The Central Bank of Kenya (CBK) has rejected a new bond trading platform proposed by commercial banks, known as the East African Bond Exchange (EABX), in favor of introducing market makers to stabilize the government securities market. The rejection has sparked discussions between CBK, the National Treasury, and financial regulators on how best to enhance liquidity and transparency in Kenya’s bond market while ensuring stability in government debt instruments.

The move comes as CBK tightens its control over the DhowCSD, the government’s official bond settlement platform, ensuring that all transactions remain within its purview. This decision effectively prevents the EABX, which had been approved by the Capital Markets Authority (CMA) in 2024, from trading in government securities unless it gains access to CBK’s systems.

Understanding the EABX Platform and Its Rejection

The EABX, backed by Kenya Bankers Association (KBA) and supported by Financial Sector Deepening Africa (FSD Africa), was established to act as an over-the-counter (OTC) bond trading platform. It sought to increase liquidity and competition in Kenya’s fixed-income market by allowing banks and financial institutions to engage in bilateral trading outside of the Nairobi Securities Exchange (NSE).

Despite receiving approval from the CMA to operate as an autonomous, self-regulated exchange, the platform faces a major hurdle: to facilitate government bond trading, it must integrate with CBK’s DhowCSD system, which serves as the official registry for all government securities. However, CBK has refused to grant EABX this access, citing concerns that the introduction of a parallel trading system could distort the bond market.

A senior CBK official familiar with the negotiations revealed that the regulator prefers to introduce market makers rather than allow an additional trading platform, following global best practices.

“We have communicated our position to them (EABX) because the whole area of over-the-counter trading is being worked on between CMA, CBK, and the National Treasury. The direction we are taking is to introduce market makers to enhance liquidity in the bond market,” the official stated.

What Are Market Makers and Why Is CBK Pushing for Them?

Market makers are financial institutions or individuals that continuously buy and sell securities to ensure liquidity in the market. They play a crucial role in maintaining price stability by quoting both buy and sell prices at all times, reducing the volatility of financial instruments such as government bonds.

By introducing market makers, CBK aims to:

1. Increase Liquidity – Ensure that investors can trade bonds quickly without large price fluctuations.
2. Improve Price Discovery – Market makers help establish fair prices by continuously quoting bids and offers.
3. Enhance Transparency – Unlike OTC platforms, which rely on private negotiations, market makers operate in a more structured environment with real-time price updates.
4. Reduce Complexity – A single, transparent trading system helps investors access bonds more efficiently.

This shift aligns with international best practices, where major financial markets rely on designated market makers to support bond trading. Countries like the United States, the United Kingdom, and South Africa use this model to maintain stability in government debt markets.

Why Government Bonds Matter in Kenya’s Financial System

Government bonds form a crucial part of Kenya’s financial system, serving as a primary source of funding for budget deficits and development projects. They also provide a low-risk investment option for banks, pension funds, and retail investors.

The bond market in Kenya is highly active, with annual turnover on the Nairobi Securities Exchange (NSE) averaging Ksh734 billion ($5.68 billion) between 2020 and 2023. Government bonds account for approximately 99% of all bond transactions in the country.

Given this significant volume, CBK is cautious about introducing an additional trading platform that could impact the pricing, settlement, and overall stability of the market.

EABX’s Response and Ongoing Negotiations

Despite CBK’s firm stance, EABX Chief Executive Terrence Adembesa remains optimistic that a compromise can be reached.

“We are currently in discussions with the Central Bank on how best to attain connectivity to DhowCSD. EABX has not envisaged a scenario where it does not attain connectivity to the Central Bank,” said Mr. Adembesa.

He emphasized that EABX was established to deepen the liquidity of Kenya’s fixed-income markets while improving governance and transparency.

The Kenya Bankers Association (KBA), which owns a 30% stake in EABX, also supports the platform’s role in market development.

“The exchange is critical for banks in enhancing market liquidity, development, and price discovery of fixed income securities,” said Raimond Molenje, Chief Executive of KBA.

The Bigger Picture: Control Over Government Bond Trading

The conflict over the EABX’s role in the bond market highlights broader issues surrounding control and revenue distribution in Kenya’s financial sector.

In 2023, the NSE and the Central Depository and Settlement Corporation (CDSC) Ltd ended a revenue-sharing agreement that had governed bond trading for over a decade. CBK then launched its own bond trading portal on August 1, 2023, effectively taking control of the market and sidelining the NSE’s role in government bond transactions.

Previously, the NSE earned a 0.0035% fee on bond transactions, while CDSC received 0.002% for hosting the trading infrastructure. CBK’s move to take over bond trading resulted in declining revenues for both organizations, reinforcing the regulator’s authority over government securities.

Impact on Retail and Institutional Investors

CBK’s DhowCSD platform, which went live in 2023, has opened up the government bond market to retail investors, allowing them to buy Treasury bonds via mobile phones. This has democratized access to government securities, making them more accessible beyond large institutions.

However, the exclusion of EABX from government bond trading could limit institutional investors’ ability to execute large trades in a competitive market.

Market experts argue that a hybrid system—incorporating both market makers and an OTC platform like EABX—could be the best approach. While CBK’s concerns about market distortion are valid, allowing alternative trading venues could increase competition, lower trading costs, and provide more investment opportunities.

What Comes Next?

The standoff between CBK and EABX is far from over. Several possible outcomes could shape the future of Kenya’s bond market:

1. CBK Maintains Its Position: If CBK refuses to grant EABX access to DhowCSD, the platform will be limited to trading corporate bonds and other fixed-income instruments, restricting its growth potential.
2. EABX Gains Conditional Access: CBK may eventually agree to integrate EABX under strict regulatory conditions, ensuring compliance with market stability requirements.
3. A Policy Shift Toward Hybrid Trading: Policymakers may push for a compromise where market makers operate alongside an OTC platform, creating a more diversified trading environment.

The final decision will likely depend on negotiations between CBK, the National Treasury, CMA, and EABX stakeholders.

Conclusion

Kenya’s bond market is at a crossroads as CBK pushes for a market maker-driven approach, rejecting a bank-backed OTC trading platform (EABX). While CBK’s focus on stability and transparency is commendable, industry stakeholders believe that allowing more competition and trading flexibility could benefit investors and market efficiency.

As discussions continue, the outcome of this regulatory battle will have lasting implications on Kenya’s financial market structure, investment landscape, and the broader economy.

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photo source: Google

By: Montel Kamau

Serrari Financial Analyst

6th January, 2025