The capital markets in South Africa are defying the economy they are situated in, indeed emerging markets as a whole. While economic growth is sluggish, stock prices are rising, and hitting new highs, and a record number of offerings are being issued to the public. Technical and regulatory improvements at the Johannesburg Stock Exchange (JSE) are continuing apace. The JSE is the best-regulated market in the world, and is evolving, with new products, better supervision and a renewed emphasis on cross-border activity. The market is innovating to become the bourse of choice for the continent and a preferred venue for some global enterprises. “We are an advanced market in an emerging economy,” Nicola Comninos, head of equities at the JSE, told OBG. “Despite our emerging status, many of our major companies are globally competitive.”
Deep & Well Regulated
The JSE was founded in 1887 during the country’s first gold rush. In 1966, computerised settlement was introduced, and the market operated on T+7 settlement. Open outcry trading ended in 1996, and an electronic clearing and settlement system, known as Shares Transactions Totally Electronic (Strate), was introduced in 1997 while the Alternative Exchange (AltX) was opened in 2003. South Africa also has a Development Capital Market and a Venture Capital Market. The exchange was demutualised in 2005 and listed on itself in 2006. In 2012 the JSE implemented the Millennium Exchange trading platform, and its trading nexus was moved from London, where it had been situated for five years, to Johannesburg. In 2015, the JSE extended its agreement with the MilleniumIT Group, which is owned by the London Stock Exchange. Under the agreement, the platform will expand to include fixed income and derivative securities. In terms of regulation, the first Stock Exchange Control Act was published in 1947 and the second in 1985, while the Insider Trading Act was passed in 1999. The Securities Services Act followed in 2004, and was replaced in 2012 with the Financial Markets Act (FMA). The 2012 act was designed to modernise the sector and keep its supervision up to date and harmonised with international standards. The act took into account a number of factors such as International Organisation of Securities Commissions principles, IMF and World Bank recommendations, G20 proposals, the 2008-09 financial crisis, developments in other jurisdictions, and domestic legislative changes.
The new law aimed to extend the types of securities covered, especially over-the-counter (OTC) products. It also created a new type of associate clearinghouse; clarified the role of an authorised user; provided an enabling provision for remote brokers; expanded the roles of the central securities depository (CSD); enabled links with foreign CSDs; added a provision for investor protection during insolvency; better aligned securities law with the Companies Act; reaffirmed the ability of the regulators to oversee unlisted securities; and clarified the function of the registrar.
The JSE has been ranked as the best-regulated market in the world (out of 148 rated) for four years running in the “Global Competitiveness Report” published by the World Economic Forum, while its market development ranking is number three. The Financial Services Board (FSB) is the main regulator of the stock exchange, but the sector is also supervised by the JSE under its Listing Rules and Equities Rules. As a self-regulating organisation (SRO), the exchange may at times find itself facing potential conflicts of interest as both a regulator of the private sector and as a participant in private sector dealings. The World Bank has mentioned this as a structural flaw that could possibly slow the development of the market. The local authorities have also recognised this potential problem and are deliberating whether or not to maintain the JSE as an SRO.
On the main board, companies must have R25m ($2.2m) of capital, three years of audited financial reports and R8m ($691,200) of pre-tax profits in the last of those three years. At least 20% of the shares must be in the hands of the public, while equity listings also need a minimum of 300 public shareholders. The AltX board requires only R2m ($172,800) of capital, 10% of the shares in public hands and 100 public shareholders. No profit history is required for AltX listings.
As with the rest of the financial sector, the capital markets are about to experience a profound change in the way they are regulated. The country will soon be initiating its Twin Peaks programme, in which the South African Reserve Bank takes charge of prudential regulation and another body will be responsible for market conduct. The JSE will still act as the primary oversight body for the stock market, but the entities supervising it will be transformed and the lines of responsibility will be changed significantly. In its 2014 report, the JSE welcomed the move, but noted that the authorities need to take care to make sure the changes are balanced and to implement them with an eye to avoiding unintended consequences.
Significant reform is also currently being undertaken with respect to the OTC derivatives market. As a member of the G20, South Africa is committed to relevant upgrades in order to achieve a more stable and transparent market. Even though its markets were relatively strong during the financial crisis, South Africa recognises the need to stay aligned with markets elsewhere. Under the 2012 FMA, licensing was established for all central counterparty clearinghouses (CCPs) and trade repositories that are active in South Africa.
Further reforms are in the works to provide the market infrastructure and an overarching regulatory framework for the OTC derivatives market. The World Bank and others believe that having robust counterparties in place for the OTC market is vital to help guarantee systemic stability. The current models being considered for South Africa include the use of CCPs in the developed markets, CCPs at home or a combination of both.
