May 18, 2017/NSE

Building African Financial Markets (BAFM) May 18, 2017:Global Best Practices to Enhance the African Capital Markets

Keynote Address by Mr. Abimbola Ogunbanjo, First Vice President, The Nigerian Stock Exchange

Bonjour Madames et Monsieur
Good morning distinguished Ladies and Gentlemen:

Let me begin by expressing my pleasure and delight at being in this ancient, yet cosmopolitan and historic city of Casablanca, the economic capital of Morocco and I extend a very warm welcome to all the delegates here present.

I feel immensely honoured to be giving the key note speech to this distinguished gathering of stakeholders of  African Securities Exchanges  and would like to thank our esteemed hosts — the Casablanca Stock Exchange (CSE) and the African Securities Exchanges Association (ASEA) — for their  wonderful hospitality.

Indeed, I am very pleased to participate in the 2017 edition of the Building African Financial Markets (BAFM) capacity building seminar, because like the ASEA President mentioned, the BAFM seminar offers a unique opportunity to not only learn and discuss topical issues but to also measure our progress towards effective global competitiveness.

One of the ways in which we ensure our place on the global stage is through adherence to global best practices.  Thus, I must commend the organizers for taking the time to select this year’s theme, which clearly shows an appreciation for the role of best practices in realising Africa’s growth potential. It is therefore with a profound sense of anticipation that I look forward to the discussions that will be taking place over the next two days.

Today, I am going to speak on a subject at the core of global best practices in the exchange industry, and a developing trend in African capital markets, being demutualization, which is evidently the most prolific shift in exchange ownership structures.

Before delving into the topic of discussion, I would like to congratulate the CSE on the recent conclusion of its demutualization process on the back of a phenomenal year in stock market performance, gaining more than 30% in 2016 representing its highest gain in almost a decade. The post-demutualization performance of CSE is first-hand evidence of the benefits of demutualization and we are now even more excited to conclude the demutualization of the Nigerian Stock Exchange (NiSE).

We are also encouraged by the Memorandum of Understanding (MoU) recently executed by the NSE and the CSE in the presence of the honourable King Mohammed VI of Morocco. We are optimistic that this will spur more collaboration amongst exchanges across the African continent and further the development and deepening of our respective financial markets.

Demutualization – Background     Until the early nineties, majority of the world’s stock exchanges were non-profit, member owned, mutual organizations with monopoly power.

However, beginning in 1993 with the Stockholm Stock Exchange, leading stock exchanges including the Australian, London, NASDAQ and New York Stock Exchanges began to undergo demutualization. Demutualization is a term used to describe the transition from a mutual association of exchange members, operating on a not-for profit basis, to a limited liability, for-profit entity, accountable to shareholders.

Essentially, demutualization separates ownership (and voting rights) from the right of access to trading on an exchange.

According to data from World Federation of Exchanges (WFE), the weight of mutuals dropped dramatically from 40% in 1999 to only ~15% in 2016.

In the same period of time, the number of demutualized stock exchanges increased from 10% in 1999 to ~85% in 2016. Of the 66 WFE members, less than 10 are currently mutual.

However, there has been an uneven pace of exchange demutualization observed between developed and emerging market jurisdictions. Within the first 10 years following the first demutualization in 1993, 21 exchanges in developed market jurisdictions successfully demutualized.

In contrast, only five (5) exchanges out of 76 exchanges in emerging market jurisdictions demutualized in that same period of time.

In Africa specifically, out of the 27 exchanges who are members of ASEA, seven (7) namely the Johannesburg, Nairobi, Mauritius, Seychelles, Rwandan, Casablanca stock exchanges and BRVM are demutualized with several others including the NSE in the process of demutualizing or considering taking on this initiative.   Why Demutualize?

The decision to demutualize is a strategic decision. Organizations that choose to demutualize make the decision for reasons that are unique to their growth objectives – to raise additional capital for expansion or for major technological investments; or to reduce control of intermediaries over the strategic growth of the exchange. The process can be cumbersome and expensive, taking several years to complete, and it is generally assisted by policies and regulations specific to the jurisdiction in which the company is registered. Nonetheless, the process has many rewards that far out way short-term challenges.

One of such rewards is the improvement in flexibility of governance structures that come with demutualization. The for-profit model empowers management to make strategic decisions more efficiently, giving utmost priority to the interests of customers and the exchange itself.

