Trust Funds for Protecting and Preserving Wealth

Earlier this week I read a newspaper story about a mineral billionaire who passed away recently, and his estate administration turned into chaos and hate among family members. In digesting what is written I thought about the role of trust funds and how helpful they can be in such situations.
Trust funds are a great way to build, protect and preserve wealth for future generations, but many people tend to shy away from them because they think they are only for the rich. Almost same perception held for stock markets investments. Although it also true that trusts have an association with rich and powerful families, but trust funds can make a lot of sense even if you are a widowed mother who just wants to leave some form of wealth to a child to help him or her complete his or her education.
Before we proceed – let us answer the basic question, what is a Trust Fund? it is a special type of legal entity that holds assets/property for the benefit of another person, group, or organization; and there are three parties involved in almost all trust funds:
• The Grantor: the person who establishes the trust fund, donates the property (such as cash, shares, bonds, real estates, investment units, livestock, art, a private business, and other valuables bequeathed to a minor as is declared in a formal will) to the fund, and who decides the terms upon which it must be managed.
• The Beneficiary: the person for whom the trust fund is established. It is intended that the assets in the trust, though not belonging to the beneficially, will be managed in a way that will benefit him or her, as per the specific instructions and rules laid out by the grantor when the trust fund was created.
• The Trustee: The trustee, which can be a single individual, an institution, or multiple trusted advisors, responsible for overseeing that the trust fund maintains its duties as laid out in the trust documents and applicable law. The trustee is often paid management fee. Some trusts give responsibility for managing the trust assets to the trustee, while others require the trustee to select qualified investment advisors or a custodian to handle the money.
Over time the need for trust funds has become increasingly popular, and in demand, occasioned by the unfortunate occurrence of death or other events, and as it should be beneficiaries (i.e. minors) are practically incapable of making choices on how to use assets/property left for them by their parents or guardians. In such cases, trust funds are great vehicles that ensure the purpose for which assets were set is met.
Even in cases where the deceased may have omitted some dependents knowingly or otherwise, Trustees would normally have discretionary rights on how to have funds distributed, however, whatever it may — it would be best to ensure that the funds are distributed according to the wishes of the deceased. In case beneficiaries they are minors, funds should be set aside as a trust to meet obligations that range from upkeep to school fees in favor of the minor.
So, why would one consider using a Trust Fund? In addition to the beneficiary’s protections, there are several reasons trust funds may be of use, among others, these may be key:
• If you don’t trust your family members to follow the letter of your intentions following your passing, a trust fund managed by an independent third-party trustee can often alleviate your fears.
• Parents often set up trust funds for their children, designed to pay educational expenses. When the children graduate, any additional principal remaining is distributed as start-up money which they can use to establish their post-college life.
• Trust funds can protect assets that you cherish, such as a family business, from your beneficiaries. Imagine you own a bottled water factory and feel tremendous loyalty towards your employees. You want the business to continue being successful and run by the people who work in it, but you want the profits to go to your son and daughter, but who has an addiction problem. By using a trust fund, and letting the trustee be responsible for overseeing management, you could achieve this. Your son would still get the financial benefits of the business, but he would have no say in running it.
What we learn is that, to a great extent, trust funds ease the burden on the guardian or the surviving spouse who now has to raise children alone, even once the children come of age, with the approval of the trustees, the remaining funds can be released to them directly.
How does it work? Trustees normally set up a trust fund which can have a pool of trusts managed professionally by a team of service providers such as a fund manager and/or a custodian who may a bank. This ensures transparency in the day today transactions of a fund. These service providers report to trustees on the schemes of performance and other functions as per their mandates.
However, bearing in mind the costs needed to set up a trust and maintain it, trustees can opt for already existing trust funds in the market, unless it is completely necessary to do so. Under the principle of economies of scale, a pool of trust funds will help in cost saving while maximizing on returns.
Although trustees can opt to continue managing these funds on behalf of the minor, having the funds managed in an established trust fund that houses a pool of schemes is often easier as directly managing the same can be demanding. This has to be done through the consent of the guardian with the sole purpose of helping them better understand the decision and why it is easier. Well set up trust funds ensures money is continually invested and good returns are realized.

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Shareholders Activism for Better Performance of Listed Companies

Often, shareholders of listed companies do not understand their roles in companies that they have invested into. This assertion will particularly in evidence where something has gone wrong with the company, or where there is lack of details about what is happening with such a company, etc. In most of these cases, investors tend to think, it is either the regulators or the stock markets that should play the role. This thinking is both true and wrong — I will explain:

One of the core mandates for the regulator or the stock market, in this context, is to promote investor education, awareness and creating public interest in the capital markets products. The aim real is to ensure that shareholders gain the necessary skills in line with their governance system to hold the board of directors and management accountable in relation to the manner in which they execute their mandates, as stewards of shareholders/investors interests in the company.

Apart from investor education, regulators and exchanges also have the role of carrying out an assessment of any proposed issuance of securities (shares, bonds, etc) to the public prior to raising capital or listing these securities into the stock market. Such assessment seeks to establish the extent to which the envisaged offer meets the eligibility requirements for capital raising from the public and for listing into the stock exchange.

Prior to issuance of securities to the public, the issuer is required to prepare the prospectus or information memorandum that provide details of the prospective security and disclosure of the relevant information that will help investors understand the nature of the security on offer, the company behind the security on offer, its strategies, its financial wellbeing, its future outlook, its risks and risk mitigation as well as its governance and control mechanisms.

Through the prospectus, and during the approval process for the prospective issuer’s prospectus, the regulator and the exchange gets an opportunity to sometimes interrogate the company’s board and management as to the facts stated in the prospectus, challenging their assumptions, ask for further details or seek clarification on matters that requires elaborations, require more detailed disclosures (if need be), etc. Once satisfied, the regulator and the exchange will approve the prospectus ready for capital raising and listing of securities. Up to this stage, the investing public is not so much engaged. Their involvement will start soon thereafter.

