JSE’s Donna Nemer: SA risks losing billions of rands if downgrades continue

JOHANNESBURG — South Africa consistently ranks as among the world’s top performers when it comes to the likes of its capital markets. But further credit rating downgrades – to below two notches of sub-investment grade – could result in South Africa’s capital markets losing tens of billions of rands, according to Donna Nemer, Director of Capital Markets at the JSE. In this wide-ranging interview, Nemer talks about the risks and challenges facing the JSE in South Africa as well as the state of capital markets in the rest of Africa. She also gives her thoughts on growing competition in the listed exchange space in South Africa amid the rise of new players. – Gareth van Zyl

This podcast is brought to you by RMB. I’m speaking to Donna Nemer who is the Director of Capital Markets at the JSE. Donna, both you and I were at the World Economic Forum for Africa in Durban last month. Looking back, how did you find the event and did you learn anything new from it?

Well, thank you Gareth. It’s a pleasure to be with you again and, yes, I thought it was a very interesting session. There was a lot of focus on leadership; there was a lot of focus on the future of the economies of Africa and a lot of discussion about inclusivity. One of the things that I think is paramount in all of that is: what are the roles that capital markets can play in building stronger economies, more inclusive economies around Africa.

What kind of role can they play?

Well, one of the things that we’re seeing is the fact that vibrant capital markets can be very important drivers of economic activity. On the one hand, the development sort of happened across the continent in pooling savings in retirement schemes and pension reform initiatives that have been undertaken. It has really started to pool liquidity that can be used to mobilise into efficient investments that are job-creating and lift economic growth. And of course, the role of the players in the industry, the ecosystem is very important in terms of being able to ensure that the savings that are mobilised are exposed to very transparent and well-regulated market infrastructures that can help direct investment to profitable and compelling investment opportunities. And we’ve seen this across the continent in terms of increasingly companies turning to capital markets to raise capital, but also the use of the capital markets for developmental purposes.

Donna Nemer, Director of Capital Markets at the JSE.
Donna Nemer, Director of Capital Markets at the JSE.

An example of that is what we’re doing here in South Africa with listed project bonds, where we’ve been working with National Treasury in the market on an initiative that will allow access to public markets for development projects in the infrastructure area. So, I think there’s a lot of focus on this kind of initiative and on the other spectrum there’s a lot of focus on, well, what can we do to provide capital for small and medium-sized companies and even the smallest of companies.

To that extent, many of the countries and capital markets’ authorities are looking at ways that capital can be mobilised through capital market structures for very small enterprises and ways that individual investors can be made to have access to the capital market. You know, we all speak about banking and access to financial services and banking. To me, just as important to that is access to investment and wealth creation capabilities in capital markets and these are the things I think that are going to be the new way forward for us in our capital markets development: to mobilise capital through ways that are affordable, accessible, and allow wealth creation and asset generation.

Obviously, Johannesburg, through the JSE, has very well-developed capital market. Looking further north to the rest of Africa, what is the state of their capital markets? It seems like they’re still quite nascent in a way.

Well, that’s one of the issues that’s under focus and many questions come from that, is that with markets that are newly developing and with issues around the liquidity and numbers of listings and so forth, is it viable on the African continent to have so many exchanges and I think that the answer to that is, yes, it certainly is possible. But what we need to do is find a way that we can engage with each other in accessing each other’s markets and there is an initiative underway that’s being sponsored by the Association of Securities Exchanges of Africa in collaboration with the African Development Bank to come up with all-alluding mechanism, where each country can still have it. It’s an exchange, but there would be four major nodes of trading where we could all access each other’s markets through order routing.

Of course, we do have, in these nodes, markets that are further along in terms of development and liquidity. Nigeria’s one, Kenya’s one and in North Africa, we have Egypt and then Morocco. But I think one of the issues that we find is that our development in capital markets to some degree needs to be overall activity in the economy. And the commodity price cycle that we went through recently, particularly around oil prices, has put a damper on some of our markets on the continent. But notwithstanding that, I’m still optimistic that we will continue to see development of the African capital markets going forward.

So, when you say that it’s put a damper on some of the markets, does that mean that there are fewer debut listings?

There are a few other things and there has been a reduction in liquidity. In countries like Nigeria, for example, that were starting to grow very nicely, the issue that the country had in terms of availability of foreign exchange did have an impact also in terms of the liquidity on their exchange. And so, that’s something that hopefully would be reversed as the commodity cycle and the economic cycle reverses.

Obviously, in Africa, we’re still quite dependent on those commodity cycles, even in our capital markets.

In some countries (yes). If you look at how South Africa, for example, we don’t have that degree of dependence. In fact, our market has quite a unique attribute in that it almost has a built in hedge. If you look at our All Share Index and our Top 40 Index, you’ll see that on a year-to-date basis – notwithstanding commodity cycles and notwithstanding downgrades – our top 40 and the year-to-date basis is up 33% and our all share index is up around just under 2%.

