With an economy worth roughly one-third of a trillion dollars, South Africa only accounts for 0.5% of global GDP. Nevertheless, the trillion-dollar market capitalisation of the Johannesburg Stock Exchange (JSE) makes the country’s bourse the 19th-largest exchange worldwide. South Africa has one of the highest equity capitalisation-to-GDP ratios globally, a unique phenomenon by international standards.
The country’s capital markets have performed exceedingly well in recent years, in contrast to the broader macroeconomic turbulence. Economic growth for 2013 was 1.9%, compared to an equity market that grew by 21.4%. This continued into 2014, with the All-Share Index (ASI) seeing double-digit growth in the first half, while the economy was largely flat, contracting by 0.6% in the first quarter and growing by the same amount in the second.
Cas Coovadia, managing director of the Banking Association of South Africa, told OBG what he sees as a key reason for the disconnect: “South Africa’s large businesses are linked more closely to international markets than they are to the local economy.” Companies like Richemont, Naspers, SABM iller and Old Mutual earn a large proportion of their money outside of South Africa. “Of the top 40 shares by market cap listed on the JSE, 40% of the revenue is derived from outside of the borders of South Africa,” according to a 2014 report by South African risk services firm RisCura.
It is not only equities that have performed well. The JSE’s other financial markets – offering interest rate and derivative products – have also grown, supported by enhanced market infrastructure and a sound regulatory regime. The JSE also held on to its top spot in the World Economic Forum’s “Global Competitiveness Report” for 2013-14 as the world’s best-regulated exchange for the fourth year in row. Private equity is another growth sector, which will feed into the capital markets as funds exit through strategies such as initial public offerings (IPOs).
While newcomers to African capital markets logically go through the JSE – it represents 80% of the continent’s equity market value with a total market cap 11 times larger than the Nigerian Stock Exchange (NSE) and average daily trading value 100 times higher – South Africa cannot afford to be complacent, as other exchanges are becoming increasingly sophisticated and competitive. In a blow to the JSE, cement group Lafarge, which announced the merger of its Nigerian and South African assets in 2014, is listing on the NSE and not the JSE.
According to Simon Freemantle, senior analyst in the Africa political economy unit at Standard Bank, this may be a growing trend as potential market players are increasingly shopping around. “Every week we have a Walmart-type firm calling and asking our views of other African markets,” he told OBG.
The market’s positive performance was not necessarily a given 12 months prior. The US Federal Reserve Bank’s announcement that it would start to taper its quantitative easing programme spooked world markets at the end of 2013. Starting in November 2008, in the immediate aftermath of the global financial crisis, the US underwent a long period of bond buying, and the slowing of these purchases led to concerns that any withdrawal of capital would adversely affect emerging markets. This was a particular worry for countries with current account deficits, like South Africa. However, while South Africa felt the pinch of tapering in January 2014, worries about the long-lasting effects that markets had feared proved unfounded.
Konrad Reuss, managing director for South Africa and sub-Saharan Africa at ratings agency Standard & Poor’s (S&P), believes that the explanation behind the market’s resilience lies in its flexible exchange rate. “The rand is South Africa’s shock absorber,” he said. It had already weakened some 20% in 2013, declining further after tapering was announced, but the rand recovered slightly once fears had abated.
The markets have had to negotiate some tricky territory, following a sovereign ratings downgrade in June 2014 by S&P to BBB- and a negative outlook from Fitch. “The ratings downgrade is negative. It will hit interest rates first and yields will change,” Warren Geers, general manager of the bonds and financial derivatives trading division at the JSE, told OBG.
The effect of these decisions was immediately reflected in South Africa’s cost of borrowing. The 2026 benchmark R186 bond saw yields increase from 8.487% to 8.500% after the downgrade.
Conversely, however, demand for developing country assets is pushing yields lower and the South African government tested markets following the ratings cut by offering dollar (2044) and euro (2026) notes. It was the first time it tapped international markets in 10 months and it was the first euro sale in eight years. In the July 2014 offer, the National Treasury sold €500m and $1bn. The premiums for the euro and dollar issues were tighter than market expectations at 225 basis points and 220 basis points above their respective benchmarks – the euro mid-swap rate and similarly dated US Treasuries.
