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BY LUKE MULUNDA
Safaricom recently announced a Sh31.9 billion after-tax profit, breaking its own record in regional corporate earnings. The company’s board of directors extended the term of its CEO, Mr Bob Collymore, by two years, in what is seen as a move to maintain the growth momentum.
But how significant is two years for such a high-profile company? Mr Collymore says his focus now is to institutionalise what he calls a value-based leadership team to steer the company over the next 20 or so years. “Our customers have trusted us for the past 15 years because we have remained relevant to them,” he says. “For us to continue to do so, we have to get a deeper understanding of our customers’ needs and aspirations and to help meet them.”
It is this keener understanding of its customers and system that has kept Safaricom ahead of the pack in the fluid telecommunications industry where other players struggle to break even. While the company is churning out record profits from all its business segments such as voice, SMS, and data, all its peers in the industry are yet to hit the critical mass needed to turn in a profit.
Mr Collymore took over Safaricom in 2010 during a vicious price war that gave its distant second rival, Airtel, a fighting chance in the market. At the time, it appeared like Collymore had been set up to fail and some market observers even projected that was the end of the Safaricom surge. With M-Pesa catching on, it felt as if the innovation bag had been exhausted. Collymore took a different approach – and it is working.
“I took an early position that the price wars were not sustainable, and made a firm decision to strike the tricky balance between offering a competitive price to customers that would also enable us to earn a margin in order to continue to invest significantly in the network,” he says. “The toll of that price war was seen in the losses that some players experienced at the time and it continues to be felt to this day.”
With voice increasingly getting saturated, Safaricom under Collymore began to put more emphasis in growing non-voice revenue with a special focus on M-Pesa and data business. The market had incidentally aligned itself in favour of non-voice services and Bob Collymore went for the opportunity. “Kenya was on the cusp of a defining moment, the undersea fibre cables had finally arrived and their impact on lower data prices coupled with our investment in the right infrastructure meant that our subscribers were able to benefit from significantly lower data pricing,” he says.
This increased uptake of mobile Internet, which stimulated a new stream of revenue as handset makers responded with cheaper but faster smartphones that made it easier for users to access the Internet by increasing screen sizes. The company has also gone deep into corporate Internet and related services.
At the same time, the growing M-Pesa agent network enabled more payments and Safaricom invested in delivering products that went beyond the money transfer concept and won a bigger share of the market. Financial institutions came on board to introduce mobile banking and loan services riding on the M-Pesa platform and utility companies tapped M-Pesa for payment services.
“This was anticipated as part of our growth strategy, informed by the fact that we had already started seeing ourselves as an integrated services provider, rather than just a telecommunications firm,” Mr Collymore says. “Our investment strategy has always seen us invest in the technologies that we believe will transform our subscribers’ lives.”
Mr Collymore had a head start, as he was not entirely new to the Kenyan market. Before being appointed CEO, he was already sitting on the Safaricom board and had insights in the company’s business and local market dynamics. “I developed a strategy to guide the company in the coming years. We called this Safaricom 2.0 at the time and it entailed streamlining our business in order to align with the changing nature of the business,” he says. “This was geared at ensuring that we had the right people to take the business to the envisaged point.”
Safaricom has been so successful to the point of being branded a monopoly, controlling more than 70% of the voice market, with over 20 million subscribers. This raised a storm that led to the Communication Authority and Competition Authority of Kenya to sign an MoU that will guide the debate around dominance. But Mr Collymore has a different view about the company’s huge market command. “We believe that being dominant in itself is not a crime,” he says. “It is a factor of market forces that comes about when customers choose to support those providers who meet their needs in the most effective way.”
He says market dominance discussion should focus on instances of abuse of dominance, rather than just the arbitrary declaration of dominance.
While the company has for long stood out as the most profitable in the region, its share price movement tells the fortunes of Safaricom. Listed on the Nairobi Securities Exchange in 2007 at Sh5 a share, the telecommunications stock price dipped, hitting Sh2.90 just a year after Mr Collymore took office.
