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Unveiling opportunities: The effect of portfolio size on equity opportunity sets

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Unveiling opportunities: The effect of portfolio size on equity opportunity sets
Vongani Masongweni | Quantitative Research Analyst

In the dynamic realm of asset management, the debate over size and performance has long been a topic of contention. While larger managers often command attention with their substantial size, as measured by assets under management (AUM), smaller managers have garnered attention for their purported ability to deliver alpha. The magnitude of assets managed by an asset manager often plays a pivotal role in determining its choice of investment strategies and the universe of opportunities it can explore.

In this article, we focus on the opportunity sets available to managers of varying sizes, measured by their AUM. Our exploration is driven by the recognition that smaller managers, often praised for their potential to outperform, may possess a distinct advantage in the form of a more expansive opportunity set. Conversely, we aim to show how a diminishing opportunity set plagues larger managers, despite their seemingly vast resources.

Our analysis primarily focuses on defining the equity opportunity landscape available to asset managers across varying sizes in the South African market. We categorise hypothetical managers into three distinct groups based on their AUM: small or
boutique managers (R1 billion (bn), and R5 bn AUM), medium-size managers (R10bn, R20bn, and R50bn AUM), and large-size managers (R100bn and R200bn AUM).

The opportunity set for each manager size is defined as the set of companies within the FTSE/JSE All Share Index (ALSI) in which managers can hold at least 5% of any share without exceeding a 15% shareholding of the total free float market capitalisation. By capping shareholdings at 15%, the analysis mitigates concentration and ownership risk and ensures diversification within portfolios. It is also intended to manage and prevent market impact to a large degree. Limiting shareholdings to 5% of any share in a portfolio helps prevent market impact, particularly for smaller managers and also ensures some diversification and breadth in an investment portfolio. The 5% holding in a portfolio also represents a conviction view on shares outside the top 10 shares by market capitalisation.

Excessive buying or selling by a single manager can influence stock prices, potentially resulting in adverse market movements and impacting trade execution. This analysis accounts for the availability of shares in the market for trading by considering free float market capitalisation. Free-float market capitalisation reflects the portion of shares available for public trading, ensuring that the analysis focuses on investable stocks with a perception of sufficient liquidity through market cycles.

Opportunity set over time

Our analysis unveils compelling insights into the investment landscape across different asset manager sizes. We meticulously stratify asset managers based on their AUM, adjusting for total market capitalisation changes over time to ensure consistency. The evolving opportunity set over time for asset managers of different sizes is represented in Figure 1.

Figure 1: Change in opportunity set

Source: Momentum Investments Group

Table 1: Manager access to investable universe as at end of 2023 (% of listed shares)

With substantial AUMs at their disposal, larger managers are often perceived as wielding significant influence in the market. However, our analysis reveals a nuanced reality. These managers, overseeing AUMs of R100 billion and R200 billion, find themselves constrained, with access limited to a mere 44 and 29 shares on the JSE respectively, leaving them with access to only 35% and 23% of the investable universe. This constrained opportunity set underscores the challenges associated with managing colossal funds, where the pool of viable investment options shrinks considerably. Important to note that this view also does not consider the practical liquidity considerations on a day-to-day basis, which can also negatively impact the opportunity set.

Medium-sized managers encounter a different set of dynamics. With AUMs ranging from R10 billion to R50 billion, these managers enjoy a more extensive opportunity set compared to their larger counterparts. However, their scope remains constrained relative to smaller managers, with access restricted to 66 shares within the ALSI. This finding underscores the delicate balance these managers must strike between diversification and concentrated investment strategies.

Contrary to conventional wisdom, which often suggests that due to their limited resources and scale, boutique managers would have a restricted opportunity set compared to their larger counterparts, we found this not to be the case.
Our analysis reveals that smaller managers, overseeing AUMs as modest as R1 billion to R5 billion, are not hampered by a lack of investment options. On the contrary, these managers benefit from a more expansive opportunity set, with access to 127 shares within the ALSI in 2023, which is 100% access to the investable universe.

This broader scope empowers skilled smaller managers to pursue diverse investment strategies, potentially enhancing their ability to generate alpha amidst market fluctuations.

Figure 2: Change in opportunity set for different sized asset managers 2004 to 2023

Source: Momentum Investments Group

The limitation on the number of shares available for investment poses challenges for larger asset managers seeking to diversify their portfolios adequately. Surprisingly, our analysis reveals that while smaller managers experience a greater absolute reduction in
their opportunity sets, larger managers encounter a more pronounced impact in percentage terms, a decline of 18% for the smallest manager compared ro a 26% decline for the largest manager.

This constraint not only affects the breadth of investment options but also translates into a notable constraint on industry diversification within portfolios. In 2024, for instance, the analysis indicates that due to the available opportunity set, larger
managers structurally exhibit above-benchmark concentration in the basic materials, financials, and technology industries, with minimal allocation to sectors such as energy and real estate. Conversely, the smallest managers maintain a similar industry concentration as the benchmark. With a diminished pool of assets to select from, larger managers may face heightened competition for the most promising opportunities, potentially compromising their ability to achieve optimal risk-adjusted returns.

Figure 3: Opportunity set industry concentration in 2023

Source: Momentum Investments Group

Liquidity constraints

Liquidity plays a pivotal role in shaping investment decisions and portfolio management strategies. Recognising the importance of liquidity in navigating dynamic markets, we conducted a comprehensive analysis to assess the trading capacity of asset managers across different sizes. By examining the relationship between opportunity set size, daily trading turnover, and the ability to execute trades without moving the market, we provide valuable insights into the liquidity challenges and opportunities facing asset managers today.

Our analysis focused on quantifying the trading capacity of asset managers by determining the number of days it would take to trade out 100% of their AUM invested. To ensure minimal market impact, we restricted trading to no more than 10% of
each company’s daily turnover.

Figure 4 presents the average number of trading days per manager from 2004 to 2023. The analysis revealed a clear trend: Smaller managers consistently demonstrated greater trading capacity compared to their larger counterparts. On average, a manager
overseeing R1 billion in AUM could completely trade out their portfolio in approximately 40 days, whereas a manager with R200 billion AUM would require approximately 330 days, representing a staggering eightfold increase in trading duration.

This disparity can be attributed to the smaller size of their opportunity sets and the higher reliance on the liquidity of the companies within their portfolios due to larger components of free float market capitalisation that need to be traded. Consequently, smaller managers are better equipped to execute trades efficiently and without undue market impact, enabling them to capitalise on investment opportunities with greater agility. In contrast to this trend, it will take managers with R100 billion AUM an average of 440 days, which is more than managers with R200 billion. This is because their
opportunity sets allow them to have access to both less liquid mid-caps compared to the largest manager with access to only large-caps.

Figure 4: Average trading days per manager 2004 to 2023

Source: Momentum Investments Group

To provide a more nuanced view of liquidity dynamics, we also examined the proportion of the opportunity set that can be traded out within 30, 60 and 90 days. This considers the relative size of the opportunity set that can be readily traded within short time horizons, providing insights into the immediacy and depth of liquidity available to managers. It allows for a comparative analysis of liquidity conditions across manager sizes and periods, highlighting changes in market liquidity over time and potential differences in liquidity risk exposure among managers. While smaller managers consistently demonstrate greater trading capacity, we observe significant improvements in liquidity conditions over the two decades under review. Specifically, there is a notable increase in the percentage proportion of the opportunity set that can be traded out within 30, 60, and 90 days. However, the extent of this improvement varies across manager sizes, with larger managers experiencing more pronounced gains in trading capacity compared to their smaller counterparts. This increase in liquidity could be attributed to several factors, as over time, financial markets may become more liquid and efficient, leading to improved trading conditions for asset managers.

Factors such as advancements in technology, regulatory reforms, and increased investor participation can contribute to enhanced market liquidity, allowing for smoother trade execution and reduced trading frictions.

The expansion of market participants, including institutional investors, hedge funds, and algorithmic traders, may also have bolstered trading activity and liquidity. Greater market depth and breadth enable asset managers to access a larger pool of
liquidity, facilitating faster and more efficient trade execution. Despite the overall improvement in market liquidity, the extent of this enhancement may vary across manager sizes. Larger managers, with greater resources and market influence, may have been better positioned to leverage improvements in market liquidity, resulting in more pronounced gains in trading capacity compared to their smaller counterparts. Moreover, the opportunity sets of larger managers are often limited to large-cap stocks, which tend to be highly liquid compared to the small and mid-cap companies within the opportunity sets of smaller managers. This disparity in liquidity access underscores
the ongoing challenges smaller managers face in efficiently executing trades and navigating liquidity constraints, despite broader market improvements.

Table 2: Proportion of portfolio that can be traded out

Source: Momentum Investments Group

Benchmark relative analysis

Expanding on the analysis, we explore alternative definitions of the opportunity set to gain deeper insights into the implications for asset managers of different sizes. Firstly, we consider a scenario where managers are restricted to holding securities at benchmark weightings, effectively mirroring the composition of the ALSI. Under this framework, all managers have access to the full investable universe. However, adherence to benchmark weights inherently limits the potential for above-benchmark performance, constraining managers’ ability to capitalise on alpha-generating opportunities.

Figure 5: Opportunity set industry concentration in 2023

Source: Momentum Investments Group

In contrast, we investigate the implications of overweighting benchmark positions by 5%, allowing managers to deviate from benchmark weights in pursuit of potential outperformance. Despite this strategic adjustment, our analysis reveals that the concentrated nature of the ALSI, with the top 10 companies accounting for over 45% of the index, significantly constrains the opportunity set. As a result, the difference in opportunity set size between holding an absolute 5% compared to overweighting the index by 5%, is marginal.

Larger managers continue to face constraints, with access limited to only 24 companies, while smaller managers retain access to the full 127 companies within the index. Thus, while overweighting benchmark positions may offer some latitude for active management, the inherent concentration of the ALSI limits the extent to which managers can diversify their portfolios and access new investment opportunities, underscoring the enduring challenges faced by larger managers in navigating constrained opportunity sets.

Conclusion

The findings of our analysis carry significant implications for asset managers, investors, and industry stakeholders alike. Understanding the nuanced dynamics of opportunity sets across different manager sizes can inform strategic decision-making and portfolio construction strategies. While larger managers grapple with the challenge of navigating a constrained universe of investment options, smaller managers can leverage their flexibility to explore a broader array of opportunities.

Our analysis also underscores the importance of agility and adaptability in the ever-evolving landscape of asset management. Rather than being solely dictated by the size of AUM, success in the industry hinges on the ability to identify and capitalise on opportunities, irrespective of organisational scale.

Our comparative analysis sheds light on the intricate relationship between AUM size and the opportunity set available to asset managers within the ALSI. By unravelling these dynamics, we aim to provide actionable insights that empower industry participants to navigate the complexities of the South African equity market with confidence and foresight. Additionally, a potential avenue for future research could involve investigating the ability of asset managers to extract factor premia based on these opportunity sets. This analysis could provide valuable insights into the effectiveness of different manager sizes in capturing factor-based returns and optimising portfolio performance.

Click here to get your latest edition of Mindfields, our research publication for more research articles.

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SARB interest rate decision: Not quite there, yet

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Carmen Nel, Economist and Macro Strategist, Matrix Fund Managers

24 November, 2022: The South African Reserve Bank (SARB) Monetary Policy Committee (MPC) opted to hike the repurchase rate by 75 basis points (bp) to 7.00% today. While the tone of the statement and the post-meeting Q&A was hawkish, the voting breakdown shifted towards the dovish (or rather less hawkish) side with the voting split 3:2 for 75bp versus 50bp. In the September MPC meeting, two members would have preferred a rather aggressive 100bp increment.

