The Republic of South Africa (RSA) stands apart from many other African nations, in that it benefits from a mature, well-structured and dynamic financial market environment, supported by modern technology, and backed by robust regulations. And despite various global and domestic challenges and uncertain macroeconomic conditions, the country has managed to maintain a strong growth trajectory.One reason is the diversity of its market participants. South Africa enjoys a wide spectrum of domestic investors, including large pension funds (including government-backed funds), nascent hedge funds, proprietary trading firms, startups and a strong retail market. On the sell-side, the brokerage landscape is varied, consisting of both smaller firms and sophisticated institutions such as Standard Bank, ABSA, Peresec and RMB, who support their clients with advanced execution algorithms, direct market access (DMA) facilities, and the capability to provide smart order routing between trading venues.
However, the technology requirements for realising these emerging opportunities are becoming more complex. In an upcoming A-Team webinar, Trade South Africa: Considerations for Connecting to and Trading the Johannesburg Markets, a panel of experts will discuss the data and technology capabilities required to succeed in this maturing financial centre.
The global perspective
One of those experts is Mike Powell, CEO of electronic trading solutions vendor Rapid Addition, who suggests that South Africa provides international investors with a solid gateway to the dynamic African market.
“South Africa is an interesting market for international investors,” he says. “It offers an opportunity to invest in Africa, giving exposure to the dynamism of the region, but through a well-structured and regulated market. With a mature primary exchange and emerging alternative liquidity sources, supported by several large, sophisticated domestic sell-side firms, investors can take advantage of both the long-term growth story and short-term volatility opportunities. The ability of member brokers to offer access to different liquidity sources, execution algos and low-latency risk filters and trade execution, along with financing, securities lending and FX, means international firms have strong partners on the ground to help them access the market.”
Richard Hills, Head of Client Engagement at big xyt, the independent provider of smart data and analytics solutions, agrees. “South Africa, and the Johannesburg Stock Exchange (JSE) in particular, is an extremely innovative trading community with a central place at the heart of the African economy,” he says. “It is also part of the southern hemisphere’s trading axis along with ASX and CBOE in Australia, B3 in Brazil, and SGX in Singapore, with many substantial dual listings, such as BHP and Prosus that sit within the Eurostoxx 50 most liquid names as truly international companies. This mosaic makes South Africa all the more interesting, and different from any other market in the world.”
Prosus is a prime illustration of South Africa’s global market reach. Headquartered in Johannesburg and traded on JSE but with its primary listing in the Netherlands, Prosus is an investment company that focuses on software and IT companies worldwide, with a significant holding in Chinese technology conglomerate Tencent. Investors in European ETFs linked to the Eurostoxx 50 may not realise that as well as investing in liquid, Euro-based European stocks, they are also investing in an emerging South African market entity with substantial Chinese holdings.
South Africa’s trading venues
The dominant exchange in South Africa is the JSE, which historically focused on equities, but is now a multi-asset exchange covering equities, equity derivatives, commodities, foreign exchange, bonds and ETFs. JSE’s main competitor is A2X, which went live in October 2017, providing the market with an alternative trading venue for the secondary listing and trading of shares. Besides the two exchanges based in Johannesburg, the Cape Town Stock Exchange (CTSE) focuses on small to medium -sized businesses and is licensed to issue both equity and debt.
Block trading platforms and dark pools are also present in South Africa. Platforms like Liquidnet, Posit and BlockMatch are certainly active, and are complemented by major international brokers such as Morgan Stanley and JP Morgan offering their own block trading facilities to their clientele.
“For a vibrant market like South Africa, competition is welcome as it drives innovation and differentiation,” says Powell. “With a strong primary exchange, but alternative sources of liquidity to create enhanced trading opportunities, this can only make the South African equity markets more attractive for both domestic and international participants. Increased liquidity and higher trading volume is good for everybody, while competition drives innovation and should again help enhance South Africa as a trading destination. With international firms increasingly used to best execution regimes such as MiFID, and similar regulations in the pipeline for South Africa, the emergence of A2X will drive a more dynamic market.”