Upon approval of the prospectus for capital raising and listing and once the process of capital raising and listing is completed; the company’s board and management are then charged with overseeing that the strategy and operation delivery of the company are in line with indicative disclosures as provided in the prospectus. The board and management are also charged with an obligation to make public disclosures whenever there is any justified material variation from the earlier disclosed outlook and forecasts/projections. They are also required to ensure that there are regular updates to shareholders. Shareholders, through the board of directors are required to approve such updates and other material disclosures that has operation and financial nature. Such updates, by way of continuous listing obligation and/or good corporate governance guidelines, are also reported to the regulator and the exchange.

Furthermore, the board and management are charged with ensuring that there is a sound risk management and controls and that mitigation mechanisms are implemented in timely fashion for smooth business operations.

So, what is the role of a shareholder in all this? I started by indicating that most shareholders tend to think that the regulator or the exchange or both has a key role as to the performance outcomes or governance of listed companies. The truth is, in many cases shareholders are supposed to contribute to the success or failure of the company to meet its performance and governance expectations. What happens is that many shareholders they lose touch with the company soon as the Initial Public Offering (IPO) process — both the issuer and the investor have a shared responsibility to this. Nevertheless, shareholders are required to increase their engagement with the company in which they have invested their money soon after the IPO process; why and how?

Shareholders selects the board to represent their interest to the company. As it is, the board, delegates this mandate to management —however the board retains the responsibility of ensuring that there is a smooth business operations and risk management mechanisms throughout the company.

By attending in the general meetings, shareholders get an opportunity to make major decisions impacting their rights, exercising their ultimate control over the company and how it is governed and managed, as well as engaging the company on any other matters of interest to them — this includes selection of the members of the board, appointment of external auditors, approval of audited accounts, etc.

With recent experiences of accounting scandals, fraud and company’s mismanagement in some parts of the world — shareholders are encouraged to approach their investment philosophy with a sense of activism, with pushy investing behavior — for better corporate governance and in creating more value for all shareholders. Activists and shrewd shareholders, compared to passive shareholders, are what is needed in the current world of investment climate, especially in recent situations where “principal-agent relationship” needs further enhancement.

Managing Investment Risks by using Collective Investment Schemes

Collective Investment Scheme (CIS), also known as unit trusts or participatory interests are investments in which many different investors put their money together into a portfolio, and then these pooled monies are managed by professional investment managers. These professional investment managers invest the pooled money in different asset classes ranging from shares of listed companies to bonds, money market instruments, to property, etc. This way risks that retail/individual investors cannot manage or mitigate given their limited skills in securities analysis, gets managed by professional investors on their behalf.

The total value of the pool of invested money is split into equal portions called participatory interests or units. When you invest your money in a CIS portfolio, you buy a portion of the participatory interests in the total CIS portfolio. The assets of a CIS portfolio are held by the trustees. A closer example of this structure is the Unit Trust of Tanzania.

The unit price of the CIS depends on the market value of the underlying investments in which the pool of money is invested. This unit price rises and falls (fluctuates) according to the value of the underlying investments based on daily calculations.

What are some of the advantages of CIS over direct investment? CIS provides an ability to:
• hire professional investment managers, which may potentially be able to offer better returns and more adequate risk management;
• benefit from economies of scale i.e., lower transaction costs; and
• increase the asset diversification to reduce some unsystemic risk.

There are two types of CIS, namely CIS in Securities and CIS in Property, also known as Real Estate Investment Trusts (REITs). I will focus on CIS in Securities – what are benefits of investing in CIS in Securities?

• They are affordable and easy – these collective investments are affordable as an investor can invest small amounts of money. This makes it possible for more people to easily invest in underlying assets that they normally would not be able to afford.
• Diversification of risk – as collective investments may be invested in a range of underlying assets, it means that your eggs are not all in one basket. The risk associated with your investment is therefore spread amongst the different underlying assets. If any of these assets perform poorly, your total investment will not necessarily perform poorly as there are other assets that may have done very well. The more diversified your capital, the lower the capital risk. This investment principle is often referred to as spreading risk.
• Good returns — the longer you leave your money invested, the greater the opportunity for your investment to grow. An investment in a CIS in Securities can be repurchased at any time, however, it is advisable that you invest the money for at least 3 – 5 years. The reason for this is that the value of the units of a CIS in Securities can go up or down. If invested for a longer period, one can expect to see the benefit of the long-term growth in the market.
• Professional investment management — an investment manager manages your investments for a fee. However, an investment manager must be registered with the Capital Markets regulator as a financial services provider.
• Your money is accessible — CIS in Securities are easy to sell which means that you can sell all or part of your investment at any time.
• Different investment options — CIS in Securities offer flexible investment options as you can make: (i) lump sum investments – these can be made at any time once you have opened your collective investment account; (ii) debit order investments – you can make regular payments, e.g. monthly, into your account; and (iii) switching – as there are many different collective investment portfolios, you can switch between different portfolios at little or no cost.
• Reduced dealing costs – If one investor had to buy a large number of direct investments, the amount this person would be able to invest in each holding is likely to be small. Dealing costs are normally based on the number and size of each transaction, therefore the overall dealing costs would take a large part out of the capital (affecting future profits).

A choice of where to invest: It is important that, before you select a portfolio in which to invest, you first understand what you are investing in, and that you carefully consider the amount you commit to invest. A licensed financial advisor should assess the amount of risk that you are prepared to take and advise you accordingly. Factors such as your age, health, income, alternative liquid assets, financial knowledge, appetite to risk, whether or not you have dependents and what your investment goals are will all influence the choice of investment.

