Africa’s financial markets have come a long way, and intend to go further still
How strong is the central securities depository network in Africa?
Kemi Adewole: African markets currently operating with a central securities depository (CSD) have varying degree of sophistication and service models. The countries are at various stages of development and infrastructural dissimilarities can make the consistency of the most basic settlement and safekeeping processes a challenge.
The continent needs to address this lack of uniformity by building a consistent framework closely aligned with global standards. The creation of a single currency and common trading platform are also deemed necessary to eradicate operating and regulatory challenges inherent with cross-border execution, settlement and custody.
Duncan Smith: Societe Generale Securities Services (SGSS), as a member of the African Middle East Depositary Association (AMEDA), has been able to see over the years considerable awareness and moves from all members to reach international standards from the governance and operational point of view (think of CPSS-IOSCO, for example).
With the exception of Malawi and Swaziland, the longer established securities markets in Africa all have well-established CSDs. In fact, many have adopted a common settlement system, provided by central provider Millenium IT, including Botswana, Kenya, Ghana, Tanzania, Uganda and Zambia, among others.
Our experience of CSDs across the continent has on the whole been a very positive one, particularly in Ghana where SGSS, using its foundation as a leading bank in the market, became a participant in 2013.
A good example of the flexibility and progressive nature that we see from the CSDs in Africa was from the CSD in Mauritius with which we worked closely to become the first remote participant in the market to provide sub-custody services from Johannesburg.
In our view, the CSD landscape will continue to develop. As an example, the initiative by the East African Securities Exchange Association (EASEA) to integrate the capital markets of Kenya, Uganda, Rwanda and Tanzania (Burundi does not have a stock market currently) into a regional stock exchange is continuing to gather momentum. EASEA has adopted Kenya’s automated broker back-office system as a way of developing an inter-depository transfer mechanism for cross-listed stocks.
This will surely be followed in time by an initiative to establish a regional CSD following the West Western African Bourse Regionale Valeurs Mobiliers (BRVM), based in Abidjan, Ivory Coast, which was established in 1998, and the Bourse des Valeurs Mobilières d’Afrique Centrale (BVMAC), based in Libreville, Gabon, which was established in 2008.
Charmaine Artman: The CSD network within African jurisdictions varies from country to country. Botswana and South Africa have CSD capabilities but rules, regulations and market infrastructure differ substantially between these countries. South Africa’s Strate and JSE Exchange has recently been rated as one of the top settlement authorities globally, with strong oversight, enforcement and minimal failed trades.
On the other hand, our experiences in Botswana are somewhat different, with CSD rules seemingly lightly enforced and sometimes agreed to between regulators and participants outside of a standardised regulatory framework. The Botswana equities market has electronic settlement capabilities and functions reasonably well, with certain pre-settlement risk mitigation funding for purchases adding to market security.
Government bonds are issued and settled in electronic format by the Bank of Botswana. All dealing and settlement in government bonds generally conform to well-designed rules and regulations as stipulated by the Bank of Botswana.
Namibia has no CSD, resulting in the direct settlement of paper-based trades between participants, which adds substantial operational and settlement risk to custodians. Thankfully, our experiences gleaned from the previous South African paper-based settlement system have allowed us to apply a number of risk mitigating controls to the Namibian market to counter the manual settlement processes.
However, we are encouraged that the Bank of Namibia has requested technical assistance from the World Bank in identifying the best approach to establishing a CSD in Namibia. We look forward to assisting this market in applying best practices.
Rajesh Ramsundhar: The region is made up of multiple countries and each country on its own is different in terms of the level of development of the capital market and the institutions within the market. The same view can be taken on CSDs in the region. You can have a well-established and strong CSD in South Africa, for example, and then go a few hundred kilometres further to Zimbabwe where we have a recently launched a CSD that is on the path of development and establishing itself in the market and in the region. Related to this, you have CSDs in large markets such as Nigeria and Kenya who have been in existence for 10 years or more and are developing and getting stronger by the day.
There is no formal network of CSDs in the region to our knowledge and this is perhaps a forum that CSDs in the region need to consider. There is certainly much to be gained with CSDs across the region sharing experiences, ideas and learnings, which will expedite the development timeline and process and get African CSDs to the levels and standards that the greater world expects.
If there were to be a lack of settlement infrastructure, how much risk would there be in the market?
Artman: Substantial risk does exist in certain jurisdiction, which then needs to be mitigated by additional operational and process controls. In addition, certain jurisdictions have minimal or unreliable communication infrastructure.
Adewole: There would be varying levels of risk consideration affecting asset servicing, settlement (cash and securities), registration, and counterparties. As an example, true delivery versus payment (DVP) and at what point settlement finality takes place.
