@Rejuvenating the Nigerian Capital Market...” – Bisi Onasanya
July 6, 2012
It is my privilege to be invited to speak to Industry experts, analysts and operators on a subject that I am inclined to believe a significant chunk of my audience may, perhaps, hold more certifications than myself and therefore are better equipped to be more knowledgeable about. I say this because the facts and figures around the events, processes, activities and indeed interventions around the Nigerian Capital Market culminating in its current weak state will probably be on the fingertips of most of you distinguished experts in my audience. I will however attempt to share not only my personal thoughts on this subject, but also in my capacity as the Chief Executive of a bank that currently contributes about N330billion to the total Market Capitalisation.
The Nigerian capital market has had a chequered history, from the founding in 1960 of the Lagos Stock Exchange with 19 securities listed on it, to the Nigerian Stock Exchange’s current position as one of the three leading exchanges on the continent.
As the Nigerian economy continues its rapid integration with the global market place, it is inevitable that in parallel with the ongoing public sector reforms that have been behind its increasing competitiveness, the nation will need to source significant amounts of funding and develop deep, efficient, and highly liquid capital markets in order to move the economy to the next growth phase. The theme of this lecture is therefore most appropriate in this regard.
I shall attempt to discuss this theme in four parts:
(i) The Capital Market
(ii) The Nigerian Capital Market: Challenges and Issues
(iii) Imperatives for Sustainability and Growth; and
2. THE CAPITAL MARKET
In the 1980s when it was fashionable to talk of Africa’s “lost decade”, the initial blame for the poor output growth rates suffered by the continent was on poor governance structures, especially the dominance of military governments, adverse trade terms, and a recurrence of famines and droughts across the continent. Several years later, particularly after the successful entry of Asian economies unto the world stage, it is clear that improperly functioning financial markets should also take prime position on the lists of causes of the continent’s failure.
Noting that a “compelling case can be made for the development of capital markets in Africa”, the meeting of the Intergovernmental Group of Experts which held in Addis Ababa in March 1997 added that “well-functioning financial markets, along with well-designed institutions and regulatory systems, foster economic development through private initiative” . In those economies where capital markets have played important development functions, especially in the United States of America, the roles of financial markets have gone beyond mobilising domestic resources. Increasingly, today, financial markets also help to pool and share risks among market players.
In the advanced economies with a functioning capital market, the capital mobilisation challenge resolves the spatial and temporal distances between entrepreneurs with a large funding need, and economic actors with capital surpluses. Accordingly, “capital markets provide a wide range of mechanisms through which individuals can pool or aggregate their wealth into larger amounts of capital for use by firms with large-scale investment projects” . Irrespective of the relative abundance of capital and the need thereof, without proper mechanisms for managing risks, capital rich sectors of an economy may well refrain from the investment options necessary to drive domestic output growth. Capital markets mitigate this possibility by permitting “multiple investors to share risk, enabling high-risk, high-return projects to be undertaken” .
Essentially, therefore, well-functioning capital markets should facilitate the “denomination, liquidity, maturity, risk (with respect to credit, interest rate, and market), and other characteristics desired by those who have a surplus of funds and those who have a deficit of funds”. However, despite the general use of the term, the capital market is not monolithic. It comprises the “money market”, where short- to medium-term funds are traded, and the “capital market” proper, where financial instruments at the long end are traded.
3. THE NIGERIAN CAPITAL MARKET
The capital market was a major beneficiary of structural reforms to the economy, which began in 1999, as a result of which the trend growth rate of the economy rose from 3% to 4% per annum before the turn of the last century, to around 7% per annum since 2003. Additional reforms to the financial services sector, including the 2004/2005 increase in banks’ minimum capital base saw further inflows of investment into the capital market.
Over the period since 1960, efforts have been made by market operators, regulators, and governments, to strengthen the capital market in Nigeria. The question as to where we are today is a function of the strength and effectiveness of the regulatory framework on which the capital market is supposed to ride. Nonetheless, a brief history of the capital market in Nigeria would include the following.
By October 2007, well over 20 companies listed on the Nigerian Stock Exchange (NSE) had market capitalisation in excess of US$1 billion. And according to the then governor of the central bank, the NSE’s capitalisation was expected to hit US$100 billion by 2008, just behind the Johannesburg Stock Exchange. A lot of this growth was fuelled by rising pension assets which needed an outlet, and which by October 2007 stood at over N600 billion .