Types of CIS in Securities: There are two types of CIS in Securities: Open-end fund: this is equitably divided into units which vary in price in direct proportion to the variation in value of the fund’s NAV. Each time money is invested, new units are created to match the prevailing unit price and each time units are redeemed, the assets sold to enable redemption matches the prevailing price. In this way there is no supply or demand created for units and they remain a direct reflection of the underlying assets.

Closed-end fund: this type of CIS issues a limited number of units in an Initial Public Offering (IPO). These units are then traded on a stock exchange. If demand for the units is high, they may trade at a premium to net asset value. If demand is low, they may trade at a discount to net asset value.

In many markets the less sophisticated investors who want to participate in the stock markets are protected from the swings of the markets and their implications by investing using CIS. Our experience is that this is the one area that needs to be developed, currently, other than UTT, private sector is yet to actively participate in this key space of the capital markets ecosystem.

Stock Exchanges for Sustainable Development Goals

As part of the global community Stock Exchanges across the global are required to step up and engage stakeholders in the capital markets eco-system (i.e. regulators, investors, financiers and businesses, etc) on their role towards creating better communities. In evaluating the 20-Sustainable Development Goals (SDGs), one will clearly find that four (4) SDGs are relevant to stock exchanges, and that exchanges are best positioned to support these goals. The four goals are Goal 5 – Gender Equality; Goals 12 – Sustainability Information; Goals 13 – Climate Change; and Goal 17 – Global Partnerships.
And so, to start contributing to the achievement of the SDGs, exchanges can make a difference with these 5 steps:
1. ESG Reporting Guidance – Exchanges are required to assist companies by providing guidance in making sustainability information public.
2. Dialogue – where Exchanges can engage fellow exchanges and investors and issuers as well as other stakeholders, in sensitization and voluntary compliances
3. Sustainability Products – Exchanges are expected to help incentivize and mobilize finance for SDG areas through products such as Environmental protection, Social Responsibility and Good Governance (ESG) indices and green bond listings.
4. Listing Requirements – where Exchanges are required to strengthen their listing requirements to encourage the disclosure and use of sustainability information – especial ESG related information.
5. Join a Global Partnership: Exchanges are encouraged to join the UN-Sustainable Stock Exchange (UN-SSE) Initiative as partner exchanges and participate in its workgroups to share best practices and promote sustainable markets.In mid-2016 the Dar es Salaam Stock Exchange made a conscious decision to join the UN-SSE Initiative. And, for the past two and a half years we have focused on engaging our members to raise awareness and sensitizing them to appreciate their role in creating a better world in course of their investments, capital raising, running businesses, etc. Our engagements have been to extent of Capacity building workshops, enhancing follow ups on continuous listing and membership obligations – especially in the area of transparency and good governance.
The other initiative towards these ongoing engagements has been the launching of DSE Members Award, which is annual event involving collection of data and information and our members about their practices and whether in their undertaking, among others, the aspects of environment protection, corporate social responsibility, gender equality, and good governance are clearly considered, monitored and reported. These activities culminate into a final event, of recognizing, and awarding members that have performed better than others in these specific criteria. To our estimate, this initiative has sharpened awareness of ESG, Sustainability reporting and Responsible investing.
Why does this matter? the global interest in sustainable investment is a catalyst for change and some DSE-listed companies, especially those which subsidiaries to multinational entities have made some positive strides in the area of ESG practices and disclosures. As we move towards integrating sustainability reporting as part of our continuous listing obligation and making these part of the listed companies annual reports, which we intend to achieve by 2020 — sustainability thinking into business strategy should be embraced, not only by listed members of the DSE, but other categories of members as well – i.e. stockbrokers, nominated advisers, custodian banks, etc.
As mentioned above, in 2016 the DSE signed into the United Nations (UN)-Sustainable Stock Exchange (SSE) Initiative — a project of the United Nations co-organized by the United Nations Conference on Trade and Development (UNCTAD), the UN-Global Compact, and the UN-supported Principle for Responsible Investment (PRI); partnering with other key stakeholders including the World Federation of Exchanges (WFE) – to which the DSE is an Affiliate member, and the International Organization of Securities Commissions (IOSCO) – for the objective of providing a multi-stakeholders learning platform for stock exchanges, investors, regulators, and companies to adopt best practices in promoting corporate sustainability. In collaboration with investors, regulators, and companies, they strive to encourage sustainable investment.
Being a partner exchange to the UN-SSE Initiative, among other requirements is for the exchange to promote sustainability thinking and strategies as well as to consider ESG factors more explicitly in their practices and disclosures/reporting, in line with international best practices. Our purpose real is about trying to get the market to think more holistically about what is important, then disclose this thinking to our stakeholders, and embedding these factors, and hopefully change their behavior on matters of environmental sustainability, becoming more inclusive and socially responsible, becoming gender sensitive in their choices, as well as pursue and practice best standards of good corporate governance – including become more transparency in their disclosures, not only in relation to the past, but also the future of their businesses.
Some of the exchanges, even in our continent, have already included sustainability and ESG reporting in their listing (membership) and continuous listing (membership) obligations rules. Stock exchanges in South Africa, Egypt, Morocco, etc are in this stage already; other exchanges have creating rules for listing green bonds – South Africa, Egypt, Mauritius, Kenya, etc stock exchanges have green bonds listing rules already, while others such as Nigeria have created Responsible Investment Indices – aiming at sharpening the awareness of responsible investing. For the DSE, as I indicated above, we are at the sensitization and awareness creation stage as well as encouraging voluntary disclosures. However, the intent is to have these issues embedded in our rules by year 2020 – later this year we intend to share with our members the Model Guidance on Reporting ESG Information.

Investors’ Risks for Investing on Unregulated Financial Markets

In a bid to diversify their investment portfolio or seek investment opportunities with high returns, some Tanzanians’, especially the youth, have been taking investment risk on investment opportunities that have the potential of exposing them to high and unmitigated risks. In their pursuit of outsized returns some of these investors temporarily seems to have forgotten the misery that befell investors who participated in various forms of Ponzi and/or Pyramids schemes which similarly promised returns that were clearly unsustainable (if could be achieved at all), but still people fell into them.

