Cytonn Saga: Ups and Downs of Investing In Unregulated Products

For the better part of last week, the internet was awash with accusations and complaints against investment firm Cytonn, with investors who had put money into the Cytonn High Yield Solutions (CHYS) over the last two years lamenting about the firm’s non-payment, despite their investments having matured.

A series of tweets and a video shared by one Lynn Ngugi went viral triggering debate about the firm that over the years has brought money markets in vogue.  In the video, Lynn complained that, even after being asked to extend the moratorium of her investments by an extra year, which has since elapsed, Cytonn is yet to pay her back – both the principal sum and her returns.

The video sparked a lot of outrage from Kenyans, with other investors coming out with similar accusations against the investment firm. 

Following the public uproar, the CHYS, an unregulated fund by Cytonn Investments, is under investigation by the Capital Markets Authority (CMA) for potential criminal violations. Cytonn has in turn sued the CMA, claiming that the regulator is acting in bad faith.

Cytonn says only 13 out of 4,000 investors were unhappy with the unanimous decision to extend the maturity of some investments by two years over what the firm argued was negative effects of the Covid-19 pandemic. 

Even as we wait for the CMA to complete the investigations and make public its findings - Note that the High Court in Nairobi on Thursday, July 1, barred the CMA from suing or probing Cytonn after the firm obtained a temporary injunction - this brings to the fore some of the perils of investing in unregulated investment products, especially for retail investors.

It is against this backdrop that we want to take a quick dive into the world of unregulated investment products and what makes them perceivably so risky for investors. To start off, let’s understand what exactly unregulated products are and how they differ from regulated products.

Regulated Vs Unregulated Markets

Regulated markets, also known as public markets, are those that operate under the guidelines of a regulatory body. The role of the regulatory body in this case is to protect public interest and to keep the products in regulated markets standardised. 

Examples of products that fall under regulated markets include shares and equities, money market funds and other collective investment schemes, fixed deposits, pension funds, and so on.

Before a product in a regulated market is offered for sale to the public, it has to be reviewed and approved by the respective regulatory body.

In Kenya, we have various regulatory bodies for different kinds of investment products. For instance, mutual funds and unit trust funds are regulated by the Capital Markets Authority (CMA), banking products by the Central Bank of Kenya (CBK), pension products by the Retirement Benefits Authority (RBA), and insurance products by the Insurance Regulatory Authority (IRA).

Unregulated markets, on the other hand, are those that are not bound by the guidelines of any specific regulator. Unregulated products are governed by the terms of the contract between the investor and the organisation offering the product.

The law stipulates that unregulated products should be offered privately, which is why unregulated products are sometimes referred to as private offers. While they are not governed by any regulatory body, all unregulated products offered in Kenya are still required to meet the conditions set in Section 21 of the Capital Markets (Securities) (Public Offers, Listings and Disclosures) Regulation of 2002.

It’s good to note that while an entity that is part of a firm may be regulated, this does not automatically mean that all products offered by the parent company will be regulated

For instance, the CMA says that Cytonn Investment Group is not a licensed and approved entity. 

’The only licensed entity is Cytonn Asset Management Limited, which is licensed as a Fund Manager and a Real Estate Investment Trust (REIT) Manager. The funds managed by the entity under the approved Collective Investment Schemes are; Cytonn Money Market Fund; Cytonn Balanced Fund; Cytonn Equity Fund; Cytonn Africa Financial Services Fund; Cytonn Money Market Fund (USD); and Cytonn High Yield Fund,” a statement by the CMA reads in part. 

The products in contention - Cytonn High Yield Solutions and the Cytonn Project Notes - are both unregulated.

The Dangers Of Investing In Unregulated Products

Today, there are several unregulated investment products being marketed to the public. They are usually very tempting, particularly because of the high prospective returns they promise.

While there are some unregulated products that offer high quality investment opportunities, there are some great potential risks that come with unregulated investment products, as the Cytonn debacle has clearly shown. These risks are even more pronounced for investors without lots of experience in the markets.

Here are some factors to consider before investing in unregulated products. 

They Are Highly Risky

Regulated investment products operate under strict regulations which dictate how they are run, and the kind of risks they are allowed to take. 

For instance, CMA regulations prohibit regulated funds in Kenya from investing more than 25% of the fund in one asset class. The aim behind such regulations is to reduce the risk for investors.

Unregulated investments, on the other hand, are not bound by such restrictions, which means that they can sometimes make investment decisions that leave investors overly exposed such as investing a majority of the funds in one asset class.

In addition, unregulated products have the freedom to invest in assets that are not available to regulated products, such as crops and timber, property, and so on. While such assets can potentially deliver higher returns, they can also carry a higher risk.

No Protection

Another downside to unregulated investment products is that since they are not regulated by the CMA or any other regulatory body, investors do not enjoy the same kind of protection accorded to those who have invested in regulated products.

When an unregulated investment product is unable to pay back the promised returns or even refund investors’ funds, the investors do not have a fallback position and cannot seamlessly claim compensation - at least under current laws.

They Require Skill And Experience

One of the reasons regulation exists is to make sure that regulated investment products are safe for retail investors, who may not often have the skill or experience to understand all aspects of the products they are investing in.

Since unregulated products are not subject to this oversight, they often may have complex and sometimes opaque structures that can be difficult for less sophisticated investors to understand. This means that retail investors may often find themselves getting into unregulated investment products that do not work as they expected.

They Are Relatively Less Liquid

Unregulated products usually invest in asset classes that are not publicly traded on established exchanges, which makes these products highly illiquid. 

In periods of financial turmoil, it can get even harder to get access to funds invested in such assets, which partly explains why Cytonn opted to extend the maturity of some investments. 

Comparatively, regulated products are more liquid since there is a ready market for asset disposal while given the nature of assets in unregulated products, periods of illiquidity exist. 

That said, regulated funds are not exactly immune to illiquidity. If a regulated fund (e.g. closed for withdrawals) or business (such as a bank under receivership) is under a strain, funds may not be accessible.  

Wrapping Up

Unregulated investment products sometimes present fantastic opportunities that can result in handsome rewards. However, unregulated products can just as easily be fraught with risks.

Before investing in an unregulated investment product, do your due diligence, read through the fine print and make sure you know what exactly you are getting into, and watch out for any red flags that could indicate the product is not what it is claiming to be. 

If you can, get a professional independent financial advisor and have them take a look at the product before you put your money into it.

Disclaimer: Money254 is not a financial institution, insurance provider or financial adviser and is not liable for any decisions any individual makes based on the information provided on the website.  Please refer to our terms and conditions and privacy policy before using this website.