However, its recovery to an all-time high of Sh17.55 recorded last month marks one of the greatest achievements of Mr Collymore. “I rarely consider our share price when I am thinking about the growth of this company,” he says. “Our focus is delivering the right products and services for the customer, and giving positive returns to our shareholders and investors.”
Safaricom is increasingly the connective tissue that drives many segments of Kenyans’ lives – from making calls, texting, sending and receiving money, borrowing loans and paying for goods and services. “Our strategy is to transform lives and we achieve this by delivering value across many segments. Our customer interactions through various marketing campaigns and corporate social responsibility initiatives have also strengthened the bond between us and our customers.”
From a technology perspective, Safaricom remains a pacesetter. Recently it brought M-Pesa servers home from Germany and it was the first to introduce 4G, just as it pioneered 3G and 2G before.
He says the challenges have been few, with unlimited opportunities. “My key opportunity was figuring out how to maintain the growth story that had seen the company through its first nine years,” says Mr Collymore. “My task was to transition from the infrastructure-led strategic focus we had at the time. Safaricom had been very busy laying the foundations for its future growth, we needed to move towards leveraging those assets to deliver a differentiated mobile experience.”
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Safaricom Limited is Kenya’s, indeed, East Africa’s leading provider of converged communication solutions. Formed in 1997 as a fully owned subsidiary of Telkom Kenya, the telecom giant entered the market with hardly three products to offer; voice and text. In May 2000, Vodafone Group Plc of the United Kingdom acquired a 40% stake and management responsibility for the company.The growth of Safaricom into the giant it is today, the axe of being declared a dominant player by the sector regulator hovering around its neck for operating way above its competitors is fascinating. From the five common product segments of yesteryears – simu ya jamii, the ground breaking M-pesa, prepaid, postpaid, business and enterprise, international roaming data and messaging, Safaricom has churned out ingenious products year in year out, most of which being the first of their kind in the market.
It has the biggest outlet of top brand, genuine mobile phone handsets. It has partnered with all leading banks with an eye on mobile phone money transfer, grown an unrivalled Internet provision base and has now plunged into the broadcast digital transmission foray with the Big box, rattling the old industry players who had taken it as their entitlement. Safaricom did not take their leading position in the market for granted. They have always ensured they stay ahead of the park in innovation, which they have done boldly even as they fended competition that come in all forms including price wars.
“I took an early position that the price wars were not sustainable, and made a firm decision to strike the tricky balance between offering a competitive price to customers that would also enable us to earn a margin in order to continue to invest significantly in the network. The toll of that price war was seen in the losses that some players experienced at the time and it continues to be felt to this day,” Bob Collymore told our writer recently in an interview carried elsewhere in this Issue.
Several lessons to be learnt from the success story of Safaricom: As a business entity, be always on the lookout of emerging trends in your line of business and ensure you are among, if not the first to exploit them. It is no longer about sticking to one line of business. The volatility of technological advancement favours only the versatile.
We have seen Kodak, the World-renowned name in photography fold for lack of foresight. Closer home, Everyday has had to close shop for staying pretty in its comfortable zone. The scare in Kenya’s mainstream broadcast industry resulting in their attempts to forestall digital migration was as a result of lack of preparedness on the leading three broadcasters on how to operate, and retain dominance in the new, emerging order.
The second and, probably the most invaluable lesson is; stability in business management is key. For the near 20 years Safaricom has operated, there has only been one change of the button, and it was smooth. Boardroom wrangles ending up in leadership coupes witnessed in most parastatals and family-led businesses can only ruin business. Mr Collymore’s term has been extended for two years, in the same fashion as his predecessor’s. It is a show of confidence in the management team by the board, which in the end helps streamline transitions. Every business, especially those in the service industry, looking to be around longer should take a leaf from Safaricom.
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By David Wanjala
He quit a top-level management job with a bank in 2006 to venture into motor vehicle leasing industry, then a virgin and fluid enterprise in the East African region. Today, Paul Njeru, 39, sits at the helm of a Sh9 billion leasing company, which has recently spread its tentacles beyond Kenyan borders, to Tanzania, Uganda, Rwanda and Zambia.
