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Benchmark: Effectiveness of Public Private Partnerships in Kenya

In 2017, the World Bank published a report entitled Benchmarking Public Private Partnerships (World Bank Report) following the review of legislation and practices of eighty-two (82) countries (including Kenya). The objective of the World Bank Report was to give empirically based authoritative guidance on Public Private Partnerships (PPPs). This comparative analysis was conducted under the framework of the four (4) main areas of a PPP cycle being preparation, procurement, contract management and approach to unsolicited proposals (USPs).

World Bank Report

The World Bank Report assesses the relative performance of each country against a maximum score of a hundred (100) in each area. Kenya was assessed to have achieved above average scores of sixty seven (67) in the area of preparation of PPP’s, sixty five (65) in procurement and fifty two (52) in the area of contract management. Before popping the champagne bottle, it should be borne in mind that there is a paucity of PPP projects (according to the PPP Unit there are only seven (7) on-going PPP projects with a rather suspicious list of past projects) even though we have had the law on PPPs in our books for many years beginning with regulations under the Public Procurement and Asset Disposal Act and since 2013, a fully-fledged Act- the Public Private Partnership Act, 2013 (the Act).

Without making a fetish of the numbers (which admittedly are somewhat arbitrary), rather tellingly, by the World Bank’s ratings, South Africa significantly outperformed Kenya in each of these areas while some of our neighbours were ranked better in some aspects. For example, for procurement Tanzania was assessed at eighty (80) while for management Uganda scored sixty eight (68).

But such raw numbers teach us nothing. The real value of the World Bank Report, despite the inherent difficulties of lack of thorough analysis given such a high sample size and the inherent difficulties in comparing politically and economically diverse countries, is its provocative value. The results present an opportunity for identifying potential trouble-spots in our legislative landscape and for reflection as to whether we can do better.

One such area is USPs, also referred to as Privately Initiated Proposals (PIPs), flagged as the area of most concern and least progress earning against what the authors of the World Bank Report viewed as good practice. The principal weakness of our system of USP/PIPs, which we apparently share only with Vietnam, is the absence of a competitive
procuring procedure. A USP presents the rather unique form of PPPs as it is where the private party initiates the process.

Unlike procured PPPs for which there is a comprehensive regulatory framework under the Act – see generally sections 29 to 57 – with competition at its heart, the law on USPs/PPPs is much less extensive. The sum total of this is to be found in section 61:

“(1) A contracting authority may consider a privately initiated investment proposal for a project and procure the construction or development of a project or the performance of a service by negotiation without subjecting the proposal to a competitive procurement process where — (a) there is an urgent need for continuity in the construction, development, maintenance or operation of a facility or provision of a service and engaging in the competitive procurement process would be impractical: Provided that the circumstances giving rise to the risk of disruption were not foreseeable by the contracting authority or the result of an unreasonable failure to act by the contracting authority;

(b) the costs relating to the intellectual property in relation to the proposed design of the project is substantial;

(c) there exists only one person or firm capable of undertaking the project, maintaining the facility or providing the service or such person or firm has exclusive rights over the use of the intellectual property, trade secrets or other exclusive rights necessary for the construction, operation or maintenance of the facility or provision of the service; or

(d) there exists any of the circumstance as the Cabinet Secretary may prescribe.

(2) A contracting authority shall, before commencing negotiations with a private party under this section—

(a) prescribe a criteria against which the outcome of negotiations shall be evaluated;

(b) submit the proposal to the unit for consideration and recommendation; (c) upon obtaining the recommendations of the unit, apply for and obtain approval from the Committee to negotiate the contract; and

(d) conduct the negotiations and award the tender in accordance with the prescribed process in the regulations to this Act.

(3) A contracting authority shall not consider a project for procurement under this section unless it is satisfied that—

(a) the project shall provide value for money;

(b) the project shall be affordable; and

(c) the appropriate risks are transferred to the private party

The Act provides for three (3) circumstances under which USPs/PIPs are possible, with seemingly unguided discretions conferred on a member of the executive to increase. As is clear, all the circumstances are situations where the legislature has decided competition is not feasible or possible. This appears to be something that the blunderbuss one-size fits all criteria adopted by the World Bank does not take into account. USPs are an exception to the norm and save for the rather anomalous discretion given to the Cabinet Secretary to expand them, they are restricted to situations in which competition is not a practical alternative. It is therefore difficult to follow the argument that our system should be faulted for the absence of competition. Of note is that according to the PPP Unit, four (4) of the seventy (70) PPP projects currently underway are USPs.

Perhaps a more valid criticism is why the availability of opportunities for PPPs should be so restricted for if the public can benefit from private sector finance in so many areas that were previously the exclusive reserve for the public. Surely, ideas and innovations on those areas should be equally welcomed. The concern should be how to ensure that this is not abused which is where competition becomes relevant and the World Bank Report is useful. Both of our neighbours, Tanzania and Uganda scored higher on USPs but that is only because of the rather arbitrary three-part criteria adopted by World Bank for assessment.

The Bangladeshi Perspective

While not as high scoring, lessons can be drawn from Bangladesh which has a broader regulation. Bangladesh’s primary legislation does not restrict the areas in which USPs are available but there is the subject of extensive subsidiary legislation, though we should add that we have not considered their enforcement.

