Part 3: Kenya’s Kes6 billion regulated gamble

Authorities in Kenya have failed to see the connection between the high rate of fraud in the country's financial markets as one of the biggest factor that discourages retail investors from the Nairobi bourse.

Kenyans losing billions of shillings, to ponzi schemes, poorly governed listed firms, companies that claim to be regulated but are not and online scams, has shaken investor confidence to the core.

Yet increasingly more people are being lured into bad investments shaping their future ideas about how the stocks market works.

When the Capital Markets Authority faced the stark reality of the bleeding investors they considered banning the market like the United States.

But according to insiders, the regulator was worried that a ban would end up challenged in court and in any case Kenyans would just go back to trading on unlicensed websites.

WWW.dot the wild wide west

But this helplessness was weird. The Capital Markets Authority, working with the Communication Authority of Kenya (CA) together with the Central Bank of Kenya had the capacity of closing down payment channels for unlicensed brokers.

According to insiders, CMA wrote a letter to CA and they have not heard back since January 2023.

As they waited on the shores the reach of forex dark web has been expanding and sweeping young gullible investors.

A photographer friend of mine who has the vaguest idea about how world currencies get their valuations asked me one day what I think about currency trading. All he knew about it himself is some social media personality who claimed to trade forex and lived a flashy life.

Interweb was not targeting the sophisticated investors, they had gone for the retail traders, village old men and excitable young hustlers looking for a quick buck. Their con was easy to spot from the multilevel marketing, the scanty details about the product offering and the illusion that anyone can trade currencies.

Their competition was stealthier. The unregulated online traders operated in the wild west collecting money and vanishing since some of these operators have no physical presence in Kenya, hence the regulator cannot follow up when punters lose their money.

Regulatory crackdown

The problem of global businesses operating without licensing or paying taxes is rife in the financial sector. It is especially widespread in the capital markets where operators have turned to social media with fake regulatory endorsements to lure unsuspecting Kenyans into sending them money on pretext of helping them to invest.

There has been a proliferation of con games targeting unsuspecting individuals by luring them to unregulated products with huge returns.

Most unregulated products are operated in obscurity as products which resemble securities or capital market instruments and some even claim to have been given regulatory approvals.

The Capital Markets Authority (CMA) told parliament it has investigated 500 unregulated products including online forex frauds, illegally pooled funds, crypto currency, real-estate and ponzi schemes, ordered refunds and instituted criminal charges.

The most common fraud cited by the regulator are online forex schemes where unregulated firms pose as brokers and collect money from the public for buying currencies online.

Foreign based firms also lure Kenyan investors asking them to send their money to offshore accounts for buying and selling currencies, shares, commodities and metals like gold online, but the firms fail to wire back the proceeds when they want to cash out.

The markets regulator has cracked down on 40 online forex traders operating without a license including Iforex time, Trends Forex Traders, AutoTrade Markets, Everjoy Forex Institute, Interweb Global Fortune and Thika Forex Trading Lounge.

For those operating abroad, the regulator does not block their sites but notifies advertisers not to market their products and payment service providers not to accept to be used as conduits to send money abroad.

CMA has also issued a joint notice with the Central Bank of Kenya warning Kenyans from dealing with unlicensed online money traders as digital tools make it difficult to catch the firms most of which operate from foreign countries.

The regulator said the solution was to get trusted brokers who investors can physically locate and report to the regulator if they get cheated.

Trojan horse

When Treasury gave CMA mandate to clamp down on the market, the regulator was convinced at the time that the best way forward was to license players to lock out fraudulent schemes.

State officials gazetted the Capital Markets Online Foreign Exchange Trading Regulations 2017  , which  brought the oversight of online foreign exchange brokerage services under the Authority, including licensing and supervision of entities.

In fact, the regulator expects the brokers to deal only with sophisticated clients, chose and manage investments prudently for its online forex trading clients and develop appropriate investment strategies to hedge for losses.

But the lure of making a quick buck and the attractiveness chic looking money manager will always do the trick.

It also brought in new revenues to the regulator who would cash out on registration fees, as the forex dealers needed to raise Sh50 million in minimum capital.

This would turn out to be pocket change as UK and Cypress firms rushed to gain local market share to trade currencies online that promised 90 percent returns.

Cyprus based online currency trader SCFM Limited trading as Scope Markets, and UK based Execution Point later renamed to EGM securities that operated as FXPesa were some of the companies that got licenses.

Others included Pepperstone Markets, Exinity Capital East Africa Limited, HFM Investments Limited (Trading as HFM), Windsor Markets Kenya Limited and Tadenex Limited (Exness Group) that were licensed between 2019 and 2022.

They saw Kenya as the perfect stepping stone into East Africa giving them the legal legitimacy of East Africa’s most vibrant capital markets.

Insiders say CMA has been receiving numerous enquiries around this license category and is currently processing 4 other applications.

Open padlock

When the regulator pulled up trading data over the last five years, they realized this was a very volatile market with sudden unpredictable price swings yet the leverage or bets were highly speculative which meant someone either won big or lost disastrously.

This market was also rigged at the global level, skewed towards liquidity providers, international financial institutions set up as banks, prime brokers or investment banks, who controlled the market by trading with each other.

These players traded very opaquely, over the counter and bilaterally and since the non dealing forex trade does not involve physical assets it was almost impossible to understand how they reached at prices.

“Due to the non-exchange traded nature of the FX Market, it is almost impossible to monitor the price discovery. The international players thus been suspected of pursuing manipulative behaviors,” an internal document by the Markets regulator seen by this writer reads in part.

If I had invested in EGM securities I would have been among the people who had invested Kes3.4 billion in the company over the last four years and there would be a 93 percent chance I would have been among those who lost Kes3.1 billion in the process.

According to regulatory data shared within the markets authority, 87 percent of those who put Kes1.4 billion in SCFM lost their money and 84 percent who put their money in HFM came out empty.

The regulatory data shared within the markets authority shows, 87 percent of those who put Kes1.4 billion in SCFM lost their money and 84 percent who put their money in HFM came out empty.

Cigarette smoking is bad for your health FX is bad for your wealth

CMA has issued guidelines on client losses that have been in effect for the last six months. Each of the nine regulated brokers is required to display their client-loss ratios on their website.

The regulator believes that if only they can warn Kenyans with cigarette size billboard warning perhaps they may just stem these huge losses.

The regulator said it now wants clients to receive regular and standardized risk warnings, including information on the overall percentage of retail client accounts that lose money when trading Online Forex/CFDs. The regulator thinks this offers the path of least resistance since the brokers who have group subsidiaries in EU and UK are already required to do the same.

The regulator says it will help investors make ‘more informed decisions drawing retail clients’ attention to the high risks including the unlikelihood of making a profit and the possibility of losing more money than they anticipated’.

But even here the regulator and the market do not agree on the metrics that constitute loss ratios. When I asked EGM securities how the move to publicly declare their loss rations are over 90 percent would impact their business, they said as of the last 12 months ending October 2023, EGM Securities (FXPesa) had 63.3 percent, the lowest in the industry.

“The new guidelines are great since they reflect the work we are doing in the industry. “The industry will be more transparent with these new guidelines and other brokers will spend more resources to educate and upskill their clients to build long-term client relationships and lower client loss ratios,” Rufas Kamau, Lead Market Analyst, FXPesa said.

Read also: Part I Hot Forex, my kind of gamble