The move to a three-day settlement cycle, the appearance of new stock exchanges, and recent rules on hedge funds were discussed by our panel in Cape Town. Chaired by George Mitton
(head of investor services, Standard Bank)Kobus Cronje
(managing director – South Africa, JTC)Andre le Roux
(head of business development and client management – Africa, Maitland)Duncan Smith
(senior sales and relationship manager emerging markets, SGSS)
Funds Global: Has the market realised benefits from the move to a three-day settlement cycle (T+3) that was completed during 2016? How complex was it to implement this change?
Charl Bruyns, Standard Bank:
It’s a success story for the South African market and one we could talk until noon about. One expectation was to increase liquidity in the market and on average, in our business, we’ve seen 5%-8% more flow. We’ve also seen a lot more efficiency, which is a benefit.
The other benefit is funding liquidity. The average daily trading volume is about 20 billion rand ($1.5 billion), so by reducing the settlement cycle by two days, that’s 40 billion of more available liquidity in the market, so that’s a real benefit. The other piece for us, as banks, is that we have two days’ less risk.
Last but not least, about a third of our market volume is traded by foreign or global investors. Getting in line with global best practice was vital for us in order to gain credibility.
In terms of complexity, I have to say the implementation was very complex. We’ve got a diverse client base. Once you start unpacking the impact for the client, you start realising how far-reaching the impacts are.
There were also some stresses from the JSE [Johannesburg Stock Exchange]. If you look at the margining methodology, after T+1, if we don’t commit on a trade as a bank, the margin to the brokers increases significantly. A month before the ‘go live’ date, we were still on 68% committed status on a T+1 basis, which meant margin expectation from brokers would be significant.
That was a big worry. We had to start looking at contingencies around lines of credit and other financial products to support the broker client base through the implementation.
Also, you have to keep in mind that a lot of the flow that hits South Africa comes from various financial centres that route though hubs like London into South Africa. You’ve got time differences, which accounts for some of the complexity.
But I have to say, the way the JSE executed this was fabulous. The way they ran the programme, the way we connected, the way we got standardised market communications out, the way we ran our risk committees, it was world class.
Duncan Smith, Societe Generale Securities Services:
We have seen a similar pick-up in liquidity and flow, so not much more to add to what Charl has said. I tend to use South Africanisms, but there’s always been a spirit of ubuntu or community between market participants, where everybody works together for the good of the common market. We can have a customer coming into our business at ten o’clock in the morning and then going to Charl at two o’clock, so we’re both competing for the same mandate. But at four o’clock, we’re sitting together in a market committee saying, “Right, what are we doing for the good of the market, can you help and how best can we make it work?” The community comes together.
At last year’s roundtable, we were talking about sovereign ratings downgrades. The situation was challenging. It was important for the market as a whole that the move to T+3 was a resounding success. We can say, ‘We’ve done it successfully, we’re part of the broader global community having joined T+3 now – come and invest, our doors are open.”
Andre le Roux, Maitland:
Our clients already trade in many global markets with different settlement cycles so, for us, the implications were fairly simple. What was interesting was the behaviour change in our fund manager clients. The level of precision and timing is different now. We spent our time engaging with clients, helping them understand that if they were to miss this date or this time, there would be margin calls. This results in a higher level of precision in our markets.
Kobus Cronje, JTC:
I’d echo the words the others have said. It was imperative that the South African industry stay competitive because the gap with international markets was beginning to widen. I’m glad there are already talks about T+2, the next phase, because, with the way that the industry is moving, the whole settlement cycle is becoming tighter and tighter.
Funds Global: What are the implications of the newly licensed stock exchanges in South Africa, ZARX and 4AX? How do you see these exchanges developing?
Again, in the spirit of ubuntu, it’s good for the market. It’s a case of embracing open architecture, not necessarily following your clients on to those exchanges, but at least embracing them and saying, “Well, you want to trade, we’ve got the connectivity, we’ve got the piping, we know how to do it, we’re open for business.” There’s been a lot of noise and nobody really knows when they will actually be open for business, but the overriding theme is positive.
It’s too early to tell at this stage what the impact will be. Everyone would agree it’s a move in the right direction. Some of the things they hope to offer, such as a more liquid market, T+0 and those sort of things, are interesting, but we haven’t seen much uptick yet in terms of interest.
ZARX is a pre-funded exchange. You have to have cash in the account. They’ll just use one custodian because they want to be able to settle in the hour. The initial view is that it’s restricted shares, such as BEE [black economic empowerment] shares. ZARX has a niche. Whether they expand from that, we’ll see. But there is a place for that.
4AX is a competitor to the JSE with the same listing rules and same licence rules. There’s been a lot of noise about them getting their licence and the JSE opposing it but, to what Andre and the guys are saying, it’s good to have another exchange on the market. It’s good to create competition. That’s part of the roadmap to push disruption.
I think it is a positive move for the market and could be a catalyst for incubation of new businesses to access the capital markets in a way that they may not have been able to do before. It will be interesting to see the manner in which innovation and technology help the new exchanges to attract flows from issuers and whether they are able to provide a cost advantage to the issuer listing on their venue as opposed to the traditional exchanges.