South Africa’s market infrastructure is highly advanced. Strate acts as the CSD and is responsible for depository and settlement. In the 1990s, the JSE and the CSD worked together to create a system that is as efficient and as sound as possible. As a result, they built a platform that achieves simultaneous, final and irrevocable delivery versus payment, making the JSE one of the first markets in the world to do so. The central bank handles the cash side on a real-time gross settlement basis. Strate is owned by the JSE and a number of banks – Absa, FirstRand, Nedbank, Standard Bank and Citibank. The authorities have been working hard to develop such a robust system because they are wary that without world class clearing and settlement, the trade of South African shares would otherwise gravitate towards London and New York.
Process improvements are ongoing. In 2013, Strate signed an agreement with Clearstream, an international CSD which is part of the Deutsche Bourse, for the latter to provide collateral management service for the former. However, deficiencies remain in the equity market infrastructure. There is no central counterparty (although the JSE will step in during the case of failed trades), and the settlement cycle does not fully meet best practices. Furthermore, the market remains T+5, one of the slower cycles in the world (most advanced jurisdictions are on T+3, with some on T+2 or faster). The exchange has been working since at least 2007 to have the cycle shortened, but the project has so far met with repeated delays.
As of September 2015, the JSE is the 18th-largest exchange in the world, a rise from 20th place in 2011, but down from 17th in 2014. A total of 328 companies are listed on the main board and 60 on the secondary board, down from 340 and 66, respectively, in 2011. A total of 18 companies were newly listed on the main board in 2014, and 6 on AltX, though the former lost 20 companies and the latter, six, through delistings.
In terms of foreign listings, the JSE currently hosts 68. Foreign shares have been allowed since 2004, and in 2011 the listings rules were updated so foreign listings would be treated the same as domestic listings. In late 2014 the exchange started a fast-track scheme to encourage foreign-traders to list on the AltX. The first issuer to take advantage of this programme was Sirius Real Estate, a German company that had already been trading on London’s Alternative Investment Market. The fast-track scheme limits red tape, cuts costs and reduces the time taken for listing.
The AltX was founded in 2004, reaching its peak capitalisation of R26bn ($2.3bn) in 2008 before declining to a low point of R16bn ($1.4bn) in 2014. The total number of companies has declined from 66 in 2011 to 60 in 2015. Despite the more recent trend in declines, proponents counter that the market has largely done what it was designed to do, with 22 companies upgrading to the main board since the market was established.
The JSE All Share Index has, by all standards, been performing well in recent years. It is up five fold in almost a decade and has risen steadily since the 2008-09 financial crisis. After falling 23.2% that year, it recorded strong gains in most of the years following: 32.1% in 2009, 19% in 2010, 2.6% in 2011, 26.7% in 2012, 21.4% in 2013 and 10.9% in 2014. The index peaked in early 2015, and although it retreated somewhat, it had almost regained that high by the end of the year. The largest company in the market is SABM iller, with 11.3% of total capitalisation, followed by Naspers (10.40%), Compagnie Financiere Richemont (7.96%), BHP Billiton (6.55%), MTN Group (4.61%), British American Tobacco (3.41%), Sasol (3.16%), Steinhoff International Holdings (3.06%), Old Mutual (2.77%) and the Standard Bank Group (2.40%).
Volume has been strong. In early 2015, the JSE hit a record high for number of shares traded (1.025bn on April 28). In late 2014, it had achieved other records, with trading in rand terms hitting R53.7bn ($4.6bn) in December, a record number of trades in October (395,969) and the market capitalisation peak of R12.3trn ($1.06trn) was achieved in July. By late 2015, market capitalisation had retreated to R11.3trn ($976.3bn).
Yet overall economic conditions have been unfavourable. In addition to the anticipation of rising interest rates in the US and the fall in commodity prices, the market has faced headwinds from the domestic economy. Growth has been relatively weak since the global financial crisis of 2008-09, while strikes, electricity shortages, high consumer debt level and low consumer confidence have weighed on sentiment. Foreign investors have been selling shares and returning to the relative safety offered by developed markets.
Despite these negative external factors and trends, shares have been doing well. Seelan Gobalsamy, CEO of Stanlib, characterised the dichotomy in the following way, “The macroeconomic environment is challenging, and South Africa’s confidence levels are subdued. However, in contrast, financial markets have been buoyant,” he told OBG, “Global liquidity has benefitted and supported asset class valuations to a point where, in some instances, it is difficult to defend based on purely bottom-up fundamentals. The search for yield and some growth is clearly evident in the pricing and mispricing of assets, both locally and globally.” Domestic investors have been filling in for lower overseas demand. Legislation requires no more than 25% of pension assets be invested overseas, so there are sustained inflows to the domestic market. As of early 2015, around 46% of the free float of the JSE was owned by foreigner investors, which was down from 48% in July 2014.