Some of the salient guidelines are set out below:

Non-Mandatory Nature of Concept Note and/or Unsolicited Proposal

The guidelines ensure that the Government is not obligated to consider and accept a Concept Note and is not prohibited from using the asset that is the subject of the Concept Note in a conventional Government Project.

Process for Submission of a Concept Note and Sector Policy Review

The guidelines establish a framework through which the Original Proponent of a Concept Note submits the same to the Contracting Authority while keeping the PPP Authority and Applicable Line Ministry in copy. This provides for a forum for discussion to clarify the scope of the Concept Note and ensure that the project is aligned with sector development plans and is likely to deliver a positive socio-economic benefit. There is a requirement for endorsement by the Applicable Line Ministry where the Concept Note is successful as well as provision for rejection and resubmission with Applicable Line Ministry feedback.

Assessment of Eligibility of the Concept Note and the PPP Project Proposal

This process provides for detailed assessment and a screening criteria through the Applicable Line Ministry, which formally submits the endorsed Concept Note and the PPP Project Proposal to the PPP Authority for processing of the same and in principal approval and makes provision for the PPP Authority to use of its own resources or seek professional support from qualified consultants in conducting its assessment. The PPP Authority may also contact the Contracting Authority, the Applicable Line Ministry and other relevant Government agencies to get more clarity on the Project.

A cursory reading of the guidelines suggests that the Government of Bangladesh has identified some of the possible exceptions and loopholes that may be created by a non-exhaustive statutory provision on USPs, the most notable of which is the provision that ensures that notwithstanding the submission of a USP, the contracting authority is not precluded from applying a project concept on a conventional project or what may be termed a solicited proposal. In addition, the fact that the guidelines make provisions and give a leeway for the use of external consultants by the Bangladeshi PPP Authority (the equivalent of the Kenyan PPP Unit) and allows it to seek support from appropriate sector line ministry resources when making its assessment gives the USP process further legitimacy and competitive justification on procedure.

The provisions of the Bangladeshi USP guidelines therefore serve as guideposts should we go the way of USPs. One only needs to take a look at the model of USP guidelines in Bangladesh to identify that a gaping hole and possibility of USP proponent litigation against the Government of Kenya and contracting authorities is real where the waters are muddied between solicited proposal tendering and a USP proposal in a situation where a project that formed the basis of a previous USP is later subjected to the conventional tendering process for solicited proposals.

Quite apart from protection of the contracting authority, the existence of USP guidelines would also ensure that the legitimacy of the USP process is not easily called into a question once a contract is awarded to a private entity, especially where a framework exists to ensure that the USP process itself was fair, competitive and received a nod of approval from sector consultants and specialists.

Conclusion

If Kenya decides to open up the circumstances in which USPs should be available, there will be need for guidelines and regulation of USPs in order to protect both the private contracting entity as well as the contracting authority. While the World Bank Report has noted that in developing economies the lack of USP regulations may be a consequence of an express desire of the public sector not to use USP procurement, it suggests that the subject may not have been considered.

Step Lightly: Matters to Consider During M&A Deals in Kenya

Among the myriad of legal issues that arise in a corporate merger or acquisition, labour and employment law considerations feature quite highly. The issues that arise are of great concern not only to employees but also to management of both the acquiring and acquired company. Typically job losses in mergers occur as a result of restructuring, duplication of roles or a desire to down-size.

The Employment Act (No.11 of 2007) and Labour Relations Act (No. 14 of 2007) make no specific reference to the effect of transfer undertakings on employees but the Employment Act does set out the basic conditions of employment and addresses the legal requirements for engagement, termination and specifically termination on account of redundancy which is a common feature in such undertakings.

It is trite law that contracts of employment are not assignable; therefore assignment of such contracts would ordinarily not be included in the assignment of assets and liabilities of a company being dissolved or absorbed into another company. An exception to this arises when the employer company is acquired by merely change of shareholder and not identity, therefore the terms of employment remain unchanged and the employment relationship continues.

Where a merger would result in a new company emerging and the old company being dissolved, the theory of corporate personality lays credence to the fact that the employee’s contractual relationship does not pass to the new entity as to create a contractual relationship between the employee and the new company. The contracts of employment are therefore terminated on account of redundancy with procedures and payments to be strictly followed in accordance with Section 40 of the Employment Act by the acquiring company. If the acquiring company adopts the approach of taking up the employment of transferred employees, they must be employed on terms that are on a whole not less favourable. The employees who are taken up on new terms waive their rights to terminal benefits, however if the employees reject this new offer they must be terminated on account of redundancy and compensated in accordance with the Employment Act.

Prior to the transfer undertaking, due diligence should be undertaken requiring a review of the other company’s employment agreements and collective bargaining agreement that relate to the conditions of service, as a buyer that steps in the seller’s shoes may be bound by them. In situations such as transfer of entity into a new entity, a buyer may assume bargaining obligations with a pre-existing union whose members are contracted by the new entity but it is not bound by the requirement of the collective bargaining agreement. Review of the company’s policies, procedures, pending employment claims, share incentive schemes, pension schemes, benefit plans, housing and building loans is also imperative. Appropriate warranties and indemnities are advised in the agreements.

