Editor’s note: This is general educational material on how a market mechanism works. It is not investment advice and it does not evaluate any company or security. It is based on the Kenyan statute, the depository’s own descriptions of its services and the exchange rulebook listed at the end.
Analysis: what the paperless market bought, and what it did not
The depository’s own long-run figures show the scale of the change around the transition, though they do not isolate its cause. Market turnover rose from Kshs. 15.3b in 2003 to Kshs. 209.4b in 2015, market capitalisation from Kshs. 259 b in 2003 to Kshs. 2.7 trillion in early 2015, and the number of deals per year from 93,300 in 2005 to 406,632 in 2015. Account growth around a single large listing is starker still: the number of CDS accounts increased from 0.8 to 1.7 million around the Safaricom listing. Automation, two major initial public offerings and a long bull phase all sit inside that period, so the correct reading is that paperless infrastructure was a precondition for the growth in deal count rather than a demonstrated cause of it.
The settlement cycle is the more useful measure, because it is a direct output of the system. It moved from T+5 to T+4 and then to T+3 in July 2011, and it has stayed at T+3 since, with the 2015 change moving the cash leg to central bank money rather than shortening the cycle. That is a deliberate ordering: settlement finality was improved before speed. It also means the securities leg is now the constraint, since a gross, trade for trade securities process and a net cash process compress differently.
What the framework does not remove is intermediary dependence. The record of depositors replaces the register of members, but the account is opened and maintained by an agent, and an investor’s access to their own holding runs through that agent. The Act’s own answer to that risk is structural rather than individual: segregation of client from proprietary accounts, fit and proper tests for agents, a default process, and a guarantee fund that stands behind delivery and payment. A reader assessing the system would look at the size and funding of that fund against daily settlement values, and at whether the T+3 cycle set in 2011 still matches the practice of the markets Kenya competes with for portfolio flows.
What the documents say
A Kenyan share certificate is no longer proof of anything. Since the dematerialisation of listed equities was completed, ownership of a Nairobi-listed share exists only as a record in the Central Depository System operated by the Central Depository and Settlement Corporation. The paper did not simply fall out of use. It was legislated out, in stages, by the Central Depositories Act, 2000 and the rules made under it.
Two different removals of paper
The Act separates the two operations that people often merge. Part III deals first with immobilisation: the prescription of securities for immobilisation, the verification of certificates and their transfer to a central depository or nominee company, and transitional provisions for trading eligible securities. Under immobilisation the certificate still exists; it is verified, lodged and frozen, and trading moves to entries against it.
Dematerialisation is the harder step. The Act provides for the prescription of dematerialised securities, requires the central depository to maintain an official record of depositors, and bars an issuer from issuing certificates in respect of dematerialised securities. On or after the dematerialisation date every issuer of a prescribed security must surrender the physical register of members or debenture holders to the central depository and supply information on any holder appearing in that register with a certificate not already immobilised. From that date, and notwithstanding the Companies Act or the issuer’s own articles, a reference to a register of members or debenture holders maintained under the Companies Act is deemed to be a reference to the record of depositors maintained by the central depository. Withdrawal is closed off as well: no person may withdraw a security prescribed as a dematerialised security from a central depository.
The depository’s own account of the timetable is precise. Operations commenced in November 2004 and immobilisation proceeded in tranches, with full delivery versus payment settlement for all listed companies achieved on 28th February 2005. Dematerialisation began in 2012 and concluded on 1st November, 2013, when shares of all firms listed at the exchange were irreversibly converted into electronic form, with corporate bonds following in 2014. Share certificates are therefore no longer recognised as prima facie evidence of ownership of shares.
Who holds the account, and what the depository actually moves
Ownership records sit one layer away from the investor. Central Depository Agents, which are stockbrokers, investment banks or custodian banks, open and maintain securities accounts, and clients’ securities accounts are segregated from participants’ proprietary accounts. A client may open accounts with several agents while keeping the same account number, and may move securities between agents by instructing the current one. Where certificates were still being deposited, the depository forwarded them to the issuer’s registry for confirmation of authenticity and credited the client account only on receipt of written confirmation, a step designed to keep invalid securities out of the system.
Collateral is handled inside the same record. A pledge is created on a standard form approved by the agent and the lender, delivered to the depository, where the securities are frozen and confirmation goes directly to the lender. A release form completed by the lender and the agent unfreezes them. Throughout, the pledgor remains the shareholder of the pledged securities, but cannot access them until the release instruction is submitted.
Settling without a certificate
Settlement uses delivery versus payment Model 2: securities settle in the depository on a gross, trade for trade basis while funds settle on a net basis through the settlement bank. Every settlement participant holds a settlement account at that bank. On settlement date the net funds transfer takes place and, simultaneously, the seller’s securities account is debited and the buyer’s credited. The depository describes this as guaranteeing irrevocability of settlement within a rolling T+3 settlement cycle. Since 2015 the cash leg has run through the Central Bank of Kenya’s real time gross settlement system, while the securities leg stayed at the depository with the T+3 cycle maintained.
Behind that sits a fund rather than a promise. The Act obliges a central depository, as a condition of its licence and subject to the Authority’s approval, to establish adequate settlement guarantee arrangements, and provides for a Central Depository Guarantee Fund. The depository describes the fund as a mechanism to ensure the selling agent delivers securities and the buying agent effects payment, built from a contribution of Kenya Shillings five million from each Central Depository Agent or such higher amount as the depository may determine in consultation with the Authority and the exchange, plus penalties and fines it imposes, investment income, a levy on every transaction through the exchange as approved by the Authority, and contributions from its own revenue.
The exchange rulebook shows where the two systems meet at the end of a day. Trading participants have fifteen minutes after the close to request trade corrections, those corrections may only be made in respect of a CDS Account, and where the exchange approves one, the central depository effects the necessary adjustment to the trade. Every correction must be made before the reference price for each security is computed.
