Should you invest in unregulated products?

Dear Dr Pesa,

I was approached by a financial advisor of an investment company in Kenya that offers very good returns but the product is not regulated by the CMA. It is an innovative investment model and maybe CMA just needs time to catch up with them. If I invest, I could make some good money. Should I invest?

Vanessa.

Dear Vanessa,

Regulation within certain industries has always been a contentious issue. The idea of a government-appointed body dictating the actions of private firms rubs some people the wrong way. Usually, companies that offer unregulated products argue that regulations inhibit new and innovative ideas that may not operate within the rules but have the potential to solve problems in their respective industries.

Yet regulation, especially in the financial services industry, is crucial because abuse could result in tears for clients who have entrusted their capital to them. In the recent past, various financial service firms have been in legal tussles with their respective regulators over which guidelines apply to their products and which ones do not. While this controversy rages on, an important question has come up: does regulation hinder the growth of the financial services industry?

The short answer is, no.

Regulation exists to protect you. Regulators ensure that fund managers operate within set rules and regulations and prohibit actions that may endanger your assets. For example, the Capital Markets Authority (CMA), the entity in charge of overseeing investment products in Kenya, stipulates how much of a fund can be invested in a particular asset class, depending on the type of fund. This is done to prevent excessive risk taking by investment firms, and safeguard your interests.

Regulation also prevents monopolies from abusing their power. If not for the CBK’s intervention, who knows how much you would be charged to use mobile money services? Most importantly, regulators provide an avenue for you to seek redress in cases where company violates the terms of your agreement. The presence of an unbiased third party provides a much-needed mediator for disagreements between companies and the users of their products.

That said, let us return to the issue under contention; does regulation restrict innovation? Not necessarily. In fact, considering most organizations’ aversion to change, regulation may actually spur innovation. Given the choice between maintaining the status quo and making changes that would disrupt their business and reduce profit margins, guess which one most firms would pick.

Companies are notorious for practices that maximize returns but sometimes hurt their users. Uber, for example, was recently ordered by California regulators to declare drivers as employees instead of independent contractors. This decision, might result in lower profits for the tech giant, but it ultimately safeguards the drivers from exploitation. Closer home, in June this year, the CBK extended its waiver of fees charged by banks and other financial institutions to transfer money to a mobile wallet and check balances. Banks will now be forced to innovate in order to maintain their profit margins.

Even so, the idea that regulation may slow down innovation is not entirely baseless. As technology redefines service delivery in the financial sector, areas that are not addressed in the existing framework become more apparent. While some might choose to go rogue and decry regulators’ lack of coverage, a more productive approach would be to actually work with them to update the rules to cover such blind spots. This is actually part of the regulators’ mandate.  A good example of this is the CMA which, upon the behest of industry players, created a new trading category for Online Forex Money Manager to match the evolving times. Now, investors who want to access the global markets no longer need to gamble with their capital by leaving it in the hands of unlicensed, sometimes unscrupulous, parties.  They can entrust it to licensed money managers. Mansa^X by Standard Investment Bank is the first product to receive this license and as more firms satisfy the criteria set out by CMA, so will the sector flourish.

Not only is working with the regulator good for investor confidence, it also creates growth in the industry.

As for your main question; should you invest in the unregulated product? That is a decision only you can make. Just be aware that if you do, there is much higher risk of losing your capital and no system to protect you if that happens.

Dr Pesa is Dominic Mutinda – Head of Compliance at Standard Investment Bank.