Intellectual Property (IP)

In the event that the company being acquired holds any IP rights either as patents, trade marks, copyrights or industrial design (as is the case in many manufacturing companies), then a due diligence will need to be conducted by the acquiring entity to confirm that the target company is the registered proprietor of such IP rights.

If IP rights are to be transferred to the acquiring company, then the parties will need to consider having a deed of assignment executed to cater for the assignments of such IP rights to the acquiring entity. Such Deeds of Assignment are registerable at the Kenya Industrial Property Institute (KIPI). The details of proprietorship in the case of patents, trade marks and industrial design are then changed to reflect the acquiring entity and respective certificates are subsequently issued.

Immovable Property
For a transfer of immovable property to be effective in Kenya, it must be stamped and registered. Where an entity is acquiring the business and assets of the target company and the acquisition entails immovable property owned by the target company, then instruments of transfer will need to be drawn, executed by both parties and thereafter stamped and registered. It goes without saying that the acquiring entity will need to conduct a search at the Lands Registry to ensure that there are no encumbrances registered against such properties. Any encumbrances in the form of charges securing the payment obligations of the target company to financiers will need to be discharged before they are transferred to the acquiring entity.
In the case of leases held by the target company, the respective landlords will have to be engaged and notified of the target company’s proposed acquisition. Confirmation will have to be sought on whether such leases will be assigned to the acquiring entity or whether the existing leases will be terminated and fresh ones entered into between the landlord and the acquiring entity.

Where an acquisition entails a mere transfer of shares in the target company and a subsequent change of name, a certificate of change of name will have to be submitted to the relevant Land Registrar who will make an entry to indicate the change of name of the target company against the document of title.

Where a transfer of controlling interest triggers a transfer event in a lease or charge document, then the consent of the relevant landlord or financier or charge will need to be sought.

Major Contracts and Licences

A review of the target company’s major contracts and licences will need to be conducted before an acquisition.

In case the contracts or licences are to be assigned as part of the transfer of the business and assets of the target company, then deeds of assignment and novation would need to be prepared and executed by all the relevant parties.

Further, such contracts or licences may contain a clause that precludes the target company from transferring or assigning the contracts or licences. Such clauses may further state that a transfer of controlling interest in the target company would be deemed to be a transfer of the contract or licence and that the consent of the other contracting party to that contract would be required before such transfer of shares.

Conclusion
Finally, various state organs and departments would need to be involved in the case of mergers and acquisitions to properly safeguard the interests of the contracting parties and also in keeping with the provisions of various statues.

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More Power to Investors: Kenya’s Promising Renewable Energy Market

No doubt, Kenya offers one of the fastest growing and dynamic markets for renewable energy in Africa. In 2015, the Climatescope Index ranked Kenya 6th out of 55 countries that invest in the generation of renewable energy. The country’s renewable energy flagship projects include the Lake Turkana Wind Power Project which aims to provide 310 MW of reliable, low cost windpower to the Kenyan grid. This is equivalent to approximately 20% of the current installed electricity generating capacity. As the single largest private investment in Kenya, the Project will replace the need for Kenya to spend approximately KES13.7 billion (USD 135 million) per year on importing fuel for electricity generation. Construction of the power plant commenced on 25th October, 2014. 50 MW to 90 MW of capacity will be ready for commissioning in September 2016. It is notable that when fully operational in April 2017, the windfarm will be the single largest one of its kind in Africa.

Smaller windpower projects such as a 90 MW windpower project in Mpeketoni, Lamu County have been proposed. Regulatory approvals have been granted for this KES 20 billion (approximately USD 200 million) project sponsored by Electrawinds, a Belgian company, in partnership with International Finance Corporation and a Kenyan company, Kenwind Company Holdings. In Kajiado County, the Kipeto windpower project is set to generate 100 MW of electricity. The project results from one of the most substantial United States foreign direct investments in Kenya. A Chinese firm was recently contracted to construct the plant at the cost of KES 22.6 billion (approximately USD 223 million). The construction phase has been estimated to be two (2) years.

In addition, SkyPower, the developer and owner of various utility-scale solar photovoltaic energy projects, signed an agreement in July 2015 with the Ministry of Energy and Petroleum for the development of 1 GW of world-class solar projects to be built in four phases in Kenya over the next five (5) years.

Centum Investments, a Kenyan investment company, together with three other foreign firms have also sponsored the construction of the 140 MW Akiira geothermal power plant at a projected cost of KES 30 billion (approximately USD 296 million). The project will be developed in two phases; it is estimated that 70 MW will be connected to the national grid.

The legal and policy framework

The above projects have been facilitated by Kenya’s extensive regulatory framework which supports the growth of Kenya’s renewable energy sector.

The Energy Act, 2006 defines renewable energy to mean “all non-fossil sources including but not limited to biomass, geothermal, small hydropower, solar, wind, sewage treatment and plant gas”.

The Sessional Paper No. 4 of 2004 on Energy, which is the foundational document for energy liberalisation in Kenya, provides for the government to undertake pre-feasibility and feasibility studies on the potential for renewable energy sources and for the packaging and dissemination of information on renewable energy sources to create investor and consumer awareness on the economic potential offered by renewable sources of energy.

