capital Market Authority then went ahead to license different players within the industry [8] . The Uganda Capital markets Industry has the following players: The stock exchange Fund Managers Brokers/ Dealers Collective Investment Schemes (CIS) Registrars Custodians

THE STOCK EXCHANGE:

The stock exchange as mentioned in the previous text has been predominantly run by the Uganda Securities Exchange since its establishment in 1998. The exchange provides the platform for trading all shares and securities that have been listed on the stock market and also gives updates on the current share prices in the official newspapers and on their online website. Stock market requirements in Uganda: In order for a company to raise capital and list on the Ugandan Stock Market it has to undergo a due diligence process, prepare a prospectus, meet the listing requirements and seek the approval of the CMA and the USE. Some of the major requirements of the CMA and USE are the track record of the company, audited accounts of the company for the past two to five years and net asset requirements.. The Central Depository System (CDS). The USE introduced CDS in 2010. This is and electronic register. When kept in paper form, for safe keeping securities owners of shares may easily misplace their certificates or even in case of robbery and thus remain with no proof of ownership. Today, all shareholders involved in the trading of shares are required to have a CDS account, in the Securities Central Depository, where ones shares are kept, credited and added to according to their personal transactions. There are still investors who hold their securities in paper form whereby shareholders not trading in shares would have certificates of ownership that indicates how many shares one would have bought and at how much.

THE ISSUERS:

Issuers are entities listed on the stock exchange in Uganda. These entities are required to undergo particular requirements in order to be listed on the stock exchange as listed below. The companies first have to make their shares available or issued to the public and this involves the disclosure of the company's position in terms of financial status, assets, liabilities etc. this is also known as going public. The companies then apply to raise capital and be listed under the different market segments of the Securities Exchange. Once approved to raise capital and/or be listed on the exchange, the companies then have to be listed under a particular market segment. The difference between these segments mainly is the level of requirements with the Main Investment Market Segment being stricter in disclosure terms than the Alternative Investment Market Segment. There are three main market segments; the main investment market segment (MIMS), the Alternative investment Market Segment (AIMS) and the Fixed Income Securities Market Segment (FISMS). The difference between these segments is the level of requirements. MIMS is stricter in disclosure terms than the AIMS. MIMS requires a company to be limited by shares with a minimum of full paid up share capital of one billion shillings (Ushs 1,000,000,000) and the assets of two billion shillings (Ushs. 2,000,000,000) plus published audited financial statements of at least 5 years according to International Standards. AIMS on the other hand requires a corporate body or registered Public issuer, full paid up capital is a minimum of two hundred million shillings (Ushs. 200,000,000) and net assets four hundred million shillings (Ushs. 400,000,000) and requires audited financials of at least two years. There is need for the USE to provide a sense of direction to the potential issuers about the alternatives they have. Many Potential issuers especially those without strong brands are not aware of the opportunities available at the sock market.

BROKERS/ DEALERS

These are the middle men in the stock market. They are involved in the buying and selling of shares on behalf of the investors. In Uganda one cannot buy or sell shares that are in the secondary market (shares already in circulation) without a broker, this is bound by the law of Uganda therefore they are very crucial players in the stock market. There are 9 licensed Broker Companies currently operating in Uganda which include African Alliance, Baroda Capital Markets, Crane Financial Services, Crested Stocks and Securities Limited, Renaissance Capital Limited, UAP Financial Services, Equity Stock Brokers, Dyer and Blair (UG) Limited and MBEA Brokerage services. Brokers receive orders from clients that wish to sell their shares and they link them up with other clients who may wish to buy shares from particular companies. The brokers earn a fixed commission of not more than 2% from all the trading activities.