To this day, part of these investors who lost funds in those schemes are still hoping that they will get some form of compensation someday, which may be a challenge, considering the fact that these entities were not under the supervision of any regulator, neither the Capital Markets and Securities Authority, nor the Bank of Tanzania, but these investments were also not insured in any way, which could have provided a form of relief to investors’ protection, in cases of such loses.

What is at stake? the onset of technology, which by and large have made financial transactions more efficient among other positive disruption attributes, has also come with the exposure to unregulated investment opportunities offered mainly through online platforms. While there are still discussions around the regulation of virtual/crypto and other form digital currencies and digital assets in various jurisdictions around the World, probably including Tanzania, but so far Tanzanians are quietly investing in such emerging investment areas such as Initial Currency Offerings (ICOs) and other forms of unregulated online foreign exchange and currency trading, unfortunately to their own peril.

As it stands, most of the entities offering such alternative investment opportunities may not be licensed whatsoever, which exposes investors to both high and unmitigated risks. While some of the investment platforms and activities have caught the attention of our regulators, but it has been only to the extent of issuing cautionary notices and warnings to the public, for the public to beware of the fact that such financial products and services are unregulated and may be risky. So far there is not action that has been taken to protect investors, and there may be many Tanzanians out there who are potentially exposed to such instruments which promises greater investment returns as it goes with some greater excitement for individuals with quick returns’ investment approach.

As we observe, to attract investors, most of the entities involved in these programs seem to promise outsized returns which may not be sustainable in the long run. Global trend in the unregulated digital currencies demonstrate that crypto (and other digital) based assets market is uncertain and has experienced accelerated boom and burst cycles which may expose investors to substantial losses.

At the global level, International Organization of Securities Commissions (IOSCO), the international body that brings together the world’s securities regulators, to which our capital markets regulator is a member, has identified several risks associated with Initial Currency Offerings (ICOs), for instance. These include: heightened potential for fraud as these products are mainly internet-based; cross-border distribution risks – i.e. difficulties in recovery of investors’ funds in the event of a collapse, particularly in cases where the ICO is operating outside the investment jurisdiction; information asymmetry – where retail investors’ may not be able to understand the risks, costs and expected returns arising from investments; and also liquidity risk – where cases of insufficient liquidity to support reliable trading and market-making activities may be hindered.

There are also unmitigated risks in online foreign exchange trading through platforms of unlicensed entities, where investors risks losing their investments and may not be protected by the law. While in the near future regulators (such as the BOT and CMSA) may consider coming up with tools and mechanisms for protecting investors in these global financial and capital market activities, local investors are meanwhile cautioned and advised to avoid participating in investment opportunities offered by unregulated and unlicensed entities, as there may be no recourse in the event of a collapse and/or loss of their investments.

The case for embracing the culture of paying taxes

According to recent reports by the Tanzania Revenue Authority (TRA), tax revenue collections reached Tsh. 7.99 trillion in the first half of the financial year 2018/19 i.e. from July to December 2018, a growth of 2.01 per cent compared to Tsh. 7.83trillion collected during the corresponding period previous year 2017. The Tsh.8trillion collection is about 89 percent of the expected revenue collection for the six-months period. One of the many reasons for such performance in which collections are about 11 percent behind the budget is the case of a narrow tax base (with Tanzania having a low domestic revenue to GDP ratio (less than 15 percent) compared with the Sub-Saharan African countries average of 17 percent.
To increase the tax base TRA have in the recent past embarked in a nationwide campaign for Taxpayer Identification Number (TIN) registration targeting new tax payers and locations of their businesses aimed at expanding the tax net base. The other recent initiative of widening the base has been on property tax whose rates of Tsh.10,000/- for ordinary houses, Tsh. 50,000/- for every floor of a storey building is meant to increase the outreach and bring more citizens in the taxpayers’ net.
Furthermore, H.E. President Dr. John Magufuli has recently issued a raft of new tax administration measures rallying on all of us to participate even more in the process of raising revenues and expand our country’s tax base. The President directed the tax administration officers to adopt a more accommodative tone towards the business community instead of being overly aggressive which makes it difficult for tax collections, in some cases.
What is at stake? the wide gap between the actual tax paying population and the total population has been a worrying trend in most countries over the years. Studies across board indicates that in most countries, especially in Africa, only a small portion of a given country’s population pay taxes.

In 2018, for instance, BusinessTech reported that only about 30 percent of the 56 million population paid taxes in South Africa. The BusinessTech further reported that although the remaining part of the population was contributing through Value Added Taxes (VAT), but that portion of the population was not contributing anything more in the form of tax revenues to the nation coffers. In Botswana the ratio is 32 percent; Namibia 24 percent; Mozambique 19 percent; etc. Now, the case for these countries in the Southern part of the continent is far much better in relative terms. For instance, in Kenya, part of their 46 million population that pays taxes is 3.9 million, i.e. about 8.4 percent. Data by the Tanzania Revenue Authority (TRA) last year indicates that the number of taxpayers who paid taxes in 2018 was about 2.27 million. Working with a population of 55 million Tanzanians, the number of those who filled for tax returns or actually paid taxes represented less than 4.5 per cent of our population.

In the case of other key parameter measuring tax payments i.e. Revenue to GDP, our revenue collections to Gross Domestic Product (GDP), at about Tsh.15trillion per annum, is just 12.8 per cent. We expect collections to reach Tsh.18 trillion in this financial year 2018/19 – however, if we manage to collect Tsh. 18million, this will still be about 15 percent of GDP. When compared to some countries in the Southern part, again, Botswana, Mozambique, South Africa – there tax revenue to GDP ratios are: 14 percent; 18 percent; and 26 percent respectively.

