The thick of it: Stockbrokers are now becoming the focus of more regulatory attention

Some of the hardest hit players during the 2008 crash, stockbrokers now look set to experience major regulatory changes in the coming years. Alongside stricter oversight and higher capital requirements from the Securities and Exchange Commission (SEC), the Nigerian Stock Exchange (NSE) is upgrading its trading platform and spinning off its post-trade settlement mechanism to allow for greater transparency and more efficient trading. Should these reforms succeed, the effect on the brokers’ market will be significant and could open acquisition opportunities for both foreign brokerages and local institutional investors.

A FRAGMENTED PAST: With some 312 registered broker-dealers and 28 member-issuing houses in June 2012, Nigeria’s stock market remains fragmented at first sight. The heyday of trading post-banking-sector consolidation to 2008 brought increased interest from domestic institutionals (mainly banks) and high net-worth retail investors, broadening the brokers’ market. A total of 14 electronic trading floors were established by the end of 2011. Yet despite this huge number of players, the top 10 brokers accounted for 53.58% of total volumes and 67.01% of total value traded in the first seven months of 2012. As foreign portfolio investors accounted for 81% of turnover in 2011 (and roughly the same in 2012), those brokers with strong connections to foreign fund managers tend to dominate. “The biggest brokers on the market are those with good distribution networks and strong proprietary trading desks, which appeal to foreign fund managers,” Wale Agbeyangi, the managing director of Cordros Capital, told OBG.

TOP OF THE PACK: Two foreign-linked brokerages – Renaissance Capital (RenCap) and Stanbic IBTC – have dominated trading in recent years, alternating between the first two places in terms of market share. RenCap, the Russia-based emerging markets investment bank, has become the top broker in the first half of 2012 with some 19.76% of average turnover, dedicating significant resources to the Nigerian market since early in the decade. Stanbic IBTC, majority-owned by South Africa’s Standard Bank (itself 20% owned by Industrial and Commercial Bank of China, China’s largest bank), is a fully fledged investment bank controlling a commanding share of equities, fixed-income origination, trading and pensions funds.

Behind the two emerging market brokers, with a 10% gap in market share, a number of players hold between 2% and 8% share of daily trades. While top-tier banks like GT Bank and First Bank compete in this space, a number of independent brokers like Cordros, Chapel Hill, ARM and CSL have gained a sizeable presence by holding large foreign portfolios, with a strong relationship with local banks and, increasingly, pension fund administrators (PFAs). While the top brokers have long held to this discipline in order to sustain their foreign inflows, wide variations in terms of conduct and solvency have characterised the lower end of the market. Quite often the smaller brokers maintain little or no research capacity, leaving them open to poaching of sales staff and traders. Brought to light during the 2008-09 margin loan scandal, structural weaknesses are being addressed by regulators.

BIGGER & BETTER: Starting in 2009, the SEC has regularly published “name and shame” lists of rule infringers in a bid to instil more compliance with established rules. In 2012 the SEC was moving to implement new rules requiring N70m ($448,000) in net, rather than gross, capitalisation.

Only 30 brokers met the higher capital requirement by the close of 2011, and the deadline for compliance was delayed to later in 2012. “I don’t think we necessarily need to raise capital requirements for brokers,”

Agbeyangi told OBG. “It may be more constructive to set minimum requirements in terms of infrastructure, perhaps instead mandating a set number of Bloomberg terminals or research teams for instance.”

Meanwhile the Central Securities Clearing System (CSCS), originally an NSE department now spun off into a public company, is making moves towards more transparency in post-trading settlements. To crack down on the potential for insider trading, CSCS now requires all initial public offering bids to be treated equally and requires all traders to use tokens, allowing for better tracking of transactions, and obliges daily settlements and timely payment of dividends. This has already reduced or eliminated unauthorised inter-member transfers amongst brokers.