INVESTORS:

These could be classified under the buyers of shares and are also the parties that determine the success of the stock market. Investor in Uganda can be categorized into four categories: Foreign institutional investors These include companies and organizations that are not based within the country and take interest in the buying and selling of shares in Uganda. These include fund managers like for pension funds that possess a lot of liquidity and use this is for investing in the stock market Foreign individual investors Local institutions These are indigenous companies and organizations that take interest and engage in the trading of shares on the stock exchange. This is also normally taken up by companies with liquidity and can afford to engage in this type of continuous trading for example private pension funds, insurance companies, etc. The National Social Security Fund (NSSF), the country's largest pension fund, is known to be the largest individual shareholder in most of the companies that are listed on the USE like Stanbic Bank Uganda, DFCU Bank, HFB Bond Uganda. Local individuals This field was initially characterized by the high net worth individuals in the country but as of 2007 when Stanbic Bank was listed on the stock market this has changed. The Bank opened the doors to the widespread ownership of shares the country has ever seen. Stanbic Bank had shareholders buying a minimum of 1000 shares which was equivalent to 70,000 Ug Shs at that time. The Stanbic IPO attracted over 35,000 shareholders. Insert table for shareholder breakdown

Fixed Income Securities Market Segment (FISMS)

This segment entails issuers of bonds who are either corporate or government. The segment is dominated by the government securities. There are a few corporate bonds whose secondary market activity is non-existent. The government bonds are traded over the counter through Primary dealers system (PDS) Primary Dealers System is Banks that are allowed to deal in Government Securities. These banks participate in the secondary market of government securities and they include Stanbic Bank Uganda, Standard Chartered Bank, Barclays Bank, DFCU Bank, Bank of Baroda and Centenary Bank.

GRAPH 1: A GRAPH SHOWING THE NUMBER OF SHARES TRADED BETWEEN JANUARY 2000 AND OCTOBER 2010

The trend in the curve above proves there was accelerated activity in 2007 that was most likely due to Stanbic Banks listing and has been the best since then. It has declined from 2008; one of the major reasons for this is because recent global crisis which saw stock market activity drop across the world. The awareness of the stock market was boosted during the Stanbic IPO period (2007) because Stanbic Bank share price was perceived as affordable and the brand was widely known among Ugandans.

STANBIC BANK (U) LTD

Stanbic Bank is part of the Standard Bank of South Africa Ltd. It is the largest financial institution with the largest branch network in Uganda. The Bank is incorporates in Uganda under the Companies Act as a Public Liability Company. In 2002 SBU acquired 80% shareholding in Uganda Commercial Bank Ltd a government institution under the Privatization policy. Stanbic Bank Uganda joined the exchange in 2007 when it was listed by on the Uganda Securities Exchange's main market segment. It was concluded to be a successful venture for the company when they realized an IPO (Initial Public Offering) that was 200% over subscribed, the highest subscription in Uganda's IPO history. The bank also received tremendous international interest from investors mainly from Kenya. Stanbic banks forthcoming transition into the stock market was first introduced during the takeover of Uganda Commercial Bank by well-known Standard Bank (Stanbic Banks Mother Company) with its headquarters in South Africa. One of the agreements between these investors and the government of Uganda was to eventually sell part of the company to the public after a period of time, and in 2007 this was done with the government giving up it 10% of the company and the investors matching 10% of their ownership and so 20% of the company was sold as shares. [9]

During companies IPO, just like Stanbic, a number of factors would contribute to the public's interest in the acquisition of shares from that particular company for example the Brand strength and recognition. Stanbic bank is a very successful bank, a branch of Standard bank, one of the biggest banks in Africa therefore the public was already aware of the company and some of its capabilities. Other factors like marketing, timing, size of share on offer also contribute to the subscription of shares. The recent Stanbic Bank Initial Public Offer was in line with the objectives of the Government's divestiture programme that seeks to remove state participation in the ownership of a variety of companies. Shares equivalent to 1,023,773,394 were offered at a price of Ush 70 per offer share, this consisted of the existing issued share capital of the company. 51,118,670 representing 1% were offered for employees of the bank at the same price. The objectives were to enable the Ugandan Public to participate in the equity of SBU and to encourage a wider ownership, provide individualism institutions, investor an opportunity to participate and also provide a market for the shareholders to realize their investments. The response was phenomenal with 37,449 applications for 3 billion shares totaling U Shs 211 billion hence a 200% oversubscription. Stanbic Bank shares are now traded on the Uganda Stock Exchange. Today the Stanbic bank stock market cap is estimated at about 1.3 trillion Shs which is about 650 million dollars as of 11.10.2010 with 5,118,866,970 shares in circulation. [10]