The Energy Act, establishes the Energy Regulatory Commission (ERC). The ERC’s key functions include the regulation of production, distribution, supply and use of renewable and other forms of energy. The ambit of its functions covers the protection of interests of consumers, investors and other stakeholder interests. To compound this, the Energy Act obligates the Cabinet Secretary to promote the development and use of renewable energy technologies.

Government policy on feed-in-tariffs

In a bid to attract private investment into the renewable energy sector, the Government issued a policy on renewable energy feed-in-tariffs in 2008. The feed-in-tariffs were originally introduced for electricity generated from wind, biomass and small hydropower sources but after revision in 2010, they also provide support to geothermal and biogas sources as well as solar electricity generation. A feed-in-tariff as described in the policy is an instrument that allows power producers to sell renewable energy-generated electricity to an offtaker (the buyer of electrical energy for the purpose of selling the electricity to customers connected to the national or mini-grid systems) at a pre-determined tariff for a given period of time.

The objectives of the feed-in-tariffs system as outlined in the policy are: to facilitate resource mobilisation by providing investment security and market stability for investors in electricity generation from renewable energy sources; reduce transaction costs, administrative costs and delays associated with the conventional procurement processes. Another objective is to finally encourage private investors to operate their power plants prudently and efficiently so as to maximise returns.

The policy provides that small renewable energy projects with a capacity of up to 10 MW shall have a standardised power purchase agreement which shall incorporate certain features such as no bidding for renewable sites and resources. Feed-in-tariff values for small renewable projects are provided in the policy which further outlines principles that underline the calculation of the said values which include as stated in Section 25, a calculation on a technology specific basis using the principle of cost plus reasonable investor return.

The policy further provides that renewable energy projects which are larger than 10 MW of installed capacity shall meet load flow or dispatch and system stability requirements. The policy gives the feed-in-tariffs for each of the renewable energy sources it covers and one of the common features is that the feed-in-tariff is to apply for twenty (20) years from the date of the first commissioning of the respective power plants.

The developer is to bear the costs of interconnection including the costs of construction, upgrading of transmission lines, substations and associated equipment. The off-taker is to recover from electricity consumers 70% of the portion of the feed-in tariff, except for solar plants connected to off-grid systems, where the off-taker recovers 85%. Finally, the policy provides that renewable energy generators feeding into the grid will require a power purchase agreement and further that the project sponsor for such renewable generation projects must be an entity legally registered in Kenya.

The promulgation of the Constitution of Kenya, 2010 changed the governance structure of the country by creating a decentralised system of government with functions that were formerly exercised by the National Government being devolved to Counties. The roles of the National and County Governments in relation to energy have been clarified and hence this necessitated the review of the energy sector framework which led to the Draft National Energy and Petroleum Policy, 2015 as well as the Energy Bill, 2015 (the Energy Bill).

The Energy Bill

The preamble of the Energy Bill provides that it aims to achieve among other things the promotion of renewable energy. The Energy Bill describes obligations of the National Government and the Cabinet Secretary is mandated to develop a conducive environment for the promotion of investments in energy infrastructure development. The Energy Bill further provides that the National and County Governments shall, in their effort to promote energy investments, facilitate the acquisition of land for energy infrastructure development in accordance with the law.

The Energy Bill establishes the Energy Regulatory Authority whose functions shall be to regulate the production, distribution, supply and use of renewable and other forms of energy as well as to protect the interests of consumer, investor and other stakeholder interests.

The Energy Bill additionally establishes the Rural Electrification and Renewable Energy Corporation, whose functions shall include undertaking feasibility studies and maintaining data with a view to availing it to developers of renewable energy resources. Also to develop and promote the use of renewable energy and technologies.

The Energy Bill also establishes an inter-Ministerial Committee known as the Renewable Energy Resource Advisory Committee. This Committee is charged with the task of advising the Cabinet Secretary on amongst other things, the criteria for allocation of renewable energy resources, licensing of renewable energy resource areas, management of water towers, water catchments and management (and development) of renewable resources e.g. multi-purpose dams and reservoirs.

Lastly, the Energy Bill establishes a renewable energy feed-in-tariff system with the objective of catalysing the generation of electricity through renewable energy sources and encouraging locally distributed generation, thereby reducing demand on the network and technical losses associated with transmission and distribution of electricity over long distances, among other objectives.

Conclusion

Although Kenya has attracted notable large scale energy projects and has sought to streamline the regulation of its renewable energy sector, the country’s renewable energy potential remains largely untapped. This could be attributed to amongst others, a focus on large scale energy projects. Efficient licensing procedures and the ease of access to information on the same would therefore bolster the growth of smaller scale renewable energy projects in Kenya.

Tightening the Reins: Fighting Financial Crimes in the Kenyan Capital Markets

A financial system can be accessed through several avenues such as capital markets, banking and insurance industries. Such access has over time opened doors for engagement in money laundering and terrorism financing, which are white collar crimes with adverse effects on the modern day economy.

Capital markets are part of a financial system concerned with raising capital by dealing in shares, bonds and other long-term securities. Money laundering on the other hand, has been defined in a number of ways. The Financial Action Task Force (FATF) which is an inter-governmental body established in 1989, with the aim of setting standards and promoting effective implementation of measures for fighting money laundering and terrorist financing, has defined money laundering as “the processing of criminal proceeds to disguise their illegal origin.”

