SA's only settlement service for listed securities, Strate, has enjoyed dominance for almost 10 years, but now there are rumblings of discontent from market players. Ruan Jooste reports on their complaints.
For close on a decade, Strate, SA's electronic settlement service majority-owned by the JSE, has been the only game in town.
Though its operations aren't always understood by the non-investor, it plays a crucial role as it is responsible for the settlement of every listed security. This makes it central to the healthy functioning of SA's financial market.
There is no real alternative to the service it provides, and issuers of JSE-traded products have had to suffer its dominance as SA's only central securities depository (CSD).
But now there are rumblings of dissatisfaction as other market makers question Strate's hold over them.
In recent months:
There has been an outcry over fee increases for 2013 from issuers, forcing Strate to back down on a proposed 15% hike, the fourth successive increase of this magnitude;
The opaqueness of its pricing has been challenged;
Market players say Strate's self-regulatory regime is prejudicial;
Market players say there is no effective policing of Strate as the Financial Services Board (FSB) to which it reports has no teeth; and
Its close relationship with the JSE helps it dominate the market.
When issuers were informed of another 15% annual increase to their total costs, they were also told that future hikes would be in that region.
They complained to the FSB and, after the outcry, Strate backed down, reducing issuer fees to 6%, which is closer to consumer price inflation (CPI).
Norman Muller, the FSB's head of department for capital markets, confirms that the FSB received a complaint on issuer fee increases, but says it has no power to prescribe fees to self-regulatory organisations, including Strate and the JSE. "Fees have to be reasonable and in line with inflation, but we do understand that Strate provides a lot of services to issuers," he says.
However, the setting of fees must follow a specific process in terms of the law, which includes consultation with the public and the FSB.
Strate is the only licensed CSD and is subject to the Securities Services Act, under the authority of the FSB, and some parts of the Companies Act.
Nigel Redford, company secretary of Super Group, says issuers were lucky to get an increase close to CPI. "We are operating in a tough business environment; contractual increases from our customers are normally CPI or less," he says.
He says Strate is in effect a monopoly with the power to levy substantial fees and pass on abnormally high increases. "Because our stock trades on the JSE - and with no other alternative - we have no choice in using Strate services," says Redford. "But the onus is on Strate and the JSE to be fair and transparent in their pricing.
"It is not always clear what costs are levied for what service," he adds. "It is difficult for us to look at our costs in isolation."
In addition to clearing and settlement services, Strate administers issuers' corporate actions and nominees and provides various forms of beneficiary reports, for which it charges.
The opaqueness of pricing is evident in a charge to issuers of 90c/trade - up from 71c/trade this year - described as a "transaction fee per JSE trading system trade". The directive does not make it clear why Strate would levy a cost on gross trades as it works on a net settlement basis. Nor does it explain why it is charging issuers for transactions in which neither the issuer nor Strate is involved.
Redford accuses it of double-charging.
"We have already been charged transaction fees by the JSE when investors buy and sell our shares; now we get charged a second time - and we are also charged several times for receiving the same data," he says.
This refers to Strate's beneficiary download system, which provides reports of shareholder information to issuers. Reports are compiled from information supplied by CSD participants (CSDPs), brokers and nominees. It appears that data provided by issuers through their agents is being sold back to them.
"It's our perception that we carry the bulk of the costs, which brings me back to my point of lack of transparency," Redford says.
Stan Lorge, CEO of Computershare SA, whose CSDP is the largest by number of shareholder records, and which acts as transfer secretary to 80% of issuers listed on the JSE, was asked by a number of his firm's clients to make representations on their behalf regarding the 15% fee increase, which it put to Strate and the FSB.
Strate CEO Monica Singer says a detailed pricing investigation done in 2009 indicated that it was not charging adequately for its services to issuers. "This was mainly because we had not implemented cost increases to issuers since our initial inception in 1999," she says.
The investigation showed that Strate's income had been heavily weighted towards recovery fees from investors - about 90% - and only 10% to fees from processing corporate events for issuers.
"In effect, Strate has been undercharging issuers for services rendered," says Singer. "To rectify this imbalance Strate introduced a phased-in approach that necessitated above-inflation increases over a period of 10 years.
"This year we conceded that settlement volumes were down and fell back into line with CPI after consulting the market. But this is not sustainable, because the gap is still there. The recouping will now probably take longer than 10 years."
Singer says Strate has made substantial investments into technology to support its products and services to issuers.
Lorge says: "Issuers feel that because they never complained much in the past, they have become soft targets."
