Sunday, April 15, 2012 /Festus AKANBI, THISDAY
Reactions have continued to pour in over the selection of 10 market makers by the Nigerian Stock Exchange to enhance the flow of liquidity in the equities market. But analysts contend there are still more hurdles to cross, Festus Akanbi reports
In what has been described as the most recent pragmatic attempt to deal with the progressive bear run in the stock market, the management of the Nigerian Stock Exchange a fortnight ago released the names of 10 market makers licensed to provide liquidity for the market and support efficient flow of the market.
Expectedly, the selection of the market makers has rubbed positively on the market, translating to a corresponding rise in investor appetite for stocks during trading and the attendant improvement in the market's benchmark All-share Index and market capitalisation in the past two weeks despite the public holidays.
The 10 stock broking firms selected from a list of 20 that applied are: Stanbic IBTC, Renaissance Capital (RenCap), Future View Securities, Vetiva Capital, ESS/Dunn Loren Merrifield, WSTC, Capital Bancorp, FBN Securities, Greenwich Securities and CSL Stockbrokers.
Market makers are companies selected, registered by the Securities and Exchange Commission and licensed by NSE to make markets in selected stocks in the equities market. By this, the market maker for any company's stock will see to it that the stock is always vibrant in the market. This means that when the stock over floods the market, the market maker will mop up the stock and offload in times of scarcity.
The action of market makers will continuously provide a buffer for the near crash of the market.
The approval of market makers was accompanied by the selection of a basket of quoted companies in which the approved market makers are expected to provide liquidity. Each appointed market maker is allotted a basket of 20 exclusive stocks and in addition, the NSE shall in conjunction with the Central Bank of Nigeria explore the possibility of the settlement banks that will provide funds to the market.
According to a report by BGL Plc, market makers are also expected to stand ready to sell, even if they have to borrow any stock in which they are making market no matter the volume demanded. In this way, market makers support efficient flow of the market by providing underlying liquidity for buy and sell transactions in quoted securities.
According to the NSE's CEO, Mr. Oscar Onyema, “This is a great milestone and a major step in the direction of turning the market round to have liquidity and depth back into it.”
Continuing, he said, “The companies selected went through a very rigorous process and met the minimum net capital requirement of N570 million. We also examined their compliance history and looked into their operational capabilities including their technology and processes.”
A market source, who was not surprised at the decision to unveil the market makers, told THISDAY off the record that the regulatory authorities had no choice but to step in to turn around the market's fortunes. According to him, the fact that the market was no longer responsive suggested that liquidity was in short supply.
“Since there was a problem with liquidity and since a lot of operators had said that the problem of the market was lack of liquidity, there was need for something to be done to shore up liquidity in the market. This brought the regulators to the resolution that market makers would be the answer to the problems,” he said.
Since the 2008 stock market decline, regulators have been trying to lure back investors to the stock market, and they hope that the move to ease pension fund restrictions could provide the much needed fillip. The main all-share index has gained just two per cent this year, after a 16 per cent drop last year.
Industry watchers were therefore unanimous that some kind of intervention was need in Nigerian equities market now more than ever because stock prices that had bottomed out were still dipping below their quotation levels. They held the view that most investors in the market are swing investors not prepared to take long positions on the market.
They noted that stocks had fallen so low that the price attraction was no longer a consideration.
According to an industry operator, “When the market becomes bullish, investors will develop confidence with the market. The foreign investors that deserted the market at the time the meltdown was biting hard will negotiate a return. And the economy will be the better for it as the equities market is the barometer for measuring any economy.”
Justifying the optimism shown by the selection of the market makers, managing director, Financial Derivatives Company, Mr. Bismark Rewane said their appointment would “increase activity level and reduce the slack in the market.” He explained that there are some stocks which were not patronised in the past because people didn't have the money to invest in them.
“It will reduce the level of inefficiency, improve the recovery process and create a bottom,” he said, adding that the appointment of market makers will be supported by a short selling product which, he described as the next process although it has not been approved yet.
In response to THISDAY enquiries last week, managing director, Vintage Wealth Management Limited, Mr. Idowu Ogedemgbe said, “The introduction of market makers on the Nigerian Bourse, which I think is long overdue, should help to enhance trading activities and the liquidity of most of the stocks quoted on the NSE.”
He believed that the anticipated turnaround however depends on the expected restoration of investor confidence and increase in mandates from institutional investors, pension fund managers, offshore endowment funds and portfolio managers.
“Equally critical for the success of market making in the equities market is the ease and cost at which market makers will be able to borrow shares in order to meet client purchase mandates when they don't have the shares in their inventory.
“It is also important that the infrastructure, structures and the processes necessary for the effective running and monitoring of the new regime is first put in place. The risk management protocol and crisis recovery mechanism among the operators should be well monitored and supervised by the regulators to prevent another prolonged market downturn due to undue exposure by the operators,” he said.
In his assessment, chief executive, GTB Securities Limited, Mr. John Ogar added, “The market makers are expected to provide liquidity in their allocated basket of stocks during intra-day auctions, via a two-way quote system of bid/offer prices. This way, it is to be expected that there will always be a market in the equities, unlike the present system whereby some stocks may remain illiquid or no trade may be done on them for long period of time.
“Sometimes, some stocks are trading in one direction, that is, it may be on offer for a prolonged period of time, without any bid and no trade being done on them. With the coming of market makers, this trend is expected to be reversed as they will always be a two-way quote by the market maker so that those who want to sell can have their offers matched with a buyer - the market maker. This should impact the equities market positively, and stem panic selling by investors.”