Heading into the meeting, the market’s pricing was split between a 50bp and a 75bp outcome, so the reaction from the rand and rates was minimal following the announcement. The forward rate agreements (FRA) curve flattened marginally, while the yield and swap curves were steady. The rand was also unaffected by the outcome, but has been trading slightly weak relative to the level on the US Dollar Index (DXY).

Relative to the SARB’s Quarterly Projection Model (QPM), the November rate hike was another front-loaded move. According to the QPM, the projected repo rate for the fourth quarter of 2022 was 6.30% compared to the 7.00% outcome from today’s decision. This reflects the committee’s views that upside inflation risks outweigh the weaker growth outlook. All else assumed equal, this front-loading should contribute to a stronger recovery in the exchange rate, weaker growth, and a lower inflation profile than projected by the QPM.

At 7.00%, the repo rate is in line with the steady state in nominal terms. However, with inflation running well-above target, the real policy rate is deemed accommodative. The MPC views the current monetary policy stance as being supportive of the economy and credit growth.

Given elevated uncertainty on the global and local inflation outlooks with concern focused on broadening pressures and the risk of inflation persistence, the SARB seems willing to take the policy stance into restrictive territory. As such, a further interest rate increase at the January meeting should be the base case.

The size of that increase will depend on how quickly inflation rolls over from the upside surprise in the October release, the details of the BER’s Q4 inflation expectations survey results, and the tone of the Federal Open Market Committee’s (FOMC’s) statement and press conference in December. Given the voting breakdown and the cumulative policy action implemented so far, a 50bp hike will be the most likely outcome. However, we cannot rule out a smaller hike of 25bp or even a pause, should it become clear that global growth strain and more rapid disinflation are set to ease local price pressures.

The market is currently pricing in a cumulative 50bp in hikes by March next year, which reflects the risk for a 25bp hike rather than a 50bp hike in January.

Ends


Caption: Carmen Nel, Economist and Macro Strategist, Matrix Fund Managers

An overly positive budget update amid significant uncertainty

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Carmen Nel, Economist and Macro Strategist, Matrix Fund Managers

26 October, 2022: Finance Minister Enoch Godongwana’s second Medium Term Budget Policy Statement (MTBPS) painted a very positive picture of the medium-term fiscal position. Not only does the National Treasury intend to move to a primary budget (revenue less non-interest expenditure) surplus in FY23/24, it aims to grow the surplus over time. In so doing, it hopes to stabilise the debt ratio at 70% of GDP in the medium term, and to outright lower the ratio from FY26/27 onwards.

Rose-tinted glasses

We think there may be too much optimism embedded in these projections. This may be merely a placeholder budget, albeit on the bullish side of the risk distribution, given significant events between now and the February 2023 Budget Statement. Importantly, the ANC elective conference in December would affect the politics of the February budget, which may have constrained the ability and willingness to be more explicit on certain expenditure or revenue items. In addition, the Financial Action Task Force (FATF) grey-listing process is set to be concluded by February, which may also have received outsized attention in the lead up to the MTBPS.

The presentation of the current fiscal year was more realistic. The tax revenue overrun is estimated at R83.5bn, with the bulk coming from corporate income tax receipts, which is no surprise in light of elevated commodity prices and strong earnings rebound. Yet, more broadly, revenues have been doing well thanks to the wage recovery, better import growth, and stronger VAT receipts (even when adjusting for refunds). The deficit was revised from 6.0% of GDP to 4.9%, which was within the consensus forecast range. The market may find it difficult to believe that the government will be able to narrow the deficit to 3.2% of GDP by FY25/26.

There are few reasons for circumspection:

·       The Treasury expects growth to hold up (around 1.8% over the medium term) despite the current slowdown in the global economy, with some of the world’s largest economies – such as Germany and the UK – already skirting with recession. As growth in China and the US move well below trend, it is difficult to see how SA’s growth will hold up when we add in domestic monetary policy tightening and what seems to be a commitment towards fiscal consolidation.

·       Linked to more sustained, albeit still pedestrian, growth, the revenue overrun is carried forward to a large extent, which assumes either a longer-term tailwind from elevated commodity prices or better revenue collection elsewhere. While we agree that capacity rebuilding at SARS is bearing fruit, it may be a tall order to rely on this to sustain revenue at over 25%/GDP, which is well above the pre-Covid level of around 23.5% – 24.0%.

·       The FY23/24 numbers include the extension of the SRD grant (for 12 months to March 2024), but there is no provision thereafter for a permanent replacement grant.

·       The FY22/23 wage bill does not reflect the current, albeit partly, settled wage agreement of a 3% increase over and above the 1.5% pay progression and cash gratuity.

·       The Eskom debt swap is still short on detail and these additional funding costs are not yet included in the medium term expenditure framework. Granted, the debt transfer should limit the need for further equity injections and so reduce the funding associated with bailouts, but the debt that the government will take on will be more expensive than that issued by the government directly and so will add to the debt service bill.

But some room for comfort

Admittedly, there is a small cushion built into the numbers with unallocated reserves of R41.3bn in FY24/25 and R47.3bn in FY25/26.

There was conditional state-owned enterprise (SOE) support of R23.7bn for SANRAL, R5.8bn for Transnet, and R3.6bn for Denel. However, Eskom did not receive additional funding over and above what was budgeted in February. The government has committed to a debt swap with a vague quantum of around R130bn – R260bn, but given the composition of Eskom’s debt – ranging from ZAR to USD denominated, guaranteed to unguaranteed, and listed to DFI loans – ironing out the details will be no easy task.

The fixed income market might be somewhat disappointed by the lack of detail on the Eskom debt swap, as well as the fact that domestic fixed-rate and inflation-linked bond issuance will be left unchanged. Rather, the revenue overrun and excess cash balances will be used to lower foreign borrowing, as well as floating-rate issuance. This is potentially a missed opportunity for the government to lower the supply indigestion in the domestic bond market, given that issuance is being done at a substantial discount compared to a relatively tight spread on the 5-year government floating-rate note. Alternatively, the government may use the floating-rate note as a flexible issuance tool on an ad hoc basis and give the market certainty in keeping the fixed-rate and inflation-linked bond issuance unchanged.

Expenditure ceiling raised … again

The overarching negative message from the MTBPS was that the commitment to the expenditure ceiling should be questioned, as this has turned into a soft rather than a hard fiscal rule. It has been raised yet again, by R51.6bn in FY23/24 and R57.9bn in FY24/25. In addition, the line in the sand on SOE support has again been crossed.

Where we could be too pessimistic is on medium-term fixed investment growth and the government’s ability (and willingness) to crowd in the private sector. A stronger growth outlook would also be more plausible if there is clear evidence that deep-seated reforms are accelerating.

Overall, markets react positively

On the surface it looks as if the markets reacted positively to the MTBPS, but closer inspection reveals that the rally in SA’s bond yields have been driven more by the decline in US yields, while the stronger rand has been a function of the weaker dollar.

Within equities there seems to be more evidence of the beneficial budget, with banks doing relatively well, but on the whole, the local bourse as has also benefited from lower US bond yields, a weaker US dollar, and higher commodity prices.

Even though offshore drivers are dominating local market performance in recent trading sessions, this budget may be enough to keep the bond vigilantes at bay until the hard decisions are taken.

Ends

Declaration of Crypto Assets as a financial product

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Declaration of Crypto Assets as a financial product

The Financial Sector Conduct Authority (FSCA) has published the declaration of Crypto Assets as a financial product under the FAIS Act, which was gazetted on 19 October 2022. The declaration, brings providers of financial services in relation to crypto assets within the FSCA’s regulatory jurisdiction.

On 20 November 2020, the FSCA published a draft Declaration of Crypto Assets as a Financial product under the FAIS Act, for public consultation. A total of 94 individual comments were received from 22 different commentators. Following this public consultation process, the FSCA published the final Declaration in the Government Gazette
and on the FSCA’s website.

The FSCA has also published a Policy Document supporting the Declaration. The Policy Document provides clarity on the effect of the Declaration, including transitional provisions, and the approach the FSCA is taking in establishing a regulatory and licensing framework that would be applicable to Financial Services Providers (FSPs) that provide financial
services in relation to Crypto Assets.

In addition to the Declaration and Policy Document, the Authority also published a general exemption for persons rendering financial services (advice and/or intermediary services) in relation to Crypto Assets, from section 7(1) of the FAIS Act.

The intention of the exemption is the following:

• To facilitate transitional arrangements for existing providers of crypto asset activities. The transitional arrangements entail that a person may continue to render financial services in relation to crypto assets without being licensed, provided that such person applies for a licence under the FAIS Act within the period specified in the exemption. The stipulated period is 1 June 2023 until 30 November 2022. The exemption will apply until the licence application submitted has been approved or declined; and
• To exempt certain ecosystem participants from the FAIS Act. These participants are crypto asset miners and node operators performing functions in respect of the security and health of the network as well as persons rendering financial services in relation to non-fungible tokens1.

To facilitate the application of an appropriate regulatory framework for Crypto Asset FSPs once licensed, the FSCA also published a Draft Exemption of Persons rendering Financial Services in relation to Crypto Assets from Certain Requirements. The draft exemption proposes to exempt licensed Crypto Asset FSPs and their key individuals and representatives from certain requirements of, amongst others, the General Code of Conduct for Authorised Financial Services Providers (General Code) and their
Representatives and the Determination of Fit and Proper Requirements, 2017 (Fit and Proper requirements). Requirements contained in the General Code and Fit and Proper requirements will apply to all Crypto Asset FSP’s once licensed, except those requirements that they are exempted from in terms of the draft General Exemption.

The draft General Exemption has been published for public comment pending finalisation, to solicit stakeholder inputs on the proposed regulatory framework that will apply to licensed Crypto Asset FSP’s. Submissions on the draft Exemption must be made using the
submission template available on the FSCA’s website and be submitted in writing on or before 1 December 2022 to the FSCA at FSCA.RFDStandards@fsca.co.za.


ENDS


Enquiries: Financial Sector Conduct Authority
Email address: Communications@fsca.co.za
Telephone: 0800 203 722

1 The terms crypto asset miner, node operator and non-fungible token are defined in the published Exemption of persons rendering financial services in relation to crypto assets from section 7(1) of the Financial Advisory and Intermediary Services Act, 2002.

Crypto assets now included under definition of financial products in South Africa

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By Ashlin Perumall, Partner, Baker McKenzie Johannesburg

FSCA Declaration
 
Crypto assets are now regulated as financial products in South Africa. On 19 October 2022, the Financial Sector Conduct Authority (“FSCA”), South Africa’s financial institutions regulator, issued a declaration (“Declaration“) that crypto assets are now included under the definition of ‘financial products’ in terms of the Financial Advisory and Intermediary Services Act, 2002 (“FAIS”). The Declaration also provides a wide definition for crypto assets, being a digital representation of value that:

  • is not issued by a central bank, but is capable of being traded, transferred or stored electronically by natural and legal persons for the purpose of payment, investment or other forms of utility;
  • applies cryptographic techniques; and
  • uses distributed ledger technology.

