Regulated versus Unregulated Markets

Mar 1, 2020

We often get questions from investors about regulated versus unregulated markets. In this week’s topical, our Research Team seeks to educate the general public about these two types of markets/investment categories, which are complementary and important to well-functioning financial markets. As such, we shall discuss the following:

  1. Regulated and Unregulated Investment Categories,
  2. Pros and Cons of Each Investment Category,
  3. Issues to Consider for Each Category,
  4. Myths About Each Category,
  5. Conclusion.

Section I: Regulated and Unregulated Investment Categories

Investment markets from a regulatory point of view can be divided into two large categories, regulated and unregulated markets.

Regulated markets are overseen by a regulator to protect the public interest in those markets, hence they are also loosely referred to as public markets. Products in this market tend to be standardized and easily accessible to the public. For example, if you want a fixed deposit you can walk to any banking hall and get one, if you want to buy shares of say, Safaricom, you can call any broker, and if you want to buy government bonds, you can call any broker or walk to a Central Bank of Kenya (CBK) banking hall. Regardless of which broker you call, you will get the same standardized share of Safaricom. The offering of the product needs to have been reviewed and approved by the respective regulated before the investment products can be sold to the public. If a product is a banking product, it’s regulated by CBK, an insurance product by Insurance Regulatory Authority (IRA), shares/equities and Unit Trust Funds / Mutual Funds by Capital Markets Authority (CMA), and pension products by Retirement Benefits Authority (RBA).

Unregulated products are not regulated by a specific regulator; however, the manner of offering is usually regulated so that it is qualified to be outside the scope of regulation. The manner of offering is usually private; hence they are also loosely referred to as private products or private offers; and because they are an alternative to public markets products, they are also referred to as alternative markets. Below is a table showing the different types of investment products available in the two categories:

Investment Products Available to Investors

Regulated Products

Unregulated Products

  •  Listed Equities e.g. Safaricom shares
  • Fixed Income e.g. Treasury Bills, Government Bonds, Corporate Bonds, Bank Deposits, Debentures
  • Mutual Funds e.g. Money Market Funds, Equity Funds, Fixed Income Funds, Balanced Funds, High Yield Funds
  • Real Estate Investment Trusts (REIT’s)
  • Real Estate e.g. Real estate Backed Investments, purchase of real estate units
  • Private Equity
  • Private Commercial Papers, such as:
    • ASL Limited @ 12.0% p.a.
    • ASL Credit at 12.0% p.a.
    • KK Security at 13.5% p.a.
    • Alios Finance at 12.25% p.a.
    • Davis & Shirtliff at 11.0% p.a.
    • Car & General at 13.5% p.a.
  • Structured Products such as:
    • Cytonn High Yield Solutions at 18% p.a.
    • Two Rivers Development Limited at 17.0% p.a.
    • Mansa Fund at 24% p.a.
    • Maiyan Holdings at 17% p.a.

Source: Cytonn Investments

Section II: Pros and Cons of Each Investment Category

Like with any investment, each investment category has its advantage and disadvantages. No product is better or worse than the other, they both serve unique purposes depending on an investor’s specific investment objective and risk appetite. The below shows the pros and cons of investing in any of the two categories:

Regulated vs Unregulated Products – Pros & Cons




Regulated Products

  • Availability of Information - Companies offering regulated products are required by law to publish information on a regular basis, and prices are generally always visible to the public
  • Standardized - Well known and easy to understand
  • High Liquidity - Ready market for disposal of the assets and thus easily converted to cash
  • Regulation - They operate under the supervision of regulatory bodies such as CBK, IRA, CMA and RBA
  • Lower Returns - Factoring in inflation, their returns are lower than alternative investments
  • High Correlation of Returns - Investments such as equities are known to have similar price movements in the market
  • The volatility of Returns - They are highly sensitive to market changes such as inflation and interest changes
  •  False Sense of Safety - This arises from the perception that regulated products are safe, as was the case with Chase Bank, Imperial Bank, Amana Money Market Fund, etc., which were all regulated