These conventional sales were followed by the launch of a sukuk in September 2014, making South Africa the third non-Muslim country and first emerging market to issue an Islamic bond. The 5.75-year, $500m sukuk was over four times oversubscribed, and was priced at a coupon of 3.9%, or 180 basis points above the corresponding benchmark rate.
Broadly speaking, the exchange provides two types of trading services – equities and derivatives. The equity market includes equities, warrants and exchange-traded instruments. The derivatives segment comprises equity and equity-related derivatives, commodities derivatives, currency derivatives and interest rate derivatives. The interest rate division also trades spot products.
Unusually for African markets – and emerging markets more generally – the exchange provides a viable and accessible route for raising funds. The World Economic Forum’s 2013-14 “Global Competiveness Report” ranked South Africa 2nd out of 148 countries in terms of the ability to raise financing through local equity markets. This is reflected by the fact that the equity market is the JSE’s biggest earner, representing 26% of total JSE revenues in 2013. The number of transactions rose by 45% to 39m year-on-year, and value traded was up 16% that year.
Unsurprisingly for the continent’s most sophisticated market, the exchange infrastructure is exceedingly developed. The JSE introduced a colocation centre in May 2014, enabling clients to place their trading equipment in the JSE data centre. Clients who move their equipment will have the fastest access to all JSE markets, benefitting from the lowest latency connectivity and real-time data receipt. Roundtrip latency is 150 microseconds at the data centre, compared to 2550 microseconds in the vicinity of the JSE head office. International clients are also taking up colocation services, which will significantly reduce their latency times. The current latency time from London is 180-220 milliseconds, according to Nicola Comninos, senior manager of equity market development at the JSE. By relying on JSE’s data centres, clients will have less reliance on third-party network providers and will also save on bandwidth costs.
The JSE has an upgraded version of its existing equity market trading software powered by MillenniumIT. The Millennium Exchange platform was first launched in July 2012 for equity market trading, with a significant upgrade in 2013. In the two years since, there has been zero downtime. Electronic trades account for 76% of the equity market value traded. Following this lead, the equity derivatives market is replacing its 20-year-old trading platform and switching to MillenniumIT in 2014.
Fees & Costs
Trading fee structures have also changed in the last two years. Fees used to be applied on a per trade basis, but have transitioned to value-based levies for equities and derivatives. In 2013 equities switched to a 0.0053% value-based charge with a maximum fee per transaction leg of R350 ($33.15). Previously, the charge for each transaction leg was 0.0055% with a minimum and a maximum.
The change has had the desired effect of increasing both traded volumes and value, and has made trading more affordable for retail clients. “This is positive for price discovery and liquidity,” Comninos told OBG. “Historically, we have seen 84% of total activity taking place in the central order book activity on the equity market. Now it is over 90%, largely because of the equity market trading billing methodology change to a value-based one.”
The settlement system is T+3 for the spot bond market and T+1 for commodities, and now the equity market is transitioning from T+5 to T+3. The first phase, which implemented an enabling regulatory environment, went live in July 2013. Phase two, which comprises user acceptance testing and a new clearing system, was ongoing at the time of print and set to complete by the end of 2014. This will pave the way for full implementation in 2015. The main motive of the transition to T+3 is to reduce settlement risk in the equity market. JSE revenues from post-trade services – equity market and clearing settlement – were up 18% to R249m ($23.6m) in 2013, and accounted for 17% of total JSE revenue.
Movers & Shakers
The last decade has seen impressive capital markets growth, with fixed-income security trading more than doubling from R10trn ($947bn) in 2004 to over R20trn ($1.9trn) in 2013 and equity market turnover quadrupling from R1bn ($94.7m) to R4trn ($378.8bn). Total market capitalisation was R10.6trn ($1trn) at end-2013.
In 2013 there were 329 companies listed on the JSE’s main board, venture, development capital and Africa boards. There were eight new listings and 18 delistings on these boards over the year. The AltX, the JSE’s alternative exchange for small and midsized listings, featured 60 companies at the end of 2013, with five added and eight removed. In the first half of 2014, 10 new firms listed and 13 delisted. Among the newcomers were two foreign listings. There were 58 foreign listed companies as of June 2014. The daily foreign activities trade has ticked up to 18%, from around 15% in the last couple of years.