Ramsundhar: Settlement infrastructure is generally in place to ensure efficient and safe settlement of securities and cash transactions. Naturally a lack of settlement infrastructure would imply inefficiencies, operational challenges, settlement and other forms of risk in the process and will result in higher risk overall. This would be the case in any market let alone Africa.
The saving grace for Africa though is that volumes and values tend to be lower than other parts of the globe and one could argue that while a lack of settlement infrastructure would naturally increase risk, it would probably be more manageable in the African markets given the small size and activity. It will, however, limit the growth of the securities market.
Smith: We have seen a marked increase in African bias by investment management companies establishing new funds in frontier markets, particularly given the returns that these markets have been producing of late.
With our global presence and experience in dealing with CSD eligible and physical markets, SGSS is able to seamlessly replicate our platforms and operational and risk management processes into those markets where physical settlement is still a reality. However, this is no doubt that a formal settlement infrastructure and confidence in the functioning of these markets, particularly in light of the thin liquidity inherent in some of these markets, is essential for this trend to continue.
A lack of settlement infrastructure generally removes the certainty of contractual settlement, increases the risk of forged, tainted or lost certificates and raises questions on certainty of ownership and timely payment of corporate action entitlements. As a general global rule of thumb, markets with a lack of settlement infrastructure tend to be more expensive to investors, which could serve as an additional detractor to investment when the manager and investors consider the total expense ratio of the fund.
With few CSDs, how are custodians across Africa coping?
Artman: Where there is no CSD, custodians, along with other market participants, formulate certain market practices to govern the settlement processes that are mutually enforced between themselves. For example, in both the Botswana and Namibia markets there is an agreement that payment has to be effected by a receiving party prior to delivery of the physical securities taking place.
The real concern for custodians is that the manual nature of most activities results in cost inefficiencies and the potential to suffer operational and settlement losses.
Ramsundhar: In the 15 markets we cover there are only two markets without a CSD and they are Malawi and Namibia. The reality though is that custodians have coped without CSDs prior to the introduction of CSDs in the African markets, but the markets were small and inactive back then. There were certainly more challenges in the certificated environment, but with low volumes it was manageable.
If we have to put this in context, we could easily manage 20 to 30 trades per day in the early 2000s in a market like Nigeria without a CSD, but if we bring this forward to the current day, it will be extremely difficult to manage 300 to 400 trades per day without a CSD.
The challenge for custodians in the current day is not the lack of CSDs but the lack integration and automation with CSDs (excluding South Africa) and this is proving to be more difficult to deal with as volume and activity increases in the region.
Adewole: With few CSDs in Africa, the largest custodians operate in the countries where they have a proprietary branch. Alternatively, the smaller players can appoint a sub-custodian. There currently is limited cross-border settlement activity except for the Francophone region, which combines nine countries operating as a single region in spite of the lack of a CSD in these markets.
What can African countries do catch up with the rest of the world in this respect?
Smith: AMEDA continually seeks to achieve this objective by sharing its experience and expertise. Given our long heritage in North Africa and the sub-Saharan region as well as our global knowledge of the rest of the world, we of course actively engage with CSDs in these markets to continue the adoption of global best practice.
As such, over the past few years there have been significant moves in Africa with CSD networks growing from strength to strength, with the Ghana Stock Exchange and CSD implementing a new system, and the Nairobi Stock Exchange’s implementation of the common platform to enable greater surveillance on stockbroker activities in the market.
Zimbabwe is a good example of a current initiative in moving the market forward with the implementation of The Chengetedzai Depository Company and its intended T+3 settlement cycle replacing the old certificated environment’s T+7 settlement cycle.
In our view, this trend will continue as liquidity and presence of international investors in the market increase.
Adewole: The first step would be to harmonise the domestic financial systems and national regulatory frameworks. This would be followed by the implementation of consistent taxation and accounting practices across the region. Finally, the creation of regional exchanges would complete the alignment of Africa with global operating standards.
Artman: The effective functioning of any market would depend on the legal framework, governance and comprehensive risk management policies. This can be done by aligning with global best practices and standards such as the International Organization of Securities Commissions (IOSCO) Principles & Methodology, and participation in global forums such as AMEDA and other similar bodies.
It would be helpful if market participants, regulators and policymakers could be better aligned in driving the creation of local markets. The frustration is experienced through extended delays in policy application, weak systems and improved risk management policies.
Another area that would aid the African markets to grow would be the creation of derivative markets in certain jurisdictions, to allow investors to dynamically hedge themselves against underlying exposures. A simple securities lending market would substantially improve liquidity, for example.
