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Navigating Post Trade Complexities in SSA

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6 Sep 2022

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What are the main obstacles frustrating investors in Africa’s capital markets and post-trade infrastructure, and can these issues be resolved by the central securities depositories?

Tremendous effort has gone into improving Africa’s capital markets and post-trade infrastructure over the last few years, but it is clear from international investors and network managers that more work is still required, especially at the central securities depository (CSD) level. But what are the main obstacles frustrating investors in Africa, and can these issues be resolved by the CSDs?

A saturated CSD market exacerbates inefficiencies in Africa

Even though it is the largest and most mature economy in the world, the US only has CSD – the Depository Trust & Clearing Corporation (DTCC). In contrast, most African countries – including South Africa, Nigeria and Zimbabwe – despite their diminutive financial clout relative to the US – have multiple CSDs operating independently of each other within each of their respective markets.

Oftentimes, there will be a CSD settling conventional equities in addition to a CSD located within the country’s Central Bank responsible for government debt or securities. While competition is normally a good thing for capital markets, a plurality of CSDs within the same country exacerbates fragmentation and causes problems around interoperability, creating confusion for foreign investors.

This abundance of CSDs in individual emerging and frontier markets is not well positioned to establish a firm foundation for growth in foreign portfolio investment inflows.  Reducing the number of depositories will improve the commercial strength of the local depository businesses, reduce operational complexities for investors and improve the competitiveness and efficiency of African capital markets.

Opprobrium about fees continues to intensify

Battling rising costs and falling margins, international investors are becoming increasingly sensitive to the charges being levied on them by service providers and FMIs (financial market infrastructures), including CSDs. A handful of CSDs in Africa – most notably South Africa’s Strate – have come in for heavy criticism for increasing their fees during this difficult macro period. CSDs across the region are implementing varied diversification strategies. Successful diversification is expected to increase scale for the infrastructures and potentially arrest the cost creep for investors.

However, some experts are defending the decision by CSDs, including Strate, to recalibrate their fee structures. The CSD business is one that is ultimately built on scale and volumes, and this correlates with the fees they charge. To summarise, CSDs that operate at greater scale are able to offer lower fees, and vice versa.

The challenge facing South Africa is that the market has been struggling over the last five years with poor economic growth, stagflation and a proliferation of de-listings, meaning there is limited scope for Strate to acquire the scalability it wants. Despite its best cost cutting efforts, there is still a need for Strate to invest into its systems and technology, so as to give foreign institutions comfort when investing in South Africa.

Accordingly, CSDs such as Strate have little option other than to increase their fees, if they are to be sustainable and ensure their operations adhere to market best practices.

Dual account structures frustrate investors

Dual account structures remain pervasive in a handful of African markets – most notably Nigeria, where they have been around since the inception of the Central Securities Clearing System (CSCS), the country’s CSD for listed equities.  Dual account structures have repeatedly faced from foreign investors, who see them as being excessively risky, mainly because they require custodians to move shares to brokerage accounts ahead of the cash being received.

So what is Nigeria doing about this?

Conscious of the emotions dual account structures elicit among foreign investors, local market participants are working diligently to improve best practices in this area.  The CSCS and Nigeria Exchange Group – together with custodians and brokers – are engaging directly with Nigeria’s Securities and Exchange Commission (SEC) on proposals to remove dual accounts and replace them with a single account model for clearing and settlement.

However, transitioning to a single account approach is not a process that can be done overnight, and would need to factor in some of the intricacies synonymous with the Nigerian market – including the impact that such a change would have on the capitalisation of brokers and how the no-fails settlement logic will be supported by the technical, legal and contractual framework in the market.

CSDs look to future proof themselves

In order to future proof their businesses and offset cost pressures, CSDs are looking to diversify the services which they offer. This is especially true for Nigeria and South Africa where trading and settlement volumes have been quite flaccid.

Strate for example, is currently exploring whether it can service a wider range of asset class types, including unit trusts, something which the CSD says can be achieved by leveraging its existing technology stack. Other providers are looking to capitalise on data, by sharing pre and post-trade data with clients, allowing them to obtain useful insights into their operations.

In addition to delivering new products to clients, CSDs are also looking for ways to generate synergies in their operations, most notably through better automation.

While some countries – including the US, Canada and India – are shortening their settlement cycles from T+2 to T+1, African markets are currently adopting a more cautious approach. The CSCS notes that while T+1 is potentially advantageous (e.g. reduced settlement and counterparty risk will correspond to lower margin requirements facilitating liquidity optimisation), it also introduces other risks (i.e. FX risk, pre-funding, etc.), and these need to be discussed with the wider market before any changes are implemented.

CSDs look to the future

CSDs in Nigeria and South Africa are facing some challenging headwinds, while a number of global investors have made their disapproval very clear about some of the regional FMIs’ pricing models and ongoing use of dual account structures.  Nonetheless, these local markets do face their own unique difficulties and complexities, which can make change difficult to enact.

Despite this, local regulators in both markets have demonstrated a willingness to embrace reform, a point reiterated by some of the CSDs in Nigeria and South Africa. This should put both markets in a good position in terms of attracting foreign investment moving forward.