The effect of the Declaration is that any person who provides advice or renders intermediary services in relation to crypto assets must be authorised under the FAIS Act as a financial services provider, and must comply with the requirements of the FAIS Act. Under FAIS, ‘advice’ includes recommendations, guidance or proposals of a financial nature furnished by any means or medium in respect of a defined financial product. ‘Intermediary service’ includes any act other than the furnishing of advice, performed by a person for or on behalf of a client or product supplier with a view to:

  • buying, selling or otherwise dealing in (whether on a discretionary or non-discretionary basis), managing, administering, keeping in safe custody, maintaining or servicing a financial product purchased by a client from a product supplier or in which the client has invested;
  • collecting or accounting for premiums or other moneys payable by the client to a product supplier in respect of a financial product; or
  • receiving, submitting or processing the claims of a client against a product supplier.

 
Exemption Application
 
Ordinarily, in terms of section 7 of FAIS, a person may not act or offer to act as a financial services provider unless such person has been issued with a licence by the FSCA. The FSCA has set applicable licences which an FSP would generally require, which are divided into different categories of licences. The full list of categories can be found here. However, on 19 October 2022, the FSCA also published notice 90 of 2022 exempting certain persons who render a financial service in relation to crypto assets from the application of section 7(1) of FAIS. In order for the exemption to apply, the relevant persons are required to comply with the following:

  1. submit an application to the FSCA between 1 June 2023 and 30 November 2023
  2. comply with:
    1. chapter 2 of the Determination of Fit and Proper Requirements for Financial Services Providers, 2017
    2. section 2 of the General Code of Conduct (“GCC”)
    3. all other requirements in the GCC excluding section 13.

The exemption is also subject to the condition that the relevant applicant must provide the FSCA with any information it requests that is in the possession of, or under the control of, the applicant, that is relevant to the financial services and/or similar activities rendered by such applicant. This application must be made by persons seeking an exemption by 1 December 2023. This exemption excludes persons categorised as crypto asset miners, node operators, and financial services in relation to non-fungible tokens, in respect of whom it is already deemed to apply.

As can be seen from the breadth of the legislative framework underpinning ‘financial products’ under FAIS, the consequences of the Declaration will be far reaching, and will impact many businesses in South Africa dealing in crypto assets. When the draft of the Declaration was published in November 2020, it was noted that the intention behind the Declaration was to capture intermediaries that advise on or sell crypto assets to consumers, so as to provide adequate protection for consumers who are advised to purchase these products. Businesses in this space that have until now been operating in a largely unregulated environment will need to move quickly to become compliant.

end
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The New York Stock Exchange and The Johannesburg Stock Exchange Announce Collaboration on Dual Listings

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NEW YORK & JOHANNESBURG, 10 October 2022 — The New York Stock Exchange, part of Intercontinental Exchange, Inc. (NYSE: ICE), and the Johannesburg Stock Exchange (JSE) today announced that they have signed a memorandum of understanding to collaborate on the dual listing of companies on both exchanges.

The NYSE and the JSE also agreed to jointly explore the development of new products and share knowledge around ESG, ETFs and digital assets.

The agreement was finalized during a visit to the NYSE by a South African delegation including JSE Group CEO Dr. Leila Fourie and South African Reserve Bank Governor Lesetja Kganyago. The signing ceremony took place shortly before the delegation rang the Closing Bell, followed by a keynote address by Kganyago on monetary policy.

“The New York Stock Exchange is pleased to sign this collaboration agreement with the Johannesburg Stock Exchange in support of the important economic and trade relationship between our two markets,” said Lynn Martin, NYSE President. “Exploring the dual listings of companies on our two exchanges stands to increase opportunities for investors on both continents, underscoring the value public companies and our capital markets generate in the global economy. We look forward to collaborating on new product development with the JSE team and to the innovation that comes when two great organizations work together.”

“The agreement that we have signed today with the NYSE will unlock opportunities for investors and issuers of both bourses,” said Dr. Fourie. “This is the beginning of a new chapter and I am excited about the opportunities we will explore together as we find synergies to grow both our markets. For the JSE, as the largest stock exchange on the African continent with unparalleled market depth and liquidity, we aim to create world-class solutions for both local and international investors.”

The United States ranks as one of South Africa’s largest trading partners and this agreement is designed to help support the economic relationship between the two nations. Today, about 600 U.S. companies operate in South Africa in sectors including manufacturing, technology, finance, insurance and wholesale trade.

About NYSE Group

NYSE Group is a subsidiary of Intercontinental Exchange (NYSE: ICE), a leading global provider of data, technology and market infrastructure. NYSE Group’s equity exchanges — the New York Stock Exchange, NYSE American, NYSE Arca, NYSE Chicago and NYSE National — trade more U.S. equity volume than any other exchange group. The NYSE, an ICE exchange, is the premier global venue for capital raising. NYSE Arca Options and NYSE Amex Options are leading equity options exchanges. To learn more, visit nyse.com.

About Intercontinental Exchange

Intercontinental Exchange, Inc. (NYSE: ICE) is a Fortune 500 company that designs, builds and operates digital networks to connect people to opportunity. We provide financial technology and data services across major asset classes that offer our customers access to mission-critical workflow tools that increase transparency and operational efficiencies. We operate exchanges, including the New York Stock Exchange, and clearing houses that help people invest, raise capital and manage risk across multiple asset classes. Our comprehensive fixed income data services and execution capabilities provide information, analytics and platforms that help our customers capitalize on opportunities and operate more efficiently. At ICE Mortgage Technology, we are transforming and digitizing the U.S. residential mortgage process, from consumer engagement through loan registration. Together, we transform, streamline and automate industries to connect our customers to opportunity.

Trademarks of ICE and/or its affiliates include Intercontinental Exchange, ICE, ICE block design, NYSE and New York Stock Exchange. Information regarding additional trademarks and intellectual property rights of Intercontinental Exchange, Inc. and/or its affiliates is located here. Key Information Documents for certain products covered by the EU Packaged Retail and Insurance-based Investment Products Regulation can be accessed on the relevant exchange website under the heading “Key Information Documents (KIDS).”

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 — Statements in this press release regarding ICE’s business that are not historical facts are “forward-looking statements” that involve risks and uncertainties. For a discussion of additional risks and uncertainties, which could cause actual results to differ from those contained in the forward-looking statements, see ICE’s Securities and Exchange Commission (SEC) filings, including, but not limited to, the risk factors in ICE’s Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC on February 3, 2022.

About the JSE

The Johannesburg Stock Exchange (JSE) has a well-established history of operating as a marketplace for trading financial products. It is a pioneering, globally-connected exchange group that enables inclusive economic growth through trusted, world-class, socially responsible products, and services for the investor of the future. It offers secure and efficient primary and secondary capital markets across a diverse range of securities, spanning equities, derivatives, and debt markets. It prides itself on being the market of choice for local and international investors looking to gain exposure to leading capital markets on the African continent. The JSE is currently ranked in the Top 20 largest stock exchanges in the world by market capitalisation, and is the largest stock exchange in Africa, having been in operation for 130 years. As a leading global exchange, the JSE co-creates, unlocks value & makes real connections happen.

www.jse.co.za 

NYSE Media Contact:

Bridget Walsh

bridget.walsh@nyse.com

(212) 656-2298

ICE Investor Contact:

Katia Gonzalez

katia.gonzalez@ice.com

(678) 981-3882

JSE General Enquiries:

Email: info@jse.co.za

011 520 7000

JSE Media Contact:

Paballo Makhetha

Communication Specialist

011 520 7331

066 261 7405 (mobile)

paballom@jse.co.za

BCBS-CPMI-IOSCO finalise analysis of margining practices during the March 2020 market turmoil

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  • Global standard setters publish a report on margin practices, highlighting the need for further policy work.
  • The report presents a data-driven analysis examining margin calls in March and April 2020 and the extent to which market participants were prepared to meet them.
  • The report recommends further policy work in six areas.

The Basel Committee on Banking Supervision (BCBS), the Bank for International Settlements’ Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) (the standard setters) today published the report Review of margining practices.

The report feeds into the Financial Stability Board’s work programme to enhance the resilience of the non-bank financial intermediation sector. It looks at margin calls during the high market volatility and “dash for cash” in March and April 2020. It also reviews margin practices transparency, predictability and volatility across various jurisdictions and markets, as well as market participants’ preparedness to meet margin calls.

The report builds on the consultative report Review of margining practices published in October 2021, which in particular was based on surveys of central counterparties (CCPs), clearing members and broker-dealers, clients (ie entities that participate in these markets through an intermediary) and regulatory authorities, and other data analyses. It takes into account the feedback received on the consultative report, including through a series of stakeholders outreach events, confirming that:

  • Variation margin calls in both centrally and non-centrally cleared markets in March were large, and significantly higher than in February 2020. The peak CCP variation margin call was $140 billion on 9 March 2020.
  • Initial margin requirements for centrally cleared markets increased by roughly $300 billion over March 2020, and varied substantially across, and within, asset classes.
  • Initial margin requirements on non-centrally cleared derivatives remained relatively stable during the stress period.

A summary of the feedback received has been published alongside the report.

On the back of the analysis, and taking into account feedback from industry, the report confirms six areas for further policy work on:

  • Increasing transparency in centrally cleared markets.
  • Enhancing the liquidity preparedness of market participants as well as liquidity disclosures.
  • Identifying data gaps in regulatory reporting.
  • Streamlining variation margin processes in centrally and non-centrally cleared markets.
  • Evaluating the responsiveness of centrally cleared initial margin models to market stresses, with a focus on impacts and implications for CCP resources and the wider financial system.
  • Evaluating the responsiveness of non-centrally cleared initial margin models to market stresses.

Notes to editors:

Margin is collateral and funds that are collected to protect against future or current risk exposures resulting from market price changes or in the event of a counterparty default.

KPMG Insurance Survey 2022: The insurance industry sees strong growth despite tough market conditions

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21 September 2022; KPMG South Africa today launched its annual South African Insurance Industry Survey for 2022. 34 non-life insurers, 19 life insurers and four reinsurers were surveyed. The results indicate that while the reinsurance market in South Africa has had a rough ride, the overall insurance industry has had a better-than-expected year – with strong gains in both the life and non-life sectors. However, there are some very real risks that face the sector over the next year and looking forward, including economic volatility, ever increasing evidence of climate change, a much-needed focus on ESG reporting, support and understanding as well as understanding how to navigate South Africa’s social cohesion challenges.

“It is great to see in this year’s survey that the non-life and life insurers have bounced back nicely after the pandemic and have shown strong recovery at the top and bottom lines – creating a strong base from which the industry is able to enter what seems to be the end of the pandemic,” says Mark Danckwerts, Partner: KPMG Africa insurance practice leader.

Non-life insurance industry

Following the significant volumes and values of business interruption claims in 2020 because of the Covid-19 pandemic, the non-life insurance industry presented robust 2021 results, with the sector increasing profits by more than double the 2020 figures to R12.1 billion.

The industry reported gross written premiums (GWP) of R131.6 billion, an increase of 7% from the prior year. The ten largest non-life insurers, when measured on GWP, have a market share of 76.5%. There were marginal shifts in this space with Escap moving into the top ten, Centriq Insurance Company Limited moving down to the tenth position and Mutual and Federal Risk Financing Limited moving out of the top ten into eleventh position.