This trend can only point to one thing; the country’s economy is being driven (at least from the tax revenue resource mobilization perspective) by a very small portion of the country’s total population. This points to the dire need for us as citizens to do more. The recently introduced presumptive tax for small scale and medium-sized enterprises and hawkers and small traders’ Identity Cards, for instance, are without doubt an apt platform to give Tanzanians outside the current tax brackets an opportunity to participate in the contribution to the national coffers.

A tax, charged at a moderate rate, say 10 or 15 percent of the business permit or trade license fees, or indicated above the Tsh. 10,000 or Tsh. 50,000 paid as property tax, are good strategies towards expanding the country’s tax base. Despite its implementation challenges and eliciting mixed reactions, but such measures, are some of the easiest taxes to comply with, and to administer. What is important is that the targeted market should fully embrace these taxes and take it as an opportunity to play the civic duty for each citizen on tax payments, especially now that there are vivid cases of better use of tax payers’ money in supporting our socio-economic development, underlying the necessity of social contract.

With these efforts, and others targeting monetary policies and investment attractiveness, from the economic perspective, we have a significant potential to largely sustain ourselves and emancipate from the burden of foreign aid and assistances which sometimes carries a lot of conditionalities, to the detriment of compromising our freedom, our cultural set-ups and our political processes. The Ministry and the Revenue Authority, should keep up the spirit of exploring more tax base expansion strategies, without necessarily imposing additional taxes to the already taxed sectors and segment of the economy and/or society. That way a substantial size of the population will have an opportunity to contribute to the national coffers.

Attracting Foreign Investments for Growth of Capital Market

Towards the end of September this year FTSE Russell, one of the leading global providers of stock market indices and associated data service, including markets/countries’ classification, reached out to the Dar es Salaam Stock Exchange (DSE), informing us that as part of the FTSE Country Classification Annual Review, the FTSE Russell Country Classification Advisory Committee and the FTSE Russell Policy Advisory Board have approved the addition of Tanzania to the “FTSE Watch List” for possible Classification into Frontier Market Status, from the current status of being Unclassified.
What does this mean, it means that by being in the Watch List, the wider global market is being alerted that there is a depth engagement taking place by the FTSE Russell with the DSE which is being considered for a classification, and therefore invites an opportunity for investors to share their experience of operating in the DSE, with regard to market and regulatory environment; Custody and Settlement of Securities; the dealing landscape and derivative markets. Thus, it means, Tanzania via the DSE is being considered for possible classification, into a Frontier Market status by September 2019. What role does country classification play in enhancing investment flows?
Often misunderstood or underestimated, country classification (into either Developed, or Emerging or Frontier Markets) has been identified as one of the leading factors that contribute to the amount of investment, particularly, passive investment funds that a country receives. Gaining a status automatically provides an opportunity for a country to access vast pools of global investment funds. It means that if the country is unclassified, as we currently are, does not have access to the pool of these global passive investment funds.
Let us get a feel of how relevant and significant this is – according to LSEG Africa Advisory Group it is estimated that, globally, more than US$1.3trillion is benchmarked to the FTSE Global Equity Index Series alone, which covers securities in 48 different countries based on Developed, Advanced Emerging and Secondary Emerging status. So, US$265billion tracks FTSE Developed Indexes; and US$130billion AUB (Assets Under Benchmarking) tracks FTSE Emerging Markets Indexes. There is also a relatively significant amount of funds tracking the Frontier markets, to which we currently do not feature into that space.
One may question, we notice that about 70 to 80 percent of trading volumes and turnover in the DSE emanates from foreign investments, so what difference does this potential classification make relative to what we have achieved already? A good question — it is well and good that we have an annual average of US$150million of foreign portfolio funds invested in the DSE listed securities, it is good in the sense that we are increasingly able to attract foreign funds to supplement and compliment the domestic mobilized funds that finances our development and enterprise activities. However, the funds we have so far been able to attract are largely “active” investment funds managed by small to medium sized fund management houses, where individual fund managers perform their own scouting, researches, analysis, scoping, recommendations and investments, given the limited volumes of research and coverage available for active investing on our economies. This makes passive investing argument much more feasible and practical – such activities are costly for individual fund managers, given the economies of scale and the significant amount of management fees involved, i.e. passive fund management strategies require a fraction of the management fees compared to those required for active investing, leading to higher net returns for passive investors. It makes sense therefore to actively attract global passive investment funds into our market, and country classification is fundamental to this process.
Thus, upon classification the DSE, and the country, will be in the investment map of global passive investment funds who allocates their investment funds only to countries that have achieved classification by global rating agencies, (and fund sizes invested in these identified particular markets depends on the market’s classification status, whether frontier, emerging, or developed market status).
So, what this means is that a country’s classification status signals confidence in a market and points to a level of sophistication through adherence to certain objective criteria required to achieve a given status. As alluded above, it also reduces costs of investing in a market, hence higher investment return.
We know that for us to continue our sustained growth, our stock market must develop in line, enabling greater employment and wealth creation within the economy. Our ability to attract global investment funds, now that passive funds have been identified as a key form of capital, providing support to economies by providing access to investors worldwide, is fundamental.
At present, only 10 countries in Africa are classified by FTSE Russell, with two Emerging (Egypt and South Africa) and eight Frontier Markets (Morocco, Mauritius, Kenya, Botswana, Cote d’Ivoire, Tunisia, Nigeria and Ghana). Looking at the entire continent, 44 countries are left unclassified which means that over 80 percent of Africa’s countries are not included in any of the global passive flows tracking Frontier/Emerging Markets. Hence, for the DSE and Tanzania to achieve a classification status will be a significant step, hopeful this will come to pass in the next few months, i.e. if some of us will continuously and consistently live into the criteria that brought us into this stage in the first place.