The Proceeds of Crime and Anti-Money Laundering Act, 2009 (the Act) defines money laundering as “an offence under any of the provisions of Sections 3, 4 and 7.” Section 3 of the Act provides that a person who knows that property forms part of the proceeds of crime and enters into an agreement or performs any other act in connection with such property whose effect is to conceal the source or assist any person who has committed an offence to avoid prosecution, or remove any property acquired as a result of the commission of an offence, commits an offence. Section 4 provides that a person who acquires, uses or has possession of property and who, at the time of acquisition, use or possession of such property, knows that it forms part of proceeds of a crime committed by him or by another person, commits an offence. Lastly, Section 7 of the Act provides that a person who, knowingly transmits or receives or makes the attempt to transmit or receive a monetary instrument or anything of value to another person with intent to commit an offence, commits an offence.

Terrorism financing has been defined in the Prevention of Terrorism (Implementation of the United Nations Security Council Resolutions on Suppression of Terrorism) Regulations, 2013 to include the offence specified under Section 5 of the Prevention of Terrorism Act, 2012 (PTA). Section 5 of the PTA provides that a person who collects, provides or makes available any property, funds or a service knowing that such property, funds or service shall be used for the commission of a terrorist act or by a terrorist group or by a natural person in the commission of a terrorist act commits an offence.

In the past, money launderers targeted banks to launder their unlawful funds. However, the global nature, anonymity, speed at which transactions are executed, ability to pool funds through means such as collective investment schemes and the highly liquid nature of capital markets, have provided fertile breeding ground for money laundering and terrorism financing. Furthermore, the capital markets sector is distinctive among other financial sectors in that it can both be used to launder illicit funds obtained outside of the financial markets and also to generate illicit funds within the market itself, through fraudulent activities such as insider trading.

In an endeavour to curb the aforesaid, the Capital Markets Authority (CMA) pursuant to powers vested in it under Section 12A(1) of the Capital Markets Act, Cap. 485A enacted the Guidelines on the Prevention of Money Laundering and Terrorism Financing (the Guidelines) in the Capital Markets vide Gazette Notice Number 1421 on 4th March, 2016.

The Guidelines, which are aligned to the Kenyan Anti-Money Laundering and Counter Terrorism Financing laws mentioned above as well as the recommendations of FATF, are meant to form part of efforts to improve corporate governance and encourage capital inflows to Kenya. The Guidelines provide an explanation of certain features of the capital markets that have made it prone to money laundering and also give an account of the three stages involved in the money laundering process. The first is the ‘placement’ stage which involves the introduction of proceeds of crime into the financial system.

The second is the ‘layering’ stage where the proceeds are moved through a series of transactions in order to distance them from their source. The third stage is ‘integration’ which places the laundered proceeds back into the legal economy.

The Board of Directors of a person licensed to transact business by the CMA (market intermediary) have under Guideline 3 been vested with the responsibility of establishing Anti-Money Laundering and Counter Terrorism Financing policies, procedures and internal controls, as well as ensuring compliance with existing legislation. The said policies, procedures and controls are to be reviewed once in every two years to guarantee their effectiveness.

To effectively mitigate money laundering risks in capital markets, Guideline 4(2) provides that a market intermediary must adopt a risk-based approach and methodologies to determine a holistic view of the level of risk posed and avoid a silo approach, when assessing the relationship between risks. A market intermediary may assess the money laundering risks of individual customers by assigning money laundering risk rating to their customers and in doing so, the market intermediary shall consider factors outlined in the Guidelines which include in relation to country risk, customers in connection with highrisk jurisdictions, for instance, those that have been identified by the FATF as jurisdictions with high strategic Anti-Money Laundering deficiencies or are believed to have strong links to terrorist activities.

Factors which indicate that a customer presents a high risk of money laundering as enumerated under Guideline 4(4)(d), include where the origin of wealth cannot be easily verified as well as a politically exposed person. Examples of customers that might be considered to carry lower money laundering risks are those with a regular source of income from a known legitimate source, those with a positive reputation and public entities. A market intermediary is to keep records of the risk assessment for a minimum of seven (7) years from their official date of creation. Guideline 4(6) makes it mandatory for a securities exchange to have surveillance systems and mechanisms intended to detect activities that might be a consequence of market manipulation or insider trading, which are offences often associated with money laundering.

A market intermediary shall under Guideline 5 obtain satisfactory evidence of the identity and legal existence of persons applying to do business with it. It should reject transactions with clients who fail to provide proof of their identity. Due diligence and scrutiny of customers’ identity and their investment objectives should be done throughout the course of a business relationship.

Where there is a perception of increased risk with regard to face-to-face transactions, a market intermediary may request for submission of additional documentation such as a reference letter from a current employer, bank statements, a lease for a rental house or business premises and a passport or a national identity card. These additional documents would enable the market intermediary obtain further independent verification.

With regard to prospective non-resident customers who wish to open an account with a market intermediary in Kenya, the Guidelines provide for adoption of effective identification procedures akin to those applied to Kenyan resident customers. Guideline 7 indicates that such customers will be required to provide identity documents, such as a copy of their passport, national identity card or documentary evidence of address which shall be certified by the embassy of the country of issue, a commissioner of oaths or notary public or a senior officer of the market intermediary. A market intermediary may further verify identity through a reputable institution authorised to carry out the role in the applicant’s country of residence.

