Why the JSE is shrinking
The exchange cannot stop the flow of delistings on its own, and it looks as if it has not been able to persuade the National Treasury to implement policies that have been successful elsewhere, writes
TThe decline in the number of South African listed companies is the subject of market mutterings every time another delisting announcement hits the Stock Exchange News Service.
The JSE has spent two decades trying to reverse this trend. Initiatives such as launching the AltX junior board, facilitating inward dual listings and introducing real estate investment trusts have all been somewhat successful, and the exchange is in the middle of another root-andbranch reform of its listings rules. But despite its best efforts, it has been unable to reverse the trend. .
The JSE can’t really be blamed for trying to deflect the delisting issue by pointing out that its equity market’s gross market capitalisation continues to grow despite the decreasing number of listed companies. The problem is that the JSE includes 100% of the issued shares of the 57 foreign secondary-listed companies in its statistics, as it must in accordance with World Federation of Exchanges reporting guidelines.
Foreign companies listed on the JSE, such as BHP, Glencore, British American Tobacco, Richemont and AB InBev — soon to be joined by AngloGold Ashanti — account for more than 60% of the gross market capitalisation of the bourse, with the vast majority of their share trade, share ownership and other corporate activities happening on foreign soil.
Even the SA Reserve Bank Quarterly Bulletin quotes the rand value of equity issuances by JSE-listed companies as if it is an indicator of local economic activity. This is despite the exchange making no distinction between shares issued locally to local investors and shares issued by these foreign companies to foreign investors with no South African or JSE involvement.
This means the equity capital markets ecosystem that sustains the public market in South Africa has withered in plain sight and now survives on less than 40% of the local market. This is not only because there are so few new local listings and even fewer local primary capital raisings, but because the JSE’s own statistics, repeated by the SA Reserve Bank, have distorted the picture and suggested things are far better than they really are.
It was little surprise, then, to read the National
Treasury’s supine response to the debate about the JSE’s delistings crisis (FM, April 20 2023). The Treasury makes it clear that it does not believe JSE regulations are a barrier to new listings — and the JSE will probably agree. Most major stock exchanges have equally onerous listing requirements and all are in a regulatory arms race to remain competitive. The JSE’s reform efforts are part of this process. If its rules are out of line, they won’t be for long, and it is not more expensive than other stock exchanges. So there is nothing to fault here.
The Treasury goes on to suggest that listings and delistings are related to the interest rate cycle; it is just the relative cost of debt vs equity capital that determines their number and there is nothing to be done but to wait out the cycle.
This is the same “cyclical” argument used by a prominent institutional asset manager when it tried to explain away the “shrinking” JSE. And it is true that low interest rates can drive delisting activity, often through leveraged buyouts, and that companies may choose to borrow rather than issue more expensive equity on listing.
But what it doesn’t explain is why public markets in other countries, which have had far lower interest rates than
South Africa, have been able to attract proportionately more listings and primary capital raisings. Or why South Africa’s delisting trend has survived multiple interest rate cycles.
When the Treasury turned to the regulation and structure of the savings industry, the wheels came off its arguments and its slip began to show.
The Treasury offered a schoolboy howler when it suggested that listed companies, by reducing their shares in issue through buybacks, boosted shares prices, increased their index weightings and thus drove liquidity to these stocks. Was it suggesting, perhaps, that large company share buybacks somehow mop up available liquidity, thus reducing the attraction of listings for new entrants?
All else being equal, a share buyback increases share prices by no more than it reduces the number of shares in issue. A buyback, on its own, does not increase index weightings.
The Treasury also turned the fund “size effect” on its head. This effect is the phenomenon in which the
And it is true that low interest rates can drive delisting activity
The result is that big funds invest only in big companies
number of available investment opportunities decreases as a fund size increases. The result is that big funds invest only in big companies, mainly because they run into regulatory and liquidity issues if they own too big a stake in too small a company; and even a large stake in a small company makes no discernible difference to the performance of a very large fund.