The Role of capital markets in empowering SMEs

Small and medium-sized enterprises (SMEs) comprise the backbone of our economy, according to some estimates, SMEs account for 90 percent of all companies (and businesses), providing over 80 percent of employment.
SMEs continues to be fundamental to the future economic success of our country, with the potential to facilitate establish a new middle class and boost the demand for goods and services. SMEs role in driving innovation, creating employment opportunities and therefore contributing to domestic wealth creation routes is critical for sustained economic development.
Despite their crucial role in driving the country’s economic development, evidences suggest that SMEs experience a severe shortfall in financing which hinders their growth. With all fairness, the challenge of SMEs financing is wide and large, a study conducted by Investisseurs & Partenaires found that 40 percent of SMEs in Africa identified the primary factor constraining their growth as accessing finance, and according to a recent report by the London Stock Exchange Group (LSEG) Africa Advisory Group, the current funding gap for SMEs in Africa is estimated to be about US$140 billion.
Ultimately, the lack of funding results in thousands of SMEs being forced out of business within a few months of beginning operations and significantly inhibits their ability to reach their full growth potential and become the future ‘blue chips’.
The lack of funding for SMEs calls into question how well our domestic capital market is serving the needs of these companies, who form the bulk of our business universe. In general, the purpose of capital markets is to promote growth in the economy by providing capital for enterprises to innovate, expand and create jobs — for an economy to efficiently work, capital must flow from investors to businesses, ranging from the largest companies to SMEs and entrepreneurs, instead of being concentrated on the large and well-established firms.
According to the research conducted by the LSEG Africa Advisory Group to the continent, there is a significant lack awareness by potential as well as entrepreneurs of the variety of financing options available to SMEs to support their growth trajectory. These options range from microfinance and angel investing to venture capital, banks, private equity and potentially listing on local exchanges. This unfamiliarity has resulted in low levels of domestic participation in the capital markets, leaving local equity markets underdeveloped. This contributes to the lack of depth and liquidity within domestic capital markets, which eventually results in a smaller Initial Public Offering (IPO) pipeline for local exchanges.
As a result, SMEs seeking to raise capital have traditionally relied on bank loans. The result is excessive dependence on the banking sector – specifically, on bank loans. As such, the financial sector has continued to grow around this common notion, with banks and other stakeholders focusing their operations on bank loans and debt financing.
As it were, the type of financing (equity or debt) that would best suit a company’s needs is heavily dependent on a company’s stage of development. For instance, debt is form of capital raising that would suit a well-established company. That said, the same would not apply to a high-growth SME where funding is required in order to finance expansion. As such bank loan financing leave a small company prioritizing loan repayments or face risking default.
In our context, the business environment poses some obstacles to debt-financed SMEs. My experience, based on personal observation, experience and engagements with various stakeholders, and supported by other studies; the following issues, as far as the matter of SMEs financing (by banks) is concern, concerns SMEs: (i) some banks constrain SMEs participation in their line of business due to the use of sophisticated scoring models when assessing creditworthiness for SMEs, it is well known that SMEs often lack the track record and meaningful data inputs required by banks; (ii) some banks do not use credit scoring for SMEs and prefer to focus on relationship-based lending — a consequence of this is that some of our banks experience higher rates of non-performing loans; (iii) credit bureaus, as good the concept as is, but have predominantly served as a negative reinforcement tool as a result of the harsh measures that some banks ends up taking in the case of delayed payments by SMEs – SMEs run the risk of being ‘blacklisted’ if a single loan repayment is delayed (caveat: this matter is somehow complicated because of regulatory and compliance); and (iv) some lenders seek prohibitive high collaterals to mitigate the high, and often unquantifiable, credit risk associated with lending to SMEs, again – this is a regulatory requirement.
As such, it is crucial for us to unleash the potential of equity capital to support SMEs that are so vital to the future of our economy. With the right combination of advice and support, SMEs can navigate the challenges, identify the right forms of equity capital raising and drive growth to support the economic development as envisaged. While the launch of EGM segment within the DSE was supposed to be far beneficial, but without the right training and a supporting advisory community, as has been the case thus far, the EGM segment is likely to be left untapped. In the these past 5-years since introduction of EGM only five companies have accessed the segment raising just over Tsh. 50 billion – definitely a relatively small amount, given the potential.

