Are African Exchanges Fit For Purpose

“Anyone who thinks there’s safety in numbers hasn’t looked at the stock market pages”, a very wise person once said. Glamorous, fast-moving, adrenaline-fuelled, cosmopolitan, merciless and volatile, stock markets are as powerful in symbol as they are in substance. They are surely one of the most central tropes of the modern financial system. Or even modernism itself. Contrary to popular perceptions, stock markets are no longer restricted to Paternoster Square or Wall Street. Africa is home to dozens of stock exchanges; and the industry is growing. But what is the reality behind the facade? Is talk of expansion premature?

Stock markets in Africa have been making steady progress recently over the past decade despite the storms of the global financial crisis. In August, the South African stock exchange reached an all-time high due to record levels of investor optimism. Resource-based companies performed especially well, as did gold and platinum mines.

Other African countries have also been experiencing very positive growth when it comes to their stock markets over the last year. Although the Nigerian bourse has had its ups and downs in recent years, on 14th August its year-to-date (YTD) growth had reached 11.55%. In Ghana on 22nd August, the YTD performance growth reached nearly 6%. For Kenya the YTD performance on the same day was almost 20%. One-year growth was also positive, at almost 9%.

African stock exchanges are also some of the best performing on the planet. They have consistently been ranked in the top 10 bourses since 1996. In 2011, the Botswana Gabarone Index earned its place as the seventh best performing stock exchange in the world, up 8.8%. The Tanzania Stock Exchange came sixth, having risen by 12%.

Moreover, stock exchanges in Africa are spreading. Before 1989, there were only five stock exchanges across the whole of sub-Saharan Africa. Now there are 29 exchanges covering the capital markets of 38 nations, ranging from Benin to Botswana.

Furthermore, in countries where stock exchanges are yet to be set up, steps are being made to fill the gap. One of those countries is Angola, which now hosts the third-largest financial centre in Africa after Johannesburg and Lagos. It wants to launch a stock market, which will be called the Bolsa de Valores e Derivativos de Angola (BVDA), and is being highly anticipated by investors.

However, plans to set up a stock market in Angola go back to 2008. Imara made an application for a stockbroking licence in order to be one of the first firms to get a foothold in the country’s capital markets. Other investors have quietly followed but the establishment of the exchange itself has been painfully slow.

Last year, however, the Commission for the Restructuring and Management of the Capital Market was set up sending out a strong signal that the Angolan government is taking the idea of an Angolan stock market as a priority.

Angola is not the only country where interest in setting up a stock market is rising. Nairobi Securities Exchange signed a memorandum of understanding with their Somalian counterparts in August to establish a stock market in Somalia. The bourse is expected to be based in Nairobi, with the long-term aim of moving the headquarters to Somalia when stability improves.

“Somalia is a very attractive business country in the near future,” said Ido Mohamed, the country’s Deputy Representative to the UN, at a press conference in August. “It is located very strategically. It has potential resources including oil and gas. Our targets are Somali banks, communications and the energy sector,” he added.

Peter Mwangi, CEO of the Nairobi Securities Exchange, who was also at the event, emphasised that the launching of a stock exchange would be a good opportunity for Somali businesses operating in Kenya. This he said, would improve “recognition of the large Somali diaspora in Kenya, recognition of the entrepreneur culture and the business success that already exists, [and] recognition of the needs that those business currently have that need to be met.”

Kenya has also expressed interest in helping South Sudan to found its own stock market too.

All this is very good news as the growth of stock markets can boost economic growth in Africa. Stock markets energise domestic and foreign investment as well as improving the quality of such investment. They are also helping high-potential companies with limited funds to grow quickly by raising money at a relatively low cost. In African countries with underdeveloped financial systems and, therefore, limited bank lending opportunities, the function of stock markets in this regard is even more important.

Stock markets also encourage domestic savings and complement domestic banking systems. Some experts, such as Isabella Massa of the Overseas Development Institute (ODI), also go so far as to argue that stock markets are key to recovery of African financial industries from the global credit crunch.

“Stock market development could well be a means to help African countries overcome the current growth impasse caused by the global financial crisis. Indeed, developed and healthy stock markets could be a key ingredient in promoting high and sustainable private sector-led growth,” argues Massa in the ODI report, Stock markets in Africa: bidding for growth amid global turmoil.

Interestingly, Massa also argues that the global financial crisis also offers a real opportunity for governments to recognise the potential value of stock exchanges and make the regulatory changes necessary for their growth.

“The crisis itself could thus offer a new opportunity to African policymakers to launch an appropriate mix of fiscal, legal and regulatory reforms to develop stock markets,” she argues.

“Possible options include a technological upgrading of the trading systems, a reduction of controls on private capital flows, an enhancement of the participation of local institutional investors and an improvement of transparency and enforcement procedures,” she adds.

Reality check?

Encouragingly, there are signs that some of the crucial changes that Massa mentions are being made. For example, many African bourses are making great strides in the technology stakes. The Nigerian Stock Exchange in August announced its intentions to upgrade to the NASDAQ OMX Group’s X-Stream platform, which, it believes, will give Nigeria the fastest trading system on the continent. It is expected to become operational in the second quarter of 2013.

The technology has a number of advantages, including the ability to operate multiple instruments, access accounts remotely from smartphones, and host other trading platforms.

“To grow our market, we have to make it more efficient and transparent to build confidence in investors,” said Ade Bajomo, the exchange’s executive director of market operations and technology, at a signing ceremony for the technological upgrade.