Since the boom days, however, the market witnessed a steep decline in trading volumes and overall market capitalisation, with the value index dropping from 33,358.3 points in 2006 to 20,730.6 points in 2011, and the value of approved new issues dropping precipitously to N2.03bn in 2011 from N1,410tn in 2006. With 201 listed equities, 48 listed bonds (including one exchange traded fund), and an average daily turnover this year of US$17m, the market capitalisation of equities on the NSE currently stands at N6.54trn, while that of bonds is slightly lower at N3.74trn.
Significantly, these numbers have been trending down, including over the last 12 months to end-December 2011, when in US dollar terms, the market capitalisation of equities dropped from US$53.4bn as at end-December 2010 to US$43.1bn over the same period in 2011. The number of listed equities similarly fell from 220 in 2010 to 201 last year. Unsurprisingly, the All Share Index fell in 2011 by 16.3% as against a 19% growth in 2010, A large part of the downward pressure on the market’s numbers has come from a fall in investor confidence. Under the then unregulated and unstructured margin lending regime, credit was freely available to anyone who cared to borrow to buy shares just as more investors, in particular, retail investors with little or no understanding of the risk of the market, especially Private Placements, were attracted into purchasing both registered and unregistered securities and got locked in as the bear market emerged. Expectedly, to a not-too-financially-literate investor community which was unaccustomed to big and prolonged market slides, panic and fear drove confidence to evaporation points. It is therefore a very tough task getting the same hurting investors back to the beat without a firm promise (and perhaps guarantee) of juicy returns. But this is more for the retail end of the market.
For the institutional investors, major confidence challenges still abound notwithstanding certain factors like the establishment of the Asset Management Corporation (AMCON), various regulatory actions and reforms which are aimed at improving financial disclosure, transparency and governance of financial institutions and listed companies and institutionalising effective regulatory oversight. Not only do foreign institutional investors still entertain doubts as to the efficacy and reach of these initiatives, especially the weak judicial system that leaves most breaches unpunished, they also have very good reason to be concerned about the rising state of insecurity of lives and property in the country.
At the international level, the chronic global economic and financial crisis forced out most non-residential investors and has continued to prevent their return. Along with falling investor confidence, some institutional and structural short-comings have also depressed market sentiments. Emerging evidence of widespread market abuses between 2006 and 2009 may have reinforced investors in the sense that they were the victim of scams perpetrated by market insiders before the collapse.
In addition, there is a strong case to be made against the public sector’s growing borrowing requirement. As the Federal Government has borrowed more it has seen an increase in the yield on its borrowing instruments. These rate rises, in turn, have increased the attraction of government debt instruments, pushed the private sector out of the business of issuing bonds, and diverted domestic savings away from the capital market to the money market. No less injurious to the fortunes of the market, has been the decision of some quoted companies, Ecobank Nigeria, and Nigerian Bottling Company to delist from the market. The above-mentioned reasons for the implosion of the capital market have clearly hindered the prospects of recovery.
Obviously, therefore, a key benefit of a properly functioning capital market is its connection with the larger economy. Indeed, studies have indicated the existence of “a long run relationship … between (the) capital market and economic growth in Nigeria”. F. T. Kolapo and others argue in favour of the positive impact played by the capital market on economic growth in the country . And in this regard, it is noteworthy that over the last three decades, Nigeria has witnessed a steady deterioration in its stock of physical and social infrastructure. Now, if the softness or “absence of effective capital market could leave most productive projects which carry developmental agenda unexploited” , then there is a very strong case for rejuvenating the Nigerian capital market for sustainable growth and global competitiveness.
4. Economic Environment
It would be apt at this stage to reflect a bit on the macroeconomic conditions that interplay in the vibrancy of the capital market.
On the strength of the broad numbers alone, the story looks good. Over the ten years to end-2011, output growth in the country averaged 6% yearly, which within the context of global output growth was very impressive performance. Ideally therefore, the country should have attracted significant levels of investment across all sectors of the domestic economy, especially through the capital markets.