As indicated, limited capacity among SMEs in the successful and sustainable running of businesses has led to diminishing trust among stakeholders who could potentially provide much needed equity capital, leading to such stakeholders rejecting financing options for SMEs. Some of the key capacity gaps that SMEs face, which hinders their access to financing, especially equity finance, include:
Fear of control loss: one major concern that SMEs have regarding equity financing is the loss of control. Many SMEs are unwilling to accept external investment and bring in new partners, as they fear relinquishing control of their company. What we normally hear from SMEs owners, is that entrepreneurs would rather own 100 percent of one than 10 percent of a hundred. Additional observations, recent times, show that this culture is starting to change, albeit slowly, as SMEs are becoming exposed to the success stories of peer companies that have benefited from external financing, both at the regional and international level.
Good governance for growth: many SMEs are unaware of the importance of strong governance for business sustainability and growth, and hence their lack of access to expertise that could improve their management structures and practices. In many cases, company board of directors are lacking altogether, with no substitute structures in place to provide sound input, hold management accountable, oversee independent audit or remuneration decisions, or perform other traditional board functions. However, institutions such the DSE, CMSA, Institute of Directors in Tanzania Government-sponsored bodies and development financial institutions, i.e. the International Finance Corporation (IFC), sometimes help train and advise SMEs on the importance of following best governance practice.
Lack of transparency: many SMEs do not have mechanisms that safeguards operating and financing processes and preserve the integrity and transparency of their operations in order to ensure that deserving SMEs receive their fair share of financing. The preference by many enterprises to pay a lesser share of their tax obligations could be one of the reasons for lesser embrace of transparency.
Financial reporting: some SMEs do not have credible audited financial information to provide to potential investors. Entrepreneurs often lack the resources to prepare accurate records, or access to an external service provider that can produce better records on their behalf. As a result, many SMEs continue to struggle to produce accurate, useful financial information without increased access to financial education and awareness of the value of this information.
Sustaining growth: lacking a strategic vision and strategic plans for how to grow the business in a sustainable manner is also preventing many small companies from scaling up. Even when a temporary revenue boost presents itself, it is almost never sustainable. A growth strategy plan is often not present, restricting long-term success.
Retaining talent: growth SMEs often underestimate the importance of managing talent by seeking to attract, develop and retain individuals who are valuable to the company. This ultimately restricts the company’s performance.
Initial Public Offering (IPO): there is a general lack of familiarity with the IPO process, from access to finance, to listing requirements, to the benefits of being a public company in term of easy access of future financing from a broader base of existing and potential investors. Many SMEs regard IPO process as unachievable or too complicated, to the extent that many SMEs would not seriously consider accessing public money and list into the stock exchange. Becoming a public company is, however, a significant contributor not only to the development of a company, but to the further robustness of the local capital markets.
Despite the existence of capacity-building and scale-up programmes, such as incubations, but according to assessments based on publicly available information there are just few incubators in existence, and have limited capacity, i.e. most incubators can only support around 20 SMEs per year on average, which is only a small fraction of the SMEs that could benefit from such services. Moreover, that ecosystem has focused on more ICT-related sectors rather than agriculture or healthcare or energy, where more patient capital is needed. Moreover, there is a general lack of trust between SMEs and support providers, and so although business support providers are emerging, a lot of SMEs aren’t using them because of a lack of knowledge and trust between the service provider and the SMEs.
Lastly, angel investors and venture capital funds, which would normally provide equity finances to SMEs are almost not in existence, currently less than a percent of start-ups are being financed by formal angel investors and venture capital funds. There is a positive trend, however, with the number of visible angel investor groups, networks and initiatives having recently grown. For instance, the establishment of the World Business Angels Investment Forum – WBAIF Tanzania Chapter may add an impetus. However, capital remains scarce and the industry-specific knowledge and mentorship of these angels is limited.
To conclude, the existence of this profound financing gap preventing efficient deployment of private capital can be largely attributed to a lack of visibility of these companies to early-stage investment. Many investors do not feel comfortable investing in SMEs on the grounds of unestablished credibility and lack of trust, as a result entrepreneurs are forced to finance the growth of their businesses independently.

On the Financing of our Infrastructure

During these past 20 years, many African economies have tried to develop domestic capital markets hoping to enhance local capacities to mobilize domestic resources for funding development projects and enterprises. And so, during these two decades number of stock exchanges in the continent has almost doubled, to the current 29 stock exchanges representing 38 countries, including two regional exchanges.

These exchanges though have a lot of disparity in terms of size, depth, liquidity, trading volumes, etc. The fact is the continent is characterized by a handful of prominent exchanges and then many new small exchanges. Yes, efforts are being made to boost exchanges by improving investor education and confidence, access to funds and make the procedures more transparent and standardized, however the outcome hasn’t been satisfactory. Almost all African exchanges lack a significant local investor base, as well as financial products such as those which can finance infrastructure projects, i.e. Infrastructure bonds. While, many countries have embarked in different infrastructure projects – for roads, railways, airports, ports, bridges, energy, irrigation, etc but only three out of 29 exchanges have infrastructure bonds issued and listed in their stock markets.

According to the African Development Bank (AfDB), road access in Africa is only about 35 percent as compared to 50 percent in other developing regions. In agriculture, just about 5 percent of agriculture in the Africa is under irrigation, compare to almost 40 in Asia or 15 percent in Latin America.

Africa’s average national electrification rate of 45 percent, is poorly compared to over 85 percent in developing countries in Asia and 98 percent in Latin America. According to AfDB, the amount of capital required to close the infrastructure gap in Africa is estimated to be in the region of over US$90 billion annually. So, we know we face a significant infrastructure deficit and its financing means.

In these three decades China has stepped in funding many infrastructure projects in the continent. Of course, with other countries, international development agencies and other development partners have continued to play the role in this space as well. But the question is, for how much long should Africa continue to highly depend on foreign countries and institutions to fill its infrastructure funding gap? Is there a possibility of enhancing its efforts to facilitate domestic mobilization of resources? Can these efforts be aligned to financial inclusion, economic empowerment and financial sector development policies and programs?

As we now know, sourcing funds to finance infrastructure project in Africa has always been fraught with difficulties. One major challenge is that development finance institutions often impose stringent policy conditions to finances, rightly so. But the fact also is that the funding required to close the infrastructure gaps is simply not easily in existence on these institutions’ balance sheets; hence a combination of both significant domestic resources mobilization and external funding is worth pursuance, at least in the short to medium term.

The other factor is that western lenders have historically been more active in financing social infrastructure such as health and education, their approach to development in Africa has by large been related to “poverty alleviation”. As it turns out, financing social infrastructure for poverty alleviation objectives isn’t the same as financing economic infrastructure which plays a critical role in spurring economic growth, which in this moment in time, has not been accorded the attention it deserves. While social infrastructure is important for socio-economic development, but, economic infrastructure is more urgent. Wealth creation and capital accumulation are better facilitated by investments in economic infrastructure.

The other fact is, the old approach of countries relying heavily on multilateral and regional development finance institutions to fund infrastructure has proved less effective, somehow incapable of closing the financing gap of the magnitude and size we face. In fact, neither the old nor the new institutions have the risk appetite for the kind of investments needed. If African countries continue to rely on these organizations and institutions, then the pace for closing the infrastructure gap will be relatively slow.
Given such context, the game-changing infrastructure projects that can make a dent in the infrastructure deficit and move economies to a higher growth path need to come from Africans’ own resources, and in some cases be supplemented by what we can be accessed from international financial markets. And, the place to start would be the debt (bonds) market where domestic savings will be intermediated and be able finance our significant economic infrastructure projects.