AFRICAN ALLIANCE

African Alliance is an investment bank in Uganda that organizes capital for firms through other means apart from the conventional bank loans. African Alliance also deals in the trading of shares and company bonds, the area I am most interested in. Clients go to the company office as buyers and sellers of shares. The buyers of the shares place a bid for shares listed on the USE for a particular company they are interested in which the company then records. The sellers of the shares also come to the company and set a price for their shares. African Alliance links these two parties when they come across matching bids and prices of share. The company earns its income through the commissions that it chargers its clients. The clients that are selling their shares are credited when their shares are bought; a percentage of the money got from selling the shares (2.1%) is paid to the company. The clients that are buying the shares also pay an additional percentage (2.1%) of the amount he is paying for the shares. The breakdown of the 2.1% commission is as follows: A 1.70% A Goes to the Broker A 0.14% A USE Levy A 0.14% A CMA Levy A 0.02% A Joint USE & CMA Compensation fund A 0.02% A Guarantee Fund 0.08% A SCD Levy African alliance is currently facing a problem of liquidating the market and getting more companies to be listed on the Uganda Securities Exchange, this is because the company earns on commission therefore their transactions are proportional to the income they earn.

Having more companies listed on the stock market attracts more investors to the country and eventually improves the economy, like I had mentioned before, a countries performance in the stock market can be used to determine the economies development. In order for the company to realize more revenues in terms of commissions from shares sold or bought. There is need to sensitize a bigger population. They need to partner with the USE on closing the information gap. With more companies or corporates listing and more people sensitized there revenues will be enhanced and ultimately growth of the company. The company's new transition into an electronic based office system has made it easier for offers and bids to be realized and has made their record keeping more efficient. Previously Certificates were held by clients when they acquired shares from the USE but were given up to the company when they placed their offers to sell shares. The certificate system made the clients vulnerable because they could easily be lost or misplaced.

CONCLUSION

The major conclusions from my study are drawn from the findings and investigations and are reported based on the Research Question, "Examining the development of the share market as an investment opportunity in Uganda" At the beginning of the investigation it was established that the stock market is not developed to the level it should be at after thirteen years in existence. I based this assumption on the other International Stock Markets like Kenyan Stock Market and the American Stock Markets. In spite of the Nairobi stock market having been in existence for over fifty years as compared to the thirteen years for Uganda, the mix of the listed companies and corporate bodies is a good indicator of a developed economy. The major reason why the share market is unpredictable in Uganda has been identified as below: There are few stocks/ shares available in the country compared to the growing population and increasing investors. This limits the investor's potential and interest in the country. The confidence the population has in the stock market is still low. The population is still rigid to jump into investment opportunities like the Stock Exchange because they do not have enough information and trust in it.

There is also a lack of a clearing house to manage efficient transfer of securities from owner to purchaser. Since trading is only done through a few brokers, the possibility of not getting the right information in a timely manner as to make an investment decision. Uganda still has mainly a family based business system. The stock and share market involves a company exposing its financial status, declaring all its possessions to a large group of people. Most of the companies listed in the Ugandan Stock Market are international institutions like Stanbic Bank and Kenya Airways; companies as identified in the review have the capacity to market and advertise before listing. The requirements of listed companies to prepare and distribute periodic reports to shareholders and the Exchange market are not very welcome by local companies as it is perceived that it will expose them to higher taxes by revenue authorities. Also a recent article in the New Vision Newspaper (06/02/2011) highlights a lack of incentives i.e. tax holidays for companies to join the Stock market. The lack of public awareness could contribute to the unpredictability of the history of the Ugandan Stock Market.