Despite the growing fragmentation of the market, from a regulatory standpoint there is currently no equivalent to the European MiFID requirements around best execution. However, that situation is likely to change as best execution regulations are currently in the consultation phase in South Africa and are expected to be introduced in the coming years.
“There’s no requirement for best execution in the regulation, which is frustrating for an exchange like A2X,” says Kevin Brady, A2X’s CEO. “Outdated regulation that favours the incumbent has been one of our biggest challenges. We’d like to see it looking a lot more like Europe or any other competitive jurisdiction and we’re hoping to see a draft version of best execution rules before the end of 2024. That will obviously help drive broker adoption on A2X and act as a catalyst for our growth, because client pressures will force brokers to show their best execution policies. In the meantime, we’ve seen a number of brokers buying into what we’re doing and positioning themselves to give their clients best execution, whether it’s required or not. Overall those brokers have definitely been beneficiaries in building their market share.”
Even without such regulations, brokers naturally compete based on their execution capabilities. And while best execution rules are expected to lead to increased market fragmentation, that comes with both positives and negatives say some.
Pros & cons of fragmentation
“The Financial Services Conduct Authority (FSCA) will implement the best execution rule at some point, probably within the next 18 months,” says Hills. “The brokers locally see fragmentation generally as a good thing, in that it should reduce some trading costs, but they’re also very realistic about it coming with extra requirements, such as smart order routers and the need to process multiple price and trade feeds that have to be kept in sync with high granular time stamping, and so on. It’s important to note that domestic brokers do not benefit from the same economies of scale as international brokers when it comes to investing in this advanced technology.”
While the FSCA is looking into the implementation of the best execution rule and its implications on domestic brokers, international perspectives on fragmentation present a more complex picture, suggests Valdene Reddy, Director of Capital Markets at the JSE.
“Globally, we’ve seen varying depths of fragmentation,” she says. “In developed markets, it’s probably reached an inflection point where it’s actually become counterproductive to what it was trying to achieve and enhance. Competition between venues is meant to stimulate better choice and bring costs down, but to an extent where fragmentation erodes market quality, on-book depth, and increases the cost of execution, is not ideal. Liquidity and market quality remains a key driver to tradeable markets, and as such, the JSE prioritises these as focus areas to ensure deep and liquid capital markets at our exchange.”
She continues: “South African capital markets are very different to the global markets in the level of digestibility of fragmentation. Through our market quality and through our competitiveness in analysis, pricing, service, and the depth of our market, the JSE continues to defend and maintain 98% market share. This evidences the focus and collaborative value the JSE ascribes to maintaining market share and relevance by providing market participants with products and services that meet their diverse and evolving needs. We have however been very pleased to see the elements of competition that have enhanced our market, such as functionality and the quality of execution metrics. And the JSE has held up strongly not just on responding and pricing, but on market impact and market quality.”
While the JSE has effectively maintained its dominant position, the emergence of new players like A2X has introduced both challenges and opportunities for local brokers in adapting to the evolving market dynamics, says Brady.
“Regarding the costs and benefits of fragmentation, there is a cost to local brokers that they’ve never really had before because we’ve always had a single provider monopoly from a stock exchange perspective, so their whole infrastructure was geared to that one market,” he says. “To have to adapt to a second market they’ve had to upgrade their front-end trading systems, add an A2X trading gateway and put in place a smart order router. But on the flip side, they get some great fee savings. We calculate, broker by broker, how much trading they need to do to break even and that figure has continually come down. As an example, we’ve recently brought on a number of niche empowerment brokers at a very affordable cost. Also, the broker community as a whole has seen cost savings, not least because of the JSE’s reaction to competition. We would estimate the market is probably saving upwards of R50 million a year because of this competition. And the cost to connect to A2X is just a fraction of that.”