MARKET MAKERS: In a first step towards introducing short selling, the SEC appointed 10 market makers in April 2012, setting their minimum capital requirements at N570m ($3.65m). These included two bank subsidiaries, Stanbic IBTC and FBN Securities, and eight independents – Renaissance Capital, Greenwich Securities, CSL Stockbrokers, WSTC, ESS/Dunn Loren Merrifield, Future View Securities, Vetiva Capital and Capital Bancorp. The aim is to inject new liquidity by allowing market makers to manage portfolio and trade risks by mapping open positions, borrowing and lending stocks, and through collateralised obligations. A key step is due in 2012 when a ban on borrowing and lending securities is lifted.

While the top incumbent brokerages are preparing for increased competition, the regulators expect that the launch of new products like exchange-traded funds (ETFs) and derivatives, as well as an upgrade to their systems, will attract new liquidity to fewer, but more solid, brokers. Should PFAs become the largest institutional investors in equities in coming years (as envisioned by new pension fund investment rules), local brokers’ market share could grow further as the domestic investor base develops to rival foreign flows.

DEBT OVERHANG: A continuing source of concern for brokers stems from the debt overhang that resulted from the margin loan crisis of 2008. As banks called in their margin loans to brokers in 2009, these often exceeded each of the affected brokers’ total equity. Banks sold their margin non-performing loans to the Asset Management Corporation of Nigeria (AMCON), but brokers are still indebted to AMCON. While stakeholders fretted about the potential moral hazard created should the loans be written down, brokers have argued that banks should provision for some of these loans given their culpability in exceeding their margin lending caps. A total of 90 brokers were said to be affected by such debt overhang in mid-2012. The NSE has also called for capping margin debt losses at 100% of brokers’ collateral in a bid to resolve the overhang, which would see most brokers liable for a maximum of just N70m ($448,000).

In July 2012 the Federal Ministry of Finance announced plans to restructure the debt overhang under a planned “forbearance package” for brokers, although details of the scheme have yet to emerge. The aim is to write down the debt to manageable levels in a bid to entice brokers to adopt more aggressive trading strategies and improve liquidity within the market. The measure would also alleviate the counterparty risk of troubled brokers for foreign fund managers. With new rules on bank margin loans to brokers capping such credit facilities to a maximum of 10% of total lending and bringing provisioning for margin loans in line with traditional loans, this package should also work to return the market to health.

NEW GEAR: Technical changes will also have their impact on the brokers’ market, forcing higher standards and more sophistication to take advantage of the opportunities of more efficient trading. While the NSE has been automated for decades, the legacy of old technology and the fact that trading is driven by prices rather than quotes has hindered the exchange’s development. The exchange is thus undertaking its first major technical upgrade in a generation. During 2012 it is investing $10m in a new trading platform, the NASDAQ OMX X-Stream. In the first quarter it has already set up the first virtual private network for brokers (called X-Net), offering high-performance, high-capacity, low-latency and low-cost architecture for trading from brokers’ offices.

The CSCS is also upgrading its systems in 2012 and 2013, prequalifying bidders to migrate platforms from the old Equator system and implementing new internal systems to match the NSE’s trading platform upgrade. By 2013, the CSCS expects to reduce the trade settlement cycle from T+3 to T+2. “This will automatically increase liquidity by one-third, which of course is good for the sellers and less good for the buyers,” Kyari Bukar, the CEO of CSCS, told OBG. The new trading platform will allow for electronic transactions in real time, which will open the doors for high-frequency trading. Here capacity in the trading and post-trading settlement systems is key, since capacity to deal with high volumes of orders will ensure timely execution of trades demanded by high-frequency traders.

The CSCS is also in discussions with counterparts in over 12 African countries like Ghana and Kenya to establish Africlear, on the model of Euroclear, to allow for more efficient and rapid settlement of cross-border trades. This will become more significant in coming years as the number of ETFs multiplies on the exchange, and cross-border listings increase as well.