GWP growth for the sector exceeded headline CPI of 5.9%, with five insurers outperforming the GWP growth rate of 7%; these are Escap SOC Limited (Escap), Guardrisk Insurance Company Limited (Guardrisk), Discovery Insure Limited (Discovery), Bryte Insurance Company Limited (Bryte) and Lombard Insurance Company Limited (Lombard). Growth came from diversifying client bases and improved new business volumes. In this period Discovery Insure reported its lowest lapse rate since inception; 2% lower than the previous year.

The sector has shown incredible resilience by getting back to pre-pandemic results, with profit after tax increasing by 110% from R5.6 billion to R11.7 billion, largely as a result of a decreased industry loss ratio of 57% (61% in 2020).

“While the non-life industry has had a strong year – the pressure is on to remain resilient. Increasing crime, weather-related catastrophe events, the continued erosion of social cohesion in South Africa, and supply chain and power supply disruptions, all paint a picture that will require tenacity, skill and an increased focus on loss-preventing technology,” says Danckwerts.

Life insurance industry results

“While life insurers faced another turbulent year, the industry experienced improvements in the volume and profitability of new business and welcomed a positive lapse experience and better equity and bond market performance. The industry demonstrated its resilience once again and was able to remain well capitalised to meet policyholder obligations,” says Danckwerts.

In 2020, several life insurers reported having paid or accrued for more claims than ever before, resulting in an overall loss of R5 billion. The life insurance industry has done well to return to profitability in 2021, reporting healthy profits of R17.1 billion. ASISA reported a 17% increase in new individual recurring premium risk policies and a reduction of 28.8% in lapsed policies.

“It is important to note however, that for many life insurers’ results have not yet returned to pre-pandemic levels and these insurers would need to refocus efforts on other drivers of profitability such as digital innovation, cost optimisation and pricing reviews,” says Danckwerts.

Reinsurance industry results

While the primary insurance industry was sufficiently protected by the reinsurance industry through the robust reinsurance structures and arrangements in place, there is no doubt that the reinsurance industry bore the brunt of the loss events that occurred during 2020 and 2021. With GWP growth of only 1%, an 11% decline in investment income and underwriting losses from all surveyed reinsurers (R3.8 billion), it is safe to say that the reinsurers did not recover well following Covid-19 related business interruption claims from non-life insurers and increased mortality experience by life insurers.

“The reality is that while reinsurers writing life insurance risks were hit much harder than non-life insurance risks, it was a tough year all round for both. Consequently, we have seen the hardening of reinsurance rates in 2022.”

“This year’s survey has shown us once again how the insurance sector has, at large, shown resilience in the face of adversity – a trend that has continued after our previous survey. However, to remain agile, insurers are going to have to consider the role they play in mitigating risk, in dealing with risk brought about by changing technology, social patterns and economic turbulence and in finding ways to innovate further to meet the unique challenges that the South African landscape presents,” concludes Danckwerts.

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South Africa: The unintended consequences of Most Favoured Nation Clauses in Tax treaties

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By Francis Mayebe, Candidate Attorney, overseen by Virusha Subban, Partner and Head of Tax, Baker McKenzie Johannesburg

Background

Bilateral tax treaties are mainly based on the principle of reciprocity. Under this principle, one state negotiates better treaty terms with another in exchange for making a particular concession. As is clearly seen in most protocols, the Most Favoured Nation (MFN) clause is usually included as a concession by a developing state looking to renegotiate particular treaty provisions. An illustration of this can be seen in the inclusion of the MFN clause in South Africa’s protocols with the Netherlands and Sweden, as it was negotiating to include withholding tax on dividends.

The broad rationale behind MFN clauses stems from the field of foreign direct investment. Throughout history, the MFN clause has seldom been accepted as a principle to be included in tax treaties. It is indisputable that the MFN clause comes with some benefits, however, its downfalls are significant. The most significant of these being that the clause creates various opportunities for the reduction of source taxation and that it exposes the source states, which are usually developing countries, to large-scale base erosion of taxes. To illustrate this, we analyse two court cases involving the Netherlands, South Africa and India.

A judicial perspective

In ABC (PTY) ltd v C: SARS 2019, the taxpayer sought to receive beneficial treatment from the South African and Kuwait Double Taxation Agreement (DTA), which provided an exemption from the dividends withholding tax. The basis for this claim had come about through a technical flaw in the wording between Sweden and South Africa’s DTA, which omitted the words “after the date of this convention”. As a result of this wording, treaty benefits afforded to another State by South Africa that are more favourable than those in the DTA with Sweden triggered the MFN clause. In effect, the exemption to withholding tax on dividends in the Kuwait DTA would automatically apply to the Swedish DTA. 

The ripple effect of this clause is that all other States with an MFN clause, like the Netherlands in this instance, could claim the same exemption afforded in South Africa and Sweden’s DTA.

It is on this basis that the taxpayer argued that the exemption of withholding tax on dividends should apply to Dutch residents, by virtue of the MFN clause, in their tax treatment with South Africa.

The tax court found in favour of the taxpayer and instructed the South African tax authorities to provide refunds to all withheld dividend taxes to Dutch residents. Therefore, the technical or unforeseen error in the MFN clause between South Africa and Sweden resulted in a huge fiscal loss of revenue for South Africa. This case clearly demonstrates the dangers of unintended consequences that come with the inclusion of the MFN clause in tax treaties.

In the case of Concentrix Services Netherlands BV WP and Optum Global Solutions International BV WP (C) the court again found in favour of the taxpayer, who was a Netherlands tax resident. This resulted in the application of a lower withholding tax of 5%, as was applied in India and Slovenia Double Taxation Avoidance Agreement (DTAA), based on the MFN clause contained in the Indian and Netherlands DTAA.

A turning point, in this case, was a condition that required the third state to be an Organization for Economic Cooperation and Development (OECD) member before or at the time the DTAA was signed between the third state and India. However, the court held a contrary view, to the effect that the condition would only be fulfilled at the time the MFN benefit was claimed and not after the treaty. This interpretation, in our view, goes beyond the scope of the ambits of the MFN clause and its intended purpose when the tax authorities included it. This largely broad interpretation violates the principle of good faith as enshrined in the Vienna Convention on the Law of Treaties (VCLT).

This case demonstrates a clear downfall of the MFN clause in that it may result in unintended consequences due to the uncertainty posed by its interpretation, particularly in the judiciary. 

Practical comments

As can be deduced from the above discussion, the MFN clause infringes on the fundamental principle of the “Pacta sunt servanda” as enshrined in Article 26 of the VCLT. It infringes this principle by altering treaty provisions that are decided upon and conceded bilaterally by states during treaty negotiation by invoking future benefits or treaty terms that go beyond the original terms agreed upon by the states in their DTA.

These unforeseeable future treaty benefits have serious repercussions for states that would not gain from the invoked benefits. As already seen after the ABC v SARS decision, the MFN clause significantly increased investment flow through South Africa and the Netherlands due to the zero-rated withholding tax on dividends, thus increasing treaty shopping and significantly reducing South Africa’s collectible tax revenue on the declared foreign dividends.

Therefore, states negotiating or renegotiating their DTAs, including the MFN clause, should exercise caution when drafting the clause, and undertake a rigorous assessment of its impact on their tax treaties within their network prior to ratifying it.

Including direct shares in your retirement annuity

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Including direct shares in your retirement annuity
By Schalk Louw, portfolio manager at PSG Wealth

Is it possible to structure your RA in such a way that you can invest in direct shares? The answer is yes, but unfortunately most people don’t know this.

A Personal Share Portfolio (PSP) allows you to tailor your own bespoke share portfolio as part of your retirement investment strategy. Most RA platforms in South Africa now offer the solution for a portfolio manager to choose a selection of local and international shares, which, as a direct share portfolio, can be included in your retirement annuity investment and be actively managed. This solution offers quite a few advantages, including: 

Tax advantages

No capital gains tax or income tax is payable within a retirement annuity, so you can have exposure to direct shares within your RA, without the usual tax implications attached to a separate direct equity portfolio (which does not form part of your RA). 

Personal attention

Unlike most asset management companies, many stockbroking companies offer you direct access to portfolio managers.

Cost-effectiveness

The current average total expense ratio for general equity unit trusts amounts to 1.56% per year with additional performance fees attached to many of these funds. In most cases, personal share portfolio management fees start from 1.15% (incl. VAT), which can be reduced on a sliding scale based on the value of your portfolio, with no performance fee charges. These fees will vary from provider and provider, and you need to negotiate the fees with your portfolio manager, so be sure to do some homework before you commit. Also bear in mind that a certain minimum portfolio size should be reached before it becomes viable and suitably diversified.

Estate planning

RAs hold many advantages for estate planning, including a potential 3.5% saving in executor’s fees. 

One of the main advantages of an RA that is also invested in direct shares is probably the fact that you have more control over your investment composition. The reason for this is that any RA is subject to Regulation 28 of the Pension Funds Act. According to Regulation 28, there are certain restrictions in terms of the weights you are allowed to allocate to different asset classes within an RA. 

Based on historical data, it is a well-known fact that shares held within an RA certainly offer the best long-term growth potential. For a young investor looking to invest directly in shares, the problem is two-fold. Firstly, Regulation 28 restricts the investment in direct shares (both locally and offshore) within a RA to 75%. 

Another problem is that if you choose to invest in equity-based unit trust funds, you should know that very few of these funds can actually invest 100% of the fund in direct shares, simply because of cost recovery and the fact that it has to have the capacity for withdrawals to be made.

By including an extra layer of unit trusts in your RA, the possibility of you reaching that 75% is unlikely. By investing directly in shares, however, you have more control, which means that you can reach your 75% target. 

The good news is that this option is now available to most investors, which can definitely give your RA a huge boost in terms of performance. 

The Pros and Cons of Public-Private Partnerships in South Africa

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The Pros and Cons of Public-Private Partnerships in South Africa
Daniel Makina, University of South Africa

In his opening of Parliament address on 18 July 2024, President Cyril Ramaphosa strongly hinted that going forward, public-private partnerships (PPPs) would be the preferred arrangement in tackling infrastructure deficiencies and other service delivery problems. To this end, he stressed, “We are simplifying the regulations on public-private partnerships to enable greater investment in both social and economic infrastructure development”. This policy option is viewed as more palatable than privatisation.

Definition of PPPs
According to the World Bank, a PPP is “a long-term contract between a private party and a government entity, for providing a public asset or service, in which the private party bears significant risk and management responsibility and remuneration is linked to performance”. Its Reference Guide further explains that the definition includes “PPPs that provide for both new and existing assets and related services, where the private party is paid entirely by service users, and those in which a government agency makes some or all payments and encompasses contracts in many sectors and for many services, provided there is a public interest in the provision of these services”. In essence, project functions transferred to the private sector entity include design, construction, financing, operations, and maintenance varying from contract to contract. However, in almost all cases the private sector entity is responsible for project performance and bears significant risk and management responsibility.

The South African Experience with PPPs
South Africa has a mixed track record with PPPs, with some notable successes and significant challenges. For instance, the partnership between banks and the Department of Home Affairs for issuing passports and smart IDs has shown promise but remains limited in scope. Similarly, Transnet has engaged in partnerships to enhance logistics infrastructure, yet the scale and impact of these initiatives have been constrained by broader economic challenges and the financial instability of state-owned enterprises (SOEs).

In the context of energy, Eskom’s dire financial situation has made it difficult to attract private investment for critical infrastructure expansion, such as grid development for renewable energy. With a debt burden of around R400 billion (US$21.3 billion), Eskom’s capacity to finance new projects is severely limited. This highlights the challenges of implementing PPPs in sectors where state entities are already struggling financially.

