Strate to business
Centralised securities registry raises confidence in time of global turmoil
DERIVATIVES BROKER Dealstream’s failure to meet its commitments to its clients has highlighted the very unnecessary risks clients face with unregulated instruments. Fortunately, the Central Securities Depository (CSD) system (or Strate), headed by CE Monica Singer – the strategy adopted by South Africa’s securities exchange of settling over the counter (OTC) contracts via brokers and a central book registry – has shielded us from the international market’s inability to meet its obligations and raised confidence in our market.
In the case of Dealstream, the contracts for difference (CFDs) – essentially, OTC contracts between Dealstream and its clients – were neither concluded on the JSE nor regulated by the JSE in terms of its rules.
Had Dealstream’s clients registered their respective positions as single-stock futures contracts with the JSE, the contracts would have simply been transferred over to another member and their positions and funds would have been secured by the JSE. That very fact – that the JSE guarantees all registered trades – has made it a very unique trading platform worldwide.
Unlike the Nasdaqs and FTSEs of the world, the JSE (as a securities exchange) isn’t a counterparty exchange and doesn’t assume the liability of the market. Its guarantee methodology stipulates brokers are the ones who must have the cash or shares in hand – or borrow the cash or shares – to trade. They’re the ones who absorb the counterpart risk.
Very simply, you can never trade on the JSE without a broker. The reasoning is simple: it takes approximately five days for a trade to settle on the JSE. On the third day of trade – with only two days until settlement – some trades are unable to settle. The JSE, which has ample resources to borrow money and shares, will ensure all outstanding positions are settled, which market estimates show is only between 1% and 2% of weekly trades. The brokers who make bad calls are issued the bill for the two-day loan cost of the JSE and are also levied a penalty.
Industry experts say that’s made brokers more sophisticated and very careful in their dealings.
“That’s what gives confidence to our market,” says Strate’s Singer. “That strategy has sheltered us from the international market’s inability to meet its obligations. In addition, the impact of short selling that now has been prohibited in some markets overseas isn’t an issue for the JSE. It was never allowed in the first place.”
According to credit rating agency Thomas Murray, SA was rated the second least risky CSD with regard to international public depository ratings in a study of CSDs in the Americas. The rating is an assessment of the extent to which a depository’s infrastructure is able to reduce or eliminate the risks associated with holding and settling securities and cash through the depository.
In a nutshell, a CSD is an
Isn’t a counterparty exchange and doesn’t assume the liability of the market.
electronic book entry system to record and maintain securities and to register their transfer. Ownership will be changed without physical movements of securities, as was the case with share certificates in the past. It’s a natural monopoly, which means every country only has one CSD, with some being shared in the European Union.
Says Singer: “Strate’s was introduced 10 years ago to mitigate risk, bring efficiencies to the market and improve SA’s profile as an investment destination.”
To put that in context, before the introduction of Strate, the JSE was considered the world’s worst settlement platform, according to research conducted at that time. It was unable to settle claims or process dividend payments – and its liquidity was only at 20%. “When Strate was introduced there were outstanding settlements of two years back (as a result of) dividends being paid to the wrong investors, because there was no up-to-date accurate register of shareholders,” Singer says.
Implementing the CSD system was no easy task, says Singer. Obtaining the required (and very expensive) technology, establishing the infrastructure and mainframe to host the technology, market player uncertainty and running the project without any income came at a price due to constant delays. SA’s four major banks (50%) and the JSE (50%) provided the initial finance of R95m but had
to refill the coffers with another R130m when they ran dry.
“Another delay and major cost was the fear of tainted script,” says Singer.
It was estimated that tainted script worth more than R2bn was doing the rounds and market players were concerned about those fake share certificates being captured on the system and distorting the market. So Singer negotiated an insurance policy with Lloyd’s of London, costing R18m to cover a possible loss of R2bn. “After five years only R2m was claimed. I had to dock up R18m for fear of tainted script,” says Singer.
It’s all paid off in the end, as Strate turned a profit in 2006 and paid back the R130m. By 2007 it paid dividends to shareholders and further reduced its share capital from R95m to R20m. It expects at least a 65% return on investment by year-end 2008 and R100m in the bank.
Singer says Strate is going to stick with the R20m share capital and pay dividends with the extra cash. “Strate has no plans to list and will remain a public unlisted company. However, the JSE is planning to acquire additional shares in Strate in the near future.”
Before Strate was implemented, the JSE averaged 4 000 trades/day. It now averages more than 86 000 trades/day, including the settlement of equities, warrants and bonds for the JSE Ltd and the Bond Exchange of South Africa. It’s planning to launch the settlement of money market instruments early next year, which is currently the biggest liquid market in the country still settled in paper.
Paperless trail. Monica Singer