Funds Global: How significant were the rules allowing hedge funds to be distributed to retail investors in South Africa? Are these regulations now clear or is there still complexity to manage?
For the converged managers, the guys who had traditionally run hedge funds as well as long-only regulated funds, the transition into this new regulated product environment was relatively easy, because they understood the regulatory overlay.
The traditional hedge funds who had high-net-worth private clients and perhaps a couple of institutional pension funds – the ‘rock star hedge fund managers’ – have had more of a struggle to deal with this regulation, because it creates another layer between them and their client, being the ManCo [management company]. It requires a lot of behavioural change.
We haven’t seen a big rush of retail investors into the product yet. We’re still not through all of the migration into this new model. That’s the next step. Once the guys are bedded down and understand the model, the reporting requirements and the daily cycles, they can get out on to the market and start selling the retail products. But we haven’t seen a big flood yet.
A lot of the market participants are still finding their feet. This extra cost layer at a time when deals and returns are under pressure is having an impact. But our view is positive. Once the industry has adapted and settled down in terms of all the changes, we anticipate a switch and a flow into the industry. We are quite bullish in a three to five-year outlook for the hedge fund space.
There is a bit of a catch-up happening in the South African industry. Eighteen months ago, if you compared South Africa with a jurisdiction like Ireland, in terms of the governance, processes, infrastructure, reporting and investor protection, there was a big gap. It is a good thing to have a shake-up in the industry.
Again, on the positive side, the larger hedge fund managers will get through this and see good growth. On the negative side, it does make it more difficult for a new market participant to enter into the market. That, to me, was always one of the exciting things about the hedge fund industry. It gave an opportunity for the surfer to put down his surfboard and start a new business, and there have been some phenomenal successes as the industry evolved.
As we’ve seen in jurisdictions such as Luxembourg and Ireland, the regulation is well thought out. The issue is fee compression. Fund managers have this other layer of oversight and don’t really want to pay for it.
It’s a positive development for the market. Hedge funds have been an active product in South Africa for some time, but because of regulation they were not able to be marketed. Placing the regulation under CISCA [the Collective Investment Scheme Control Act] is positive. Institutional funds have the option to appoint a trustee whereas retail funds have to appoint a trustee. We have seen that most institutional funds appoint trustees, which is positive and talks to the value it adds to the investor base.
Funds Global: One of the obstacles preventing capital markets growth across Africa is a shortage of liquidity. What developments have you seen that promise to improve liquidity, both in South Africa and the continent as a whole?
I don’t see it as an obstacle. It’s part of an evolving market. But I also agree, if you don’t have the liquidity, it’s going to stagnate, so you have to stimulate it. In South Africa, we spoke about T+3 stimulating liquidity. Yes, maybe with new exchanges coming up and lower holdings and less appetite, you might struggle with liquidity on those platforms, but in general, we don’t have a problem in this market.
Across Africa, the catalyst would be for the growth in the savings industry. That stimulates demand for investment assets and, effectively, economic growth. We have markets in Africa where certain government funds are the only pension funds and these invest in government securities largely. We need to see more institutional funds investing in broader asset classes stimulating increased activity in wealth management products. That’s the evolution that’s required.
The change is happening rapidly in the more advanced markets, such as Kenya and Nigeria. We’ll set up the derivatives exchange in Kenya and we’ll be one of the first clearers there. We’re working with the CMA [Capital Markets Authority] to get the securities lending regulations out. It creates a lot more liquidity in the market.
Further, we want to see, for instance, Nigeria investing in Kenya, Kenya in South Africa, and more inter-Africa investing. You need to stimulate that inter-Africa financial market rather than just playing in the international corridors the whole time. South Africa has done good things. I’ve seen the uptake from the largest funds manager in South Africa pushing big chunks of money into Africa. I had a Moroccan bank phone me the other day, saying they wanted to invest in South Africa. That’s also going to grow and stimulate the market.
If you look at the history of Africa, South Africa’s capital markets started because of the raising of capital required for the gold industry but in the rest of Africa, with the big telecoms and oil companies coming in, they haven’t had to raise capital in the country. From that perspective, globalisation has been terrible for Africa, because we’ve just had these global juggernauts coming in, funding projects and taking money out. I’m struggling to see what is going to be the catalyst. The savings industry being forced to invest in-country may be one catalyst, but now we need to find more stocks.
It will be technology-driven as well. Things like cellphone banking, the cryptocurrencies and a number of things like that could be the catalyst to get the savings industry off the ground in the rest of Africa. From our perspective, there’s certainly been an increase of interest in the last 18 months from private equity investors overseas looking at countries in Africa. That indicates a belief in realising assets in-country in places like Rwanda and Tanzania and so on.
Funds Global: A growing number of exchange-traded funds (ETFs) are launching in Africa. What is the potential for these products and what is holding them back (such as problems related to liquidity and tracking error)?