Stringent measures that ought to be taken with regard to establishing the true identity of corporate and legal entities have been outlined in the Guidelines. For a body corporate, there should be evidence of registration, a corporate resolution authorising a person to act on behalf of the body corporate, as well as a copy of the latest annual returns. In the case of partnerships and unit trusts, the identity of all partners and signatories to the account must be verified and the relevant deeds and documentation should be obtained. The Guidelines emphasise the need for particular care to be exercised when trust, nominee and fiduciary accounts are set up in locations with strict bank secrecy or confidential rules, as the said accounts are a popular vehicle for money laundering.

The Guidelines also provide that all records of customers, business relationships and transactions shall remain up-to-date, relevant and accessible and that a market intermediary shall maintain and keep the said records for a minimum period of seven (7) years, from the date the relevant transaction was completed or following the termination of a business relationship.

Robust measures and procedures are to be undertaken while using new technologies and non-face-to-face business transactions. These measures include confirmation of the customer’s address through the exchange of correspondence or other appropriate methods, certification of identification documents, confirmation of the customer’s salary and any other reliable verification checks.

A market intermediary incorporated in Kenya, as stated under Guideline 9, shall develop a group policy on anti-money laundering and countering financing of terrorism which shall apply to all its branches and subsidiaries, where applicable outside Kenya.

A market intermediary is required to report suspicious transactions to the Financial Reporting Centre established under Section 21 of the Proceeds of Crime and Anti-Money Laundering Act, 2009 within seven (7) days of the date of the transaction. In addition, a market intermediary is required to report to the Financial Reporting Centre, all cash transactions carried out by it equivalent or exceeding USD 10,000 (approximately KES 1 million) or its equivalent in any other currency whether or not the transaction appears to be suspicious.

The issuance of a licence or an approval to a market intermediary by the CMA shall be determined by the market intermediary’s compliance with the Guidelines and similar legislation. A market intermediary is required under the Guidelines to monitor on an ongoing basis, its business relationships with its customers, as well as conduct training programmes to ensure that the requirements under the Proceeds of Crime and Anti-Money Laundering Act are well understood and implemented. It is an offence for anyone who knows that a disclosure has been made in connection with an investigation into money laundering or terrorist financing, to inform the person who is the subject of a suspicion of the disclosure.

Finally, in relation to combating the financing of terrorism, the Guidelines provide that market intermediaries shall, upon receipt from the CMA, keep updated the various resolutions passed by the United Nations Security Council (UNSC) on counter-terrorism measures, maintain a database of names and particulars of listed persons and ensure the database is easily accessible to its employees. Market intermediaries are required to conduct regular checks on names of both the new, existing and potential customers against the names in the database. Moreover, where there is any name match and there has been confirmation of the identity, the measures to be taken include freezing the customer’s funds and informing the relevant bodies.

If properly implemented, there is no doubt that these Guidelines will to a large extent curb money laundering and terrorism financing in the capital markets. The Guidelines mark a bold and laudable move by the CMA to rein in financial crimes.

On the Rise: How REITs are Changing the Real Estate Landscape

Real Estate Investment Trusts or REITs as they are commonly referred to, have become the new frontier in the investment sector in Kenya. This is despite the fact that they have always been available as an investment option but for one reason or another, REITs have become more popular and increasingly attractive, even to the average investor who had always seen REITs as a niche investment for a select few. For most people, the possibility of owning property as expansive as Garden City Mall in Nairobi for instance, was next to impossible. This has been bolstered by a growing real estate market and advancement of earning power and net worth of individuals in Kenya. These changes, coupled with the access to information and the increasing interest in other forms of investment have resulted in the attractive allure of REITs today.

What is a REIT?

REITs are regulated investment vehicles that enable collective investment in real estate. Investors pool their funds and invest in a trust that is divided into units with the intention of earning profits or income from real estate, as beneficiaries of the trust. A REIT is an entity that owns and typically operates income-producing real estate or related assets which may include among others, office buildings, shopping malls, apartments, hotels, resorts and warehouses.

A REIT is a vehicle through which investors earn a share of the income produced through commercial real estate ownership without actually having to go out and acquire commercial real estate. REITs also allow the investor the opportunity to have its properties managed by a professional real estate team that knows the industry, understands the business and can take advantage of opportunities. Most importantly REITs are excellent for the investor who wants to avoid capital risk as much as possible while enjoying a decent dividend or interest yield.

The Legal Framework governing REITs in Kenya

REITs are regulated by the Capital Markets Authority (CMA) under the Capital Markets (Real Estate Investment Trusts) (Collective Investment Schemes) Regulations, 2013.

The high interest rates associated with real estate development and the undersupply of housing especially for the lower segment of the market have proven to be a challenge towards the further advancement of this sector. To remedy this, the Government seeks to encourage investment in real estate through REITs.

How do REITs Operate?

The Trustee acquires the Property and holds it on behalf of the beneficiaries (the Investors). The Trustee is responsible for the appointment and supervision of the Manager. It is also the Trustee’s responsibility to ensure that the assets of the scheme are invested in accordance with the Trust Deed and the Offering Memorandum and ensures that distributions from the assets of the REIT are made in accordance to the Offering Memorandum.