Several high-market-cap companies drive the ASI. As of the end of May 2014, the largest companies by market capitalisation were BHP Billiton with 16%, British American Tobacco (10%), SABM iller (8%), Richemont (5%), Naspers (4%), MTN (4%), Sasol (3%), Anglo American (3%), Standard Bank (2%), FirstRand (2%) and Vodacom (2%). This group encompasses the diversity of the country’s economy, covering mining, beverages, consumer goods, retail, media and communications, energy and financial services firms.
Unusually for Africa’s emerging markets exchanges, the JSE has also managed to attract a number of IPOs in recent months. Five out of eight new listings in 2013 were in the property and real estate sector. This year has seen some big names join the market. In November 2013 global mining group Glencore Xstrata listed on the JSE to become the third-largest listed company on the exchange. Two months later, Alexander Forbes, an insurance and retirement funds company, relisted on the JSE. The relisting valued it at over $1bn. Alexander Forbes was delisted in 2007 when private equity firm Actis led an R8bn ($757.6m) buyout. Expectations of further private equity exits may pave the way for more IPOs in 2014.
The last year has seen growth in the exchange-traded fund (ETF) market. At the end of 2013, ETFs issued debentures worth R15.2bn ($1.44bn), more than three times the 2012 issuance of R4.7bn ($445.1m). First-half 2014 saw R14.8bn ($1.4bn) issued, almost matching the full-year 2013 total. Up to 95% of debentures are held by institutions, but individual appetite for EFTs is growing.
Listing activity has been bumpy in the last couple of years. In 2013 three new exchange-traded products (ETPs) – including exchange-traded notes ETNs) – came up, compared to 16 in 2012. In the first half of 2014, there have already been 10 new listings. ETPs are seen as an affordable way to diversify risk. They first started with the launch of the Satrix40 in 2000. While Satix remains a top player, today there are a broad range of ETPs with exposure to a number of asset classes. South Africa’s main ETPs cover the gold, platinum and palladium extractive sectors.
South Africa’s bond markets are set up very differently from equities, with a smaller scale, lower liquidity and no electronic platform. “The JSE did implement an electronic trading platform for government bonds, but unfortunately it never materialised as anticipated,” Geers told OBG. “The JSE is licensed to trade government bonds and the National Treasury is in the process of exploring the electronic trading for these products via the JSE, but initially only for the dedicated primary dealers of the South African bond market.”
South Africa had 1640 bonds with a nominal value of R1.84trn ($170.5bn) listed on the JSE by 134 different issuers at the end of the first quarter of 2014. Issuance in terms of nominal value and volume has nearly tripled over the last seven years. The National Treasury is the largest issuer by nominal amount, while corporate paper accounts for the majority of the individual listed instruments.
In 2012 increased demand for bonds along with low inflation drove five-year yields below 6%. However, with both of these factors reversing, yields edged over 8% in early 2014. The decline in bond demand was a result of successful equity markets in 2013, according to the JSE’s 2013 annual report. Bond market volumes declined by 10% year-on-year in 2013 to a nominal value of R20.6trn ($1.95trn).
South Africa’s derivatives markets are both sophisticated and large – among the top 20 in terms of size for stock index futures and options exchanges, derivatives exchanges and single stock futures and options exchanges. The JSE has four derivative markets: equity, commodity, currency and interest rate derivative markets. Equity derivatives are the highest earners of the four, and make up 8% of the JSE’s total revenues. Equity derivatives revenues increased by 17% to R132m ($12.5m) in 2013.
The value of equity derivatives traded rose by 21% in 2013 to reach to R5.1trn ($483bn) and the number of contracts increased by 59% to 217.5m. Open interest at the end of 2013 was 15.9m, up 31% from the previous year. There are more than 100 current members, of which around 60 are active.
The JSE hosts the 30th-most-liquid index future globally, the ALSI. The ALSI is not to be confused with the 165-strong all-share future index, but represents the top 40. The ALSI’s value traded is 89% of the total for index futures. “The daily trade of all index futures is around $2bn,” Magnus de Wet, equity derivatives market manager in the bonds and financial derivatives division at the JSE, told OBG.
Some 80% of the equity derivative contracts traded are futures. “This is the opposite of the US and other markets, where the options share would be larger,” De Wet said. Given the current market conditions, one of the reasons for the dominance of futures is that options writers are not incentivised to price options. “Volatility is at an all-time low and volatility runs inverse to share prices. With low volatility and high prices, there is no room to write in sufficient premiums, so there is a lack of appetite.”