“There are direct and indirect costs,” counters Reddy. “Direct costs are where you have to access a market, deploy algorithmic strategies and order routing, deal with things like the noise in data and the noise in trading flow and activity. The costs associated with these varied mechanisms brings into perspective the balance between costly access to address market flow and liquidity versus efficiency in execution. The JSE has been very proactive to reduce direct costs and enhance market access. Absolute price points have been lowered and ease of access has been increased through managed and shared services.”
John Owens, Director of Global Exchange Relationship Management at infrastructure and connectivity solutions provider IPC Systems, believes that the growing need for sophisticated trading technology in South Africa is good news for tech vendors.
“Trading firms and investors are looking more and more to technology to ensure that they’re achieving best execution,” he says. “The challenge is that without the right systems in place, firms don’t have visibility of prices across these fragmented markets. That situation offers potential opportunities for data vendors, O/EMS vendors, trading platform providers, and technology firms like ourselves, who can provide high availability, low latency systems and infrastructure that can support the kind of well-established regulatory changes we’ve witnessed in Europe and in the US. As best execution regulations come in and new venues emerge, those are the key services that trading firms are going to be looking for as things progress.”
Powell agrees that next-generation trading technology providers can make a significant impact, particularly as local incumbent vendors are viewed by many as outdated, costly, and lacking in quality service.
“South Africa is a sophisticated market and is traded by major international asset managers and hedge funds,” he says. “However, it is also a relatively small market. And while it is positive that investors have the choice of trading through a broad spectrum of brokers, this also means that trading volume is shared across a relatively large number of brokers in comparison to the size of the market. They are also trying to serve a wide variety of needs as the ‘buy side’ community ranges from retail through to international HFT firms. Larger legacy vendors, while having done a good job in the past, do not offer the flexibility and functionality needed by larger brokers competing for the more sophisticated order flow in a competitive market, but are too expensive for SME brokers supporting smaller clients or more vanilla trading workflow. The JSE has made some interesting announcements such as managed co-lo and infrastructure services, but cloud is yet to be fully leveraged for trading. The new generation of trading technology providers can help address this, empowering the larger brokers with flexible, cost-effective solutions while SME brokers will be attracted to web-based trading desktops that offer advanced functionality with a lower cost of ownership.”
Leveraging state-of-the-art tools can also enhance overall market quality and deliver value to investors, says Richard Hills.
“If all participants are using good technology and good data analytics, then there should be an improvement in market quality generally and ultimately savings to the end investor – measured in terms of the average spread paid,” he says. “Exchanges can provide this data consistently and cost effectively to help their broking ecosystems to measure and monitor market dynamics and to understand how they are performing against market benchmarks. In South Africa we see that the JSE is among the first to bring such services to the market and this is an antidote, if you like, to the economies of scale challenge for the domestic broking community.”
For international participants wishing to access the South African markets, cost-effective solutions that allow for flexible entry and scaling can be provided through aggregated infrastructure, says Owens.
“Geographically, South Africa is a difficult place to reach,” he says. “So how do you manage those services from afar? How do you manage those resources in a country where you may not have people? And then of course you have the age-old considerations around buy versus build. Are you going to invest in building the technology you need yourself? Are you going to buy what you need to get you started? What if you want to dip your toe in the water and test things out before scaling from there – how easy is it to do that? That’s very much the space we fit into, and we make it cost efficient because our model is based around aggregated infrastructure. We can charge for a ticket rather than trying to sell a bus.”
Matching engines and colocation facilities
The JSE’s matching engine uses LSEG’s Millennium Exchange trading platform, which sits in the JSE’s own colocation facility in Johannesburg. Recently, the exchange announced a collaboration with Beeks Group and IPC, to establish ‘Colo 2.0’, an advanced managed Infrastructure-as-a Service (IaaS) solution that will provide JSE clients with cloud-based colocation services.
