Sands to shift on JSE’s monopoly

South Africa’s financial market amounts to one name: the JSE. But very soon the local stock exchange is likely to have competition on its home turf, with a number of licence applications for new exchanges pending.

The country’s central securities depository, Strate – of which the JSE owns almost 45% – is also set to face its first competitor.

Strate provides all the electronic settlement of the equities and bonds bought and sold on the JSE. Though it has publicly shrugged off the arrival of newcomers, those developing the new trading arenas believe the competition that they will bring will be a boon for investors.

The vertical integration of the local market – where the trading of securities, as well as their clearing and settlement, is done for the most part through one dominant channel – is something that needs changing, they argue.

The advent of the Financial Markets Act of 2012, which repealed the old Securities Services Act, paved the way for the introduction of new exchanges.

One of the new hopefuls is A2X. Unlike other newcomers, A2X will go head to head with the JSE, competing on trade in equities, the firm’s chief executive, Kevin Brady, told the Mail & Guardian.

Nevertheless, Brady believes this venture is not just about going after a portion of the JSE’s existing pie. It is also about the growth of the South African market. “We want to provide an alternative platform to buy and sell shares,” said Brady.

The company has applied for a licence to operate an exchange, as required by the Financial Markets Act of 2012, but will be styled on the European multilateral trading facility model.

Secondary market
According to A2X, a multilateral trading facility model is a regulated trading venue that creates a second market for trading securities, with a primary listing on another exchange. These facilities were provided for under changes to European regulations in 2007 with the aim of increasing competition in financial markets.

In the case of A2X, it will not offer primary listings, but will instead provide a secondary market to trade in equities listed on the JSE, with the aim of bringing the costs of trading down. Settlement, however, will still be done through Strate, Brady said. “Although the JSE does have a big stake in [Strate], it is open for business,” he added.

Brady explains how having another exchange in South Africa will work by drawing parallels to the currency market. Much like a central bank issues currency, which can then be bought and sold at a number of venues like banks and foreign exchange companies, A2X will be a place to buy shares that are listed and regulated on the primary exchange. It will feed all the records of its trades into Strate, which will record the ultimate ownership of the shares.

The company aims to reduce transaction costs, specifically trading and clearing costs. According to Brady, A2X expects cost reductions to be in the order of 30% to 50%. It will also offer a T+3 service – meaning trades will be made and settled in the space of three days. Currently the JSE operates on a T+5 model, but is in the process of moving to a T+3 model.

The company is partnering with United Kingdom-based Aquis Exchange, which will be providing its technology. Aquis already operates a pan-European multilateral trading facility.

With no legacy costs and the use of leading technology, Brady believes that A2X will achieve its aim of ultimately saving investors money. International experience has shown that competition reduces direct and indirect costs, increases market efficiencies, deepens liquidity and encourages innovation, he said.

Brady is keenly aware that the barriers to entry in South Africa are high, and acknowledges questions over whether South Africa is large enough to sustain a competitor to the JSE. But given the JSE’s well-publicised profitability, he believes this is a sign that there is ample room for new entrants. “That is [a] big profitable pool,” he said.

The company aims to “go live” by mid-2016, provided that variables, such as its licence being granted, do not slow the process down. However, Brady said the Financial Services Board has been responsive to A2X’s application and it has had constructive interactions with the regulator.

Guard against market fragmentation
The realities of how a new exchange will get off the ground remain to be seen, however. Although competition would help drive down costs and benefit consumers, the Financial Services Board has to guard against market fragmentation, said Solly Keetse, head of the department for market abuse at the regulator.

In making decisions, the board will be guided by the objectives of the Act, he said, including ensuring a stable financial markets environment, reducing systemic risk and promoting the international competitiveness of South African financial markets.

The United States, which has more than a dozen exchanges, has a market large enough to support them, he pointed out. Australia, like South Africa, was in the past dominated by a single stock exchange, the ASX. The arrival of alternative exchange Chi-X in 2011 shook things up: it has grown its market share to between 15% and 20% in value traded on most trading days, according to a recent media release.

Not all of the new exchanges will take on the JSE directly, however. Some of the applicants, such as ZAR X, will initially be focused on creating a platform to trade restricted shares, formerly bought and sold over the counter, particularly black economic empowerment shares and those of agriculture co-operatives.

Etienne Nel, the founder of ZAR X, said that the Financial Services Board’s efforts in 2014 to regulate over-the-counter trading partly informed the decision to start ZAR X. He estimated the existing value of the over-the-counter market to be between R30-billion and R35-billion.

According to Nel, the arrival of new trading platforms will, “if anything, strengthen capital markets in South Africa” rather than fragment them. “Currently, we have a large pool of investors’ capital chasing a small pool of investment opportunities on one exchange,” Nel said.

Like the JSE, Strate has had a monopoly on settlement as South Africa’s sole central securities depository. This looks set to change after Granite CSD was recently granted a licence by the Financial Services Board.

Granite, which is expected to launch in the first quarter of 2016, will focus on the bond market, with money market and other instruments to be introduced in the future. “It will offer choice to the investor and issuer,” said Leon Rossouw, Granite’s chief executive.

The company also aims to address some “operational inefficiency” that currently exists in the system, said Rossouw, by offering more frequent settlement runs during the day, running as often as hourly.

A greater say
Granite is targeting a “user-owned, user-governed” model, inviting market participants such as asset managers, international banks and other financial market institutions to invest in the central securities depository.

This will allow the players who generate the bulk of revenue for this institution to have a greater say in its strategy and governance, Rossouw said. He added that it is important for market infrastructure to be owned by the market. Strate is currently owned by the JSE, which holds just less than 45%, and by the four major banks: Absa, FirstRand, Nedbank and Standard Bank.

Granite will also be looking to the rest of the continent, beginning with the Southern African Development Community countries, to help provide much-needed support for trading, Rossouw said.

Exchange stays ahead of its game

What new entrants will mean for the JSE remains to be seen, but the company has built up a reputation as one of the best-run exchanges in the world, and remains synonymous with South Africa’s high global rankings in financial market development.

Its recent interim financial results revealed it is in the pink of profit, cashing in R430-million off the back of R1-billion in revenue.

Zeona Jacobs, the director for marketing and corporate affairs, said the potential for another exchange “is always a possibility for the JSE”. “Competition is not new to the exchange as we compete with exchanges across the globe.”

Similarly Strate, which had been in existence for more than 10 years, could hold its own as a company in the face of any newcomers, she said. In response to complaints that the exchange was simply too expensive, Jacobs said the JSE was a high fixed-cost business and the fees charged had to cover those costs.

By upgrading technology and services, the amount of local and international trade going through the JSE had grown well, which had reduced the cost per trade, she said, and allowed it to reduce prices “significantly” in recent years.

The growth in trade had most recently meant a 20% cut in back-office fees on transactions from August 31 2015, she said, but that was not in response to fact that new competitors were waiting in the wings.

Jacobs said, over the past few years, in agreement with its clients, the JSE had completely reworked how it charged for equity market trades to reduce and simplify fees. A few years back, it began by changing and reducing trading fees. Changes to clearing fees followed in July last year, she said. – Lynley Donnelly