Vaell (Vehicle and Equipment Leasing Limited), which Njeru runs as regional managing director and head of strategy, is a local pioneer motor vehicle leasing company that is also a leading player in an industry that has since picked up in Kenya, especially with government having, since 2010, embraced the new model of acquiring vehicles for its departments, particularly the National Security organ.
Vaell is eyeing the Mozambican and Ethiopian markets.
“I will be in Mozambique in early June, when I hope to put final touches on setting up there,” he says. Even as he makes these plans, Njeru is fully aware that setting up shop in Ethiopia is a daunting task – it is a closed nation with regulations that only allow locals to do most of the businesses.
We caught up with the easygoing Njeru, an early riser, at Quipbank, the company’s new facility along Mombasa Road, between Athi River tunnel junction and Mlolongo. He had set up the meeting for 7 am and, indeed, it kicked off as scheduled. Ours was a fact-finding mission, more so the company’s journey and how he, barely forty, successfully runs the service industry empire.
VAELL will celebrate 10 years next year. Njeru’s family ran a car hire business in 2006 that was overwhelmed by leasing requests from clients. Even though they had attempted leasing they could not pull it off due to the complexities involved. “Arranging the lease was very difficult – the calculations and the contractual obligations of each client were overwhelming.” At around the same period, Stanbic Bank, which he worked for, also had numerous requests for car leasing services but which, as a bank, they could not do.
It was enough, however, to rattle the business conscience in the young banker. Motor vehicle leasing, nascent in the Kenyan economy as it was, was the new business frontier. It had been beckoning for a while and someone had answer to the need. He embraced the challenge.
In the same year, he handed in his resignation. He surprised his colleagues, he says, when he told them he wanted to leave to go help with the family car hire business and convert it into a leasing firm. The bank would have none of that, at least until six months later, in 2007, when they let him go. He left and joined the family business. To manage the leasing side of the business they had to set up the vehicle and equipment-leasing department.
Thus Vaell was born.
It was at a time when leasing as a business had not grown to be recognised as an industry and the little that was being done was by foreign companies.
Njeru knows only too well the importance of a brand in business. Vaell, coincidentally emerging from the acronym of “vehicle and equipment leasing limited”, has helped in the growth of the company, moulding it into a brand that one cannot ignore in the growing leasing industry. First, it gave the company a foreign aura. In a culture where a majority believes that foreign is superior, the name could not have been any more apt.
“We did not realise it but many companies would later say, after they had signed all the papers, they did not know we were a local company. That has helped a lot. We were actually lucky to find it does not mean anything vulgar in a different country or language. It sounds a bit French so we have quite a lot of French customers; it’s a good coincidence,” Njeru says.
The raw material in leasing is cash, and leasing is very capital intensive. Vaell, for instance, does not see over 90% of what they lease until it goes back at the end of the lease. Here is how it works: a customer defines what s/he needs to the company – afterwards the leasing company may help him choose the dealer best suited for his need. Thereafter, paperwork follows, which involves managing the finance partners. Once the dealers are paid, the vehicles are delivered to the customer. Banks, therefore, play a major role in the leasing business. To this end, Njeru is grateful to over ten banks with which he has partnerships, including Bank of Africa, ABC Bank, Chase Bank, Co-op Bank and Eco Bank.
The leasing industry has come a long way. It is an industry that was left to chart its own path, by trial and error, with hardly any defined principles to guide it. The consequences have more often than not been damning. As usual, unscrupulous businessmen have masqueraded as leasers, taking advantage of the near nonexistence of regulations, to flout industry best practices and fleece ignorant members of the public in the name of leasing. That has given the industry a bad name and slowed its growth in the country.
Njeru agrees that even as Vaell, they learnt a lot in their first two years of operation from their customers who had prior experience of leasing from other jurisdictions.
“Bamburi Cement, I think, are one of the first clients who took us through an important lesson. They told us what not to charge, and what to charge and why. Clients who had been exposed to leasing previously were very helpful; through them, we were able to structure different leases,” he narrates.