…But Concerns Persist
However, in his assessment of the introduction of market markers in the stock market, the chief executive of a market research firm, who spoke on the condition of anonymity, explained that the 10 market makers would probably account for about 65 percent of the entire transactions in the market, led by Renaissance Capital.
“On the face of it, this makes sense yet the point must be made, and a crucial point at that - market makers are valuable when the market is liquid - that is, they must be able to look at the primary market as a guide for actions in the secondary market.”
The question, he asked, is where is the liquidity? “Now how is it possible to have market makers in a shrinking secondary market as the sentimental analysis for Q1 2012 produced by a Lagos-based investment company, Proshare revealed?”
He maintained that in a market where there are no new issues, market makers can only have a minimal impact.
“What is the volume traded, what is the level of transactions in the market, who are they going to market? Secondly, the financials, that is, fundamentals that guide the decisions must be supported by sanctions against profit forecasts failures or financial information incongruence, inside related trading, etc.
“Unless we bring in liquidity, by way of share buy-backs to release funds or we pass a capital formation bill to create a growth-inclusive economy that brings more of the economy into the market; in the absence of new issues for the last three years... I am uncertain as to the attraction for banks to fund the risks inherent in market making.
“How many units of Nestle Plc or Total Plc shares are tradable as at today. Take Dangote Cement Plc which accounts for approximately 21 per cent of the total market cap, for example, where is the float to trade in? Secondly, if a bank stands as a liquidity provider, is that not a conflict with what the CBN sought to draw a distinction?
“Also, the practice of 'naked' borrowing, that is, the ability of a market maker to go and shop for a particular stock by say, 'creating shares that do not exist' is an area loaded with mines and serious risks. How do we treat dividends and bonuses? Is it possible to take over a company through multiple orders with more than one market maker? How does this provision sit with our CAMA?”
He said that his research firm was still conducting a detailed scenario analysis and would be able to issue a research paper on this aspect of the market maker rule.
One of the challenges said to have frustrated similar efforts in the past was the failure of banks to share the same level of enthusiasm with the stock market regulators to introduce market makers. Rewane was of the opinion that such constraints still exist, explaining that market makers may be frustrated without banks' readiness to lend their support.
“How much does each market maker have to perform its roles without banking support? Banks will lend market makers based on their (makers) capacity but banks won't take positions,” he said, adding that the issue of funding would be inevitably tied to the activities of pension fund administrators, who he said have the required capital/investible funds to invest in stocks.
In addition to the Financial Derivatives boss, who raised the issue of access to adequate funding, BGL, in its report last week, was also uncomfortable with the disposition of Nigerian banks to capital market funding. The report noted that the last attempt at creating the market making space in the Nigerian stock market was hindered by the lack of willingness on the part of the banks to provide liquidity to potential market makers.
“This was due largely to the liquidity challenges that the banking system faced at that time as a result of the market meltdown and their exposures via margin lending. While we recognise that banking system stability has improved in recent times as a result of the CBN intervention through Asset Management Company of Nigeria , it is unclear if the banks will be willing to commence large allocations to the stock market through the market makers.
“Unfortunately, the high interest rate environment could make it operationally inefficient for the market or short term market funds for their operation at this time. We are however optimistic that the low level of stock prices could mean that the average value of transaction costs will be low,” the report noted.
On the other hand, Ogar expressed his belief in the workability of the present arrangement saying, “Market making activities on the stock market should commence in earnest, in the very near future. The other necessary conditions for their take-off include the availability of liquidity-providers, as these market makers will need to access the banking system for the necessary liquidity to finance their positions.
“It is my understanding that the engagement between the officials of the Nigerian Stock Exchange, Securities and Exchange Commission with the Central Bank of Nigeria should make for a smooth take-off of market making once the CBN issues the necessary policy directive to participating deposit money banks to provide financing to market makers for their operations.”
However, unlike BGL, Ogah held the view that the 10 firms picked have the financial muscle to meet the kind of challenges anticipated by BGL. “I believe the ten firms chosen in the first round of this exercise are eminently qualified. They passed through a rigorous selection process midwifed by the Nigerian Stock Exchange against some set criteria. As long as the rules governing market making are not breached, the appointed market makers should acquit themselves well.”
According to him, “This development will enhance orderliness in the market primarily. It will also enhance market development and performance in the long term as it works to introduce other market initiatives to enhance liquidity and foster investor confidence.”
Role of Pension Funds
The nation's equity market struggled to sustain a recovery after more than a 60 per cent fall in 2008, which led to the mass exit of local retail and institutional investors, including pension funds.
According to a Reuters report last week, the federal government intends to increase limits on pension funds' investment in the stock market to half of their portfolio, from a quarter currently. Reuters quoted proposals from the regulator for the move that could boost activities in the market.
Nigeria's pension funds were estimated at $13 billion in 2010 and have been growing at a rate of 30 per cent per year. Under the regulatory changes being proposed by the National Pension Commission (PENCOM), “PFAs (pension fund administrators) shall invest pension fund assets with the objectives of ensuring safety and maintenance of fair returns.”
Under the last regulatory review, in 2010, PENCOM allowed pension funds to invest in corporate bonds and private equity for the first time, enabling firms like Lafarge Wapco, Flour Mills and UBA to tap a more liquid debt market.
Another issue raised was the number of stock in each allocated basket. According to the guidelines on market makers, the lowest total market capitalisation of baskets of stocks was set at N432 billion while the average will be N643 billion.
On this issue, BGL noted, “Of course, the basket that has Dangote Cement Plc is in excess of N1.7 trillion. To make market in 20 per cent of the market capitalisation of the average basket of stocks allotted to each market maker therefore requires an amount in excess of N120 billion. In relation to the aforementioned liquidity concern, this may be too large for these players to manage and could result in a skewed market.”