Demutualized exchanges are also able to restructure, merge and form alliances with other exchanges and capital market institutions to maximize economies of scale and scope, accessibility and market reach. In addition, more agility and flexibility enable exchanges respond more swiftly to increasing competition arising from the emergence of alternative trading systems and globalisation.

The primary factor that has driven the demutualization of exchanges is the increased pressure on capital market traditional sources of income. Technological advancements that have resulted in drastic reduction in trading costs and enabled exchanges to overcome national boundaries have also reduced the intermediary role of exchange members, thereby forcing exchanges to seek other revenue opportunities.

As a demutualized entity disciplined by profit-seeking, African exchanges will be in better stead to capitalize on new income opportunities, free from any limitations arising from conflicting member interests.

To this end, it is worth noting that academic research on the effect of demutualization on the financial performance of 20 demutualized exchanges between 1996 and 2008, suggests that the return on equity increases by an average 5% to 20%, with the average net profit margin increasing by 14% to 30% (according to Rand Merchant Bank).

Demutualization has also contributed positively to stock market performance. On the back of strong macroeconomic performance, improved regulation and other factors, the JSE All Share Index has grown by 280% since its demutualization in 2005 to reach 53,817.31 points as at the end of April 2017.

Similarly, The Nairobi SE All Share Index gained 16% since its demutualization process, reaching an all-time high of 176.00 points in February 2015 prior to commodity bubble and global flight to safety following the US Fed’s increase in its benchmark lending rate.

While African exchanges might have limitations in raising the funds required to effectively compete in a dynamic business landscape as member-owned stock exchanges, as demutualized exchanges, they can tap into the capital markets as a publicly owned stock exchange. Capital raised by African exchanges in an Initial Public Offer (IPO) or a private placement, like any other business can be used to upgrade systems and attract high-calibre human resources, thereby enhancing its ability to compete domestically and internationally.

Following demutualization, a number of our peers have re-positioned their markets, building alliances or consolidating within and across borders in order to enhance their attractiveness. For example, in 2006, the Australian Stock Exchange merged with the Sydney Futures Exchange to form the Australian Securities Exchange (ASX).

The following year (in 2007), the New York Stock Exchange (NYSE) merged with Euronext to form NYSE Euronext, creating the world’s largest stock exchange with revenues of $4.5Bn.

More peculiar to emerging markets, demutualization could serve as a means of collaborating with strategic shareholders with specialized know-how aimed at importing international skills, knowledge and technical efficiencies into our domestic markets. Additionally, it will enable African exchanges be more agile and responsive to the intensifying global competition for capital market order flow, and presents African exchanges with the opportunity to expand into new markets.

The NiSE’s Progress At the NiSE, study tours are vehicles for increasing our knowledge base, learning global best practices and processes, as well as establishing mutually beneficial relationships. Last year, in preparation for the launch of our derivatives market, the National Council and NiSE management participated in a technical tour of the Chicago Mercantile Exchange (CME) Group, the world’s leading and most diverse derivatives marketplace, and the Chicago Board Options Exchange (CBOE), the largest US options exchange.

At the CME Group, the CEO at the time – Mr. Phupinder Gill, highlighted the crucial role of demutualization in enabling the CME increase direct access to its trading systems and develop high-calibre staff.

He opined that had the CME not demutualized, three (3) of its subsidiary exchanges would not be in existence today. Accordingly, he urged us to remain steadfast in our demutualization drive. The same message was conveyed to us at CBOE, which recently joined ranks with other great blue chip companies listed in the S&P 500 after the acquisition of Bats Global Markets, highlighting its strong growth since going public in 2010.

To strategically position the Nigerian capital market for the next phase of growth, I and my colleagues on the National Council, along with our Management made the strategic decision to demutualize the NiSE in our overall ambition to reform and transform the Nigerian capital market into a world-class market. Following this, we employed an extensive Request for Proposal (RFP) process in the appointment of legal and financial advisers for the demutualization project in 2015.

Recognizing the importance of demutualization to the vitality of our business model, the National Council held a strategy session in the first half of 2016, solely to discuss the NiSE’s roadmap to manage issues that could affect the process, including potential regulatory and political concerns.

Subsequently, a meeting between the National Council and past Presidents of The Exchange was held with six (6) past Presidents in attendance to discuss solutions and insights on a clear path forward. The value gained with this engagement has dramatically enhanced the likelihood of a successful and seamless demutualization process.

Today, we have submitted a draft demutualization Bill to the National Assembly, which will allow for our legal status as a demutualized entity.