Many people confuse “leasing” with “rental”, and rogue leasing companies have exploited that ignorance. The difference is synthetic but, says Njeru, there is an accounting principle that has to be adhered to, if leasing transactions are to be above board. You cannot, in a lease, charge more than the value of the equipment for the entire period of the lease. “That is the first place where you will find the market breaching the industry’s common practice. A transport company will give their trucks to you as a lease; even a car hire company will call rental of six months or more a lease. Then we all get excited about leasing and put it out there.”
But, he goes on, there are a few companies in the market who for any lease quotation, have to abide by those principles for reputational purposes, especially where the bulk of their clients are multinationals. Multinationals or any reputable local businesses have auditors who must verify the leases they take. On top of that, Vaell, for instance, have their own, PKF, who must audit adherence to the best practices and principles of leasing.
Accordingly, “a Sh15 million bus, leased for three years, should not fetch more than Sh14 million. The mark is 90% of the buying price. When it exceeds that, it should not be called leasing. You would have actually bought the bus. An audit firm will have to advise the client to cancel the deal as that can only be reflected in the account books as an acquisition and not a lease.”
Leasing companies recoup from what is called volume obsolescence, when they sell off their fleets at the end of the contracts. The biggest challenge, however, lies in high value vehicles whose resale prices are much lower than their purchase price. Vaell, for instance, is stuck with more than four, three- to four-year old Jeeps that were returned at the end of their leases. They have covered under 10,000km and are going for between Sh3 million to Sh3.5million. They were each bought from the dealer for about Sh10 million. To beat this constraint, Vaell has set their long-term focus on yellow equipment and heavy commercial vehicles.
Leasing, Njeru says, tends to be a subtle and secretive market-penetration tool for businesses. As such, save for Bamburi and one or two others, he is guarded on the information of his clients. But he reveals that over 90% of industry leaders in every business sector are leasing, from airlines to cigarette and beverage companies. Vaell, he reveals, has worked with at least 90% of industry leaders. “I realised it actually in our third or fourth year. Companies that work with us first make it clear that they want it very confidential. Two, they actually come for huge amounts.
“In the cement industry, for instance, when one of them wants to start something brand new, they go leasing. They won’t use their money. So for a while, the competition is wondering who’s actually funding the project,” he says.
Yielding a little, he talks about how Bamburi, in partnership with Vaell, seven years ago introduced ready-mix cement at building sites in Nairobi. Vaell leased the trucks for Bamburi on a very confidential basis. When Vaell went to Tanzania in 2009, East Africa Breweries Limited (EABL) had just acquired Serengeti Breweries. They needed a quick visible presence across the country. EABL leased 100 vehicles with Vaell in a process that took hardly 90 days, from zero to 100 vehicles. The deal was confidential.
“There are companies that have approached us and kitted a whole factory, end to end and said they did not want the competition to hear they were doing it. Within two years they have locked in a lot of the market because most of the equipment was very expensive. It also helps their pricing,” Njeru says.
In 2009, Vaell ventured beyond the Kenyan borders. Traditionally, the first stops were in Uganda and Tanzania. Surprisingly, Njeru says those markets were already ahead of Kenya in the business of leasing. They were exposed to leasing earlier, just like in the mobile telephony industry, and so setting up and penetration was not a big deal.
“We found them better markets in that they are not actually too suspicious about leasing. They have been aware of the practice for longer,” the father of two says, adding, however, that, just like in the telecommunication sector, Kenya is bound to overtake the other East African Community member states, especially with the Government of Kenya reawakening to the reality of leasing as a better option.
Vaell has 80 employees across the group, 50 of whom are based in Kenya. They hope to list on the Nairobi Securities Exchange towards the end of the year to “have Kenyans own a piece of Vaell,” but more so to secure funds to facilitate the various expansion projects in the company’s pipeline.
It has not been all glitter though. “I remember a time when I told the team, about four years back, to start looking for other jobs because we were not sure we could be able to even make salary payments. Someone fainted on hearing that. But we were blessed we did not reach that level; but on and off it has been a very challenging period,” Njeru narrates, adding that they have over the years resisted take-over attempts by banks and foreign firms.