However, close to half of the growth in GDP over this period was accounted for by agriculture. Of a subsistence, and rain-fed nature, this sector of the economy was (and still is) not sufficiently developed to attract investment of a substantial nature. Reforms of a fundamental nature to the sector will thus be needed if we are to attract investment to agriculture, and eventually to have agro-allied establishments quoted on the floor of the capital markets. In the event, of the formal sectors, those with a presence on the floor of the stock exchange, manufacturing, and the wholesale and retail trade segments were big contributors to output growth.
Part of the difficulty with attracting investments into the economy is the diverse risks for which would-be investors require a premium on expected returns. The proximate risk in this regard is inflation. Despite the best efforts of the monetary authorities, this has remained in the lower double digit range for some time now. Adjusted for changes in the movement of domestic prices (and with inflation averaging 11% in the ten years to end-2011) the 6.00% average growth rate in GDP turns out to be negative and not as attractive as it appears at first.
For foreign portfolio investors who plan to repatriate funds, exchange rate stability is also a prime concern. In this regard Nigeria has performed quite well over the past decade except for the unexpected step change in rates that occurred in 2008. As I speak, there are real concerns over the ability of the domestic authorities to support the domestic currency in its current exchange band. In part, this is the result of falling oil prices on the global markets. Having reached a new height of US$128.47pb mid-March this year, the price of the nation’s benchmark crude, the Bonny Light, has dropped steadily (in response to dismal economic statistics from the world’s major economic groupings). Since the beginning of June this year, the naira has trended southwards. Currency volatility along this lines further complicate the economy’s ability to attract investment, as would-be investors worry that adverse currency movements might see them incur losses on their investments, whenever they decide to repatriate such.
Invariably, investors in the economy over the last ten years have sought returns on their investments that compensated them for both this inflation risk, and the exchange rate risks that they faced as the price of the domestic currency responded to threats to the economy’s competitiveness. In the period up to 2008, the return on investment in the economy was high enough, especially in the capital market to compensate for investors’ need for high returns.
However, current financial and economic conditions compel us to take a second look at the attractiveness of the domestic economy for investments. Between 1980 and 2011, gross national savings rose from 24.83% of GDP to 40.40% indicating the availability of a domestic pool of savings from which investments may go to the capital market. Over the same period, gross national savings in East Asia averaged 42%, again indicating the need for further reforms to the economy if we are to match the investment levels reached by the Asian tigers. On the other hand, inward FDI flows as a percentage of GDP has remained stuck in the 3% range except for a short-lived spike in 2009 when it touched 5.0% (it closed 2011 at 2.8%). According to UNCTAD numbers, whereas inward FDI flows into India, Singapore, and Indonesia was between US$10bn and US$49bn in 2010, with China and Hong Kong averaging over US$50bn, Nigeria only managed to attract a little over US$3bn in the same period. Indeed, Hong Kong, China, Singapore, Republic of Korea, India, Malaysia and Taiwan have over the last five years become exporters of capital in their own rights.
To its credit, government has taken these challenges in its stride, and is designing forbearances for brokers on the floor to help jump-start activity in the market. But further reforms to the economy, including such reforms as are necessary to boost final demand, especially through the availability of credit at the retail level will be essential to drive a return of domestic savings to the capital market in the medium-term.
Larger economic concerns remain too. From a contribution of 41.84% to GDP in 2009, agriculture’s share of domestic output fell to 34.47% in the first quarter of this year. Coupled with shortfalls in oil output (as against this year’s budget benchmark of 2.48mbd, we have managed 2.09mb 2.18mb, and 2.13mb in March, April, and May this year respectively), it is no surprise that the Coordinating Minister for the Economy has warned of a likely recession in the near-term. It is doubtful how much investment the economy can attract in this circumstance.
Still, there is some space for institutional reforms to the capital market as part of a process of rejuvenating the sector.
5.IMPERATIVES FOR SUSTAINABILITY AND GROWTH
The nature of the reforms that have to be implemented if the capital market is to drive sustainable growth are diverse. Thankfully, the Nigerian Stock Exchange is alive to these challenges, and has defined a roadmap for change.
(i) The NSE’s Reform Agenda
The NSE’s CEO’s review and outlook published January, 23 2012 set out key initiatives for the current fiscal year. Arguably, a couple of these initiatives have a medium-term implementation horizon, but the most important include:
• Plans for revitalising the secondary market in bond trading ;
• Dematerialisation of documentation of securities;
• Exchange-to-exchange (E2E) trading;
• Trading automation;
• Introduction of value added services;
• IFRS compliance; and
Further down the road, the CEO’s plans include the start of trading in options in 2013 and financial futures in 2014.