"Part of the frustration," says Redford, "is that no forum exists to interact with either Strate or the FSB. It is important for us to engage with Strate so we can understand what we are paying for, find middle ground and create a realistic position."
He says the solution lies in more transparency on pricing and establishing formal representation for issuers.
Annamarie van der Merwe was appointed to the Strate board to represent the Company Secretaries Interest Group but the association disbanded in 2007.
Lorge says Computershare would be happy to represent issuers. "Of course, that would have to be acceptable to Strate," he adds.
Singer admits that Strate has not allocated sufficient resources to look after issuer concerns and has now employed a relationship manager to deal with this.
However, she adds that issuers need to take more responsibility for the efficiency of their operations. "Many investors are involved in electronic trading but are still hanging on to their share certificates. That doubles your cost base."
Redford concedes that there is some complacency among issuers. "Though Strate fees aren't our biggest costs, listing costs are, and we need to manage them more efficiently," he says.
Singer says the reluctance of market players to dematerialise - convert paper share certificates to electronic records - has been one of the biggest frustrations of her career. Though the first electronic settlement of an equity took place more than 15 years ago, Singer says more than 20% of SA retail investors still hold paper.
"It is time-intensive and expensive to prove ownership of share certificates," says Singer. "Also, a lot of fraudulent certificates are making the rounds."
Lorge says CSDPs like Computershare look after individual shareholders while the banks concentrate on big-value clients like the fund managers. "SA's shareholder population is around 3,1m, of which 800000 are still in certificated form."
The local securities market has undergone rapid change over the past decade, since the electronic settlement platform for equities was introduced. It is now also responsible for settling JSE bonds, which were previously traded on the former Bond Exchange of SA, and execu-ting money market deals.
Before the introduction of electronic settlement, volumes traded on the JSE were at about 2,3m trades a year but they shot up to more than 26,5m/year by December 2011.
The global financial crisis exposed the shortcomings of financial markets. The wave of government policy and legislative recommendations that followed has emphasised the role of CSDs across the globe as regulators push towards greater use of market infrastructure, as with over-the-counter derivatives.
CSDs are also subject to global standards and benchmarks stipulated by organisations such as the Committee on Payment & Settlement Systems (CPSS) and the International Organisation of Securities Commissions (IOSCO).
"The adoption of these standards has proven to be invaluable to the local market," says Singer.
Strate is currently regulated by the Securities Services Act (SSA) , but the legislation will be replaced by the Financial Markets Act (FMA) next year, which will incorporate G20 recommendations to ensure global market stability.
Similarly, the JSE regulates its members under the authority of the FSB, in terms of the act.
"The regulation function is significant," says Singer, "as CSDPs and qualifying brokers act as agents for investors and have a statutory duty to protect their records in the electronic environment."
But many market players think the self-regulatory regime is prejudicial.
Lorge says Strate's two functions are contradictory. "How can a regulator also compete for the same business with the organisations it regulates?" he asks.
National treasury and the FSB would like a securities ownership register (SOR - a centralised register for beneficial ownership) for equities and, as Strate already owns the SOR for bonds and money market securities, Strate has assumed that it will be responsible for that as well. "We object to that," says Lorge.
He says a potential solution lies in extracting the regulatory and inspectorate functions from Strate and the JSE and putting them where they belong - with the FSB.
But Singer says Strate's supervision division is accountable to an independent committee of the board and the FSB and not to executive management. "I don't even attend the meetings on supervisory matters," she says. "We are not allowed to compete with the banks."
She says the appropriate Chinese wall has been put up between Strate's two roles. "Structures have been established and the procedures that must be followed to prevent the inadvertent spread of confidential information between these two roles are non-negotiable."
The structures prevent Strate's supervision division from sharing confidential CSDP-related information with other business units.
However, there are no confidentiality barriers in respect of business units sharing information with the supervision department when a CSDP might be in contravention of the SSA or other rules and directives, or introduces risk into the market.
The FSB has been accused by market players of having no teeth in managing its relationship with Strate - or the JSE - though a representative of the FSB attends all board meetings of both the JSE and Strate.
The FMA, however, is likely to give the FSB more say over Strate. "We will be obliged to do a comprehensive assessment on Strate on an annual basis to ensure it is fulfilling its mandate in terms of the law," says Muller.
A code of conduct for CDSPs will also be introduced. Currently only a code for JSE members exists .
Muller says the bill will possibly be signed into law by the president next year. "In addition, we [the FSB] are reviewing the self-regulatory approach to determine whether there are gaps within our regime and whether our powers over the JSE and Strate should increase," he says.