As the regional managing director and head of strategy, Njeru is focusing on partnerships the company is forming, specifically with dealers and other international parties as they edge closer to the shareholding venture.
The biggest challenge has been in the ignorance of the leasing principles and practice in the potential clients, on both levels of government, and corruption. County governments, either out of crook or ignorance, seem to be confident with unscrupulous leasing entities that, in the end, give the leasing industry a bad name.
“We have seen many new entrants who seem to be designed for just one deal, especially in the counties. You discover their existence only after their first lease and when you check them out, you realise they haven’t leased before. They also tend to disappear after their first lease. It is pretty strange. From a regulatory environment, it is really for the public to begin questioning some of these transactions. We feel a lot of pressure when we attempt to question, getting implications that we may not be included in the next round of tenders,” he says.
Njeru quips that it is because of such underhand dealings that counties have ended up getting into long-term leases for ambulances at the exorbitant expenses of Sh600, 000 per ambulance per month when they could get it at half that much if they got exposed to clean and reputable leasing companies.
Some of Vaell’s clients have also let them down big time sometimes, he points out. The MD says some of them have cancelled big contracts midstream without the option of compensation exposing them to high risks.
Moving forward, the MD is enthusiastic. The sky, it seems, is the limit. He has lined up three strategies, besides listing and regional expansion, which he believes will be the rainmaker for Vaell. First, within the Kenyan market, the company has grown fast beyond Nairobi. They have focused to tap in on the opportunities availed by Devolution.
But, the real future strategy for Vaell is triple-pronged; individual leasing, medical equipment and airplane leasing. Individual leasing is complicated by the tax regime in that while a company can reclaim VAT on a lease, an individual cannot, making leasing an expensive and unrealistic affair for an individual. However, the company is working on how to beat it and, several years from now, terms will become better.
Making a rather bold prediction, he offers that medical equipment is the next big thing in the leasing industry. “Looking at dialysis machines, for instance, people queue for hours on end and one shot of dialysis of between one to two hours costs Sh10, 000. One machine will therefore cover about five to ten patients a day. We can lease a machine for slightly less than Sh100, 000 per month. Considering how much hospitals make every month, if it adds another 10 machines and the cost of dialysis is brought down by 50%, it could still cover its costs comfortably. People will stop flying to India; lives will be saved. We simply need to demystify how simple it is to acquire some of this equipment.”
As for the plane-leasing concept, the inspiration comes from the West African market. Here, Njeru says, every CEO of a middle class business going forward has a plane at his/her disposal. He gives an example of a CEO of a West African Bank with presence in Kenya, who has up to four planes at his disposal, paid for by the bank.
“It should make a lot of sense for our KCB MD to be able to travel across the region in his own plane without having to queue for a ticket in an airport. It should be acceptable. We just haven’t gotten there yet. It is simply a matter of the market beginning to accept to take it to that level,” Njeru says.
Over 80% of leases of planes in the market are foreign. Most planes are leased but they have to be leased from Mauritius or Europe – there is very little local capacity to manage plane leasing. To this end, Vaell has formed a plane leasing division to guide Kenyans through.
“You may be surprised some planes are less than Sh10m, which means you could actually have a plane at your disposal for Sh200, 000 per month. That is cheaper than most of the top business MD’s cars with some going for as much as Sh20m,” he says.
Besides, Vaell, Njeru says, is reengineering the DNA of leasing, which is structured such that it is the client who seeks out and presents himself and his needs to the leasing company. That formation, in the eyes of Njeru, has been outlived. At Vaell, the company now goes out to actively seek clients, demystifying the leasing concept and exposing businesses to why they are best off leasing than acquiring assets.
The secret behind Vaell’s success story is in the company’s employment philosophy, which focuses on the youth. “Our average age is still below 30 years and we are proud of it,” Njeru says. The company gets its workforce straight from college and trains them into senior management. As such, it has built an ingenious, enthusiastic and committed workforce to which the managing director attributes the firm’s success story.