The initial public offering (IPO) market in South Africa heated up in early 2015, with three issues posted in the first quarter, the most in a first quarter since 2008. Later in 2015 the trend weakened. By end-September, five companies had listed on the main board, down from the eight companies listed through the same period in 2014. In total, nine companies were newly listed on both boards in the first three quarters of 2015, down from 13 in the same period of 2014. Also, Virgin Active’s highly anticipated listing was suspended in May 2015. The company was taken private instead, and some analysts have noted that this may be the result of a recent trend favouring mergers and acquisitions over IPOs (see analysis).
Bonds & Derivatives
The Bond Exchange of South Africa (BESA), which handles secondary bond trading, was formed in 1996 from the Bond Market Association, which itself was founded in 1989. BESA was acquired in 2009 by the JSE. South Africa has a deep and mature bond market. Its yield curve extends out 26 years, and while the municipal bond market has little trading, some corporate bonds are highly liquid. The country has 28 sovereign rand issues outstanding, as well as nine dollar, two yen and two euro issues trading in the market. On the corporate side, a total of 11 issues are denominated in rand, 33 in dollars, 14 in euro and four in Swiss francs. Securities issued by Eskom, Transnet and the South African National Roads Agency are particularly liquid.
South Africa has a highly evolved derivatives market, beginning in the 1980s as an informal market operated by Rand Merchant Bank. The derivative division of the JSE was formed in 1990. It allowed for the trading of warrants, stock futures, and index and interest rate futures and options. Commodity futures were introduced in 1995. The JSE subsidiary Safcom acts as the central counterparty for exchange-traded derivatives, standing between buyers and sellers and taking the trades from each. It has applied for recognition from the European Securities and Markets Authority.
In late 2014, the JSE started offering currency futures for trade between the rand and a number of African currencies. Included in the new product range are the currencies of Zambia, Nigeria and Kenya. The contracts will allow companies to hedge their trade within the region and speculators to bet on regional exchange rate movements. The JSE already offered futures in the following currencies: the US dollar, the euro, the Australian dollar, the yen, the Canadian dollar, the New Zealand dollar, the renminbi, the Swiss franc and the Botswana pula. The new futures are a key part of South Africa’s decisive shift towards the African continent. As domestic businesses and banks focus on regional opportunities, they will need efficient, cheap and transparent hedging of the currencies of the countries in which they deal. “Everyone is talking about Africa, and we are doing something about it,” Warren Geers, JSE head of interest rates and currencies, told OBG. “There’s a lot of appetite for the African currencies,” he added.
Overall, the South African capital markets are highly evolved. Market capitalisation of the bond market is 57% of GDP and the stock market is worth 288% of GDP. These ratios are in line with those found in more developed markets, according to the IMF. The mutual fund sector has been particularly strong with total assets more than doubling between 2008 and 2013, from R661bn ($57.1bn) to R1.5trn ($129.6bn). As a percentage of GDP, assets in the mutual fund sector have risen from 29.3% to 42.1%.
Other subsectors within South Africa’s financial markets are also highly advanced and growing. Private equity almost quadrupled in size between 2005 and 2013 in terms of total funds under management, and is up 11.8% annually on average since 1999. While South Africa still ranks far behind developed markets – especially the US, UK and South Korea – in terms of private equity as a percentage of GDP, it is ahead of Japan, China, Turkey and countries in the Middle East and North Africa, according to a 2014 KPMG report. South Africa also ranked fourth in the number of deals, ahead of India and behind France, suggesting the market is active, though the deal size is on average small. Meanwhile, assets under management for hedge funds have doubled since 2011, and future growth prospects are good. New rules will require that these entities have independent administrators and trustees, meaning hedge funds could continue to gain business from pension funds.
The South African capital markets are enjoying healthy growth in the context of improved regulation and supervision. Already ranking among the best of the developed markets, they are now working to address some lingering issues, especially in terms of the settlement cycle and systemic risk related to OTC securities. Market players are also working to capitalise on the growing interest in Africa and to establish South Africa as the centre for listing and derivatives trade for the region. As the soundest and safest market in Africa, the JSE stands to benefit as issuers seek listings, corporations look for hedging solutions and investors seek opportunities. The market will continue to be buffeted by international factors and a weak global economy, but it should do well over time as its fundamental strengths allow it to operate well regardless of the environment.
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