The pros of PPPs
First and importantly, PPPs provide access to private sector finance and expertise, a fact acknowledged by the President in his opening address to Parliament. Furthermore, the state can leverage innovative solutions that the private sector brings onboard to projects, thus improving the efficiency and quality of public services. Thus, the utilization of private sector practices and standards enables public services to be delivered more effectively and efficiently

Secondly, PPPs allow the sharing of risks such as financial, operational, and technical risks. This has got the effect of reducing the burden on either the state entity or the private entity. Using the private sector expertise in project execution and management, cost savings could be achieved as opposed to the state managing projects alone.

Thirdly, PPPs may accelerate the development of infrastructure projects in South Africa where deficits are glaring. For instance, in the energy and logistics sectors, the main state players Eskom and Transnet are so heavily indebted to fund both refurbishment and expansion of infrastructure.

The cons of PPPs
Despite PPPs being able to offer significant benefits, as outlined above, they also bring some challenges that need to be managed. Firstly, PPPs are complex contracts that require expertise and resources to negotiate them. In South Africa, this is further complicated by the high indebtedness of state-owned enterprises (SOEs). For instance, Eskom needs about R390 billion (US$21.30 billion) to expand its grid to accommodate renewables, but because it is already unsustainably indebted to about R400 billion, it is not easy to attract private sector partners for its grid expansion project. One option in such complex contracts is to consider creating escrow accounts whereby a neutral third party holds the funds and releases them when both the SOE and private sector partner have met their obligations. Another option is to establish offtake agreements with private firms that would fund construction in exchange for future earnings

The second challenge linked to the complexity of PPP contracts is that allocating risks appropriately between partners can be challenging and requires expertise. Deficient skills in the South African public sector are likely to result in poor risk allocation causing financial losses for the public sector. A good example illustrating the complexity of PPPs is the Department of Home Affairs’ partnership with banks in the issuance of passports and smart IDs. Despite its relative success since its inception in 2016, it has remained a pilot project with only a mere 30 bank branches enrolled for the e-Home Affairs service in the entire country. It is speculated that the obstacle to rolling out the service country-wide is the delay in finalising the PPP agreement between the Department of Home Affairs and the Banking Association of South Africa.

The third and critical challenge is that the private sector is driven by the profit motive, and this can have the effect of raising costs of public services. The fact that present costs of services are already high because of the inefficiencies of SOEs, raising them up further in a PPP arrangement can cause social unrest. The present energy tariffs of Eskom are considered too high, and consumers are protesting by non-payment and going to the streets. Therefore, PPPs can become a highly contested terrain of social objectives versus economic profit.

The fourth challenge is that PPPs are often long-term projects that can run for 20 years or more so that the private entity can recoup its outlay and profits. This reduces the state’s flexibility to respond to changing needs, priorities and circumstances. Thus, once the state is locked into a poorly structured PPP it may not easily exit without penalties.

Structuring Effective PPPs
For PPPs to be successful, they must be carefully structured to balance cost-effectiveness with social well-being. This requires aligning the profit motives of private partners with the public interest goals of the government. Comprehensive feasibility studies are essential to determine the economic viability of projects, governance structures, and oversight mechanisms. Risk should be allocated to the party best equipped to manage it, and contracts should include provisions for monitoring and evaluation to ensure ongoing accountability.

The Way Forward for South Africa
Given the high levels of public debt, which amount to over R5 trillion (74% of GDP), alongside the financial difficulties faced by SOEs and municipalities, the government may find it challenging to attract private sector partners for PPPs. Those who do engage are likely to demand safeguards, such as escrow accounts or offtake agreements, to secure their investments. Therefore, a blended approach to private sector participation, incorporating privatization and concessions alongside PPPs, may be necessary to meet South Africa’s infrastructure and service delivery needs.

Furthermore, addressing the skills gap in the public sector is crucial for the successful implementation of PPPs. Training programmes, such as the 6-module PPP online course that is offered by the World Bank, can help equip public sector officials with the expertise needed to negotiate and manage these complex contracts effectively.

In conclusion, while PPPs offer a promising avenue for addressing South Africa’s infrastructure challenges, their success will depend on careful planning, skilled negotiation, and a balanced approach that considers both economic and social outcomes.

WFE data: trading value and volumes surge as investors flock to markets

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WFE data: trading value and volumes surge as investors flock to markets

New data published on 13 August 2024 by the World Federation of Exchanges (WFE), the global industry group for exchanges and central clearing counterparties, shows that investor appetite for listed securities rose in the first half of 2024. Trading value increased 11.7%, and volumes rose 9.6%, as markets were highly liquid globally despite the backdrop of economic and geopolitical uncertainties. The volatility we have seen in markets in recent weeks shows this uncertainty has carried over to the second half of the year. 

In the six months to July 2024, global equity market capitalisation was up 5%, driven largely by the Americas, whilst the rapid growth in the APAC region reported at the end of 2023 slowed. EMEA’s market capitalisation was flat. 

Compared to the previous half, IPOs fell 24.2%. The number of IPOs in the Americas rose by 36.4%, whilst both APAC and EMEA registered decreases, down -30.8% and -31.7% respectively. The number of listed companies is down marginally by 0.3% globally, though the number of listings in the Americas fell less than the same period the prior year. The EMEA region saw the sharpest decrease in number of listings, and APAC listings grew by 0.48%. 

Despite the overall decline in capital raised through IPOs, the average size of an IPO went up 18.8% compared to H2 2023. This was partially due to seven unicorn listings. The largest unicorn, Puig Brands, listed on SIX Group’s BME Spanish Exchanges. SIX Group’s Swiss Exchange also hosted the second largest unicorn, Galderma Group, a pharmaceutical company.

Looking at other asset classes, exchange traded derivatives continued the growth trend over the last few years, rising 11.6%. There was a dramatic drop in currency options, down 38.2%, due to a regulatory change in India which requires ownership of the underlying asset before buying the derivative. The impact is marked because India was the largest market for currency options. 

Key highlights:

  • Equity trading value and volumes increased 11.7% and 9.6% respectively compared to H2 2023, and 9.71% and 18.25% compared with H1 2023, witnessing the highest number of trades in a half-year in the last five years, including the peaks observed during the pandemic. The APAC region recorded its maximum number of trades in a half-year in the last five years (18.68 billion trades).
  • The volume of exchange-traded derivatives increased 11.6% compared to H2 2023 and 52.2% compared with H1 2023, amounting to 85.04 billion contracts. 
  • While, compared with H2 2023, equity and interest rate derivatives volumes saw double digit increases (16.5% and 16.3%, respectively), their highest level in the last five years, currency and commodity derivatives recorded double digit declines (-38.2% and -15.4%, respectively). ETF derivatives increased only 6.8% in H1 2024. 
  • Global equity market capitalisation increased 5% in H1 2024, compared to H2 2023, reaching USD 116.16 trillion, with over USD 5 trillion added to stock markets worldwide. While markets in the Americas region grew the most (+9.4%), APAC markets increased 1.4%, while EMEA markets were flat. When compared with H1 2023, there was an increase of 9.36% globally, mainly driven by the Americas region (15.82%).
  • The number of IPOs decreased globally by 24.2% with respect to H2 2023 and by 8.7% with respect to H1 2023. While in the Americas region the number of IPOs rose by 36.4% with respect to H2 2023 and by 20% year on year, both APAC and EMEA registered decreases (-30.8% and -31.7% respectively, with respect to H2 2023 and -11.9% and -19.8% respectively, when compared to H1 2023). Global markets hosted 501 IPOs in H1 2024.
  • The capital raised through IPOs saw a 10% decline compared to H2 2023 and a 17% decline with respect to H1 2023, a result driven by the APAC region, which in H1 2024 recorded its minimum level in the last five years, while the Americas and EMEA regions experienced significant increases (97.1% and 121.4% respectively, compared to H2 2023; and 89.2% and 86% respectively, compared with H1 2023). Despite the decline, global markets hosted seven unicorns in the first half of this year.


Dr Pedro Gurrola-Perez, Head of Research at the WFE commented, “For the second half of the year a decline in inflationary pressures and an ease in monetary policy may support the positive trends we observed in H1 2024. The persistent geopolitical tensions, a potential slowdown in the U.S. economy coupled with the uncertainty derived from the U.S. election, could inhibit market growth. If that’s the case, it will be hard on companies looking for capital, investors looking for attractive assets and savers looking to maximise their savings.”

Nandini Sukumar, CEO of the WFE commented, “Investor demand for exchange-traded securities continued to grow, reflecting the fundamental stability of public markets in times of uncertainty. The data shows that investors are here and are looking for capital allocation opportunities. Exchanges call on governments and regulators to pull the necessary policy levers to encourage businesses to float and benefit from public finance. Without a strong pipeline of companies coming to market, the whole economy suffers.”  

The full paper can be read here.

Sub-Saharan Africa: Mobile Money

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Sub-Saharan Africa: Mobile Money

Travis Robson CMgr MCMI (UK), MBA, FIFM

Sub-Saharan Africa has become a prominent frontrunner in the worldwide adoption of mobile money, revolutionizing the manner in which its people interact with financial services. This region has had an exceptional increase in the utilization of mobile payments, surpassing that of numerous established economies. The continent’s distinct economic and social environment has provided favourable conditions for the widespread adoption of mobile money services, which have significant consequences for individuals, businesses, and governments.

Rise of Mobile Money in Sub-Saharan Africa

Sub-Saharan Africa’s dominance in the global mobile money sector is evident, as the area possesses a significant majority of the world’s mobile money accounts. Since 2013, the region has witnessed a rapid and significant increase in the usage of mobile money, establishing itself as the market leader in this industry.

Factors Driving Growth

Several factors have contributed to the rapid growth of mobile money in Sub-Saharan Africa:

Unbanked Population: The region’s extensive population without access to banking services has discovered mobile money as a simple and easily accessible alternative to traditional banking. Mobile money services have effectively addressed the issue of limited access to traditional bank branches, thereby enabling millions of people to actively engage in the formal economy and achieve financial inclusion. Traditional banks sometimes neglect rural areas due to the exorbitant expenses associated with establishing physical branches. However, mobile money has effectively addressed this gap by capitalizing on the extensive adoption of mobile phones to provide financial services. This technological advancement has enabled individuals residing in distant areas to securely store, transmit, and obtain funds without necessitating the possession of a traditional banking account.

Mobile Penetration: The widespread use of mobile phones has played a crucial role in promoting acceptance and usage. With the rapid increase in mobile use, the utilization of mobile money systems also experienced significant growth. Mobile phones have become extremely common in Sub-Saharan Africa, frequently surpassing the number of bank accounts. The significant level of mobile adoption has created a well-established foundation for the successful development of mobile money services. Individuals can conveniently utilize these services via their mobile devices, thereby substantially reducing the obstacles to financial inclusion. The increasing popularity of mobile money systems can be attributed to their simplicity, as they just require basic mobile phones rather than smartphones.

Remittance-Dependent Economies: The economies of the region, which rely heavily on remittances, have greatly profited from the establishment of mobile money corridors. These corridors have made it possible to transfer money between countries more quickly and at a lower cost. A significant number of families in Sub-Saharan Africa depend on financial transfers sent by their relatives who are employed outside. Conventional means of transferring funds, such as bank transfers and money transfer operators, might incur high expenses and experience delays. The method has been revolutionized by mobile money, offering a more cost-effective and expedient option that allows receivers to access payments nearly instantaneously. This efficiency has not only enhanced household incomes but also strengthened local economies by enabling a greater circulation of money within the community.