However, Njeru’s own training, background and experience in the banking sector have often come in handy. Having joined Barclays Bank as a clerk after completing his Bachelor of Commerce studies from Daystar University, he rose through the ranks to middle level management before he Joined Stanbic Bank, leaving in 2007 as a senior level manager. Besides, his country-managing director is a former director with Stanchart Bank for 15 years, who boasts 19 years banking experience. The combined banking experience of the two has immensely contributed to their remarkable growth. Under their watch, Vaell has featured in the top 100 best SMEs from when it was six years old in the market. “Last year we were number 1 in transport and number 2 overall, and I say a big ‘thank you’ to the team,” he says.
Born in Maseno in mid 1970s, Njeru was christened Onyango by his parents’ local social circles and to date, he goes by that name. His passport has ‘Onyango’ as his middle name.
“Right now as we expect (US President) Obama, I am very confident when you only refer to me as Onyango,” he jokes. He grew up in Kitale where they moved two years after his birth, which is where he spent most of his childhood before moving to Nairobi. That exposure has had a positive impact on his leadership skills.
Njeru is the third born in a family of five. He was brought up in very strict family values to which he still adheres. “It is not a story we can ever conclude without appreciating the grace of God. There are many times we wondered whether we would survive the year,” he says.
He spends his free time with his seven and four year old daughters in his livestock farms in Namanga and Narok.
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In 1999, Ng’ang’a Wanjohi founded Kaskazi, a massive and aggressive last mile distribution of products on behalf of fast-moving consumer goods companies and for a very long time, his team used bicycles. He employed a team of young people who went to the mass market and sold off the grid, collected cash and took it back to the shop owner.
Today, Kaskazi is a brand name, engaged in the distribution of products. He has since up-scaled to motorbikes and so a rider can visit close to 30 outlets in one market in a day. That would translate to 3000 outlets if you had 100 riders.
“I have relationships with wholesalers across the country so if you have a product, I can go to a wholesaler that you did not even know existed and tell him ‘I have got this particular product, this is the size, this is the price, this are our margins. I would like you to buy this quantity and I will guarantee you that I will sell it out for you’. He will buy it and I will hire somebody and take him to that particular wholesale shop, wherever it is in the country,” Wanjohi explains.
Wanjohi did a research on retail shops in the whole country, established their number and location and put the data on a server. He has a wealth of information of retailing business in every county and once he enters a distribution deal, say with BAT to cover Busia County, he will know what number of riders is required. He presently distributes for Kenya Breweries, Cadbury Kenya and Multichoice’s set top boxes for GOtv, to mention a few. It is labour intensive.
The major challenge for Wanjohi was that while his core business is service, he had to invest heavily in what he calls the tools of trade – bicycles and motorbikes. Even after acquiring them, tying down a lot of cash, the other headache was how to dispose of them once they have served their purpose. Besides, riders tended to be reckless with the tools of trade. It became a big problem as the business grew.
“Our nature is not to invest in assets that are not directly related to the business and we are not comfortable owning our tool of trade, which is the bicycle or motorbike. When you own something, it is misused,” Wanjohi says. To beat it, he developed a formula in which he bought the bikes and sold to the riders for a stretched payment. “When that motorcycle belongs to the rider, he takes better care of it, that is what we came to learn with our bicycles,” he says.
The nature of Kaskazi’s distribution is modelled such that he pitches for business opportunities in companies. Once he wins a distribution deal, he develops it into a project. He facilitates it by buying motorbikes and contracting people to push through the project, which may last for a year or two. Once it is done, he has to dispose of the bikes since a new project will have to begin with a new set of motorbikes.
“Our biggest challenge was in capital cost, which was not in our focus. We did our first project where we bought a certain number of motorbikes, and then we started growing. We did another project where we had to buy again, it reached a certain point where we asked ourselves, how many motorbikes are we going to buy,” says Wanjohi.
Late last year, Wanjohi landed a job whose massive need for motorbikes he could not sustain, and that is how he thought of leasing. A friend recommended Vaell and, just like that, his capital and disposal of the tool of trade problems were fixed. And because he now had unlimited access to motorbikes to push his projects, he has expanded his distribution empire with many more clients coming on board.
Wanjohi has leased more than three hundred motorbikes, becoming the first business to enter into a contract of such magnitude in Vaell’s motorbike sector.
