This article first appeared in Brainstorm.
For the better part of a century, the JSE ruled the corporate seas. This was the default venue for any company seeking capital to grow. A JSE listing was – and still is – a badge of corporate achievement. To get there, you must surmount an Everest of legalistic and regulatory tick boxes. The prize is public visibility and a ready market for your shares.
If the JSE built the best mousetrap out there, why would two new exchanges come along to steal its cheese? But that’s exactly what A2X and ZAR X are doing.
Both exchanges have been established because their founders believe there are inherent distortions in SA’s financial landscape. For example, retail investors in SA account for less than one percent of all trades on the JSE. The big funds and investors are doing all the trading, so the pricing and market systems are skewed in their favour. High transaction costs and lack of accessibility are two reasons why retail investors choose to acquire shares through Collective Investment Schemes (CIS) rather than directly on the exchange.
Here’s another problem with the current picture: these managed funds are all massively invested in a pool of about 40 old economy stocks. Smaller, newer companies just don’t get a look-in from those with the funds to invest.
Notwithstanding its monopoly, the JSE recognised that without modernisation, capital would flow to more congenial markets where trade was quicker, cheaper and less risky. So it pumped millions of rands into new computer systems and revamped its listing rules to match the very best in the world. It launched new products, such as stock futures and options. For a country that generates around one percent of the world’s gross domestic product, the JSE punches well above its weight, and for many years has ranked among the top 15 largest exchanges in the world.
Enter the newcomers
A2X and ZAR X are two startup exchanges challenging the JSE’s monopoly. They expect to grow rather than cannibalise the existing market for share trading in SA. Not that either of them is anywhere near toppling the JSE from its lofty perch. In January 2019, the JSE clocked up trades worth about R700 billion.
A2X currently has 17 ‘counters’ on its exchange, and last year generated about one percent of the JSE’s trade value. But CEO Kevin Brady expects to grow this share to between three and five percent in fairly short order. A2X’ technology is licensed from Aquis Exchange, which was launched in 2013 and now accounts for five percent of all European stock trades.
Unlike the JSE, A2X isn’t a market for raising capital. It’s appealing to companies already listed on the JSE to allow ‘secondary listings’ on A2X, where transaction costs are roughly half that of the JSE. In practical terms, A2X will charge about 0.49% of the transaction value, against the JSE’s average of about 1.2%.
The arrival of A2X means traders and investors have an alternative market for shares such as Naspers, Standard Bank, AVI, African Rainbow Minerals, Sanlam and Growthpoint.
The rate of adoption by JSE-listed companies is accelerating. Once marquee names such as Naspers, Standard Bank and Sanlam announced secondary listings of their shares on A2X, scores of others started showing interest.
“Our offering for investors and brokers is our low transaction costs, which we’re able to achieve through technology and innovation, and we pass on these savings to the users of our exchange,” Brady says.
A2X now has a total market capitalisation of about R2 trillion, and is attracting interest from big players such as high frequency traders, quantitative funds that use complex statistical techniques to trigger buys and sells, and liquidity providers that generate profits by buying and selling stocks when demand is high.
One of the challenges A2X had to overcome was to convince brokers – the lifeblood of any exchange – to invest in smartorder routers that check prices and execute trades across multiple markets in microseconds. Should Naspers’ price on the JSE deviate from A2X momentarily, buyers will quickly snap up shares on the cheaper market. To participate in A2X, brokers also need to upgrade their front-end systems to allow trading across multiple markets, and this means further training for staff in brokerage houses. Post-trade systems also have to be upgraded to allow for the clearing of trades executed on A2X. Clearing and settlement involves the transfer of money for shares between buyer and seller, and this is undertaken over a three-day period.
Fast and frequent
“Speed is vitally important when you’re trading in multiple markets,” says Brady. “This is why brokers need to upgrade their systems to optimise their trading opportunities.”
One area where SA lags other countries is financial regulation. As things stand, A2X needs the permission of companies to trade stocks on its market. In other countries, no such permission is required. The Financial Markets Act is currently being amended to remedy this. Once that happens, A2X will be free to list any stock it wishes.