Ramsundhar: As we have pointed out, most of the countries in the region have CSDs, so establishing CSDs is not the requirement. The requirement is more around CSDs pursuing automation and integration with market participants to support a larger market more efficiently.
The challenge, though, is that most markets are not big enough to pursue automation and integration to the levels suggested. This is where we need collaboration between countries and the CSDs in the region. A single country on its own may not have the scale and capacity to get its CSD infrastructure up to global standards, but if two, three or more countries get together and look to develop a single CSD operating a single technology platform and rules, they would have the scale to undertake the necessary development and catch up with the rest of world in a short space of time.
It’s not only about catching up with the world though, it’s also about contributing towards a safe and efficient capital market where the seekers and providers of capital can meet and transact, and thereby get the capital engine flowing to help Africa realise its potential.
Further to this, and beyond safekeeping settlements, CSDs in the region need to look corporate actions, income collection and proxy voting. Outside of South Africa, CSDs in the region have little to no involvement in these functions within the market. It is generally dealt with between the custodian and the transfer secretary and is mostly an inefficient and challenging process for custodians to contend with, let alone the underlying clients. There is an opportunity for CSDs to get involved in this process and bring about the experiences that custodians and their underlying clients are used to in the rest of the world.
What others areas of risk mitigation are in need of most work in Africa, and why?
Artman: From an investor point of view, the ability to hedge currency exposures would substantially improve the underlying security of investment. The JSE has recently launched currency derivatives against the Nigerian naira, Kenyan shilling and Zambian kwacha. These products will aid both the primary and secondary markets in these countries, albeit that the products trade on the South African markets and generally settle in ZAR.
Another area for consideration is to ensure that engagement between key stakeholders and/or custodians continuously takes place with a view to agreeing principles and procedures to manage liquidity and counterparty risk associated with the settlement process (across all financial instruments). Risk arbitrage is not healthy for any market so a commonality of approach to remove core risks will substantially improve investor confidence in the long run. Factors that can be included in these discussions include counterparty/credit management through the reserving of funds and pre-settlement margining.
Ramsundhar: In any market you can have a state of the art infrastructure and system, but this needs to be backed with the appropriate rules and regulations to manage activity in the market. It’s not that rules and regulations don’t exist in the African markets, it’s more about how comprehensive and clear the rules and regulations are in the market to support and enable the activity that takes place. Rules and regulations generally aim to provide safety and security in the market, which in turn instills investor confidence and more activity.
Related to this is the need for proper regulatory inspection and oversight on market players including CSDs and custodians. There is a need for regulatory to be properly skilled on the CSD and custody functions and for them to be more active in terms of overseeing these participants and enforcing regulations.
Adewole: The underlying factor driving risk across Africa is the lack of uniformity in policies across the continent. The absence of standard policies on taxes, corporate governance, and foreign exchange, coupled with the changing political landscape, still leave room for significant settlement risk. The establishment of robust and integrated custody networks coupled with the collaboration of all market participants will be key to build and deliver a robust securities environment in Africa.
Smith: While settlement cycles have reduced considerably over the past 20 years, mainly through introduction of CSDs and technological innovation permitting higher automation levels, as a continent Africa still arguably has the longest settlement cycles in the global context.
Swaziland, Tanzania, Namibia, and Malawi are still operating on a T+5 settlement cycle. From our global experience, these longer settlement cycles, by their nature, result in a prolonged potential exposure to a failed trade. With the liquidity constraints and buy-in procedures in some markets, and non-settlement in central bank funds in others, we have seen the finality of settlement for an investor being at risk for a longer time period, despite the existence of an established and robust local or regional CSD network.
Inter-country payments are another potential risk area that has been identified and is receiving focus. The launch of a common platform allowing traders in East Africa to receive payment in real time and in local currency markets is a positive step following the integration of Real Time Gross Settlement systems by commercial banks in Kenya, Uganda and Tanzania.
In this regard, SGSS is an active participant in the recent Southern African Development Community Integrated Regional Electronic Payment System (SIRESS) initiative to settle regional transactions among banks in the SADC countries on a real-time gross basis, reducing the settlement and payment risk.
Lastly, enhanced market surveillance by exchanges in markets experiencing fast growing liquidity will become increasingly important, particularly as internet-based trading and potentially direct market access accompany the increased trading volumes.
The Nairobi Stock Exchange implementing a common trading platform across its members in 2012 to allow the exchange, the CSD and the regulator to automatically track trades in securities improving surveillance and the capability to identify market abuse.
We expect this trend to continue in other markets, in turn boosting liquidity and potentially attracting new listings to market.