Economic and Social Impact

The impact of mobile money on Sub-Saharan Africa has been far-reaching:

Economic Growth: Mobile money has stimulated economic growth by facilitating commerce, enhancing financial inclusivity, and promoting entrepreneurship. Accessible financial services have facilitated the flourishing of small firms. Entrepreneurs now have enhanced convenience in receiving payments, making supplier payments, and obtaining financing, resulting in a substantial increase in business activity and economic production. In addition, mobile money has optimized supply chains and decreased transaction expenses, hence improving economic effectiveness.

Social Development: Mobile money has significantly contributed to social development by enhancing accessibility to healthcare, education, and government services. Mobile money platforms have been utilized to distribute social welfare payments, facilitating the effective and transparent allocation of cash. Healthcare providers utilize mobile money as a means to gather payments and offer health insurance, hence enhancing the accessibility of medical services for the underprivileged population. In the same manner, educational establishments can collect fees using mobile money, guaranteeing increased access to education for a greater number of youngsters.

Challenges and Opportunities

Despite its success, mobile money in Sub-Saharan Africa faces several challenges:

Network Connectivity: Ensuring reliable network connectivity in remote and rural areas remains a significant challenge. While mobile networks have expanded rapidly, some regions still suffer from poor connectivity, which hampers the consistent use of mobile money services. Addressing these connectivity issues is crucial to ensure further growth in mobile money.

Cybersecurity: Protecting users from fraud and cyber threats is crucial for maintaining trust in mobile money services. As the use of mobile money grows, so does the risk of cyberattacks. Service providers must invest in robust security measures to safeguard user data and transactions, ensuring that users feel confident in using mobile money.

Financial Literacy: Enhancing financial literacy is crucial in enabling customers to make educated decisions and maximize the benefits of mobile money services. A significant number of users lack familiarity with conventional financial institutions and may possess little comprehension of the optimal utilization of mobile money. There is a requirement for educational initiatives to impart knowledge to individuals on the advantages and potential dangers associated with mobile money, enabling them to utilize these services in a responsible manner.

Future Prospects

The future of mobile money in Sub-Saharan Africa is bright:

Integration with Fintech: By combining mobile money with other innovative financial technologies like blockchain and artificial intelligence, we can tap into new possibilities and improve the delivery of financial services. These advancements have the potential to optimize procedures, minimize expenses, and bring new financial offerings, hence enhancing the adaptability and advantages of mobile money.

Conclusion

In conclusion, Sub-Saharan Africa has emerged as a leader in the adoption of mobile money, surpassing many established economies. This growth can be attributed to factors such as the large unbanked population, widespread mobile phone penetration, and the reliance on remittances in the region. Mobile money has had a significant economic and social impact, promoting economic growth, financial inclusion, and access to healthcare and education. However, challenges such as network connectivity, cybersecurity, and financial literacy need to be addressed. The future of mobile money in Sub-Saharan Africa looks promising, with the potential for integration with fintech to further enhance its benefits.

Leadership Strategies for Cross-Border Financial Services

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Leadership Strategies for Cross-Border Financial Services

Travis Robson, CMgr MCMI (UK), MBA, FIFM

In the ever-changing and fast-paced world of financial services, strong leadership is of utmost importance. As industries continue to globalize, the challenges of effectively managing diverse teams across many countries and cultures become more apparent. With my extensive experience in managing teams in EMEA (Europe, Middle East, and Africa) and leading the expansion into Africa and the Middle East in the online trading and fintech industry, I intend to offer valuable insights into the distinct challenges and effective strategies for leadership in cross-border financial services.

Understanding the Challenges

Cultural Diversity

Cultural diversity refers to the presence of a variety of different cultures within a society or community. Cultural difference poses a major obstacle when it comes to managing cross-border teams. Every nation possesses a distinct collection of cultural norms, values, and commercial practices. For example, in certain Middle Eastern nations, religious practices and local customs might have an impact on business operations, whereas European countries may place importance on a distinct set of corporate etiquettes and communication styles. Acknowledging and valuing these distinctions is essential for establishing confidence and promoting cooperation.

Regulatory Variations

Financial regulations exhibit substantial variation across different countries. Leaders must adeptly traverse an intricate network of regulations in order to ensure compliance while simultaneously upholding operational efficiency. For instance, data protection legislation in the European Union, such as GDPR, put strict criteria on data management, which may vary from those in African countries. It is crucial to possess a profound comprehension of these regulations and their impact on corporate operations.

Coordination and Alignment

Ensuring coordination and goal alignment across diverse geographies might provide difficulties. Discrepancies between time zones, diverse workweek arrangements, and unique public holidays can hinder communication and project schedules. To ensure that all team members are aligned with the same objectives and that their efforts are coordinated, it is necessary to engage in meticulous planning and implement effective management methods.

Communication Barriers

Efficient communication is the fundamental support of every successful team. Nevertheless, the presence of language hurdles and differences in communication styles might provide considerable obstacles. For example, in cultures with a more hierarchical structure, direct communication, which is commonly favoured in Western countries, may be interpreted as impolite or confrontational in other regions.

Best Practices for Effective Leadership

Emphasizing Cultural Sensitivity

Cultural sensitivity entails acknowledging and respecting the cultural disparities present within your team. Leaders should allocate time to acquire knowledge about the cultures they are collaborating with and provide an environment where team members are encouraged to openly discuss their cultural experiences and viewpoints. This promotes an everyone-encompassing atmosphere where all individuals feel appreciated and recognized. Introducing culturally appropriate training programs can also yield advantages. Hofstede Insights suggests that leaders can adapt their management strategy to diverse cultural environments by considering cultural aspects such as individualism versus collectivism, power distance, and uncertainty avoidance.

Promoting Open and Effective Communication

In order to overcome obstacles in communication, it is crucial to develop unambiguous and transparent channels of communication. By employing technology, such as video conferencing tools and collaborative platforms, it is possible to overcome geographical barriers and enable immediate contact. In addition, fostering a culture of transparency and promoting feedback can effectively reduce misconceptions and cultivate stronger relationships. Leaders should also be cognisant of non-verbal communication indicators and adjust their communication style to align with the cultural context of their audience.

Leveraging Local Expertise

Having knowledge and experience in the local market is quite useful when it comes to understanding and dealing with the complexities of various marketplaces. Leaders should delegate authority to local managers and teams, utilizing their expertise and understanding to guide strategic decision-making. This not only guarantees that the company is effectively adjusted to local circumstances but also cultivates a feeling of ownership and responsibility within local teams.

Granting local managers autonomy empowers them to make judgments that are most suitable for their specific market conditions. This encompasses placing trust in their ability to make sound decisions regarding regulatory compliance, market strategy, and customer engagement techniques. Leaders can enhance the effectiveness of their initiatives by entrusting decision-making authority, which allows for a more precise alignment with local requirements.

Investing in the training and development of local teams is crucial for their growth and success. This may involve offering resources to comprehend global corporate objectives while acknowledging and honouring the unique characteristics of local markets. Training programs should prioritize the development of leadership skills, market knowledge, and comprehension of the wider industry landscape for local managers.

Collaboration and integration involve incorporating the knowledge and skills of local experts into global initiatives, resulting in more complete and efficient corporate solutions. Leaders should promote the collaboration of local and global teams, creating an environment that appreciates and integrates insights from different areas into the overall strategy. This can be accomplished by conducting frequent meetings, workshops, and joint initiatives across different regions.

Building a Cohesive Vision

A holistic view is crucial for coordinating multinational teams towards shared objectives. Leaders must effectively communicate a distinct and persuasive vision that deeply connects with team members in various geographical areas. This vision should be all-encompassing, considering the many viewpoints and valuable input from every member of the team. Consistently conveying the vision and illustrating how individual roles contribute to the larger aims can improve motivation and teamwork.

Conclusion

In conclusion, effective leadership in cross-border financial services requires understanding and addressing the challenges of cultural diversity, regulatory variations, coordination and alignment, and communication barriers. Leaders should emphasize cultural sensitivity, promote open and effective communication, leverage local expertise, and build a cohesive vision that connects with team members in different geographical areas. By implementing these strategies, leaders can successfully manage diverse teams and navigate the complexities of global financial services.

References

  1. Hofstede Insights. (n.d.). Country Comparison. Retrieved from Hofstede Insights
  2. Bücker, J. J. L., & Poutsma, E. (2010). How to Assess Global Management Competencies: An Investigation of Existing Instruments. Management Revue, 21(3), 263-291. Retrieved from ResearchGate

Are South African Financial Markets Experiencing “Irrational Exuberance” or Sustainable Buoyance Following the Formation of GNU? 

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Are South African Financial Markets Experiencing “Irrational Exuberance” or Sustainable Buoyance Following the Formation of GNU? 

Daniel Makina, University of South Africa

Following the consummation of a Government of National Unity (GNU) and the election of Cyril Ramaphosa as President of the Republic in the first sitting of the National Assembly after general elections held on 29 May 2024, South African financial markets went into a state of “exuberance”. The JSE surged, and by 19 June 2024 when the President was inaugurated it achieved its highest index level breaching the 81 000 mark. In the bond market yields fell and prices rose, and new issues were oversubscribed. In the foreign exchange market, the rand appreciated and briefly falling below 18 to the dollar and becoming the best performing emerging market currency. This raised the proposition that financial markets are leading indicators of the future performance of the real economy for evaluation and validation. The question for consideration is: does the behaviour of financial markets really tell us a good story about the economy going forward? In other words, is their optimism sustainable? 

In his memorable speech on 5 December 1996, Alan Greenspan, the Chairman of the Federal Reserve at the time, described US financial markets as exhibiting “irrational exuberance”. This was based on his concern over the rapid rise in asset prices in the stock markets during the mid-1990s. He questioned whether the surge in asset values in the stock markets reflected the fundamentals of the economy or if they were driven by overly optimistic investor behaviour. In essence, he thought that financial markets were becoming excessively overvalued, driven more by psychological factors and speculation than by sound economic fundamentals. During that time, stock prices, especially in the technology sector, rose to unprecedented heights as investors channelled funds into internet and technology stocks, the so-called dot.com stocks. This was done without evaluating their business fundamentals of these dot.com stocks. This speculative frenzy was driven by the belief that the internet and related technologies would revolutionize business leading to massive profits. The result of this “irrational exuberance” of markets ultimately led to a bubble and collapse in prices of technology stocks by the year 2000. 

Unlike the American market “exuberance” driven by the promise of a profitable technology sector, the South African one stems from optimism following the formation of a GNU which markets viewed as business-friendly and reformist. There have been several examples when financial markets rallied following election of pro-business governments. Such election outcomes can significantly impact financial markets based on investor expectations of new economic policies and reforms. For example, when Donald Trump won the U.S. presidential election in November 2016, the stock markets in the USA rallied as investors became optimistic about his promises of tax cuts, deregulation, and increased infrastructure spending. Similarly, the Indian stock market rallied after the victory of Narendra Modi and the Bharatiya Janata Party (BJP) in the 2014 elections as investors anticipated economic reforms and pro-business policies under his leadership. Also, following the election of Jair Bolsonaro as Brazilian President in October 2018, Brazilian financial markets rallied as investors became optimistic about his plans to reduce the fiscal deficit, reform the pension system, and his promise to implement market-friendly policies. The question is: Are such market exuberances following favourable election outcomes sustainable or short-lived?

