By Victor Ogiemwonyi
Two recent proposals are being discussed at the Nigerian Stock Exchange (NSE) with brokers and regulators that have far reaching implications for the market that will also have a revolutionary effect on investor confidence and trading at the Exchange.
Straight Through Processing (STP)
The first; is the proposal to migrate to a modern platform of Straight Through Processing (STP) which is designed to eliminate settlement risk and ensure that all trades settles cash versus securities. In other words, there will be no failed trade and all trades ideally will settle same day.
The most important feature of this will be that all cash settlement will go straight to Investor bank accounts, thus eliminating once and for all, the nagging issues of rogue brokers, who sell their client’s shares without authorization.
This has been a major confidence issue with some investors in the past and has contributed to labeling all brokers as fraudulent even though, the records show that the brokers involved in these condemnable acts are few and far between. The fact that this can happen at all, is reason why a solution like this is desirable. Implementation of this proposal will also have other positive implications.
For example, the requirement for Investor bank accounts that will be tied to a CSCS account for every investor will enhance the ‘Know Your Customer’ ( KYC) rule, as it will be another check for knowing who the account holder is. It will eliminate mystery investors who launder money through the stock market. Since all bank accounts receiving money from stock market trading can be traced to match CSCS accounts of owners. This has been a major omission in the past.
No one can open a brokerage account today in any advanced market, without a corresponding bank account to keep records of the inflow and outflow of cash.
There is also the added benefit to stock brokers, as it will eliminate customer payment duties in their back offices, leading to more efficient back office operations that are a major challenge for small broker offices that currently rely on manual processes that is fraught with errors and delays, with the attendant client dissatisfaction.
The resulting back office efficiency will enhance broker income and allow focus on the more important aspects of their functioning in the market.
The combined benefits of implementing the program and the expected results will instantly increase trading volumes and investor confidence which should translate to liquidity.
The New York Stock Exchange when it adopted STP in 1995, after a 203 year history ushered in a new era with automated trading of this type and shortened processing time witnessed huge volume increases, we expect the same to happen here.
Interestingly, implementation will have minimum disruption, since all that will be required will be for clients to submit their bank accounts to their brokers who will cross check their validity with the banks.
Expanding the current trading band
The other proposal on the table is aimed at improving trading economics by expanding the current trading band. I see this as another forward looking proposal likely to move the market forward quickly.
Many analysts have questioned the rationale for limiting the price movement to a daily plus 5% up and minus 5% down and have called for its elimination. That view in my opinion is drastic, and may bring about volatility that we may not be able to manage. The new suggestion to move gradually by upping the current position to plus 10% up and 10% down has my support. There is no doubt that the current low volume of trade and sluggish upward movement of prices means no profitable trades can take place.
Even though average daily volume has increased since the crash of 2008, the price decline has meant average trading value has remained below 2007 and 2008 levels. This has affected Broker/NSE revenues. By widening this trading band, we will see increased activity as investors will be more willing to trade their accounts.
This will also dramatically improve liquidity and provide a basis for the current stabilized market prices to appreciate more steadily and give room for faster correction of bubbles when they appear as investors and brokers trade to take profits quicker and correct market imperfections in stock prices.
Last word on margin guidelines.
The margin guidelines jointly provided by the Central Bank of Nigeria and the Securities and Exchange Commission seem to be an overreaction that will quickly and definitely produce the bubble in share prices in the new future corrections are not made before implementation. This will be contrary to what their objective of avoiding another market bubble that can lead to a crash.
First, they want all bank stocks eliminated from margin lists for margin financing purposes, a situation that affects 60% of market capitalization, then they want a 50% maintenance limit and then 10% market cap on exposure to margin lending within banks portfolios. While some of these are best practices, like the 50% maintenance limit, concentrating margin financing to only 40% of the market may actually provide us with the situation where the most liquid of these 40% are the only stocks banks will agree to finance, leading us back quickly to bubble prices.
The second half of the year 2010 has already provided us with evidence of what is likely to happen, second half volume is lower than the first half for same period last year. Total returns for the year have declined from 30% at peak, to less than the current 15%.
The advances/decline ratio is also reduced, while cumulative volume for the year which was looking promising to exceed 2009, is now weakening and may barely match 2009 levels. I think the appropriate thing will be to use percentage guides, for example no margin financed portfolio should carry more than 25% bank stocks. This is important, because the liquid stocks to achieve 50% maintenance are mostly bank stocks.
There is also the need to fast track introduction of the margin list as this will give clarity to this aspect of the market and reduce panic selling. Finally, the market needs to be sensitized to the technical details of how margin accounts work, and how it will operate under the new guidelines.
It should be clear that margin accounts are an important part of the market. The problem was not margin account themselves, but the operation of the margin accounts.
Victor Ogiemwonyi is the MD/CEO of Partnership Investment PLC, Ikoyi Lagos.