Disruption arrives in SA’s share market – ZARX to become second exchange

The father of disruption, Clayton Christensen, describes the classic process as one where a new entrant focuses on a segment where incumbents see little economic value. By the time it works up to full blown competitor, more efficient processes give it an advantage over established players. This could be the trajectory ZARX, which is moving through the regulatory hurdles on its road to being licenced as a Stock Exchange by the Financial Services Board. ZARX founder Etienne Nel explains the rationale to Biznews.com’s Alec Hogg.

Etienne Nel is with me in the studio. We met when you were running an OTC market, Etienne.

Yes, that’s right, Alec.

That was Equity Express. You’ve moved on from there, perhaps onto bigger things.

Yes, Alec. It’s been a lifelong dream of mine, to one day, run an exchange. If your mind’s focused in that direction, I guess those sorts of dreams do then ultimately, come true.

It is a dream. If you look at South Africa, we have the Johannesburg Stock Exchange, this powerful organisation. They would call themselves a sole supplier. The rest of us would call them a monopoly. Now you’re having a go at a second stock exchange.

I think that’s well put, Alec. We’re definitely having a go at a second stock exchange. It will be a full, multi counter exchange (if you want the full legal term). I think there’s a need in South Africa for something that…let’s call it ‘pre-JSE’ or ‘an incubator’ if you wish, where restricted BEE-type shares can trade. We’ve had big demand coming through from the Agri companies with the old co-op model where you have to be a farmer to be a shareholder – that sort of thing. Additionally, there are companies that just want to have liquidity in their shares and give their shareholders the ability to transact. Let’s call it a trading venue, for lack of a better word. Our model is literally, ‘let’s look at this to make it easy’. I almost want to say, “We’re trying to do to capital markets what the cellphone did to telecommunications.” Make it wireless. Make it mobile. Simplify it and give the man on the street access. I think that’s the model.

You’ve worked in this industry for many years (previously, as a stockbroker). Have you been able to take things that frustrated you as a stockbroker in dealing with the stock exchange, and make them different?

Indeed, Alec. We’ve had a number of instances where things would go awry in the OTC market when I was running at BJM at the time. I definitely saw what works and what doesn’t work, and we certainly included that in our listing requirements as well as the exchange’s rules and regulations, which are now open for public comment. To the extent that we’re trying to simplify things, there are certain Government requirements you can’t get away from and I think we’ve managed to get the best of both worlds going.

I guess that’s why you’ve also brought in a couple of partners, who are really strong in that field (the compliance field). Who are they?

Yes. My partners in the business are Jeff Cook, who used to head up compliance at Investec and Graham Wellsted, also from a compliance and legal background (similarly, ex-Investec).

Who’s backing you?

We are in advanced discussions with a number of funders but obviously, I can’t disclose them

Getting to this point though, must have taken quite a lot of funding. Is that out of your own back pocket? Did you take a second bond?

Indeed, we did. Nothing focuses the attention, energy, and effort as much as when it’s your own money on the table. You tend to then really, get down to the nitty-gritty and push hard to get the end result.

From what you learned at Equity Express or in the examples at Equity Express and before that, at BJM? You clearly have a good understand of what we know, as the OTC market but there would be a hope that at some point in time, there would be a competitor to the Johannesburg Stock Exchange. Can you grow there?

Alec, not really. I don’t see ZARX as being a full-on competitor to the JSE. The reason I saw that is the JSE have an impeccable track record from a compliance perspective and they are rated #1 in the world in that regard. We see ourselves almost as pre-JSE, incubator type of model where the listing requirements aren’t as onerous but similarly, we have fairly restricted trade practices. For example, we won’t allow derivative trades and short selling, etcetera, which obviously start complicating the life a bit from a governance perspective and then obviously, by extension, adds cost. If you want massive liquidity, huge volumes traded in your share, and a very full PE then your market would be the JSE. To the extent that you merely wish to create liquidity or have some restricted share where the shareholders have access to some form of trading, then ZARX is your model.

Come on. You have to be thinking big there. The JSE’s an enormous organisation. It’s worth billions of Rands in market cap. A disruptor always comes in at the bottom and then disrupts by growing into the future. Is that not even on your radar or is it just too far off, that you’re not concerning yourself with it now?