Empirical evidence suggests market exuberances following favourable election outcomes are generally not sustainable. Their longevity is dependent upon several factors. If the economy is not strong, market gains are more likely to be short-lived because markets tend to revert to their underlying economic fundamentals. The initial market’s reaction depends on the ability to implement proposed policies effectively. Delays or failures in policy execution can frustrate investor enthusiasm. The sustainability of market gains can be influenced by external factors such as global economic trends, geopolitical tensions, and international trade. If subsequent news or economic data do not meet expectations, initial optimism can be replaced by pessimism or caution.

By and large, the South African financial markets’ exuberant reaction was short-lived and can, therefore, be viewed as irrational. In less than a month, it had fizzled out, except for the bond market, which has continued to be buoyant as foreign investors rebalanced their portfolios to take advantage of better South African bond yields compared to those in similar emerging economies. Why? After digestion, markets realized that their expectations were not based on a growing economy. In other words, expectations were not grounded in strong underlying economic fundamentals. The GNU comprising business-friendly parties gave hope that public-private partnership arrangements would take root given the success of Operation Vulindlela.  However, it is increasingly being realized that Operation Vulindlela is more of an ad hoc fire-fighting strategy focusing on the energy and logistics sectors rather than a broad-based economic reform programme. Furthermore, markets could have realized that the Cabinet of the GNU was very bloated, akin to the biblical Tower of Babel in the Genesis book, leading to likely gridlock in policymaking.

The IMF has maintained its growth forecast for South Africa, projecting the economy to grow by 0.9 percent this year and 1.2 percent next year, with a medium-term growth average of 1.4 percent. This unchanged forecast highlights the economic challenges facing the country. While the IMF has not specifically commented on the outcome of South Africa’s recent general election, officials have underscored the importance of addressing these challenges.

In early June, the IMF reiterated that South Africa’s economy continues to face significant hurdles. It emphasized the need for an ambitious structural reform programme to remove bottlenecks to growth. Key areas of focus include improving the efficiency of state-owned enterprises, enhancing the regulatory environment, and fostering a more competitive business climate. These reforms are crucial to unlocking the country’s economic potential and achieving sustainable growth.

Furthermore, the IMF stressed the importance of fiscal consolidation to manage and reduce public debt. Achieving these goals will be vital for restoring investor confidence and maintaining economic stability in the long term. The jury is still out on whether the GNU will be able to address these challenges effectively.

Quantitative Tightening and Expansionary Policy Effects on the Global Banking System

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Quantitative Tightening and Expansionary Policy Effects on the Global Banking System
By Clarke Chesango, MIFM

Quantitative tightening is a monetary policy instrument of increasing interest rates to tame increasing inflation and discourage borrowing by businesses and households. Companies will downsize to rein in increasing costs.  This means unemployment will likely soar and cause social instability if the governments do not come up with intervention programs to mitigate poverty.

The opposite is an accommodation policy where the central bank lowers interest rates to encourage borrowing so as to stimulate demand and expand economic activities.

The adoption and implementation of these two central bank monetary policy tools depends on the economic environment existing in the specific country or globally.

The 2007-08 financial crisis and the Covid era prompted governments to implement an accommodation policy to cater for depressed demand and systemic paralysis in economic activities.

The early 2022 to the current period, we are seeing a world tightening regime to fight inflation brought about by a decade of low interest rates and the Covid era, which gave rise to excessive borrowing underpinned by relaxed underwriting standards by lenders chasing elusive risk premiums.

During the low-rate regime, banks loaned out a lot of money as can be measured by the Debt to GDP ratio to businesses and households. Interest service costs are manageable as long as the business deploys the loans to increase productive capacity to meet increasing demand.

The ability to service the debts was hamstrung by the effects of the Covid 19 era. In order to contain the virus, governments around the world implemented various measures. For example, China implemented a zero-covid policy which was a total closure of all businesses. Other countries implemented a partial closure of businesses and only allowed critical service businesses to continue operating within strict guidelines.

In order to mitigate the effects of Covid and the financial crisis, central banks injected liquidity into their economies by buying government bonds and other securities from banks. The result was excess cash on bank balance sheets to on-lend to the productive sectors and households. Some governments also borrowed from the International Monetary Fund due to inadequacy of revenue streams as economic activity had declined. This led to fiscal imbalances as interest costs became unsustainable to service the loans. It also led to exchange rate volatility risks as some loans were foreign currency dominated.

Interest rates play a big part in the overall earning capacity and capital structure of banks and companies.

Depending on the conditions of the loan agreement, some portfolios are structured with adjustable rates.  They are then exposed negatively to positive movements in interest rates, unless the duration of the assets and liabilities is structured to minimize the negative effects on the capital adequacy and structure.

Quantitative tightening effects on Banks

Banks with fixed rate assets on their balance sheet will experience fair value losses due to the inverse relationship between interest rates and fixed rate assets. The tightening regime increases the probability of systemic risk. For the banks to minimize this risk, they either have to hedge their interest risk exposures through interest rate derivatives or they have to sell some assets early. Due to the costs of hedging, only part of the risk is usually hedged, leaving the banks still somewhat exposed. In addition, full hedging will likely eliminate all profits.

Some depositors looking for higher interest rates move their funds currently in bond portfolios to higher interest earning money market funds. In order to raise deposits, banks have to increase their deposit rates, and thereby reducing their profitability.

Leveraged positions increase their exposure during the tightening period and deleveraging has to be done earlier to mitigate systemic risk. This also applies to hedge funds who apply leverage to make profits, but this strategy is a problem in an increasing rate environment.

Banks must increase their loan loss provisions as the ability of customers to continually service their debts is constrained. In South Africa and elsewhere, most banks reported an increase in loan loss provisions in their financial statements this year (2024). There is credit migration from high quality graded debt to sub-investment and or even junk debt and to some extent, to defaults. This makes raising capital in the capital markets more costly as investors request higher premiums for the increased risk. Some banks with fragile balance sheets cannot continue increasing loan loss provisions, and hence they have to resize and restructure earlier, or they will fail.

Financial stability oversight entities and central banks worldwide will increase their surveillance and supervision to counter systemic risk within banks. This is necessitated by the interconnectedness of the banking ecosystem.

Quantitative easing effects on Banks

The US Federal Reserve Bank and the European Union reduced interest rates to near zero during the financial crisis of 2007-09 and the Covid era but this failed to stimulate the economy.  Since there was no space to reduce interest rates further, they employed quantitative easing. They bought government bonds and other securities from banks so as to inject liquidity into the banking system. This gave banks ample liquidity to on-lend to the productive sectors of the economy, which has the following consequences.

Excessive borrowing

Due to low interest rates households and businesses load their balance sheets with unnecessary loans which do not support their strategic impetus and assets. Banks engage in poor underwriting standards so as to lend more money. Banks’ balance sheets will be loaded with poor loans which will not withstand adverse economic conditions.

Misallocation of financial resources

Funds end up being employed to undeserving sectors of the economy as the economic system is altered to cater for the low-rate policy. The demand and supply rules are no longer applicable.

Asset bubbles

Asset values are increased without a fundamental or underlying basis to support these values. This is because of increased competition for profits which are hard to find in the low-rate environment.  As a result, companies and households end up entering a speculative bubble by investing in risky distressed debt.

Inflation creation

Too much money building up in the low-rate regime ends up creating inflation by bidding up prices of goods and services.

Policy suggestions and opinion

Forward-looking central bank analysis

The central banks must be proactive by adjusting their supervision and regulation with changes in bank risk profiles, complexity and changes in economic conditions. Fair value losses going forward can be estimated in advance and corrective measures applied before the risk materialize. As the interest rate increases, fair value losses also increase on fixed asset holdings on the banks’ balance sheet. Assumptions can be made in advance, taking into account individual banks where the fair value losses with deplete the required capital holdings beyond a certain interest rate.  Immediate solutions can be found to contain this risk before it spreads to bankruptcy and contaminating the whole bank ecosystem and the economy at large, locally and even globally.

Bank resolutions and moral hazard

Previously, banks’ profits were retained by private shareholders, while their losses were potentially covered through bailouts by the government using taxpayers’ money. Bank boards of directors could therefore enter into risky lending as long as they knew in advance that a bail out was going to come from taxpayers’ money. I foresee directors being held accountable for risky lending that is not in the banks interests. Taxpayers will lobby the governments to do away with bailouts using taxpayers’ money unless negligent risk-taking is penalized and the bail out approved by relevant authorities. The best solutions will be to sell saleable assets to the right takers or to find the best banks with ample liquidity to take over problem banks.

Uninsured deposits

This gives rise to panic withdrawals, and I therefore argue that full coverage of all deposits will be created in the near future to create confidence in the banking system.

Already South Africa recently created the Corporation for Deposit Insurance (CODI) to protect qualifying depositors in the event of bank failures.

Financial literacy

I believe that the marginalized communities will, in the future, need to undergo financial education before being given loans.  Banks should be mandated to educate these communities so that they are part of the inclusive and transformation agenda and stand to benefit from diversity and inclusivity policies.

Tokenization to Become a Reality in South African Financial Markets

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Tokenization to Become a Reality in South African Financial Markets
Daniel Makina, University of South Africa

The Treasury’s 2024 Budget Review reported that the Intergovernmental Fintech Working Group (IFWG) is currently examining the potential effects of tokenization on the financial markets. A paper on the overview of tokenization is expected to be published by June 2024. Then by December 2024 a discussion paper on the policy and regulatory implications of tokenization and blockchain-based financial market infrastructure is expected to be published.

What is tokenization?

It is generally accepted that definitions or meanings are derived from authoritative sources. For English word meanings, the Oxford Dictionary is usually taken as an authoritative source, but it is no longer the sole source, especially for technical words. There are other competing sources that have emerged over the years. When it comes to technical financial terms, we have the IMF, BIS and others that are considered as credible sources for definitions. The BIS defines tokenization as “the process of recording claims on real or financial assets that exist on a traditional ledger onto a programmable platform” that typically relies on distributed ledger technology; while the McKinsey Institute defines it as “the process of creating a digital representation of a real thing.” In simple terms, tokenization is the digital representation of asset ownership on a blockchain. Real assets such as real estate, stocks, commodities, etc are represented as digital tokens on a blockchain. Blockchain technology, in particular Ethereum and its smart contract functionality is the root of tokenization.

Tokenization offers a range of advantages, including immediate global reach and streamlined cross-border remittances. It also allows for fractional ownership, enhances liquidity, and speeds up the transferability of assets, making previously illiquid assets tradable and accessible to a broader spectrum of investors. The widespread adoption of tokenization can deliver substantial economic benefits by increasing economic efficiency via lower transaction costs, simplifying asset management, and boosting market liquidity. Moreover, the expansion of the tokenization sector could generate job opportunities across various industries, including technology, finance, agriculture, and legal services. In the long run, by democratizing access to investment opportunities, tokenization can promote greater financial inclusion and fairer wealth distribution, thereby encouraging economic growth and stability in developing countries.

Global trends of tokenization

The tokenization technology is now maturing, and regulatory frameworks are being developed to govern tokenized assets, with a view to balance innovation with investor protection and market stability. Furthermore, tokenization has brought about an expansion of asset classes beyond traditional assets (such as real estate, commodities, and securities) to include art, collectibles, intellectual property, etc. The emergence of non-fungible tokens (NFTs) like art, music, and virtual real estate has shown the potential for tokenization beyond financial instruments. The concept of decentralized finance (DeFi) leverages tokenization to create decentralized alternatives to traditional financial services.