  •  Higher Returns - Offer potential of high returns in comparison to traditional investments products
  •  Low Correlation of Returns - They have their own value that is not dependent on factors that affect traditional investments, and thus able to provide a real return to investors
  •  Diversification – There are benefits through a greater selection of investment options
  • Enables investors to returns that are hard to access
  • No Regulation - They operate in private markets, which heightens the perceived risk of investments made
  •  Lengthy Process - They are mostly tailor-made to the clients’ expectations and thus takes time to structure
  •  Limited Information - They entail private transactions and thus there is little information on details of investments unless you are specifically offered or referred
  •  Periods of Illiquidity – Given the nature of the asset classes, there are periods of illiquidity in the investment

Source: Cytonn Investments

Section III: Issues to Consider for Each Category

There are a number of areas for an investor to consider before making an investment decision, and this usually boils down to financial planning and unique preferences for an investor, after they have considered the pros and cons of each category:

  • Risk Appetite: An investor has to evaluate the two types of categories and then make a call on the uncertainty that an investment may not earn its expected rate of return, and as well risks such as interest rate risk, currency risk, re-investment risk, and credit risk,
  • Return: These are the earnings from investments, and they vary depending on the type of investment e.g. dividends, rent, interest and capital appreciation. Investors should ask themselves whether the return profile meets the risk-reward proposition,
  • Liquidity: This is a definition of how quickly an asset can be converted into cash. Investors will usually find that unregulated products have a higher chance of being illiquid compared to regulated products,
  • Taxation: It is critical for investors to understand their tax status for tax planning purposes. Regulated products such as bank deposits and Unit Trust Funds in Kenya attract a 15% withholding tax, which is final, whereas unregulated Structured Products attract a total 30% tax rate on any returns made,
  • Governance: Governance around regulated products usually involves a Regulator, Trustee, and Custodian, who provide oversight over funds being invested. In unregulated products, governance is usually done by select investors who are investors in the funds themselves, alongside the Investment Manager and their Investment Committee, and,
  • Sophistication: Regulation exists to provide oversight for less sophisticated investors. These include retail investors who may not fully understand the characteristics of products they are investing in. Unregulated products are for sophisticated investors who understand the characteristics of their investments and have taken time to understand the underlying asset class / economic activity that is delivering the return.

Section IV: Myths About Each Category

Given our interaction with investors, we felt it best to bring out and debunk many myths that we have heard surrounding both categories of investments especially given that we are still an emerging market were private products are less prevalent:

Myths about Regulated Products:

  1. Always Safer: The myth has always been that regulated products are safe and investors will not lose money in regulated products. However, experience in Kenya has shown that investors in regulated products such as banking and capital markets have lost funds due to isolated cases of lapses in corporate governance. As such, investing in a regulated institution or is no guarantee over the safety of your investment. The Kenya Deposit Insurance Fund, for example, only guarantees Kshs 100,000 worth of deposit for each account in a banking institution. Some of the regulated products that have recently run into trouble leading to billions of losses include:

(All values in Kshs unless stated)

Shareholders’ Loss for Regulated Entities Largely Due to Poor Corporate Governance


Peak Share Price

Current Share Price

No. of Shares (bns)

Loss in Value (Kshs bns)

Kenya Airways**





Imperial Bank















Chase Bank




















*Last trading price before suspension

**Peak share price since the 2012 rights issue

Source: Cytonn Investments

  1. Very Liquid: While regulated funds are likely to be a lot more liquid than unregulated, there are times when a regulated business or fund undergoes a strain, there shall be periods where funds are not accessible. This could be in the case of a Unit Trust Fund being closed for withdrawals, or a bank under receivership; a good example is what Amana Money Market Fund has recently experienced
  2. Don’t Invest in Alternatives: Regulated funds and products usually all have an allocation to alternative investments. The simplest example is that any deposit in a bank is then pushed forward by a bank and lent to an individual for a mortgage, or a developer to undertake a development project. Unit Trust Funds in Kenya as well, as per the regulations, are allowed to invest in alternative investments such as real estate and private equity,
  3. That the Regulator Fully Understands the Investments: Whether regulated or unregulated, investments always entail risks that even the best analysts, let alone a regulator, may not uncover. Investors should not think that just because it was signed off by a regulator, that they totally understood their investment; investors should still do their own due diligence.

