Changing Mindsets

Anita Hawser looks at the evolving African markets

Africa is one of those markets that incites mixed emotions among investors. There are those that still think of it as a relatively underdeveloped market particularly when it comes to dematerialisation and settlement efficiency. Increasingly, however, those kind of views tend to be in the minority. South Africa, which is the largest and most well-developed market in sub-Saharan Africa, has done a lot of work to dispel any notion among the international investment community that it lags more developed markets. In fact when it comes to adhering to international standards, South Africa is already there, and in some cases even exceeds more developed markets.

Johannesburg-based CSD Strate already offers delivery-versus-payment (DVP) settlement and 100% dematerialisation for all transactions on the Johannesburg Stock Exchange (JSE). “We pride ourselves on being one of the top rated CSDs in the world,” says Tanya Knowles, head of corporate affairs, STRATE. “We’ve got a very good Thomas Murray rating—AA. There’s only five or six markets ahead of us. So we’ve definitely achieved a lot of the things we wanted to do.”

A lot of South Africa’s ambition can be attributed to Strate and the determination of its CEO, Monica Singer, who has made no secret of her ambition to take risk out of the market; and it appears her work is not yet done. One of the biggest projects Strate has invested in for a number of years is its participation in Luxembourg ICSD Clearstream’s Global Liquidity Hub. “What this will essentially give us, in partnership with Strate, is a better ability for collateral to be available in the market to support risk management,” says Leanne Parsons, chief operating officer at the JSE. “It taps into more than just what’s available in the South African market, and given that markets are more and more global and money moves as quickly as data does on wires, we can’t isolate ourselves.”

Strate also recently implemented segregated depository accounts, which are designed to shield CSD participants from the failure or insolvency of another participant. “Client assets are completely segregated and not bundled together with the assets of the participants,” Knowles explains. Its work in this area also appears to have influenced provisions within the South African Financial Markets Act (FMA) 2012, which came into effect in June this year. According to Angela Hardwick, head of product development, custody and trustee services at Rand Merchant Bank, the FMA provided the enabling legislation that deals with CSD failures. “Now there is a very large manual that talks through the whole process of moving clients from one failing CSD to another, and how that would work,” says Hardwick. “Securities are already ring fenced and protected in terms of the legislation relating to nominee companies and in terms of some of the offerings that Strate has now put together with segregated depository accounts.”

With respect to cash, the impact is a little bit different to securities. Normally, in the event of a failure Hardwick says the cash would be frozen because it falls into the pool that’s under the liquidator’s management. However, she says Strate has put together certain proposals relating to suspended accounts managed by the CSD for the proceeds of corporate events and so on not to be paid back into the frozen cash pool. “Both the national treasury and the self-regulating organisations in South Africa realise that these risk matters need to be addressed,” says Hardwick.

“The global regulatory winds are strong and they’re blowing in multiple directions,” observes Parsons of the JSE. When it comes to risk management she says there are a number of developments that have impacted the stock exchange. At the end of last year, the JSE’s clearing house for listed derivatives Safcom, was the first to be certified as CPSS-IOSCO compliant. The JSE is also interested in applying for a license to become a CCP for OTC derivatives clearing. “That’s still a business case in development,” says Parsons. “We’re in discussions at the moment. We have not yet lodged an application. We’d really like to have an initiative that is driven by us but supported by the markets and that is still in its embryonic stages but we’re having good conversations.”

South Africa is also a leader when it comes to implementing Basel III. According to Emilio Pera, lead financial services director at Ernst & Young, South Africa implemented Basel III at the beginning of the year ahead of other African markets and globally. “Because we’ve had a slightly more conservative approach previously from a capital perspective, and because we’re an emerging market we’re well within the requirements from Basel III,” he explains. Pera says there is definitely a move in the rest of Africa towards the Basel framework but probably Basel II rather than Basel III. “If there aren’t projects already running there is a clear indication from regulators that they are moving in that direction,” he says. “If you look at a country like Nigeria, which is the second largest economy after South Africa, as a result of their own crisis they are definitely becoming more regulated, and not only from a Basel perspective but also from a governance perspective there have been significant changes there.”

Shortened settlement cycles

When it comes to aligning South Africa with international best practices, Hardwick says the Financial Services Board (FSB) is also putting pressure on the JSE to move from T+5 to T+3 settlement. “In fact the FSB made it a condition of the JSEs license to act as an exchange that they do move from T+5 to T+3 in an agreed time frame,” she points out. Knowles of Strate says T+3 settlement is a major priority for the market as it is the only G30 recommendation that South Africa doesn’t comply with. “So there’s a big push now from the JSE to do it, and the other thing is we are wanting to implement a new debt instruments solution into our country. So firstly we will go to T+3 and then we will replace the bonds technology.”