The Scheme is managed by a Professional Manager who is answerable to the Trustee. The Manager’s duty is to oversee the investment of the assets of the scheme and maintain proper accounting records and other records of the scheme. The Manager also collects rent and other income on behalf of the Trustee. The income is distributed to the Investors at the rate agreed upon in the Memorandum or at any other rate as may be agreed between the Trustee, the Manager and the Investors.

Prior to issuance of the Memorandum by the Trustee, the Scheme as well as the Offering Memorandum should be approved by the CMA. On invitation by the Trustee, the Investors pump capital in form of units with a view of having a return on investment within a specified duration.

Types of REITs

There are three types of REITs namely: Income REITs (also referred to as I-REITs), Development REITs (also referred to as D-REITs) and Islamic REITs.

I-REIT is a form of REIT in which investors pool their resources for purposes of acquiring long-term income-generating real estate including housing, commercial and other real estate. Investors gain through capital appreciation and rental income, with the latter being distributed to unitholders at the agreed duration.

D-REIT is a type of REIT in which resources are pooled together for purposes of acquiring eligible real estate for development and construction projects which may include among others housing or commercial projects. It should be noted that a D-REIT can be converted to an I-REIT once the development is complete where the investors in a D-REIT can choose to sell, reinvest or lease their shares or convert their shares into an I-REIT. An offer or issue in a D-REIT may only be made as a restricted offer to professional investors.

An Islamic REIT is a unique type of REIT that invests primarily in income-producing, Shari’ah-compliant real estate. A fund manager is required to conduct a compliance test before investing in real estate to ensure it is Shari’ah compliant and that non-permissible activities are not conducted in the estate and if so, then on a minimal basis.

Benefits to Investors

Investing in REITs offers the following benefits to investors:-

a) REITs offer investors especially the middle income class, easier access and ownership in the growing real estate sector in a manner which is not as capital intensive as a direct purchase of property.
b) More often than not, the value of the property appreciates thus minimizing the risk of capital loss.
c) Unlike direct investments in property which are generally illiquid, investments in I-REITs may easily be converted into liquid cash by selling the units in the market or offering them for redemption in the case of open-ended funds.
d) Investors in REITs have the advantage of investing in a variety of real estate e.g shopping malls, residential projects industrial projects e.t.c.
e) REITs provide investors with access to professionals such as property managers and fund managers who understand the industry and the business and can take advantage of opportunities.
f) REITs offer predictable income streams because of long-term lease agreements with tenants thus rental income and management expenses are predictable in both long and short time frames.
g) REITs are considered to be efficient from a tax perspective. This is discussed in detail below.

Taxation of REITs

One of the key advantages of investing in a REIT is the tax regime that governs REITs both from the REIT’s perspective and also from the investors’ perspective. The Kenyan government in an effort to encourage investments in real estate has put in place a tax regime that favours REITs. A REIT is generally exempt from taxation if it complies with REIT Regulations and remains registered with the Capital Markets Authority and the Commissioner of Taxes.

However, REITs are not exempt from withholding tax on interest income and dividends. These are taxed at the rates shown in the table below:

Type of income Resident(%) Non-resident(%) Exempt(%)
Dividends 5 10 0
Interest 15 15 0

When a REIT distributes its income to its unitholders, the same will be deemed to have already been taxed. The unitholders will therefore not be required to account for further taxation. This is also the case with payments for redemption or sale of units received by investors.

In the event that a unitholder transfers its share in a REIT or redeems its units from the REIT, they will be obliged to account for capital gains tax on the gain made. However it will be exempt from Stamp Duty.

Shortcomings of investing in REITs

a) Economic and political situations that could lead to depreciation in the value of the property. However, gauging from the trend in the Kenyan property market in the past few years, the values of properties have been escalating.
b) Decrease of rental income as a result of termination of lease agreements or non-renewal of lease agreements and failure to secure replacement tenants in good time.
c) For close-ended REITs, the Investor is not able to access their investment before the end of the investment period. In a close-ended REITs, the Investor cannot seek to redeem his investment before expiry of the investment period unless there is an arrangement with the Trustee’s consent for the sale of the Investor’s units.

The trend of REITs in Kenya

RElTs in developed capital markets have been in existence in their present format since the 1960s, but they were actually introduced in the 1800s. The US has the most advanced REIT in the world. In Africa, growth in this market has been limited by the absence of enabling legislation. With the opening of the Stanlib Fahari I-REIT public offer, Kenya became the fourth African country to launch REITs. South Africa has traded in REITs for the last 10 years, while Ghana has had access to REITs since 1994 and Nigeria 2007.

Testing the Safety Net in Banking: Is Deposit Insurance Adequate?

Recent events in the banking industry in Kenya have caused the Central Bank of Kenya (CBK) and other financial regulatory bodies to pause and rethink the current approach towards the regulation of the banking sector. Presently, the main issues facing Kenya’s banking industry are excessive insider lending, non-performing loans, inadequate or non-existent credit documentation and securities, liquidity problems and the poor management of banks (and other financial institutions). These issues have in some cases proved to be sure recipes for highly-publicized scandals or the downright collapse of the financial institutions involved.