Lorge says that besides regulation, the concern is the vertically integrated model of the two (see organogram on page 35).
The self-regulation and the fact that the JSE is listed and profit-driven are the reasons a securities register should be independent and not a 100% subsidiary of Strate, he argues.
In SA, transactions are done at the level of CSDPs and not at CSD level, one of the few markets to do so.
There are about 10 CSDPs operating in SA, including Computershare and its direct competitor, Link Investor Services, with the rest being banks.
To put it into context, in the UK there are only three options: Capita, Computershare UK and Equiniti. It is easier to communicate with such a small pool of registrars and to share information, whereas in SA shareholder information must be collected from every CSDP before one can get a holistic picture of the market.
The records of the CSDPs are balanced and reconciled every day with the records kept in Strate's system, the SA Financial Instruments Real-time Electronic Settlement System (Safires), where the total balance of dematerialised securities is kept. Investors receive regular statements detailing their electronic holdings from CSDPs.
Singer says the current model is not ideal and that the solution may be segregated depository accounts (SDAs).
These allow investors to open an account at CSD level while maintaining existing relationships and services with the custodian.
Not only are investor securities held in a separate account, they also benefit from increased protection in the event of insolvency of a custodian bank.
It would appear that legislation could also be biased towards Strate, when local pension funds begin investing in hedge funds. A new regulatory framework released in September will give hedge funds the option to hold their assets in SDAs. Only the concept of segregation is mandatory.
The relationship between Strate and its largest shareholder, the JSE, is also a point of contention.
Issuers have complained that Strate's JSE shareholders were excluded from recent price hikes and that the lines between Strate and the JSE have become blurred, raising questions about its independence.
The former and current CEOs of the JSE, Russell Loubser and Nicky-Newton King, both serve on the Strate board, with Bobby Johnson, the former chairman of the JSE, now the chairman of Strate. Nigel Payne has served on both boards for years.
Strate started out as a wholly owned project within the JSE, and later became a 50% investor after a shareholder agreement between Strate, the JSE, Standard Bank, Absa, FNB, Nedbank, Mercantile Bank and Citibank was signed in September 1999.
Its shareholding was diluted to 41% after the merger of the Universal Exchange Corp and Strate, but increased to 44,6% in February 2005 when the SSA became effective. The law states that market participants may not hold more than 15% of a self-regulatory organisation without the permission of the FSB.
As a result Nedbank and Standard Bank decreased their 16,8% stake to 15% each. The JSE, however, was allowed to exceed this limit.
The FMA will change the rule somewhat, allowing a 25% or more shareholding with the approval of the minister of finance, but ownership of under 15% will still be approved by the FSB.
Its exception to the rule has served the JSE well, with Strate paying its first dividend in 2006 with a pay out ratio of 20% (five times cover) in 2006 and a total dividend paid by Strate amounting to R13,3m. A dividend of R1 686/share was paid out a year later. The dividend cover was decreased to a more market-related level of two times in 2008, resulting in shareholders receiving R4075/share.
Strate declared and paid an ordinary dividend of R3551/share, based on the two times cover dividend policy, and a special dividend of R2460/share last year. An ordinary dividend of R3670/share was paid at the end of March this year.
Singer says the JSE spent a lot of money on Strate before signing the initial shareholder agreement of around R84m. She says the JSE and banks will provide cash support if it is needed. However, Strate has been conservative in its cash management, and has R190m in the bank.
The numerous issuers the FM spoke to said the proposed price hikes were unnecessary, given the mega profits that Strate, as a monopoly, earns every year and the huge dividends it pays to shareholders.
Strate reported a net profit of R71,6m for the 2011 financial year.
Singer says the company always intended to operate profitably and generate a return on capital for shareholders.
She says Strate foresees that it will no longer pay special dividends as its debt to shareholders, who carried it in the years when it was not profitable, has now been settled.
Strate enabled its cost-to-income ratio to improve to 65%, from the targeted range of 65%-75%.
Newton-King says Strate is an essential part of the value trading chain. "It has become essential to reinvest in technology to deal with increased volumes and new regulation, but in a way that does not come back to the investor or shareholder," she says.
Over the years, Strate has embarked on a number of projects that aid risk management within the market, deliver benefits to all its stakeholders and align market infrastructure with international benchmarks.
It recently launched a tri-party collateral management service (see page 41) and SDA, both of which aim to contain risks in the SA financial market.