But that is on the back of the fact that when markets are concerned about risk in South Africa, they would tend to go into what we call rand hedge stocks, which are the gold producers, companies in South Africa that have a high percentage of their earnings from offshore. So they will turn to those counters and in times when the risk is gone, when there’s optimism about the local economy, then they will turn and look at stocks such as our banking sector, our large industrial companies and so forth. So, we have a unique attribute in our market where within the same industries you can basically hedge a risk, if you will.

Talking about our local markets, Moody’s this week has downgraded a number of big JSE listed companies, some of our big banks. I think MTN was also downgraded. Does this type of development concern you?

Well, you know, it’s interesting. We’ve spent a lot of time studying the impact of downgrades and particularly the impact on the equities market. What we found in the case of Brazil, Russia, and some of the other countries and what we did find is that a downgrade was to some degree a lagging indicator. Because if you look at it, the downgrades typically go in sub-steps. They don’t go from a very high level of triple A down to C, but they go in stages and so the market tends to anticipate based on where the current rating is and based on their view of where the major indicators are headed. They can pretty much anticipate whether they think another downgrade is coming or not.

So, we certainly saw that looking at Brazil and Russia, where we saw trading activities trend down, almost in anticipation of the downgrades and we saw that the downward trend, in terms of sales, was led primarily by international versus local investors. We’ve gone through exactly the same thing here where the downgrades have been anticipated. We’ve seen an acceleration of sales by foreign investors and not as much by local investors. What is interesting about Brazil is that as soon as the economic and the political situation in the country started to look better – and there was a period of time that it did improve, of course it’s deteriorated again since then – but in that period of time it was quite remarkable how quickly the market recovered in terms of its trading activity.

But if you look at South Africa, the biggest impact we had was not in these downgrades that we’ve had over the last four or five months. The big drop and the big step change in our market actually occurred in December 2015 when the market did not anticipate that the President was going to dismiss the Minister of Finance Nhlanhla Nene. Therefore, we had a sharp turn of trend in December 2015 and if you look at the activity and the levels and so forth from then until now, it’s been fairly predictable because the market has anticipated it.

There was some anticipation that perhaps Minister Gordhan wouldn’t remain in his office and a lot of that was speculated in the media. There was speculation that there would be downgrades. That was covered in the media. So, to some degree the markets had that information and could price it in, not just in terms of prices of shares and bonds, but also in terms of their strategies. But that was not the case in December 2015 and that’s when we saw a real sharp turn.

Do you think that suggests that there’s an element of predictability that’s returning to South Africa?

No, I wouldn’t say that’s the case now. What we’ve seen globally is that – notwithstanding all of the news events – the markets have not been very volatile and up until recently the VIX index, the volatility index that is sponsored by the CPOE in Chicago was at a 23-year low with around 9%. The one day that James Comey was released from his position (as FBI Director) in the United States, it jumped up to 15%, but now it’s still back down to about 10%, 10.5% and that’s a 23-year low. In the case of South Africa, the South Africa volatility index started in 2008 and we are at among the lowest levels we’ve seen since that index started.

Therefore, notwithstanding all the news we’re seeing in the market, the market has not been volatile on the back of that, the market to a great degree here has been driven much more by corporate actions, such as the Barclays sale of their shares in Absa and some of the other capital agents that we’ve had and so forth. So it’s been much more driven by global events and by local corporate actions. I do think, though, that in terms of rating agencies and so forth, at the moment, South Africa still has that split rating. This is because Moody’s is still one notch above sub-investment grade, but I do wish to point out that if Moody’s and S&P go below two notches of sub-investment grade, at that point South Africa could fall out of the World Covenant Bond Index, what’s called the WGBI.

There’s an enormous amount of Asian tracker funds, Japanese tracker funds that track that index and I think that could be a benchmark that could worsen our situation quite significantly. In other words, there is still a lot of work that we can and should be doing to prevent further downgrades because if we do fall with both Moody’s and S&P to below two sub-grades below investment grade and South Africa comes out of the WGBI, I would imagine that there’s probably R30bn to R50bn of funds that would leave the country to have strict index trackers.

Apart from the political challenges that exist and some of the downgrade risks that exist, the other challenges that the JSE has to deal with is new competition from the likes of ZAR X and some of these other players that are expected to come onto the market by year-end. How does the JSE adjust itself and adapt itself to compete in this environment?

Gareth, I’m glad you mentioned this in the context of new competitors because we have been competing with other solutions and other exchanges for many years. In fact, if you look at the counters that are listed on the JSE, of the close to 400 counters we have listed,  between 25% and 30% of them trade in other markets. So, we are used to having competition in terms of where shares trade. And, also, we’re used to competing for listings and of course on our derivatives markets, we’re also accustomed to dealing with the UTC market. Thus, competition in and of itself is something that we have been accustomed to, but there are new competitors coming into the local market and I think that is very important to point out.