Alec, I’ve just been told we’ve been approached by one or two AltX companies, but we have not included any of those numbers in our forecasts or budgets. To the extent that someone comes to us and says, “We’d like to list on you”, I’m definitely not going to point business away but right now, it’s not a target market. Take the JSE Top 100 companies. We assumed that 40 percent of those companies might need some BEE structure. ZARX can actually give you a ‘once empowered, always empowered’ BEE structure for listed companies so the parent might be listed on the JSE and the BEE structure listed on ZARX. That more than keeps us busy for at least, the next five years.

That’s something, which some of these big companies are now whining about – having to re-engage or re-engineer their BEE systems. They should have thought it through more carefully in the first place. Let’s take FirstRand. I know they have a huge structure. The BEE component is now expiring. Those people who had the shares might want to sell them. The Government says, “You have to issue new shares.” Under what you’re proposing, that wouldn’t have been a problem.

Exactly right, Alec. We’re proposing a model where a company (like FirstRand) would create a new vehicle/special purpose vehicle where they have black-only shareholders who can trade between themselves on the ZARX Stock Exchange. Giving FirstRand a ‘once empowered, always empowered’ type of profile…to talk to an earlier point, companies were anticipating a ‘once empowered, always empowered’ type of scenarios once their BEE deals had run out. Their thinking was, “Well, we’ll do a ten-year deal and then after that, we’ll still have the BEE points”, and Government’s policy clearly states the opposite. You need to have empowerment, virtually in perpetuity, and that’s what our model offers.

You can shout as much as you like. Those are the rules. Work according to the rules. It sounds very similar to what you were doing at Equity Express anyway. What’s the difference here?

Alec, it is very similar, indeed. The difference is that this is regulated. A huge amount of work that went into setting up the process flows, the settlement and clearing processes, and the segregation of client funds because the big mandate that the FSB had (or their big push) is obviously, investor protection. The OTC market is not regulated by the FSB and therefore, poses a risk to the man in the street – that they might be targeted by some unscrupulous operators. We’ve had our fair share of Ponzi schemes and the FSB is merely looking out for the man on the street, and I think that’s eminently reasonable.

It is going to be more costly, though.

No, it will be marginally so but not significantly. To be honesty, our service providers whom we’ve engaged with have really come to the party. The biggest participant – obviously – is Strate, which is the largest CSD in the country. They’ve honestly sharpened their pencils significantly, by virtue of the fact that our settlement model is T + zero settlement. Effectively, meaning delivery versus payment, so there’s no settlement risk to the investor or the participant in the market.

Etienne, are you expecting other, new stock exchanges? You’re the first in the queue to apply for a new licence, but are their others?

Alec, there’s been lots of talk and some media reports about other exchange applicants out there, but I could comment as to the success or outcomes of their applications.

You don’t expect to be the only one though. It won’t just be you and the JSE, which would suggest that it could be quite a crowded space (at least, initially).

Alec, that’s a difficult one to answer simply because policy from National Treasury would dictate the number of exchanges out there. I’m sure anybody can apply for an exchange licence. The question is ‘would it get past the regulatory hurdles’ and by extension, the policymakers who say ‘well, we want competition in this market but only to a limited extent’. From our perspective at ZARX, we’d like to think that in the fullness of time, there might be three exchanges. Someone focusing on the high frequency trading model, which is algorithmic and is a big trend worldwide where you see computers and black boxes doing a lot of the trading. Obviously, the JSE would remain the largest exchange and then obviously, we on the lower end of the market where liquidity would be less and volumes would be lower but obviously, it would be a lighter type of market.

That’s the story for now. One doesn’t know how these things develop in time. Before we finish off, ZARZ (the name)…

Well, ZAR is the denomination for the Rand in terms of the currency denomination. Most currencies have a three-letter code. For example, USD being the U.S. Dollar. We thought ZAR is a nice starting point and then obviously, X indicates the exchange.

When might it be doing its first trading?

Alec, that depends entirely on the regulatory process. The next step would be for public comment to be completed. The regulator would consider public input and any objections. Once its passed that hurdle, we’d put the application before the Licencing Committee, who would then decide on whether or not to grant the licence.

Give us an idea on the timeframe. Is it five years, three years, or three months off?

Alec, internally, we’re hopeful that we’ll have a response before the end of the years.

If you do get the licence, when can you start?

If we do get the license, we’re quite confident that we’ll be up and running within three to four months, post license.

Etienne Nel with potentially, the second stock exchange in South Africa, returning to the glory days when the gold miners were around and we had dozens of these exchanges. Who knows what might come next?