Myths about Unregulated Products:

  1. Risky Investments: Unregulated products are not that risky, especially when they are sourced by a competent research and investment team, and one that has experience in managing illiquid and alternative assets. Take real estate for example, where the project has been sourced through detailed research and is delivered by a well-run and professional project manager, and there is visibility over pre-sales. Such an investment would be an attractive investment for those seeking diversification in their portfolios,
  2. They Are Too Complex: Unregulated investments are really no more complex than regulated products, in spite of the jargon that usually accompanies them. Accessing private or unregulated markets is down to experience and skill of the management and investment team, and their ability to package the unregulated asset class into investible security,
  3. They Cannot be Offered by Regulated Entities: Regulated entities can offer both regulated and unregulated products. For any regulated product, it is approved by the respective regulator, and as well any unregulated product needs to pass through the respective regulator.
  4. Have to Only be Distributed to a Few Individuals: There is a myth that for an unregulated private product, it must only be distributed to a few individuals. There is ample case law to demonstrate that what matters is the manner of offering, NOT the number of investors. Courts have concluded that an offer even to one person is deemed a public offer if it was offered in a public manner, and can offer even to a million people is a private offer if it was offered in a private manner. Case law in developed markets shows us that unregulated products can be widely distributed:
    1. United States: The leading case in the United States with regard to ‘transactions by an issuer not involving any public offering’ is Securities Exchange Commission vs Ralston Purina Company 346 US 119 Supreme Court, where an offering was made to at least 7,000 members of staff. The eligibility criteria were simply an employee eligible for a promotion, an individual sympathetic to management, the courts concluded that it was not a public offer even though the regulator wanted it deemed a public offer.
    2. United Kingdom: In Nash vs Lynde, a case where a question was raised over the distribution of shares, the questions framed by the Court were, amongst others, whether a private company could be held to have offered and issued its shares to the public as 20-30 prospectus was issued. The Court in this matter held as follows ‘The public is a general word and no particular numbers are described. Anything from two to infinity may serve perhaps even one ….’. The Offer, in this case, was therefore not deemed a Public Offer, as those the offer was being made to were specific and shared a common goal. A key takeout is that numbers are not a determining factor as to whether an offer is made to the Public or a Section of the Public.
    3. Australia: The leading case for Australia is Corporate Affairs Commission (SA) VS Australian Central Credit Union (1985), where it was held that an Offer to 23,000 persons would not amount to a Public Offer. This was on the basis that the law expressly allowed for this exemption on the basis of persons with a common interest.

Based on the above, it is clear that our own securities regulations need to undergo judicial interpretation as to what is a private offer and a public offer.

Section V: Conclusion

For investors, they need to first understand their investment objective, risk appetite, then understand the investment products available to them before they make an investment decision towards or away from unregulated products. We highly recommend that you speak to a Financial Advisor before you invest in any of the two categories of investments.

For market participants and the regulatory framework, we need to evolve from the mentality that all financial products must be regulated, and clearly demarcate what is a private offer and what is a public offer, and allow the two to co-exist for the benefit of advancing our capital markets.


Disclaimer: The views expressed in this publication are those of the writers where particulars are not warranted. This publication is meant for general information only and is not a warranty, representation, advice or solicitation of any nature. Readers are advised in all circumstances to seek the advice of a registered investment advisor.