The Markets Jacques Magliolo
South African institutions are strong enough to avoid being forced into bankruptcy by a “loose operator”, especially under present statutory regulations.
To determine whether a Barings-type financial disaster could happen in South Africa I looked at the exposure of a number of institutions’ to non-equity financial instruments, such as bonds and derivatives (futures and options). Exploitation of derivatives caused the downfall of Barings.
Futures are traded on the South African Futures Exchange, and options are traded on an over-the-counter market. A future is an obligation to deliver or take delivery of a security at some time in the future, while an option is a right, but not an obligation to take delivery or deliver.
At present, investors can only buy a future or an option on a gilt or on an equity index — not on actual commodities. This rule is going to change and when it does institutions and stockbrokers will be forced to review their risk management techniques.
In the gilts market, dealers have three issues to consider when buying gilts which check against a dealer exceeding his authority. These include a discount on the purchase price, a coupon rate and a yield-to-maturity rate. If a buyer gets a R1-million gilt today for, say R775 000, the difference is called a discount. When the government buys the bond back in 15 years’ time (maturity rate), it pays the full R1-million for the bond. The discount, together with the interest the bond holder gets for buying a gilt (coupon rate), forms the yield-to-maturity.
This rate is now 16,6 percent and is usually linked to the perception of political stability in South Africa.
All three markets are used by institutions and they account for extremely high daily turnovers. Last week investors witnessed R10,3-billion worth of bonds purchased (year to end-February: R173-billion), compared to the equity market of R976,7-million (R9,0-billion).
Even if all these bonds went against institutional perception of future trends, they would not wipe out institutional asset bases.
One reason for lumping these markets together is that it is difficult to distinguish them in annual reports. Institutions differentiate between shares, bonds and “other interest bearing investments.” This makes it nearly impossible to analyse the effect of a single instrument on the company.
Experts said that in South Africa derivatives are not traded directly, but used as an insurance against losses in the equity market.
The present rule is that institutions’ total exposure (shares, bonds and derivatives) cannot exceed 85 percent of total asset base. Old Mutual’s total exposure is estimated at 83 percent, Southern’s at 77 percent and Sanlam at 73 percent. Of this total exposure, most lies in equities and little in “other” markets,” with Old Mutual showing a 25 percent exposure, Southern 21 percent and Sanlam 16 percent.
Finally, while it is unlikely that a single dealer would have access to, or ability to trade in, all three market simultaneously, problems would only arise if an institution could not pay the daily margin call. This means that if, on any particular day, an institution did not have cash on hand to pay for a loss on a security, it would have to liquidate assets.
Life assurers face shaky future
Life assurance companies will take some strain over the next five years, reports Jacques Magliolo
Life assurance companies are under threat. Government intervention, increasing competition from banks and the effects of Aids on income will weaken the security of life assurance firms in the next five years, says Andersen Consulting, a member of the Arthur Andersen group.
Every four years Andersen Consulting undertakes, on behalf of assurers, a comprehensive study of factors which could affect the industry. Research for its latest report — called Delphi — focused on direct business underwritten by long term assurers and excluded personal and commercial short-term business.
Problems the industry could face include:
* Operating under continued economic uncertainty until the turn of the century.
However, Andersen Consulting does not expect to see the government adopting a nationalisation programme, but it will increase its interference in the marketplace.
* Government regulation will increase through a re- introduction of prescribed assets and greater financial disclosure. Under a prescribed asset system institutions are forced by the government to invest about 15 percent of their funds in government-type bonds.
Wally Strictland, head of Andersen Consulting’s Insurance Industry Practice says: “The ever-rising income, the enormous growth in assets and the healthy cash flows of the large insurance companies have attracted the attention of South Africa’s new government as a source of funds for the reconstruction and development programme.”
* Another threat is growing competition between assurers and banks/building societies for consumers’ savings. Andersen Consulting says: “Competition is becoming more intense as contractual savings products from assurers are often taxed at more favourable rates in the hands of consumers than, for example, funds lodged in banks accounts.”
Assurers also face growing competition for their long-term products from companies offering health care cover. The report says the life industry is likely to pre-empt this competition by acquiring a controlling stake in health care and managed health care products.
Managed care companies grew by 29 percent, health care companies by 30 percent and retail banks by an impressive 33 percent.
* Increased labour mobility, meaningful steps through affirmative action progammes and steadily rising incomes are identified as some of the factors which will lead to greater demand for assurance products.
“Whereas previously the demand for assurance products among less sophisticated consumers was geared towards funeral, life and disability policies, a new generation of prosperous and more enlightened consumers will almost certainly evince an active interest in investment-type policies and other long-term products.”
Finally, assurers are likely to face the future with greater government focus on consumer protection. It seems certain that steps will be taken to legislate on the disclosure of expenses and possibly commissions.