The launch of ZAR X in 2017 was a watershed in SA’s financial markets, marking the arrival of the first competitor to the JSE in 58 years. It’s the only fintech in SA operating as a stock exchange – and the only one focused on enabling financial access and inclusion. The exchange has some heavyweight endorsements, including from the Public Investment Corporation (PIC), which bought into ZAR X. The PIC’s head of corporate affairs, Deon Botha, says the transaction provided the PIC with an alternative platform from which to trade and list companies. It should also accelerate transformation of the financial system. “We believe that transformation of this industry is necessary if we’re to realise our long-term objective of achieving real and tangible inclusive growth,” he says.
Unlike A2X, ZAR X is both a primary and secondary exchange – meaning it facilitates the raising of capital through the issue and sale of shares, and the subsequent trading of those shares on the exchange.
ZAR X currently trades three stocks – Senwes, SenwesBel and TWK – all of them, coincidentally, in the agricultural sector. The first two were listed in February 2017, and were adopted when orphaned by the then Financial Services Board, which strangely declared war on the lightly regulated ‘overthe- counter’ market.
“We saw a gap in the market for an alternative to the JSE, which is heavily focused on institutional investors,” says ZAR X cofounder Geoff Cook. “The relative size of funds managed by institutional investors forces them to focus on large companies to the relative exclusion of small to mediumsized companies that have found it difficult to raise capital. We need to look for a new pool of investor capital and therefore wanted to bring in more retail investors to offer a listings platform for companies looking to raise capital and gain exposure to the broker market. Our aim was to afford retail investors with as little as R1 000 the opportunity to buy into successful companies. To do this, you have to offer very low transaction costs with zero monthly fees.”
On average, brokers will require a balance of at least R50 000 to open a trading account, with some brokers requiring a minimum investment of R3 million, which means the vast majority of South Africans are excluded from opportunities for growing wealth through share investing. The JSE has had a patchy history in attracting small and medium-sized companies to the exchange, in many cases because of the high costs of listing and administratively heavy listings regime. ZAR X has slashed its listing costs to make it more attractive for companies to gain exposure to the exchange and has adopted a paperless principles-based listings regime.
ZAR X has a number of other advantages over the JSE. All trades are pre-funded and pre-cleared, meaning the accounts of both the buyer and seller are checked beforehand to ensure they have the cash and the shares to trade with each other. This means transactions are cleared and settled in seconds, rather than the three days it typically takes at the JSE. Information is also free, which means brokers can transact low-value transactions profitably. Then there’s the ZAR X Mobi app, which enables South Africans to open a trading account and trade from their smartphone.
By using technology to slash transaction costs by up to 80%, ZAR X enables small and medium-sized companies to list alongside large corporates, and that potentially represents a huge step forward for raising capital in SA.
The costs of listing a company on ZAR X are substantially lower than on the JSE. “We want companies of substance, but our rules are issuer-friendly. In other words, we make it easier and cheaper for companies to get listed. For example, you don’t need an exchange-approved sponsor to list on ZAR X, which can be a major obstacle and cost for companies seeking access to the capital markets,” says Cook.
Although there are just three listings at present, the pipeline is full of interesting opportunities. Another three or more listings are planned for the first half of 2019, but this is likely just the start of a major ramp-up. Tax legislation was recently amended to allow for the listing of Real Estate Investment Trusts (REITs) on exchanges other than the JSE, and another possible addition to the exchange is the listing of registered CISs, of which there are roughly 1 500.
Then there are so-called 12J (under the Income Tax Act) venture capital investment vehicles that offer 100% tax deductibility if the investment is held for at least five years. For individuals paying the top marginal tax rate of 45%, the tax deduction can be claimed in the year the investment is made, so a R1 million investment into a 12J company effectively costs just R550 000. None of these 12J companies have yet been listed because of the regulatory difficulty in restricting investment to qualifying individuals and trusts. That problem has been solved by ZAR X, says Cook.
ZAR X CEO and co-founder Etienne Nel says it’s the only exchange in SA capable of imposing 12J-specific trading restrictions on a realtime basis. “This means that venture capital companies have tight control over investor activity and can, therefore, maintain compliance.
“Nowhere is radical change more desperately needed than in the capital markets,” adds Nel. The model that has dominated for more than 60 years is stagnant, with no broadening of the capital markets. It’s also hopelessly skewed against the private investor.”
A2X and ZAR X employ about 12 people each, and have hitched their business success to cutting-edge technologies that have started to get them noticed in the broker and investment community. The JSE has been around for more than 100 years, so perhaps it’s time for some new blood to bring excitement and disruption to the financial markets.