Why market makers are unlikely to end bear run at the NSE

Having all-star players doesn’t guarantee success.

The Capital Markets Authority (CMA) is on the same path. Late last year, they announced a new class of licensees; market makers with the aim of boosting liquidity (the ease with which an asset can be bought or sold in the market without affecting its price) – very low liquidity is one reason why the Nairobi Securities Exchange is still not a top tier exchange. Will market makers change this?

To start, there’s plenty of research touting the benefits of market makers. Unfortunately, most of it is centred on developed markets and almost none on frontier regions such as Kenya.

It is, therefore, unclear what studies the CMA relied on in making the decision. Be that as it may, there’s plenty of notable conclusions about the subject.

For instance, as market liquidity is asymmetrical (it is high in a bull market but may be very thin in a bear market), market makers are needed to have sufficiently large capital resources.

This is because they often have to buy large quantities of securities during a bear market phase, which they off-load at a later stage.

This means market making may likely be unprofitable (or even costly) during a bear run. As a result, during heightened market volatility, some market makers are going to be less willing to take large positions. The big question is; do we have these capital-rich entities ready to take up this risk?

Further, the above challenge leads to the next one, a severe conflict of interest. Often, to mitigate bear market losses (and as a way to entice players), market makers are allowed the right to trade in dual capacity or operate as a principal and an agent at the same time.
This is what the CMA market maker licence is offering.

Although the counter-argument about having Chinese walls may work - I have argued here before that these “fictitious walls'' are a myth.
That said, poor liquidity is obviously hurting trading at the NSE. With liquidity declining over several years, we have no choice - equities turnover has been on a downward trend since 2019 while the average turnover ratio has perennially danced below 10 percent.

Therefore, helping to improve the overall quality of liquidity will pay dividends for investors. For this reason, market makers are a critical component to any market despite the obvious hurdles.

The regulator needs to find and encourage players with adequate finance to step forward and fulfil this role. Maybe, just maybe, onboarding these players could help us win in the uncertain game of liquidity.

Mwanyasi is MD, Canaan Capital