We have also completed five (5) key reports in support of the project including:

i) Inception; ii) Legal Due Diligence; iii) Tax Due Diligence; iv) Member Register Review; and v) Assessment of Business and Operational Plan reports. In March 2017, we successfully conducted an Extra-Ordinary General Meeting (EGM) to formally empower the demutualization project team (DPT) to fast track completion of the project.

With the expectation of the successful passage of the draft demutualization Bill into law, the National Council, Management team and I will continue to devote our efforts towards completing all necessary documentation stipulated in the SEC rules and effecting the requisite changes in our MEMART. Ultimately, we look forward to reregistering the Exchange and assigning shares to Members based on an agreed apportionment.

Corporate Structuring Consideration Given my legal background, corporate structuring is of the upmost importance and cannot be taken lightly as we collectively embark on this journey to create a more dynamic financial market across Africa.

Exchanges may opt for a number of corporate structures upon demutualization. The demutualized exchange may adopt a for-profit private company structure where only members or members and outside investors are the owners. Alternatively, the exchange can be listed on a recognized exchange (most times, on itself) with or without restrictions on the number of shares that can be owned by exchange members and non-members.

For most demutualized exchanges, a private structure is usually the first step before publicly listing, an example being the JSE which demutualized in 2005 and listed on its own exchange in 2006.

Notwithstanding the overarching corporate structure adopted by the exchange, demutualization brings new conflicts of interest arising from the objective to maximize profits and the self-regulatory function of the exchange.

For-profit exchanges can establish a separate entity to conduct regulatory functions, thereby avoiding conflict-ofinterest issues.

This can take one of two forms, the independent subsidiary model (i.e. establishing a subsidiary with an independent governing board and management, separate from the exchange holding company) or the supervised subsidiary model where the subsidiary’s governing board is the Regulatory Oversight Committee (ROC) of the exchange holding company.

Alternatively, demutualised exchanges can adopt the supervised division model, whereby the regulatory function remains within the exchange and reports to the exchange holding company CEO and ROC.

The choice of regulatory model the exchange adopts will depend on several factors: Are there mechanisms to ensure adequate resources to meet the regulatory mission? What is the relationship between the regulatory subsidiary CEO and holding company CEO? If not independent, what is the relationship between the regulatory divisional head and holding company CEO? Further considerations would relate to who will be responsible for rulemaking, rules interpretation and resolution of disciplinary matters post demutualisation.

Conclusion

Illiquidity and higher costs of capital, characteristic of underdeveloped markets, are known to deter foreign investors, and steer capital raising efforts of large domestic companies’ to foreign markets.

By listing on a stock exchange, demutualization provides an opportunity to unlock the value of African stock exchanges, providing an exit mechanism for former members and a unique opportunity for the public to partake in the profits of the exchange, thereby creating wealth for the general populace.

Perhaps the most important outcome of demutualization of African exchanges over the long term would be addressing the liquidity challenges faced by African capital markets.

Demutualization appears to be the logical next step for African exchanges especially if we are to remain relevant in our role of powering Africa’s economic growth and development.

However, it is noteworthy that African stock exchanges must proceed cautiously, as certain key preconditions such as critical mass of stock exchange trading and related services as well as a sufficiently liberalized market are necessary to drive a financially viable operation post demutualization. Other preconditions include existence of rule of law, high financial literacy rates and sound corporate governance practices, absence of which would undermine any demutualized regime.

Therefore, African stock exchanges that do not currently meet these preconditions may wish consider demutualization as a long-term objective. In the interim, these African stock exchanges should prioritize financial deepening, promoting professionalism and expertise, and enhancing macroeconomic stability necessary for building critical mass of listings and trading activity.

We can all agree that implementing a demutualization program can be a very complex undertaking as I am sure our counterparts who have already successfully transited will attest. The process represents a wholesale cultural transformation of the business as well as changing every dimension of the exchange.

The fact that majority of the world’s leading exchanges have embraced demutualization is indicative of the significant benefits that accrue to the entities that have undergone the process, however a proper understanding of all the issues, openness to new approaches and a high level of co-operation amongst an exchange’s stakeholders are fundamental to any successful demutualization.

With that said distinguished ladies and gentlemen, I thank you most warmly for your attention to a topic which I hope will embolden those exchanges that are yet to be demutualized.

 Je vous souhaite de fructueux débats.

Mr. Abimbola Ogunbanjo First Vice President  The Nigerian Stock Exchange