”We believe strongly that investors should not be constrained in their investment decisions.”
South Africa’s financial market provides a role model for financial market development in Africa. This interview looks at some of the key challenges to establishing a functioning financial sector and what emerging markets can learn from the experiences of the Johannesburg Stock Exchange.
KT. Institutional Investors: South Africa has a high number of foreign investors (as a percentage of total investment), what are the risks associated with external shocks, and how does an emerging market stock exchange mitigate the effects of foreign investors disinvesting?
NNK. The extent of foreign participation in our markets varies – depending on the specific market in question – but, for equities and bonds, it averages between 25% and 35% of daily activity. Obviously foreign disinvestment, therefore, has an impact on the market. That said, we believe strongly that investors should not be constrained in their investment decisions and, as an emerging market exchange, we therefore focus on the following:
a. Making sure that market risk is the only risk consideration that investors have to deal with i.e. they should never be concerned about operational or counterparty risks when participating in this market. In essence, we try to take care of the hygiene factors so that you know that if you trade in the Johannesburg Stock Exchange (JSE), you will get your shares or your cash and that the market systems will be up and running if you need to buy or sell.
b. We work with JSE-listed companies, and government representatives to “sell” the South Africa story internationally. In October 2013, we organised a US roadshow and will most likely repeat the roadshow later this year. Additionally, we constantly visit Europe and Asia to promote the JSE and South Africa as an attractive investment destination.
c. Finally, we don’t lose sight of our domestic investor base. While foreigners are a large part of our market – and we will always seek to attract foreign investment – the core of our investors are local investors, and we have to remain relevant to their needs. We spend a lot of time understanding what local investors and intermediaries need from the exchange, ensuring that this is their first choice for investment.
KT. One of the big attractions of investing in emerging markets is the ability to reduce correlation and diversify assets away from developed markets. However, as in the case of the Asian Contagion and more recently the so-called Emerging Market Contagion, we saw an increased correlation as large foreign investors attempted to withdraw cash simultaneously. What can emerging market stock exchanges do to alleviate the effects of these types of risks?
NNK. During a global financial crisis, markets are impacted around the world. I don’t think it’s possible to remove this correlation as this is not activity that is driven by specific investment sentiment but rather by (as you correctly reflect) some level of contagion. These tend, however, to be short-term dislocations; so what is important over these times is to continue to run markets properly and avoid the temptation to overreact. In addition to this, however, exchanges can also seek to diversify the range of products and services they provide. While equity markets may run in parallel – either across emerging markets or globally – equity and bond markets may move in different directions. Likewise, commodity derivative products are often driven by very different considerations to other types of markets. Reducing reliance on trading activity alone – through, for example, the selling of “market data products”, also reduces vulnerability to shocks.
KT. In certain situations, foreign investors can create higher volatility in a stock exchange due to a short-term investment outlook. When there are periods of low growth, this makes foreign investors more likely to pull their cash first. At the same time, many emerging markets lack a highly developed domestic savings pool. What role does the JSE play in educating investors regarding the positives of long-term investing?
NNK. The JSE has a long history of working in communities to improve financial literacy and to explain the benefits of investing through the exchange. The flagship efforts in this regard are probably our Schools and University Investment Challenge games, whereby high schools and universities compete to generate investment returns by investing a virtual sum of one million rand in the stock market.
In 2013, we had nearly 10,000 high school learners and tertiary students taking place in the challenge. More recently, the JSE has been working with its retail broking community to ensure its participation in preferred tax savings and investment accounts being launched by National Treasury.
KT. As domestic emerging markets develop, there is an increasing diversity in the types of investors who are holding securities. What type of investor are we most likely to see participating in a more active role in the next five to ten years?
NNK. To focus on two completely different types of user groups, the JSE is encouraging participation in this market:
1. We believe the JSE holds enormous potential for investors looking for access to the African growth story, through exposure to JSE-listed companies which operate elsewhere on the continent.
2. The exchange is working very hard to encourage a broad range of South Africans to save and invest. Growing the retail investor base is a focus for the JSE because we believe that this is important for the country, its economy and its citizens.
KT. If an emerging market company is thinking about listing, what are the benefits of choosing to list on an emerging market stock exchange, as opposed to a larger international exchange?
NNK. There are a number of advantages for companies to list on the JSE. First, a large percentage of investors in the JSE understand emerging markets – and the peculiarities of operating in emerging markets. They are, therefore, more likely to be able to make accurate judgements of the investment prospects of these types of companies.
Second, while the JSE may be an emerging market exchange, we have well-developed institutional investment markets, as well as strong links into international markets, which means that companies are able to access the capital they require through a JSE listing. While there may have been an argument in the past for listing in a more developed market, companies can now access many of the benefits of an international listing, without incurring the higher costs often associated with such listings.
KT. A higher risk premium is often associated with a lack of transparency, low liquidity and a heightened sense of political risk in emerging markets. What can emerging market stock exchanges do to moderate these effects and entice investors to allocate assets to emerging markets?
NNK. Emerging market exchanges must ensure that they mitigate those risks that fall within their control. Thus, rules relating to market participation must be clear, consistently applied and understood. There should not be differences in treatment between domestic and international investors (where possible). There should be legal protection and certainty around transactions concluded on the exchange (i.e. those who have traded will get their shares). Exchanges should ensure that accurate data is disseminated in as “real-time” as possible. Essentially, exchanges must ensure that the only risks associated with investing in an emerging market, are the risks associated with the particular asset – not the operations of the market as a whole.
