Strate to busi­ness

Cen­tralised se­cu­ri­ties reg­istry raises con­fi­dence in time of global tur­moil

Finweek English Edition - - Business Strategy - RUAN JOOSTE

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

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