Currency derivatives have seen a 40% year-on-year growth for seven years, according to Geers. “The dollar is the main tradable instrument against the rand. Between 80% and 90% of currency trade is in dollar-rand, and it is expected to stay that way,” Geers told OBG. The number of currency derivative contracts traded rose by 81% year-on-year to 34.3m. Open interest at the end of 2013 was up 60%, to 1.8m. Market growth was attributed to a new pricing strategy, currency volatility and asset management firms moving over-the-counter derivative trades on-exchange, according to the JSE’s 2013 annual report.
Midway through 2014, currency derivative trade volumes were already up 18% from the 2013 total. In early October 2014 the JSE expanded currency offerings, launching three new futures contracts that track the exchange rates between the rand and the Kenyan shilling, the Nigerian naira and the Zambian kwacha. These will allow investors to hedge their exposure to several major African currencies.
Private equity is very much a nascent phenomenon in most of Africa, and while the “Africa Rising” narrative of high growth and high returns has attracted private equity managers from London and New York, deals make up only a fraction of the volumes seen in most OECD countries.
South Africa is an exception to the rule, however, and private equity funds have a long history on the JSE, with several of Africa’s larger outfits domiciled in Johannesburg. At the end of 2013, funds under management were R162.2bn ($15.4bn), up 16.9% from the year before, according to the latest KPMG and SAVCA “Private Equity Survey”. Of this, R58.6bn ($5.6bn) is in undrawn commitments, among which R27.6bn ($2.6bn) is with independents, R22.8bn ($2.2bn) is with captives-government and the bulk of the balance is with captives-financial services.
Warren Watkins, head of private equity markets at KPMG, observed that the R58.6bn ($5.6bn) in undrawn commitments is at almost the same level as the total funds under management in 2006, which highlights both the growth and the opportunity of the market in South Africa. “The question is, how these funds will be deployed,” he said.
Most of the captives-government share relates to the Government Employees Pension Fund (GEPF), whose allocation to private equity is managed by the state-owned savings manager Public Investment Corporation (PIC). PIC was responsible for a significant share of growth in 2012, when the allowable allocation of private equity in its portfolio rose from 2.5% to 15%. PIC has a total of R1.3trn ($123.1bn) under management. While it has a conservative approach to its private equity portfolio, the firm is responsible for much of the sector’s growth. “PIC has added 80% of new undrawn commitments in the last two years,” Watkins told OBG.
A big reason for the industry’s growth in 2013 was successful fundraising, which comes in spite of an increasingly competitive environment as foreign domiciled funds look to Africa and seek new capital. A record R27.3bn ($2.6bn) was raised in 2013, representing a fundraising increase of 45% over 2012. The private equity sector in South Africa has grown at a compound annual growth rate of 11.8% since 1999, when the KPMG and SAVCA survey began.
While South Africa was the main source of fundraising in 2013, one-fifth of third-party funds raised were from overseas, with North America taking up half of that. The overseas slice was larger before PIC skewed the private equity market two years ago.
Private equity investment represented 0.13% of GDP in 2013, which is the same as Brazil and significantly higher than China (0.07%), Turkey (0.03%) and Russia (0.01%). By comparison, the same indicator was 1.02% in the US and 0.89% in the UK. Almost half of the investments in 2013 were in infrastructure, followed by manufacturing and media. The year’s largest deal was a R4.7bn ($445.1m) investment in a renewables project, Bokpoort, with GEPF taking one-quarter. Watkins is optimistic that private equity will be a growth area, based on relative underinvestment at present. “In South Africa, pension funds invest only 1% in private equity, compared with a global average of 4%,” he said. High-net-worth individuals also present opportunities. “After their basic requirements are met from banks and equities, most of the rest goes into private equity,” said Watkins.
Despite the challenging economic outlook, the JSE is expected to continue to perform well. Equity markets will receive a boost through infrastructure improvements and market conditions like private equity exits. Private equity is set to see strong growth as institutions have not reached their full investment potential. On the bonds and financial derivatives side, the array of products is set to expand, with Islamic debt having made its debut. The Treasury plans to raise $1.5bn annually for the next three years, including the sukuk. Islamic products have also attracted supply-side interest in currency trading. “The JSE is exploring sharia-compliant products in the foreign exchange market,” Geers told OBG.
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