There are global efforts to improve interoperability between different blockchain networks to facilitate the seamless transfer of tokenized assets across platforms. Financial institutions are exploring tokenization to improve efficiency in processes such as securities trading, settlement, and cross-border payments. Examples of financial institutions embracing tokenization include the following.  Over the years JPMorgan has been exploring blockchain and tokenization through its Quorum blockchain platform and has the JPM Coin initiative for cross-border payments. Deutsche Bank is similarly exploring blockchain technology and tokenization for various financial assets. Société Générale is involved in blockchain initiatives and tokenization projects in areas of trade finance and derivatives. Goldman Sachs is participating in blockchain, and tokenization projects related to digital assets and is exploring potential applications in trading and settlement. Furthermore, the concept of tokenization is intersecting with other technologies such as the Internet of Things (IoT) and Artificial Intelligence (AI) to create new use cases and business models.

The above trends reflect a growing acceptance of tokenization and its growing potential to reshape the global economy. Several leading companies and platforms are engaged in tokenization. Ethereum is considered a key player in tokenization and pioneer of smart contracts and decentralized applications. Because of its low transaction costs and compatibility with Ethereum, on the other hand, Binance Smart Chain has become the popular platform for token issuance and DeFi systems because of its compatibility with Ethereum as well as its low transaction costs. For tokenization projects seeking scalability and interoperability, the Polkadot blockchain protocol has been an attractive solution, whereas Tezos, a decentralized ledger hosting the digital token Tez (XTZ) offers a blockchain platform that supports tokenization and smart contracts.  Cardano, a public blockchain platform that is open-source and decentralized, has a goal to provide a secure and scalable platform for the deployment of smart contracts and tokenized assets. Its emphasis on peer-reviewed rigorous research methods is attractive to projects that are looking for a robust foundation for tokenization.

The above platforms and others are pioneering tokenization, each of them offering unique features and capabilities to support the issuance, management, and transfer of digital assets across various industries and applications.

Africa stands to benefit significantly from advancements in tokenization and blockchain technology. A report by PwC predicts the tokenization market in Africa could reach $100 billion by 2025[1]. In alignment with this potential, the African Development Bank has established a $10 million fund to encourage blockchain and tokenization initiatives across the continent[2]. Moreover, several African countries are exploring the tokenization of land ownership records.

South African use cases

In 2018 DoshEx, a Bryanston-based exchange and South Africa’s first developer of tokenised ecosystems, formally launched the trading of tokenized assets on its exchange. While tokenization is still a novel concept in South Africa, it has great potential as a tool for leveraging corporate growth for businesses with international aspirations.

To some varying degrees, several financial institutions in South Africa are embracing tokenization. The South African Reserve Bank (SARB) is exploring the potential of tokenization, in particular the viability of central bank digital currencies (CBDCs). The largest bank in South Africa, Standard Bank, is involved in blockchain and tokenization initiatives whereby it is exploring applications such as cross-border payments and trade finance. Similarly, ABSA and FirstRand Bank are exploring the use of blockchain and tokenization in various areas of their operations.

Notwithstanding the high demand for tokenized solutions in South Africa, the major constraints are scarce local skills and absence of blockchain and cryptography training. The tertiary education sector is still figuring out an appropriate curriculum for the innovation.

The financial system of the future

In a recent paper, a staffer of the Bank for International Settlements (BIS) and an Indian entrepreneur sketched the elements of the future digital financial system. They termed it the “Finternet” which they define as “multiple financial ecosystems interconnected with each other, much like the internet, designed to empower individuals and businesses by placing them at the centre of their financial lives”. Tokenization is one of the innovations that the Finternet leverages alongside other technologies such as the internet, blockchain technology, distributed ledger technology and unified ledgers. The Finternet is touted as a user-centric approach capable of lowering barriers to access to financial services and thus fostering financial inclusion. However, since its realization will depend on proactive collaboration between public authorities and private sector institutions, the jury is out there.

[1] https://www.businesslive.co.za/bd/opinion/2023-08-15-tokenisation-could-be-the-secret-to-unlocking-africas-economic-potential/

[2] ibid

Bank Runs and Associated Impact

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Bank Runs and Associated Impact
By Clarke Chesango, MIFM

Long queues were all over the bank`s branches. In three days, panic withdrawals topped three billion pounds (£3billion). This was compounded by wide publicity in the news media. The bank was caught in this crisis because of its business model of securitisation where the mortgage loans on its books were packaged and sold to investors locally and worldwide. Some of these assets were transferred to the bank` s own self-created special purpose vehicles, either with recourse and or non-recourse. A transfer with recourse means the bank is still obligated to meet any shortfalls in case of failure of the special purpose vehicle as well as to take control of the assets back into its balance sheet. Non-recourse means without risk and the bank is insulated from any bankruptcy or inadequacies of the special purpose vehicle. The funding and credit markets for this particular asset disappeared and the bank could no longer fund its operations. The bank was solvent but illiquid. The UK Treasury and central bank came to the bank’s rescue by guaranteeing all deposits and offering a discount window for borrowing, albeit at penal rates to discourage moral hazard. This was Northern Rock Bank, a UK bank caught up in the crisis of the US financial crisis of 2007.

Lessons from the Northern Rock Crisis

1.Rollover Costs

The cost to renew maturing liabilities exceeded the return on assets, hastening default due to business insolvency. Thus, the return on the assets is less than the funding costs.

2.Concentration of Funding

The risk was inability to secure more funding to continuously run the business in a sustainable manner. It is therefore important to diversify funding sources to minimize business disruption in severe or acute economic conditions.

3.Correlation

Sources of funds that move in correlation with the economic environment should be scaled down. Negative correlated sources of funds will aid business in countering funding hurdles as it minimizes depth of the crisis and cost.

4.Communication

Proper communication in a crisis scenario should be well managed so that it does not exacerbate the situation. Business crisis communication procedures should be activated to counter negative publicity and to manage reputational damage. It should also spell out recovery procedures to the public. Public buy-in can yield positive results hence all stakeholders should be informed.

5.Resolution Speed

The central bank should have ready-made solutions to assist banks in crisis. Various crisis scenarios should be tested at central bank level so that it becomes easier and faster to implement resolution procedures. The more the delay, the more customers and investors lose confidence in the bank and banking system at large. Customers and investors will miss contractual obligations as they are not able to access their accounts. The resolution should also take into account penalty costs in terms of failure by customers to make good their obligations in time. Who should be responsible for these costs? I suggest the bank shoulders the costs.

Deposit Insurance

The stipulated amounts guaranteed by the deposit corporations will not serve purpose as long as the covered deposits are less than the uncovered deposits. I suggest banks should then tailor coverage based on their balance sheet mix to counter withdrawals in crisis situations. In current position deposit corporations are after creating confidence in the bank system and protection of retail customers.

Technology and Innovation

Due to technology, withdrawals are made at speed. This is a new factor which needs to be planned for so as to mitigate systemic funding issues.

Maturity Transformation

Some short-term deposits are used to fund long term assets. As the short-term funds mature, they will have to be refinanced at prevailing rates in the market. As long as there is negative duration gap value of equity is increased. However, if funding is concentrated in the short-term deposit market there is bound to be a crisis if this market is closed. The bank needs to have contingency funding plans to cater for the specific bank funding incidents or a market wide shock. Contingency funding plans should be tested and updated with changes in micro and macroeconomic factors.

Capital Adequacy

Regulatory capital buffers are a minimum requirement to cater for cyclical downturns and crisis economic situations. The bank risk profile and complexity of its products plus its capital structure determines the requisite capital to sustain the business strategy within its risk appetite and tolerance. The bank supervision can still increase the capital limits depending on the riskiness of the bank operations over and above the regulated capital.

Human Capital

Continuous training of employees to adapt to the changing business landscape is a cornerstone of business success. Tangible training plan including succession planning is of utmost importance in achieving targets and organisational goals. A dedicated expert in risk management from the central bank should also be included in the bank board of directors as non-executive director. His independency will in some way increase effectiveness of the board overall function and oversight.

Central Bank Stress Testing

The mother bank should also be stress tested under different worst-case scenarios to gauge effectiveness in resolution and crisis management over its financial stability role of banks.

Stable sources of banking funding promote the achievement of banks short- and long-term strategic targets and objectives. The structure and diversity of bank funding is of primary importance in meeting profitability, capital adequacy and positive shareholder returns.

It is not only the funding source but also the bank’s core strategy that can give rise to costly funding mismatches. Board of directors should have clear oversight of the bank strategy as the responsibility lies with them despite delegation to senior management.

In adverse economic environments all normal plans and strategies are inadequate to meet intended targets. Hence there is need to readjust and resize with speed to cater for the new normal in adverse economic environments.

Demystifying Blended Finance

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Demystifying Blended Finance
By Thomas Meyer

Working in development finance, I often get asked what kind of “blended finance” solutions we have available for projects. According to the OECD, blended finance is the strategic use of development finance from multiple sources, including public and private sectors, to mobilize additional capital towards projects with social or environmental objectives in developing countries. It’s like mixing different ingredients to create a more potent solution.

Typically, blended finance involves combining concessional funds (often from governments, NGOs or foundations) with commercial capital (from private investors or financial institutions). The aim is to mitigate risks and attract private investment to projects that might otherwise be deemed too risky or financially unattractive. By leveraging public funds to catalyze private investment, blended finance can help address funding gaps and support sustainable development goals. It maximizes the impact of limited public resources and encourages private sector involvement in addressing global challenges.

In practice, people tend to think that blended finance is a magic wand, that can fund any project that does “good things” in society – irrespective of the project’s risk-return profile. For finance nerds, this means allocating capital to projects that are not on Robert Merton’s Efficient Frontier. For others it means investors accept inferior returns because the investment achieves a developmental goal. On paper this is indeed correct, but since the concessional finance component is the limited resource in this equation, there will always be heavy competition for the use of this magic wand.

So how do the custodians of concessional capital decide on the merits of allocating this scarce capital? I recently responded very intuitively to this question at a conference, and since the analogy seemed to resonate with the audience, it might also be useful here: Imagine that you are a first-time home buyer, and you have found the perfect house. The seller wants 100. The bank offers to lend you 80 and you have 10 in your piggy bank. Where will you find the remaining 10? The reality is that it would most likely have to be a relative, like an uncle, who would do it for one of two reasons: Firstly, the fact that he knows you personally and can judge the likelihood of you repaying the money. This would address the asymmetric information around your (perceived) credit risk, which moves this investment for the uncle back towards the efficient frontier. The alternative is, that he understands the (softer) benefits of you owning your own house, which motivates him to part with his money despite the likelihood that you might not be able to repay him. It is unlikely that he would do the same, even for your best friend. The result is that he uses 10 of concessional funding, to leverage another 90 from the private sector, so that you can buy the house.

Moving back to societal needs, the analogy demonstrates that project developers need to find their own “uncles”. Uncles who are motivated by the objective that their concessional capital would achieve, the main driver being the leverage that such concessional funding can achieve in the quest to address any specific sustainable development goal. And once project developers have found their uncle, they might have to do some of the “blending” themselves, just like when you buy your first house. Real magic wands in finance are very scarce, even though you might be lucky enough to find one from time to time.

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