“He’s proved himself and so we want to take him along with us. We’ve already introduced him in Uganda, we now want to take him to Tanzania and every other of our markets in the region,” Says Paul Njeru, regional managing director, Vaell.
After doing the legal agreements, Wanjohi says, Vaell delivers the motorbikes. They are fabricated at Kaskazi’s premises along Ngong Road to customise them for the distribution. They, for instance, add the carriers.
Rather than take the bikes back to Vaell at the end of the lease, Wanjohi, who confesses to believing in empowering the youth, facilitates the acquisition of the bikes by his riders.
“When we are doing our negotiations with Vaell, we ask them the residual value of the motorbike, (the price of the motorbike at the expiry of the lease). We then apply the same principle; we tell the rider, ‘this motorbike is yours, it is going to cost you this much if you will pay over this period of time’. So what he does is he manages it like it is his. At the period of the lease Vaell does the insurance, we incur both the maintenance and fuelling costs and the rider takes it away at the end of the lease.”
When Wanjohi wanted to acquire his first fleet of motorbikes, he went to a commercial bank flashing his contract of a distribution deal. They demanded for security to which he responded with an LPO but that didn’t help.
“They told me to give them an asset that is 100% because the value of the loan must be 70% of the asset. I was completely helpless,” he decries.
Leasing, Wanjohi advises, is the easiest way to scale up one’s business. “If I had known about Vaell earlier, I would be leasing even the computers I use (whose useful life time is two years), and even the seats we use – they start wobbling after two years. Leasing improves the cash flow in the business.
“Why would I invest in a motorbike when I can use that money to buy software that can run my business better? It takes my cash away from the core things in my enterprise. I am in the business of distribution. I give a service. I want to invest in a better and more efficient service.”
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By Dr Kellen Kiambati
While banks continue to withdraw liquidity from the capital markets by making fewer loans, pension funds and their asset managers are well suited to fill that funding gap. Because mandate of pension fund is to fund the retirements of workers who may not be leaving the workforce for decades, they are able and willing to make very long-term investments.
A long time horizon fits both the large scale and global nature of our operations and fiduciary responsibility. More important, maintaining a long-term perspective benefits pensioners. It is, however, not only a matter of ability and willingness. There is need to create the right incentives and at the same time remove barriers that constrain long-term investment. Unfortunately, regulation often forms one of those barriers.
Obviously, regulation is vitally important: it serves as a traffic officer in the crowded streets of the financial markets. When drafted and applied correctly, it can be an effective tool for creating financial stability and restoring and maintaining confidence in the financial markets. When it functions to enable long-term investment, it can pave the way for citizens to meet their future financial needs.
But when regulations have the unintended effect of discouraging or even prohibiting long-term investment, they need to be identified and eliminated. Over the past few years, an enormous number of new rules have been created in reaction to the global financial crisis. In many cases, these rules have been too wide ranging. Failure to appropriately tailor regulations can close off opportunities to make long-term investments that could be widely beneficial.
For example, new margin requirements for derivatives are meant to reduce systemic risk. Pension funds are highly creditworthy institutions that pose little or no such systemic risk to the financial markets. Forcing them to set aside assets for collateral purposes in the same manner as a bank or hedge fund does not make sense, and it results in a direct loss of long-term-investment opportunity.
Categorizing the impact of regulation on long-term investment
The impact of regulation on long-term investment is a complex matter. This is not only due to the fact that such investments involve a variety of products, market players, and jurisdictions. It is also because the inhibiting effect of regulation is often difficult to see and to quantify. The rules that encourage long-term investing (positive impact) are to be separated from those that discourage it (negative impact). Both forms of impact can either be direct or indirect.
Rules that apply to other levels, such as investors, or to other products or parts of the market can also impact the ability or willingness to engage in long-term investment. This is called the indirect impact of regulation. That results in four categories of impact: direct and indirect positive impact and direct and indirect negative impact.