Although most other developed capital markets are moving from T+3 to T+2 settlement, Knowles says the jump from T+5 to T+2 is too big for the South African market. “If we can move to T+3 then I think we can start a new project to move to T+2,” she says. Bertrand Blanchard, managing director of Société Générale Securities Services (SGSS) Johannesburg says there is a clear plan to move to T+3 settlement by 2014, but he says a more realistic deadline is perhaps sometime between 2014 and 2016. “It’s [T+3] our number one priority,” says Parsons of the JSE. “We implemented phase one in July, which was really about setting up some of the foundation elements; a lot of internal work, some external facing stuff but not too much.

“Phase two and three are progressing. Phase two, which is planned for the second half of next year, will see us implement all the technology but still keep us on T+5 settlement, and then phase three, as soon as possible thereafter, will see us move to T+3.” Parsons is reluctant to give any firm timelines for phases two and three, she says, because it is still not clear when the rest of the market will be ready to move. “The intention is by the end of this year to come out with a timeline that the market can then work within,” she explains. “There’s a significant mindset change that needs to happen just in terms of how the market operates and deals with this. There is going to be some quite significant business process re-engineering for all the market participants from banks to CCPs, brokers, even institutional investors, and notwithstanding the offshore parties in terms of understanding what’s required of them.”

The rest of Africa

South Africa aside, Hari Chaitanya regional head, investor and intermediaries sales, transaction banking, Standard Chartered Bank Johannesburg says the rest of Africa is still very much evolving. “What has been happening over the last few years is that as the interest of foreign investors is increasing that is driving the growth process of the capital markets. And if you look at the development of the markets over the last five to seven years every market now has a functioning market—an exchange and a CSD (except Zimbabwe, which is working on it).” Chaitanya says a number of African markets are also actively promoting domestic unit trusts and pensions markets, and along with that they are also looking at meeting international standards. “There is still a long way to go though,” he adds. “If you look at the exchanges, out of 24 in the region only four have membership of the federation of exchanges. Similarly, a market the size of Nigeria has only recently become a member of IOSCO.”

While there is a focus on regulatory development Chaitanya says it is more as part of an evolutionary development of these markets rather than as a result of the global financial crisis. Growing investor interest in the region is also forcing markets in the region to bring their securities market infrastructure up to speed. Although liquidity in most African markets is still relatively low, over the last 18 months or so Blanchard of SGSS Johannesburg says there has been a significant increase in investor appetite for equities and for higher yielding debt. In terms of values traded, Parsons of JSE says it exceeds 2008 levels. “From last year to this year we’ve had 22% value growth,” she says. “We’ve had good growth in all markets not just in the cash equities markets where we’ve had a 58% increase on transactions and where we are 22% up on value traded.”

Blanchard says the most populous markets—Nigeria, Ghana and Kenya—are most in demand among investors, and to a lesser extent smaller markets—Botswana, Mauritius, Zambia and the Ivory Coast—where political risk is less of an issue. “That is why we’ve created this hub for African custody out of Johannesburg,” he explains, “not only for investors from outside Africa coming into Africa but also for investors inside Africa looking to invest in other African markets.” However, liquidity remains a challenge for most African markets. “In terms of listed companies and turnover, it’s still very small,” notes Chaitanya, “and if you have increased allocations coming from the emerging market funds and the frontier funds, even a 1% uptick could be a large amount for a small market to handle.” But as foreign investors become more interested in these markets, it is important for them to attract more listings, says Chaitanya, and to encourage domestic players to get involved, which is already happening in markets like Kenya, Ghana and Nigeria.

Chaitanya also argues the case for consolidation among custodian banks in Africa, particularly amongst the smaller sub-regional or single market players. When Ghana recently opened up its pension fund market last year, he says approximately 20 banks applied for a custody license. “That number of players says to me that they have no idea as to what kind of commitment or investment levels are required. Again, this is part of the evolution of the region.” There has already been some consolidation with Standard Chartered acquiring the African custody business of Barclays in 2010, followed by the acquisition of the South African custody and trustee business of Absa Group. Chaitanya says a number of South African fund managers who are now investing in the rest of sub-Saharan Africa are looking for providers who can give them a one-stop shop. “One of the prime drivers for the Absa acquisition was so that we could service these fund managers in the rest of the sub-Saharan region and beyond taking advantage of our global footprint.”

Blanchard of SGSS Johannesburg says South Africa is gradually coming into line with US and European capital markets. “We’re starting to see the same trend of having players dedicated to securities services. So what will happen is because this market is really crowded, efficient and competitive, we should see more consolidation in the future.” Blanchard says there will be more demand for outsourcing from asset managers, and in future the market will demand players that can offer this level of service. “It will be interesting to look at South Africa, and beyond to sub-Saharan Africa five years from now,” he says. Africa is going through a fantastic phase, says Chaitanya, but it needs to continue to work on three areas: liquidity; governance; and domestic investment.