If you look at the growth of the South African ETF market relative to the rest of the world, you’ve got to say, what’s wrong in our market? There may be structural challenges. Generally, products are sold by brokers and the brokers are not earning as big commissions on ETFs. If you look at the really big ETFs, which are the commodity players such as palladium ETFs, they’ve done relatively well. But those are institutional products.
The long-only active asset management industry has a phenomenal reputation in South Africa. Companies like Coronation and Allan Gray are the brands we trust and love. Investors think, we’re not going to look at this ETF. From my perspective, I’m surprised that there aren’t more ETF participants, and managers trying to sell them, but it’s almost like there isn’t an incentive.
The size and scale of these products is much bigger in Europe. They’re run in one portfolio and they’re passported across seven, eight or nine different jurisdictions under Ucits. They’re sophisticated and with such large scale, the managers are able to run a compelling product with a low TER [total expense ratio].
From an Africa point of view, we’re dependent on sufficient liquidity and investor demand before the ETFs can truly reach scale. This will come in time as the savings and investment markets in Africa develop. One of the things I’ve always said is that investing in Africa is like a five-day cricket test match. You walk up there and you stand and you bat and you’re trying to nudge one through the covers and take a single to build an innings. If you’re trying to hit sixes, you’re going to get bowled.
ETFs are a low margin scale game. We have seen consolidation on this front in Europe and some large players taking the lead. I expect to see a shift in our markets with consolidation happening. It’s expensive to buy scale, very expensive, but you need that consolidation to be successful.
Funds Global: What other regulatory issues not discussed so far are occupying your time at the moment?
A number of years ago in the UK there was the famous ‘Dear CEO’ letter, which asked the CEOs of asset management companies whether they understood who their service providers were and what resilience they had against the failure of the service providers. That’s now been pushed quite a lot by our regulator.
We’re spending a lot of time on creating oversight frameworks to help our clients have oversight over us as a service provider. A lot of people are struggling with what sort of resilience they have, what sort of failover they have, what sort of exit plan they have. The costs of creating a resilience plan, a back-up plan, are massive – fee compression again. That, for us, is the biggest challenge.
The main things for us are what’s happening in Europe and the US and how the South African regulatory environment is reacting to that. An example is CRS [common reporting standards]. There is also the AIFMD [Alternative Investment Fund Managers Directive]. It’s been in now for 18 months but there are still regulators out there that can’t receive the reporting. The period from when a regulation is tabled and implemented to when the actual output or benefits are realised is getting longer.
There are two types: direct regulation that sits on us as a bank – I think there are 49 pieces we need to attend to – and indirect regulation that affects us because it impacts our clients and we need to respond to it. We don’t sit only in the realm of South Africa. We’re banking foreign clients, and that means we have to consider Ucits and AIFMD, to name but two. With this flux of change, and also being one of the G20, it’s a massive amount of regulation to adopt. It’s a constant challenge.
If I look at the investment spend in my business, before 2008, we would spend 80% on business development and 20% on regulation, which was largely coming from local regulators. Now I would say regulation accounts for 60% of our investment spend.
But, I have to say, although we’ve got less hair, the attention to regulation can be positive. A big part of the programme is people and training and the rigour and the thinking that builds in our business is good. It’s also driving innovation. I was talking to some guys who are putting artificial intelligence into their compliance systems so that, instead of having four people sitting for a month doing it, they’ve got one robot that does it in an hour and 30 minutes.
You’re right. There’s been a big pick-up in interest and conversations around automation and blockchain and the like, These are options which were not readily feasible two or three years ago. Experts from all horizons have been brought together to test different types of technology within the Societe Generale Group in order to seize the opportunities they provide when appropriate. Similarly, we have seen regulation first introduced in Europe and now in Africa such as CRS and others. The benefit is that once you’ve understood it in one jurisdiction, it’s easier to understand it in another.
Funds Global: When you look ahead to the next 12 months, are you optimistic or pessimistic about the potential for your businesses?
I’m always positive. In my business, we run 14 markets in Africa. We are opening two more this year, in Angola and Côte d’Ivoire, so that’s exciting. What’s also exciting is our ability to focus on new technologies. It makes you get up in the morning and go to the office. However, there’s a lot of uncertainty globally and it is unclear how that will affect frontier and emerging markets. That could put some pressure on the business.
JTC has been in South Africa for two years now and we see opportunities both in South Africa and broader Africa. As a leading service provider in South Africa, despite the rand last year being relatively strong, we think we are still highly competitive to export services to Europe and the US.
There’s a lot of regulation with all this change and clients want us to help them. If you’ve got the right temperament, you’ve got to be optimistic because clients are asking you to do more and more. Whether they’re going to pay you for it is always the debate, but we’re optimistic because there’s a lot of work still to do.
To go back to the cricket analogy, if you want to buy a ticket after tea on a Tuesday afternoon of a test match, you’re not going to see lots of sixes being hit. The spinners are on and the batting side is grinding through the overs. What you are not seeing is that one batsman is building up a nice little innings and starting to gain lots of momentum.
Regulation in Africa, improving financial education, blockchain and so on, are all laying a foundation. You won’t see huge sparks coming out of the game at this stage but I am certainly optimistic for the future.
©2017 funds global mena