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Buying and selling shares through matching mechanisms, whether automated or not, are functions which are regulated by the Financial Services Board. After the Financial Services Board announced that existing OTC market operators are trading illegally, Singular Systems, the company that built the country’s leading OTC platform, Equity Express, set about to bring to life a mechanism that would still allow companies to remain unlisted while giving their shareholders a legal framework to trade shares.
By Jeremy Hart and Kirstin Purves*
Going back to 2011 when Equity Express had just started there were two options available for companies that wanted to trade their shares in South Africa:
- Become a listed company and trade shares on the Johannesburg Stock Exchange
- Remain unlisted and trade on an OTC basis
Trading OTC has been a popular option for many companies and a particularly efficient way to facilitate trade in restricted shares – think B-BBEE share scheme and co-ops. These OTC infrastructures took the form of spreadsheets managed by company secretaries or more sophisticated outsourced solutions such as Equity Express.
Fast forward to July 2014 where the FSB released a directive coming down hard on what it referred to as “illegal exchanges” operated by companies facilitating trading in their own securities, with investor protection and systemic risk being cited as its main concern. It was a crushing blow, particularly to those companies that had been responsibly operating thriving OTC facilities. These companies were forced to regularise their affairs in one of four ways: list on a licensed exchange; obtain an exchange licence; cease their illegal trading or rearrange the manner of trading to fall outside the definition of an “exchange” in terms of the Financial Markets Act.  The JSE largely caters to the needs of institutional investors through their broker network which has the result that the ordinary retail investor is squeezed out of the market. This is problematic especially for B-BBEE schemes with a huge number of shareholders that are largely unsophisticated first-time investors. With the announcement in February of the licensing of two new stock exchanges, neither of which have ever operated before, the investment choices seem to have widened but these offerings do not meet the needs of companies that do not want to be listed but still want the ability to trade their shares.
For many companies, listing is perceived to be a positive step in their journey to maturity but what happens when a company does not wish to be listed? Many companies don’t want to be listed for a number of reasons. These often include: the increasing accountability to public shareholders, maintaining dividend and profit growth, becoming vulnerable to takeover, heavy compliance and regulations enforced by governing bodies, increased costs of compliance and reporting, and a loss of privacy as a result of media interest, to name a few.
Existing OTC operations have been deemed to be exchanges by the FSB, hence they require a licence. We have to ask where these companies are turning to in order to handle their specialised OTC schemes where a listing is not what they want. To date over 170Â 000 deals have traded through Equity Express equating to R4 billion for 13 companies. None of the licensed incumbents can meet the needs of these companies since by definition these companies have to be listed to trade on these markets.
The FSB has made it clear, that if you want to trade using matching you need to list your company on a licensed exchange. OTC Express was developed and launched to directly target all these companies that don’t want to list, but want to trade their shares legally. Singular Systems has been working on a solution that allows companies to remain unlisted yet still trade their shares. OTC Express was designed for companies with a small to medium sized shareholder base and often with unique share schemes rules – bear in mind that Equity Express was servicing 500 000 B-BBEE shareholders within specialised schemes. The key differentiator of this mechanism is that it falls outside of the definition of an exchange and shareholders engage in bilateral negotiations while protecting themselves against any risk. After all, the point is not to circumvent the law but rather to make sure that shareholders are protected. Singular Systems dedicated itself to understanding the law, working with respected legal practitioners and obtained FSB consensus that its share trading platform did not fall within the definition of an exchange according to the Financial Markets Act.
This mechanism has appealed to companies such as Lenmed, who have opted not to list at this stage but still require an efficient platform for its shareholders to trade their Lenmed shares. Since they moved from Equity Express to OTC Express there has been no marked reduction in the volume of shares traded.
OTC Express is definitely not for all companies. The nature of the mechanism, and particularly the need for bilateral negotiations between parties, means it caters for niche needs and the company secretary is often close to the process. It allows companies to be in control every step of the way without having to deal with the substantial administrative responsibility of maintaining their scheme.
The benefit of allowing shareholders to trade their shares is that shareholders who want to exit now can, and a company and all stakeholders benefit from knowing the valuation placed on it by the market.
- OTC Express is a solution that provides these companies with a legal mechanism to trade their shares freely among investors over-the-counter and without the FSB regulatory issues.
- Jeremy Hart is Business Development Consultant and Kirstin Purves is OTC Express Process Manager.