In 2007, the interest was at its highest because the bank created awareness and population saw an opportunity to invest at a relatively low price but the lack of sufficient knowledge led to the interest's decline because the investors were now satisfied with their involvement which should not be the case. The public is also not made aware of the market segments like the AIMS which provide fewer and easier requirements to fulfill. They presume that disclosure terms are all similar. It is important that the USE provides a sense of direction by informing the public about the possible alternatives in joining the Stock Exchange. The prices of stock and shares are still high relative to the earning per share. In 2007, Stanbic bank sold their shares at a 70shs, an affordable price and the Sock Market witnessed the largest interest in buying of shares. Companies that listed after Stanbic priced the share much higher, hence having less enthusiastic from the public. 

In order for the Share market to develop fast and more steadily in Uganda the following suggestions could be taken into consideration. The government should quickly put in place incentives and policies to attract investors in the Capital Market. The government should also attract more SME's and local corporates by putting policies in place that would assist businesses in times of losses. The Uganda Securities' Exchange together with the Ugandan Government should organize a campaign to sensitize the public about the operations of the Stock Exchange, attracting more companies on the benefits of saving as alternative methods to using banks. Investment advisors should be recruited to provide information and recommendations to the local investors and to interest new investors as well to participate in the Stock Market. Electronic awareness either through mobile message or email to owners about the share price would increase sellers and hence more buyers and fluctuations in the share price.

Data collection tools

Appendix I: Interview with the African alliance Staff

My name is Vernon Kihuguru. I am a Business and Management student at Aga Khan High School doing my Extended Essay in Business and Management. My topic is the introduction and development of the Ugandan stock Market which Stanbic Bank Uganda Ltd as my case study. Below is the interview I carried out with a management staff of Africa Alliance. It was a pre- written interview where I used an interview guideline which was answered without my presence and sent to me by email. The limitation of this interview is based entirely on the nature of African Alliance's line of work hence their inability to give detailed information about their operations.

What kind of financial institution is African Alliance?

African Alliance is an Investment bank.

What exactly does African Alliance do?

As an investment bank, we organize capital for firms through new channels apart from the conventional bank loan a firm can apply for from commercial banks. We have three departments: Corporate finance: - deals with arranging deals like IPOs (Stanbic, DFCU), private placements (Good African Coffee) , rights issues(New Vision) Securities: - that deals in the trading of shares and corporate bonds Unit Trusts:- deals with managing clients funds, be it saving or pensions (similar to NSSF)

How do carry out your everyday operations?

In securities, which most people are familiar with, clients place purchase orders to buy stocks listed on the Uganda Securities Exchange (USE), while at the same time clients with the intention to sale place their shares offers on the same market. If the prices of the sellers (offers) meets that of the buyers (bidders), then a deal is struck.

What challenges do you face in this industry?

We face challenges of making the market liquid. Finding buyers and sellers to transact as often as possible is the main goal for we are paid on commission. We have challenges of getting more companies listed on the exchange, for it gives more investment avenues and options to prominent investors.

How do you earn from the stock exchange?

We earn in for of commission per transaction we carry out. Let's say we have client selling 1,000 Stanbic shares at UGX 265. His shares are worth UGX 265,000. But we charge 2.1% of that value, hence we take UGX 5,565 and we transfer to his account UGX 257,435 and vice versa for buying client taking the 1,000 shares, he would have to top up the UGX 5,565.

What advancements have been made in your sector since the start of the market in Uganda?

We have moved from a paper based system to and electronic trading platform. Before April 2010, all clients received certificates when they bought shares from the (USE) and gave them up when the offered to sale. Now we run on an electronic system where shares bought are placed into an electronic account held by the exchange (USE) and when selling are debited off the account.

Appendix II: Interview with Secretary of Stanbic Bank

What is Stanbic Banks Involvement in the Ugandan Stock Market?

Stanbic Bank Uganda is an issuer of

When did Stanbic Bank get listed and why?

Stanbic Bank was listed in 2007 under the

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