Of utmost concern obviously is the impact that the collapse of several financial institutions has had on their depositors, bondholders, creditors and customers. Serious questions have been raised regarding the adequacy of the measures put in place for the protection of their deposits in the form of deposit insurance or otherwise. Indeed, anyone affected by the failure or collapse of a bank or financial institution should take a keen interest in the role that deposit insurance plays in such a situation.

Deposit insurance is a mechanism that has evolved over time to provide protection to depositors of commercial banks or deposit-taking entities, in the event of failure of the institution. It is also intended to play a critical role in contributing to the stability of the financial system of a country and in fostering economic development while encouraging savings.

The Deposit Insurance Fund

Kenya has in place the Deposit Insurance Fund (the Fund) which provides insurance protection to depositors against potential loss of their deposits in the event of failure of a member financial institution. The Fund is managed by the Kenya Deposit Insurance Corporation (KDIC), which was established under the Kenya Deposit Insurance Act, 2012 (the Act). Membership is compulsory for all institutions licensed to carry on deposit taking business such as commercial banks, financial institutions, mortgage finance companies, building societies and micro finance institutions.

The Banking Act (Cap. 488) also empowers CBK to intervene in the management of a bank or other financial institution by among other things, appointing KDIC to administer or liquidate any institution if it is established that its assets are less than its liabilities to its creditors.

KDIC is both publicly and privately funded. It is autonomous in its operations and not subject to the control, direction or supervision of any other entity in the exercise of its rights, powers, and privileges. However, any party aggrieved by the exercise of those powers may apply to the High Court for appropriate orders.

Degree of Protection

As stated above, one of the functions of KDIC is to provide and manage a deposit insurance scheme for depositors. However, the degree of protection provided to depositors and customers of collapsed financial institutions in Kenya is fairly low in comparison to that provided by other countries. KDIC offers limited coverage for deposits placed with an institution up to KES 100,000 (approximately USD 1,000) or such higher amount, as it may from time to time determine.

Furthermore, the Act provides that where a depositor owns more than one deposit account with an institution, the aggregate of those deposits is insured up to only KES 100,000 – hardly an incentive to keep a large deposit or have more than one deposit account in the same institution. Nonetheless, in recent months CBK has allowed depositors to withdraw up to KES 1 million (approximately USD 10,000) in situations where a bank or financial institution is placed under receivership. This has been a great relief to small depositors but it is disadvantageous to large ones whose deposits far exceed the maximum amount that can be claimed.

The deposit insurance scheme in other countries such as the United Kingdom and the United States of America is relatively advanced in terms of funding and coverage. For instance, in the US the Federal Deposit Insurance Corporation covers up to USD 250,000 (KES 25 million) depending on the type of account one holds with an institution. This amount is quite generous and lends credibility to the ultimate objective of deposit insurance. In the UK, quite apart from insuring deposits, the Financial Services Compensation Scheme extends the protection offered to insurance policies and insurance brokers. Furthermore, deposits are covered up to a maximum of GBP 75,000 (approximately USD 100,000) (KES 10 million). Naturally, this kind of protection comes at a price as it is commensurate to the high premiums levied on member institutions.

Interestingly, it has been argued that the deposit insurance system in the UK is unduly expensive and that it unfairly subsidizes poorly managed banks. It has also been argued that deposit insurance undermines market discipline. The rationale being that as a result of having such an insurance scheme in place, financial institutions tend to take undue risks while customers take little or no interest in the way these institutions are being run.

In Kenya, despite the relatively low level of protection offered, unscrupulous financial institutions do not seem to shy away from taking very high (and in certain cases illegal) risks with depositors’ funds. Such unrestrained risktaking, coupled with depositors’ disinterest, ignorance or blind trust in financial institutions ultimately leads to their imminent failure or collapse.

Ideally, deposit insurance should reduce the risk of a bank run based on the premise that depositors who are assured that the insurer will reimburse their deposits in the event of a bank failure, are less inclined to withdraw their deposits in the event of an institution’s insolvency.

Need for Reforms

While the country is experiencing a number of long-awaited reforms in the banking sector, more focus should be directed towards the reform of the existing deposit insurance legislation. The current approach to banking in Kenya is reactionary as opposed to pre-emptive, with protective measures being adopted after the event of a collapse, failure or liquidation of a financial institution, often being a case of too little, too late. In the absence of a significant increase in deposit insurance coverage which is aligned with the current inflation rate, it is doubtful whether the objectives of the scheme will ever be achieved.

The Act provides that premiums are limited to a maximum of 0.4 per cent of the average of a members total deposit liabilities in a twelve (12) month period prior to assessment. This percentage needs to be adjusted upwards for the deposit insurance to be of any relevance and coverage of deposits should also be increased, so as to be in tune with changing economic times.

Such reforms will serve the country better in terms of enabling KDIC to fulfill its deposit insurance mandate, as well as enhancing confidence and, in turn, stability in the financial system. Indeed, President Franklin D. Roosevelt aptly remarked while exhorting citizens to remain calm and avoid making the panicked withdrawals, which had crippled America’s banking system in 1933: “After all, there is an element in the readjustment of our financial system more important than currency, more important than gold, and that is the confidence of the people.”