“We will work aggressively to go live with the Nasdaq platform by the second quarter of 2013, but this will depend largely on the need to carry along other market operators,” he added.

Despite these achievements, many remain sceptical that African countries can indeed host efficiently performing stock markets. They point to the poor financial infrastructure within African countries and funding constraints as stumbling blocks.

While this is an overly dismissive attitude, given the ample evidence that African stock exchanges can perform well and develop, at the same time, there is recognition that Africa’s stock exchanges are having to contend with some serious challenges.

One is that even Africa’s most well-established stock markets lack maturity. Trading is typically limited to a select handful of stocks, which means that the larger listings often tend to have an disproportionately major impact on the performance of a given bourse. Another is that market capitalisation and liquidity rates in Africa are low.

Odhiambo Odera, PhD Candidate at the University of Southern Queensland with expertise in African stock exchanges, agrees that financial constraints are a problem for the continent.

“African stock markets are still very illiquid,” Odera says. “Low liquidity means that it is harder to support a local market with its own trading system, market analysis and brokers because the business volume is simply too low. Shares are rarely traded and there are large gaps between buy and sell orders,” Odera adds.

African countries also still face formidable technological constraints. Manual systems, although they are slow and unreliable, are still widely used.

“Trading, clearing, and settlement systems are so slow it can take months to execute a single transaction. This slows information production, hampers activity and turnover, and renders financial integration difficult. Similarly, most markets do not have central depository systems, and some restrict foreign participation and consequently such bottlenecks induce inactivity,” adds Odera.

According to Odera, countries thinking of setting up bourses may be getting their priorities for economic development wrong, not least because of the huge costs involved in setting up a stock exchange.

“I would rather Angola concentrate first on the development of its banking and financial sectors, set up credible institutions of law and order, and gradually install democratic accountability before venturing into stock market development. These will ensure that domestic savings and investment are protected and limited corruption will help reduce political risk and enhance the viability of external finance,” Odera argues.

Isabella Massa from the ODI also argues that the financial crisis still throws up dangers for Africa’s stock markets. “The recent global downturn due first to the 2008 to 2009 global financial crisis and currently to the euro zone crisis may affect African stock markets through financial contagion spillovers as well as through shifts in investor market sentiment and changes in investors perception of risks,” says Massa.

“There is evidence that during the 2008 to 2009 global financial crisis stock markets in African countries such as Kenya, DRC and Zambia suffered financial contagion effects. On the other hand, in 2011 during the Eurozone crisis, stock markets in Nigeria and Kenya experienced heavy sell-offs as a result of global flight to safety,” she adds.

Is bigger necessarily better?

There is also some uncertainty about the extent to which regionalisation and integration of stock markets can prove successful in Africa. Stock market regionalisation is not a new idea in Africa. The first regional stock market, the West African Regional Bourse (BRVM), which is made up of eight Francophone countries in West Africa, was set up in 1998.

There is now talk of exchanges also possibly being set up in Anglophone West Africa, to incorporate Ghana and Nigeria, as well as an East Africa stock exchange comprising of countries which include Kenya, Tanzania and Uganda. In Southern Africa, stock exchanges making up the Southern African Development Community have plans to link their order and trading systems in the near future too.

That stock market regionalisation should take place in other regions in Africa is supported by various economists because it appears to be the ideal solution to many of the fundamental challenges that African stock markets face, including illiquidity, fragmentation and limited financial expertise and resources. Some have also argued that regional stock exchanges will help the financial systems of African countries become more globalised.

“Globalisation and regionalisation are not necessarily antagonistic, but rather mutually reinforcing. African stock exchanges need to integrate with the rest of the world and, in doing so, they must first come together and establish their own regional blocs,” writes Professor Nicholas Biekpe, President of Africagrowth Institute, in the advanced copy of a UN paper on regionalisation in Africa’s capital markets sector.

But smaller countries have signalled some concern that integration could drown out their power. For example, when South Africa mooted the idea of a regional stock exchange for Southern Africa, the idea was not greeted with much enthusiasm by Botswana, who voiced concern that it could lead to their country’s funds being diverted to the Johannesburg Stock Exchange.

Kenya’s decision to help set up stock exchanges in Somalia and South Sudan has come under close scrutiny in the local media. Kenya which, after all, has limited funds and an immature financial infrastructure itself, can surely only give Somalia support within serious limits. And some argue that stock markets in very unstable regions can even be counter-productive.

“The destabilising effects of introducing stock markets into these countries with underdeveloped legal, regulatory and monetary systems can produce economic instability that outweighs potential gains (as noted by Michel Isimbabi of Johns Hopkins University),” says Odera.

“For South Sudan, which gained independence in July 2011 after decades of armed conflict, it is still in the infancy stage of economic development therefore I believe that an emphasis on promoting stock markets in these two countries is premature. At this stage I don’t want to speculate on the real intention of Nairobi Stock Exchange being so keen to help set up stock markets in such countries,” he says.

Massa from ODI also offers a guarded response. “Such efforts might contribute to develop stock markets in countries that are too small to establish viable capital markets. Nevertheless, given that both Somalia and South Sudan are in very early stages of development, I believe it will take some time before these stock markets become fully operational,” she says.

Clearly, Africa’s stock exchanges have some way to go before they will be comparable to Paternoster Square or Wall Street. And it is important to contextualise and scrutinise both talk of the sector’s expansion and theories which emphasise the importance of stock exchanges. That said, stock exchanges are making important progress in Africa. And, overall, it can only benefit these countries’ financial systems as well as their economies.