It is on such basis, that countries have to be encouraged to facilitate enhancement of capacities of domestic capital markets to raise funds for infrastructure projects. The good news about this is that ways can be found where external financiers and investors can use our domestic capital markets to finance local projects and enterprises, somehow enhancing our investor/financier base.

Railways and canals in America, and Europe, were/are largely financed with capital raised through issuance of products such as infrastructure bonds. From records of history, big infrastructure projects have been financed with funds from the capital market, why? because national budgets are often unable to support the required infrastructure expenditure. Country’s balance sheets in many cases lacks the fiscal space to accommodate the substantial financial outlays required for infrastructure development.

Challenges and Opportunities for Regulating Commodities Trading

As it is — ambiguity, uncertainty, and lack of clarity regarding policy and regulations around commodities trading impacts the efforts to harness the potential and prospects in commodity markets; this fact applies across, at the local, regional and global levels. The possibility of integrating and harmonising the legal/regulatory framework and embedded institutions could unlock the potential and empower the commodity trading ecosystem to grow and mature in a manner similar to that of securities markets.
In the case here, integration and harmonization of legal/regulatory frameworks around storage, warehousing, marketing, trading, pricing and other supporting infrastructure around this space could be a matter of necessity. And so, the legal/regulatory environment relating to Warehouse and Warehousing Receipts Systems; the Mercantile Exchange, Cooperative Unions/Societies, Agricultural Produce Marketing Boards, Capital Markets and Securities, etc will have to harmonised to enhance the coordination for efficiencies.
Commodity markets are critical — studies point out high correlation of commodity prices with domestic economic growth, inflation and the pace of exports in developing countries. To bring this perspective into context – let us consider our case: as data indicates – we are a commodity dependent country, agriculture is still one of the most important economic sectors contributing about 25 percent of the National GDP and over 75 percent of the rural household income. The Sector provides almost 95 percent of the National Food requirement and livelihood to more than 70 percent of the population. The Sector contributes about 30 percent of total exports and almost 65 percent of the raw material requirements for industries. These, and others, are clear indications that the sector has a strong influence in the national economy.
However, for the realization of expected sectoral growth level of not less than 8 percent (it has been at about 7 percent according to recent data), it is important to ensure that formal commodity marketing and trading systems are effective and efficiently working, capable of guaranteeing social and economic benefits to producers, traders and consumers. As it stands, the current commodity marketing and trading system is yet to attain such desired outcome. The marketing and trading systems and its embedded institutions are fragmented, uncoordinated and unpredictable. There are sentiments that for most agricultural produce, farmers are receiving the low end of the bargain while consumers’ prices are high with no relationship to the transaction costs. Likewise, the regulatory systems, marketing institutions and enforcement mechanism are somehow inefficient to the expense of farmers and sometimes consumers.
The development of organised commodity market(s), exchange platforms and related market infrastructure and ecosystem has of recent assumed significant interventions in the financial development policy of many countries. As stock markets assumed importance as instruments to enhance allocative efficiency of financial resources, commodity trading /exchanges emerge as a powerful instrument in managing price risk management, so vital for sustained economic growth.
The Regulatory Agenda
This being the case, what should be the regulatory agenda of commodities regulations? We underscore that we are at an early stage, but as we strive to become sophisticated, let’s consider where the global regulatory agenda is as far as commodity trading is concern. These are some global trends: (a) Paper trading value for commodity far outstrips physical trading; (b) There is prevalence of a complex range of trading strategies and technologies; (c) Trading houses are emerging as major players, in some counties, replacing banks; (d) There is financialisaton of commodity trading with more of fund management, investment products and diverse categories of investors participating in trading.
Other global trends include: (e) Consolidation of the commodity exchange industry that extends to other market segments; (f) the growing power of commodity producers; (g) growing linkages between commodities markets across the world and a wide range of investment and trading products; (h) volatility in commodities markets quite often turning into issues of public unrest leading to ad hoc policy interventions and measures; (i) and the issue of managing the interests of various stakeholders engaged in the value chain of commodities trading, and so on.
Influencing factors
These trends and developments could surely have a bearing on the regulatory framework that needs to be built up, going forward, our commodity trading system will have to make way for a complex market structure with more players, products, instruments and innovations that could call for a proactive and agile regulatory framework. At present, the scope of merchantile exchange is quite narrow and limited to just few envisaged products. Some brokers have been identified, trained and licenced, but as it has been the case for our stock exchange — the strategic and operational roles of banks, market makers, liquidity providers and institutional investors as far as trading in commodities exchange is concerned is yet to be clearly determined, this could limit appetite and liquidity in the exchange.
Historically, at the global level, the development of regulation of commodities trading has evolved under these six key areas: (a) price stabilisation and liquidity enhancement instruments; (b) transparency and reporting; (c) regulation of Over the Counter (OTC) trading and dealing activities; (d) banning certain trading strategies and actors; and (e) strengthening regulatory and supervisory authorities and international cooperation.
The background for an integrated framework for commodities regulation at the global level was initiated by the G20, followed by several other global and regional regulatory initiatives that, among others, include: the Dodd Frank Act, IOSCO (Principles for the Regulation and Supervision of Commodity Derivatives Markets), Markets in Financial Instruments Directive (MiFID), European Markets Infrastructure Regulation (EMIR), Markets in Financial Instruments Regulation (MiFIR), and Market Abuse Regulation (MAR). By the way MiFID II has further strengthened the scope of monitoring trading activities.
Regulatory issues
In conclusion, with respect to regulation enhancement and better coordination, the key issues to consider include: (a) bringing commodity firms, venues and products under the merchantile exchange regulatory scope; (b) greater regulatory oversight by transaction reporting for commodity trading; and (c) commodity benchmarks used in financial contracts to be brought under regulation.