KT. According to the World Bank, Angola, Kenya and Nigeria are predicted to become some of the fastest growing countries in the
world, with growth rates far above the estimated global average. As their local markets develop, will increased activity on the African continent be a positive to the JSE, or rather - will it reduce activity in the South African market?
NNK. There is no objective answer to this question – the growth and development of the rest of the continent will be as positive or otherwise as we choose to make it. We have no divine right to be part of it. That said, we happen to believe that the continent’s economic growth and development provides enormous opportunities for the JSE – particularly in conjunction with the exchanges in some of the markets that you mention.
We have very good working relationships with both the Nairobi Stock Exchange and the Nigerian Stock Exchange and we see these strengthening over time. In addition, we believe that the JSE offers opportunities for companies in these fast-growing markets to access international capital more cost-effectively and more efficiently through a JSE-listing than a London or other listing. Likewise, we have a well-developed product set on the JSE that we think will be of interest to investors in these other markets.
“We believe that the JSE offers opportunities for companies in these fast-growing markets to access international capital more cost-effectively and more efficiently through a JSE-listing than a London or other listing.”
KT. The JSE offers a wide variety of investments in the commodities and resources sector, ranging from equity to futures trading. Commodities currently make up a huge weighting of the JSE – with the strikes and recent negative sentiment surrounding mining companies in Africa – could we see a change of the weighting structure of the JSE?
NNK. The choice offered to investors through the JSE’s product diversification over the past 25 years – from purely equity to an integrated market – clearly occurred by design. This greater choice is all the more pronounced in the resource sector where investors could gain exposure through companies or through the commodity itself on the derivatives market. Having offered the choice, the JSE leaves it to investors to select the alternative suiting them best. The diversification works for investors – as does the diversification of companies listed on the exchange, which reflects the growth in South Africa of sectors including financial services, telecoms and others. This phenomenon certainly doesn’t imply the diminishing importance of the resources sector for the exchange. The mining sector has shown its resilience over the years. Though it has experienced several challenges, such as the labour issues at present, the sector has shown itself able to trade through its ups and downs, with investors continuing to show appetite for the sector.
The JSE is about to introduce co-location – whereby brokers plug directly into the terminal at the JSE, which would effectively reduce latency and encourage algorithmic and high frequency traders to enter the market.
KT. Co-location: There has been a substantial amount of negative press recently on the dangers of high frequency trading (HFT). The JSE recently introduced co-location – whereby brokers plug directly into the terminal at the JSE, which effectively reduces latency and encourages algorithmic and high-frequency traders to enter the market. As South Africa only has one exchange – exploiting HFT between exchanges isn’t really possible, but what effect will co-location have in increasing market liquidity, thereby enhancing the JSE’s attractiveness to foreign investors?
NNK. The first point to note is that there is no consistent definition of HFT. So it’s not always clear what people are talking about when they refer to HFT. While we have only one exchange in South Africa, we have a fairly high degree of electronic/algorithmic trading in our markets. Currently, 76% of the orders on JSE equities market are initiated electronically by the likes of broker algorithms, direct market access or black boxes – some of which people would call HFT. But the South African market is very different to the US market for a number of reasons:
As mentioned, we have a single execution venue which reduces “gaming” benefits that can be derived from attempting to execute across multiple venues. We don’t have “maker-taker” pricing models, but rather value-based charges only. The bulk of order execution (over 90%) happens in the central order book. In addition:
• We have had circuit breakers since 2002
• We have clear trade cancellation policies
• We have compulsory trade flow identification and origin (via assigned trader IDs)
• We have order rate management (maximum messages per second limit)
• All authorised users of the market are required to register their order entry applications with the JSE
We have always been focused on increasing transaction activity in our markets, as more activity means lower costs for users. Co-location is but one part of this. Again, what is important to note, in this regard, is that we have a non-exclusive policy in terms of who can take up space in the co-location facility. Once someone is in the facility, they have the same latency as anyone else in the facility (someone will not be allowed to pay more to get lower latency) and the same public data feed is available to everyone – whether co-located or not.
KT. The JSE is planning on implementing a new derivatives trading engine, similar to the equities market engine. Is this aimed at attracting more international derivative traders into our market? And if so, will this increase market stability due to increased liquidity?
NNK. We are moving our other markets onto the same trading technology as our equities market. While we currently have international participants in our derivatives markets, technical constraints limit their ability to participate. Once we move onto a new platform, it should be easier for international participants to access our other markets. In addition, it will also align the performance of the various markets. We will continue to invest in the best, relevant technology for our markets, with the aim of increasing liquidity for all participants.
KT. A growing proportion of revenue from the JSE is coming from selling live-feed data internationally. Is the JSE looking to grow its foreign investor base?
NNK. We constantly seek to expand the range of participants in our markets – types of participants and geographic spread. If people don’t know about your market, they won’t invest in it. Thus, data is a good way to let people know about the JSE and what is available from an investment perspective.
Nicky Newton-King is the Chief Executive Officer for the Johannesburg Stock Exchange. She spoke with Katherine Tweedie, Executive Director of the Investment Institute of Investec Asset Management.Download PDF