The Treasury, however, disagrees, and says that if funds, in particular retirement funds, were further consolidated and increased in size, as is their stated policy objective, they will be prepared to take on more risk and invest more in smaller companies — supposedly because the membership base of the fund has been increased and diversified.
This is an interesting view but not one borne out by evidence. A cursory review of the holdings of large funds in South Africa shows that they overwhelmingly limit their investments to just the top 80 to perhaps the top 120 companies by size and liquidity. Not only that, the managers of large funds routinely publicly describe companies outside the top 100 or so as “uninvestable” on size and liquidity grounds alone.
The Treasury posits that there are no regulatory impediments to fund managers offering higher-risk funds that can invest in smaller companies, supposedly as an argument for why regulations are not the cause of the delisting problem. On the face of it this is true, as about 0.25% of collective investment scheme funds by assets under management are mandated to invest in small and midcapitalisation shares — a pitiful amount and hardly evidence of a resounding policy or regulatory success.
But what is more telling is that the Treasury’s default position is that institutions should invest in the smaller end of the exchange, ignoring the fact that direct retail investors continue to be discriminated against and discouraged by the Treasury’s own policies.
The Treasury suggests that funds’ shift to passive investment strategies drives investment into the large end of the stock exchange. This is also true, but why does it think the entire regulatory environment must relate to institutional funds and that there is nothing more to be done?
The Treasury’s arguments that there is nothing wrong with the regulations and therefore nothing to be done certainly serve the 10 large institutions which already manage 90% of savings in South Africa — and which, either individually or through their industry association, attend many meetings and other forums every year with the Treasury, as policymaker, and the Financial Sector Conduct Authority, as regulator.
On the other hand, it is not known if the Treasury has ever met with representatives of private investors or emerging companies looking to raise primary capital.
The negative inference here is deliberate, as it is hard to believe policymaking is not being influenced by large institutions to the inevitable detriment of the market as a whole. In fact, favouring large institutions appears to be the Treasury’s explicit objective as it tries to concentrate the retirement funds industry.
It has done that in the way it has forced individual investors to place any equity investments in tax-free savings accounts with institutional asset managers; and by ensuring pension fund and collective investment scheme taxation favours institutional investment over personal share portfolios, thus crowding out direct investment.
Equity markets that thrive and compete globally, such as the ASX in Australia, the TSX in Canada and AIM in the UK, are the product of thoughtful, active regulation where the interests of institutions are not allowed to suffocate those of the market.
There are multiple examples of regulatory interventions to support dynamism and activity in the smaller end of the market. They include the UK providing capital gains tax relief to investors on the AIM; Canada using tax-incentivised flow through shares to finance listed mineral exploration companies and Australia allowing self-managed superannuation (retirement) funds.
Many of these interventions have proven track records of success in encouraging wider market participation, new company listings and primary capital raisings. Generally, however, they do not enrich large institutional fund managers — and perhaps this may explain why they have not been tried in South Africa.
The JSE cannot hope to solve the delisting crisis on its own, and it appears to have failed to persuade the Treasury to take proven policy steps to help reverse the tide. It seems the JSE, historically one of South Africa’s great strengths, punching way above its weight in a small economy, does not have its policymaker in its corner.
It must be noted, of course, that the very institutions that dominate the SA savings industry are also the JSE’s biggest customers and collectively its biggest shareholder too. How assertive can the JSE be in its efforts to arrest its own delistings decline?
The trajectory is now clear: the JSE, having already all but ceased to be an effective venue where primary capital can be raised, will inevitably shrink to about 100 or perhaps 120 large, listed companies, most of which will be foreign businesses with very little presence in South Africa’s economy. They will be supplemented by synthetic listed products such as actively managed certificates and exchange traded funds. And South Africa’s institutional investment industry will continue to grow larger and fatter.
JSE, if you want to solve the delistings crisis you are well and truly on your own. Your policymaker, your biggest customers and your own major shareholders couldn’t be less interested in helping you solve the problem.