Reddy highlights the significance of the colocation data centre in facilitating low-latency trading and its growing prominence among market participants. “Regarding low-latency liquidity provision, the best measure for enablement and growth is when we look at the percentage of volume that goes through our colocation data centre,” says Reddy. “Not all of it is low latency, but currently our colocation facility generates a large percentage of the total volumes on the JSE. We have seen low latency clients doubling down on their rack space at the JSE over the last three years or so. This has accelerated to the point where now about 70% of the total rack space is occupied. Most of that demand comes from low latency market participants. Most low-latency players already trade very well-established markets like the US, Europe, and UK. And our trading platform allows them to interact and trade the South African market with the same ease in terms of technology sophistication, as they would with other global markets.”
She continues: “We recognise that there are different types of clients, so we make sure we’re responsive with our market execution and functionality enhancements. We’ve added in a complex order suite and we’re bringing in different types of matching mechanisms, because we understand there’s a local base that’s institutional, there’s a traditional offshore base that’s also fundamentally institutional, and there’s a rise of new capital that wants a technology savvy, easy access to the market. They all add different elements of liquidity and depth to the market.”
A2X’s core exchange platform, which includes its matching engine, surveillance system and a bespoke clearing system, is provided by Aquis Technologies and runs out of Teraco’s JB1 data centre, also in Johannesburg. Co-location and direct cross-connect Ethernet connectivity is available in both A2X’s primary and DR datacentres.
Power instability & load shedding
Despite the many opportunities it presents, South Africa’s trading environment is characterised by specific infrastructural hurdles that market participants must navigate, says Gordon McArthur, CEO of Beeks Group.
“One of the unique challenges with South Africa is the load shedding, i.e. the power outages that regularly happen each day,” he says. “With data centres, office buildings, trading infrastructure and so on losing power multiple times a day, you have to be in colocation in order to take as much infrastructure out of the equation between you and the exchange as possible. Also, there’s a lot of network instability in South Africa, with massive network outages that can last for days. But every participant in the market faces these challenges.”
In the midst of these challenges however, there are signs of positive change and potential solutions on the horizon, suggests Brady. “Everything suggests that we’re still going to have load shedding for a while, but the level of it will reduce because there have been some really concrete efforts to try to sort it out,” he says. “First of all, the government doesn’t want to go into next year’s election with regular load shedding because it’s a pain that people feel daily. So there’s definitely a real incentive there. Also, much of the load is being taken off the system because of the rollout of solar power in recent years, which has been massive. If you add it all up, the solar power output roughly equates to one of the big power stations that they’re having problems with. And that’s people literally sticking panels on their houses or on shopping centres, for example. So there’s a lot happening, albeit not fast enough for everyone down here. But the outlook for less load shedding is certainly positive.”
If factors such as energy instability, macroeconomic indicators, political implications, and a sovereign rating demotion are already factored into its pricing, perhaps even to an excessive degree, then some would argue that South Africa’s risk premium is exaggerated and that the market is undervalued, trading at a rate lower than both emerging and developed markets. And if this is the case, South Africa presents significant opportunities for investors. The resilience of its marketplace is evident, and there’s now an active dialogue between the public and private sectors on how to pragmatically approach challenges and attract capital inflows.
However, for those looking to participate in the South African financial markets, MacArthur has some final words of advice. “South Africa is a smaller community than some of the European and US environments, so my advice to potential participants would be to talk to the exchange, they will help you understand the challenges. Talk to other market participants, and make sure you understand the unique challenges of doing business in South Africa because it’s not just a technology play. So, talk to local participants, go in with your eyes open and be open to the fact that there are solutions to everything. But you need to pick the right partners.”
Register for A-Team’s upcoming webinar, Trade South Africa: Considerations for Connecting to and Trading the Johannesburg Markets, here.
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