The problem is not only with the regulations that exist but also with the regulations that do not exist. In circumstances where regulation could have a positive impact on long-term investment but is lacking, it needs to be created. This goes for both the direct and indirect forms of positive impact. For example, standardization of regulations relating to covered and green bonds and cross-border investment through real-estate investment trusts would encourage more long-term investment.
In a more indirect way, a general regulatory push for increased availability of long-term-investment projects and harmonizing of local insolvency regimes would also have a positive effect. Failure to fill existing regulatory gaps will ultimately depress long-term investment.
Understanding the four kinds of impact can help bring about rules that safeguard markets while maximizing the opportunity for long-term investment. In addition, they may help inform thinking in general on the different ways regulation can encourage or inhibit long-term investment.
Standardizing the rules regarding covered and green bonds would be a straightforward way of creating direct positive impact. Covered bonds, which are backed by a dedicated pool of assets, are subject to regional and even bank-specific rules. Regulators and investors should work together to create a global level playing field. In particular, standards should be formulated for overcollateralization, haircuts, valuation, the legal position of bondholders, and the treatment of residual debt. In addition, regulators and the industry should work to create common accounting standards for bondholders, as well as clear collateral requirements.
Standards should include a requirement that covered bonds be rated by at least two rating agencies. Similarly, green bonds, which could be a powerful force for mobilizing capital for projects with environmental benefits, must be supported with effective regulation that mitigates the risk of greenwashing, or the unjustified appropriation of environmental virtue. Failure to formulate effective regulations will dampen the growth of this potentially beneficial market. Real estate, too, should be an important asset class for long-term investors.
One barrier to long-term investment is a shortage of long-term-investment projects. Even taking market-generated and government projects together, there are simply not enough opportunities. There should be a broad assessment of how to stimulate the demand side of long-term investment through supporting regulation. Part of that assessment should take into account risk-return profiles and other relevant investment criteria for large institutional investors. The World Economic Forum’s Infrastructure Investment Policy Blueprint could provide pointers. This should include eliminating fossil-fuel subsidies, higher prices for CO2 emission rights, and increased support for research into cleaner energy, to make investments more attractive to pension funds and allow them to meet their sustainability goals.
The regulatory framework for securitization transactions has had a direct negative impact on investment behavior. Solvency II and Basel III proposals and resulting uncertainty about capital charges and liquidity treatment for securitizations have reduced investors’ appetite to invest in this asset class. Securitized assets are an appropriate investment for pension plans, assuming they are properly structured and of good quality. They allow pension plans to contribute to the financing of real economy assets such as residential houses, consumer-loan leases, and loans to small and medium enterprises.
There seems to be recognition today that the securitization markets need to be revived. In resetting the regulatory framework, however, special care must be taken to avoid unintended consequences. Rule makers must acknowledge that not all securitizations carry the same level of risk and make efforts to avoid unduly burdensome regulations.
The increased banking costs that result from new regulatory measures are another source of indirect negative impact. Those costs are passed along to clients, including pension funds, once again reducing the amount available for long-term investment and forcing pension funds and other clients to pay the price for a crisis they did not cause. The net stable funding ratio, created by the Basel Committee on Banking Supervision, could prove to be yet another source of negative impact, since the rules would make it much more expensive to provide for certain equity products that are frequently used by pension funds.
In the global debate on ways to enhance long-term investment, pension funds have correctly been identified as a potential source of nonbank funding. Executed correctly, regulation can stimulate our ability to engage in long-term investment. Done poorly, it can have the opposite effect. Care must be taken to avoid regulation that results in constraints on long-term investment in both direct and indirect ways. The serious problem of indirect negative impact, in particular, tends to be overlooked in this debate.
In general, the unintended consequences of regulation must be avoided at all times. The total impact on long-term investment of all individual pieces of regulation—plus how these pieces add up and affect one another—must be understood. Rules should be appropriately tailored for different market participants. Unnecessarily broad rules cause needless constraints and ultimately a loss of return for pensioners. For the long-term-investment debate to be effective, all forms of impact must be analyzed and carefully considered. This is not an easy job but one that must be undertaken to successfully encourage long-term investment.
- The writer is a member of the Institute of Human Resource Management of Kenya and author of Business Research Methods