September 14, 2012 / Greenwich Research
• The Management of The Nigerian Stock Exchange (NSE) has announced September 18, 2012 as the commencement date of its Market Making Program.
• Prior to this announcement, the management of the NSE had appointed ten dealing members of the NSE as Primary Market Makers (PMMs) to execute the market making process.
• A Market Maker can be described as a broker-dealer that stands ready to buy and sell a particular stock on a regular and continuous basis at a publicly quoted price. The market maker must also quote bid and ask prices for the stocks on which it makes market and makes a profit from the bid-ask spread on such stocks.
• Primary market makers as selected by the NSE in no particular order includes:
• Each appointed PMM has a basket of securities on which it would make market. In order to ensure the smooth take-off of the initiative, the NSE authorized the PMMs to start the process with at least a stock from the basket of securities, as a pilot implementation of the market making process. The stocks selected by each market maker for the pilot process are stated in the table above.
• A notable adaptation of market regulation for the purpose of market making includes the adjustment of the price movement limit of 5% above and below a stock’s opening price, which has now been modified to 10% above and below the opening price on the stocks selected by the market makers, while the 5% limit remains for all other quoted stocks.
• In addition, the minimum volume of 50,000 shares required for the movement of share price, would upon the resumption of market making be reduced to 10,000 shares for Dangote Cement Plc, Guinness Nigeria Plc, Mobil Oil Plc, Nestle Nigeria Plc, Nigeria Energy Sector Fund, Nigeria Breweries Plc, SIM Capital Alliance Value Fund, Skye Shelter Fund and Total Plc . The minimum volume of 10,000 shares for price movement will also apply to stocks whose share price are above N100.
• In order to implement the market making process, the securities lending process was also introduced into the NSE to work in sync with the market making process.
• Securities lending or stock lending refers to a temporary transfer of securities, usually on a collateralized basis from one party (the lender) to another (the borrower). The borrower is obliged to return the equivalent securities and other accrued benefits, either on demand or at the end of the agreed period.
• Securities Lending is pivotal to the market making process, as an event may arise when the market maker may not have inventory of the stocks on which it is to make market. The market maker may then proceed to the security lenders to obtain the shares, with the promise to return such shares to the lenders at a later date, based on pre-determined agreements.
• Short Selling is the end point of the securities lending process. It involves the sale of securities not owned by the seller which may be a market maker. It is also described by any sale that is completed by the delivery of a security borrowed by the seller.
• In developed markets a variation of short selling, known as naked short selling is often practiced. This involves the sale of a security which has not first been borrowed. When the seller fails to borrow the securities within a required time frame, this results in a “failure to deliver” and exposes the short seller to losses in event of rising prices of the security. This process contributed to the collapse of many stock exchanges in the developed market during the global crisis of 2008 as it was shrouded in many irregularities.
• In the Nigerian context, naked short selling has been prohibited by the management of the NSE and thus NSE regulations states that a dealing member will not accept a short sale order in any security from another person, or effect a short sale in any equity security for its own account, unless the dealing member has, “borrowed the security, or entered into a bona-fide arrangement to borrow the security which will be delivered on the date of delivery, which is three days after transaction date (T+3); or a reasonable ground to believe that the security can be borrowed so that it can be delivered on the date delivery is due, which is, T+3,” .
As already observed in developed markets in which these processes are fully operational, some of the known advantages of the market making and securities lending process include:
•Price discovery on stocks quoted on the Exchange;
•Increase liquidity on traded stocks;
•Tapping into the country’s volume potential by increasing market participation rate;
•To facilitate a more deepened market and promote capital market stability;
•To reduce securities transaction costs within the market; and
• General restoration of investors’ confidence in the Nigerian Capital Market.