The South African securities lending market is modest in size but can offer rich pickings to those willing to enter a market that might seem quite alien to institutional European or US market participants.
James Burgess, chair of the South African Securities Lending Association (SASLA), explains: “The South African market isn’t as deep or sophisticated as we would like at the moment, but we are working hard to change that. To put it in context, for Europe and the US, general collateral runs at anything between 10 and 20 basis points (bps), but in South Africa it’s 40 bps.”
“From a European point of view, we look twice as lucrative, but if you look at the market and what’s actually out on loan, it’s not huge. SASLA members only make up about 10 lending desks, working with just under $10 billion of fixed income and equity,” Burgess explains.
In terms of overall value of South Africa’s securities lending market, FIS Astec Analytics’s data shows the cyclical nature of the market’s on-loan volumes month-to-month. This year marked a turning point in the market’s trajectory with overall borrowing value dropping steadily from roughly US $3.8 billion in October 2015 to around $1.8 billion at the end of December.
The new year saw borrowers return to market, driving market value back up to around $5.4 billion in mid-April, before calming to bob between $2.8 and $3.1 billion throughout early June.
Re-joining the pack
The securities pool is shallower and the number of market participants is smaller than those of the EU and North America, but the biggest differentiator between South Africa and other regional markets is the perseverance of the T+5 settlement cycle—but that’s is all about to change.
As of midday on 11 July, the Johannesburg Stock Exchange (JSE) will put years of preparation into practice and initiate a long overdue market overhaul to bring South Africa’s market back into step with the US T+3 cycle (at least until Q3 2017 when the US shifts to match the EU’s T+2 standard), which could prove a catalyst for future growth in the region by creating a more familiar market environment to outside investors that could diversify and expand markets such as securities lending.
South Africa is the last country still operating on a T+5 basis, including other emerging markets, and that needs to change if its financial markets are going to remain competitive.
The JSE’s move to T+3, which is mandated by the Financial Stability Board, is primarily aimed at making the South African financial markets, including securities finance, more easily accessible and attractive to investors in the long-term, but there is also the immediate advantage of removing the last barrier holding back South Africa’s global benchmarking.
South Africa is ranked 56 out of 144 countries on the World Economic Forum’s Global Competitiveness Index 2014 to 2015, a slip of three places from its 2014 to 2013 rank, which was out of 148 countries. Furthermore, the T+5 settlement cycle is the final barrier holding back South Africa’s standing on the FTSE requirements for an ‘advanced emerging market’.
In a presentation given by the JSE on the initiative, the exchange cited increased liquidity through improved collateral velocity and rehypothecation and reuse options, along with allowing margin to be called earlier in the cycle, as key reasons to push ahead with the move.
Reducing the number of trades outstanding will also reduce settlement exposure and mitigate credit risk and systemic risk.
Given the combined weight of these reasons to make the transition to T+3, the JSE must have a significant counterpoint to delay such a move, and it does: fear of forcing more fails.
Brett Kotze, head of operations for clearing and settlement at the JSE, outlines the exchange’s current commitment to minimising market fails, stating: “The JSE provides settlement assurance to all trades done on the central order book of the exchanges system subject to price discovery.”
Kotze explains: “In T+5, we have a rolling contractual settlement methodology, which means each business day is a trade day and a settlement day. The contractual basis, is that a client trading on the JSE is contractually obliged to ensure settlement takes place. When moving to a T+3 settlement cycle, the same thing applies, except it is a shorter settlement cycle.”
The main risk of shrinking participant’s settlement window by two days is increased risk of market fails. Part of the solution to avoid this scenario, according to the JSE, is boosting the securities lending industry.
In the same presentation, the exchange highlighted the need to increase securities lending and borrowing in order to boost liquidity and ensure the conclusion of settlements.
Burgess, commenting on the regulator’s timing to improve South Africa’s settlement cycle, said: “It is our understanding that they have made the conscious decision not to be the first mover, although not to be the last one either, when it comes to regulation. This method allows us as an industry to learn the lessons from Europe and the US before deciding upon our own framework.”
“We are happy to be led by the G20’s Financial Stability Board. We are a G20 signatory so we have to apply its rulings—but maybe not be first. Having said that, for our industry we feel that the European Securities and Markets Authority is the most vocal body and so naturally we are more inclined to look to Europe to get an idea of market trends and regulation than we are the US,” he added.
In a few weeks, South Africa will leap forward to re-join the modern market after years of deliberations and testing and the country’s securities lending industry has the chance to play a pivotal role in the modernisation of the wider financial market.
The JSE and SASLA, along with other financial institutions, have been doggedly working to coach the country’s market participants to a point where they are ready for the shorter cycle. The exchange specifically has been engaged in an ongoing campaign over several years to educate its market on all essential areas necessary to make this move a success. Now, on the eve of one of the biggest market overhauls in recent years, the mood on the ground is one of confidence.
Kotze concluded: “The JSE firmly believes that the market is ready to move to T+3. All that remains is finalising the deployment of the T+3 code.”