So, what is the impact then on us? The first thing I’ll have to say that it’s really sharpened our focus in terms of the value proposition we have to the market, where we’ve been looking very carefully at the products and services we offer, where can we integrate. We’ve been looking at pricing, making sure that we have a proper price value proposition and we’ve been looking at service levels in terms of ensuring that the quality of our markets and that the quality of our service stands up to these global accolades that South Africa has been receiving for so many years in terms of the World Economic Forum in competitiveness rankings, where we rank so high as a global capital market.

We’ve been focusing on that. I would say that some of the new exchanges that have come to the markets, some of them were previously OTC offerings that were focused on restricted share schemes and they have launched and we’ve seen a couple of listings there. We have a big listing coming up soon of a co-op on our exchange. We’ve had a couple of new listings on the Altx Board which competes directly with these new exchanges that are focused on SMEs. We feel that we have a competitive offering, but we’re actually happy to see these other exchanges because one thing we do need in our economy is more opportunities for small and medium sized companies to raise capital and we’re hoping that as they raise capital and as they grow, that they would have a look at their main board in terms of a next step, in terms of where they may wish to list their company.

There is one competitor that has a different model than that and that is the A2X offering. Their licence was just recently approved and they’re really looking at a model where they will have secondary trading of our primary listed counters. There, I think what’s important and what’s important really in all capital markets in today’s regulatory environment, is making sure that the quality and the quantity of liquidity on the market is as high quality as one can get. Because with the new regulatory regime coming in in Europe and the United States around best execution, there’s going to be more and more obligation, both on buy side investors and on brokers in sell side intermediaries to ensure that investors are getting the best possible execution.

We’re also very focused on that in terms of insurance transparency in our market, offering the market new order types that allow them to navigate in a large central voter book where you have all kinds of different types of investors ranging from large buy side to high frequency trading. We’re really focused on making sure that we have the right kind of order types, that we have deep and robust liquidity, strong price discovery processes, good data availability, so that the quality of our market is robust and the quantity is there so that investors will say, “Well, I want to trade on the JSE because I know there’s liquidity there and I know I will get good quality liquidity there”.

The JSE challenged the FSB’s licensing of ZAR X and that challenge was struck down. But in reaction to that, you were reported as saying that the JSE welcomed the decision but that you were concerned about standards being lowered and the quality being lowered. Do you still feel that way seeing as a few months have passed?

Well, you know what, in effect what happened there, Gareth, is that with the ZAR X appeal that we lodged, it wasn’t against ZAR x themselves. In fact, ZAR X was one of the entities that was operating as an OTC offering, but what we were concerned about, was really – there were couple of things. One was the lack of overall information that we had about that particular application where we could understand it and, secondly, we had some concerns about the surveillance process and what that meant to cross markets and there were some other things, as you say, about market structure that we were concerned about. However, when we read the decision of the appeal board, their decision was primarily based on whether or not it was good to have competition in the exchange world in South Africa and we had publicly said that we agreed that it would be good to have competition.

Therefore, we didn’t take the appeal further because we realised that the decision making was based on whether it would be good for the capital markets to have one exchange. We didn’t have an argument with that and so the issues that we had around the regulatory framework and interoperability and how all this would work in a multiple exchange environment. We elected to take it offline, with the industry and the regulator, to voice our concerns and to give our input in terms of how we thought our high quality markets could be maintained in an offline sort of out of the court system, if you will, and deal with it that way. So that’s why we didn’t take that appeal further and we haven’t appealed on the other licence application.

Were those offline discussions quite productive then?

Well, I think that it’s really in the hands of the FSB in terms of how they want to take things forward. So, we’re certainly putting in our input in terms of how we think the market could work in a way that would allow vibrant competition, but also maintain the quality. I’m not sure if your listeners are aware that South Africa has been number one, two, or three in the world for the past eight years in terms of the quality of the regulation of our securities market. This is in the world, it’s not in Africa or in emerging markets, it’s number one in the world, we are number one, two, or three rather.

In the case of raising equity capital in the local market, we are number one in the world and we’re number one in the world in terms of the protection of minority shareholder rights. We’re number one in the world in terms of the strength of auditing and accounting standards. So these are worldwide rankings that we have where the quality of our markets are recognised and so what we’re doing is putting in our input on how can we make sure that as we move into the competitive exchange environment that we maintain this quality that has attracted international investment into South Africa.

Donna, it’s been a very interesting discussion. Thank you very much for taking the time to chat to me today.

It’s been a great pleasure. Thank you so much.

Great, thank you very much. This podcast is brought to you by RMB.

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