Capital market shake-up needed for inclusion of retail investors
Debt funding still remains inaccessible for a large number of collective investment schemes
Nowhere is radical change more desperately needed in SA than in the capital markets. The model that has dominated for more than 60 years is stagnant, with no broadening of the capital markets. It is also hopelessly skewed against the private investor.
The equity market is too concentrated and the debt market remains inaccessible and opaque. Despite there being nearly 1,300 collective investment schemes as well as many broker-managed discretionary portfolios, allocations are nearly all aligned to a limited number of old economy securities. Passive investment products such as index trackers simply compound the concentration.
Due to regulation and the structural funding imbalance between the capital market and the collective investment schemes industry, asset managers are in effect restricted to investing in securities with large market capitalisation.
It is therefore difficult for innovative (new economy) small and medium-sized companies to raise capital from asset managers. They need direct access to retail investors or bespoke asset managers who can invest in smaller companies.
It is anecdotally understood that on average less than 0.5% of daily market volume on the JSE is retail-driven. In contrast, retail volumes in comparable markets are multiples of ours. Put in perspective, there are understood to be less than 300,000 active retail clients, across all brokers, loaded within the JSE’s broker deal accounting (BDA) system.
ASSET MANAGERS ARE RESTRICTED TO INVESTING IN SECURITIES WITH LARGE MARKET CAPITALISATION.
Even if the number were closer to 1-million clients, it is woefully inadequate.
Stokvels, whose members are active savers and investors, have more than 2-million members. The Zion Christian Church has about 4-million contributing members. The potential size of the "uninvested" retail market is unknown, but I would suggest it is in excess of R700bn. The market system has ignored it.
But even if it wanted to include this market, it cannot feasibly do so. Brokers cannot execute low-value transactions profitably because of the excessive cost structures imposed on them by the JSE’s T+3 exchange model. Brokers need high levels of capital to cover client settlement risk, to pay for the use of the BDA system, and to receive live market data.
On the revenue side, asset managers have aggressively driven down institutional execution commissions to below 10 basis points to enhance the fund return (and hence the management fees that are earned). Brokers give way because they need the managers’ high value order flow to survive.
Nearly all equity listings are now done by way of private placement, which requires a minimum investment of R100,000 per subscriber. Offers to the public are rare as brokers cannot facilitate smaller retail client transactions profitably. With high costs and insufficient order flow brokers focus on providing discretionary managed portfolios, which attract higher fees but have higher financial entry requirements.
The "uninvested" retail investor is therefore totally excluded from directly participating in the capital market. Their only access is indirectly via a collective investment scheme that, if they did, would further perpetuate the shrinking of our capital market.
The concentration of order flows to fewer institutional brokers is detrimental to efficient and transparent market pricing. With thin net margins, institutional brokers use their balance sheets to secure revenue flow by engaging in principal trading, high-frequency trading (HFT), and facilitation trading, including dark pools.
Michael Lewis claims in his best-selling book, Flash Boys, that the stock markets are rigged, with HFT brokers skimming sizeable amounts off trades. He also alleges that exchanges offering collocation are in on the game to boost their own profits. In 2016, nearly 30% of JSE trading volumes and of trade value was derived from brokers that have collocated.
Exchanges providing collocation argue that they increase liquidity and pricing efficiencies. This argument may hold where multiple execution venues exist for the same securities, but not in a market with one venue and where liquidity in the Top 40 is guaranteed due to market concentration. Our market may have become less price efficient. While paying less in commissions, asset managers may not be getting great deals.
Only severe disruption will return the financial markets to any sense of reality and social relevance. That disruption has arrived. Brokers can now execute a R1,000 order profitably through a world-leading T+0 prefunded execution model that does not require settlement risk capital, in which trading and administration applications are provided at minimal cost and where live data is free to all.
The capital markets now have access to R700bn and listings of less than R100m will become more common. One has to ask why it has not been done before.
• Cook is ZAR X director and cofounder.