If this reform agenda can be faulted, it is perhaps only in the ambition of its reach. Still, it is not possible to cavil at the necessity of any of the planks on the reform platform. Proper sequencing will thus be key to its near- to medium-term success.
Looking forward, a number of initiatives already in the pipeline recommend themselves as useful options for rejuvenating the capital market.
Despite the broad reach of this roadmap, there are a number of other initiatives with possible beneficial effect on the outlook for the nation’s capital market. These include:
(ii) Forbearances for Market Operators
The fact that the capital market crisis has dragged on for so long without any sign of prompt recovery, suggests that we may not be looking at the broad range of policy responses needed to solve this crisis. And in view of the experience in other sectors of the economy, this is indeed a surprising turn of events.
Across the economy the macroeconomic authorities have responded to the effect of the global financial crisis on the domestic economy by taking action to put a floor on the losses of key sectors. Accordingly, to take but two prominent examples, both the banking and aviation sectors have benefited from quasi-fiscal operations by the Central Bank of Nigeria (CBN). There is no doubt that the intervention by the Asset Management Corporation of Nigeria (AMCON) was instrumental in the quick recovery of the sector from the adverse environment created by the details of the August 2009 Special Audit of the nation’s banks. Similarly, we have seen evidence of the positive impact of the Aviation Fund on the health of the nation’s airlines.
Within this context, it is difficult to understand the continuing absence of an intervention fund for the capital market sector. I note, in this regard, the Coordinating Minister of the Economy and Finance Minister’s reiteration of the Federal Government’s plan to work out a forbearance package for stockbrokers as part of measures to stimulate confidence in the Nigerian stock market and increase liquidity.
Although details of this package is still being worked out, at the very least, it must include two ingredients. First is the provision of funds at concessionary rates. These new levels of liquidity will help brokers begin the balance sheet adjustment necessary to return to functional levels of liquidity in the market.
Nonetheless, funds at concessionary rates would still be inadequate to address the over N300 billion operators' debt overhang. In order to address this, the capital market would need forbearances on the debt owed by operators, including long-term restructuring of margin facilities. AMCON has addressed the bulk of margin lending driven by bank debt. But the bulk of the outstanding debt is owed on proprietary positions, and the obligations attendant upon this has been the single most important cause of industry operators’ insolvency.
(iii) Broadening and Deepening the Exchange
A fundamental part of the current problem with the capital market is its shallowness and lack of breadth. Currently, less than 10% of listed equities are actively traded, while the NSE offers only basic products. There have been arguments, though, to the effect that the NSE’s product offering has only reflected the domestic economy’s financing needs. However, on account of the economy’s radically changing financing needs, including the recourse to the public private partnership (PPP) arrangement as a solution to the nation’s infrastructure dearth, opportunities should now abound for a broadening of the exchange’s product offerings to include key derivative categories, expansion of listed mutual funds, index funds etc.
(iv) Changes to Regulations
However, the extent to which the opportunities presented by new product offerings may be exploited will depend a lot on the ease with which statutes and rules are adjusted to expedite and deepen the conduct of business on the exchange.
While I concede that the change to the rules are of a slightly lengthier implementation horizon, there are a few low-hanging fruits that recommend themselves as part of the process of getting the capital market back on its feet. The easiest of the latter is the design of mechanisms that help attract back to the trading floors those who retreated to the sidelines in response to the losses they suffered in 2008 and 2009.
(v) The Regulatory Challenge
As the economy has made the transition from a public sector-driven framework to a private sector-driven one, there has been a tendency to underplay the importance of an effective regulatory framework. Largely, this has been due to the persistent use of the term “deregulation” to describe the gradual process of official disengagement from economic management.
Nonetheless, it is gradually clear every day that the role of the regulator is essential to the success of any sector. In this respect, the Securities and Exchange Commission (SEC) owes a duty of care, to ensure adequate governance and process transparency on the floor of the exchange. To some degree, this role is consistent with the SEC’s mandate of oversight over the exchange to prevent breaches of market rules and discourage and unearth unfair manipulations and trading practices. Furthermore, foreign investors in particular (who account for the majority of NSE trading volumes at present) seek stability and independence in a regulator, and ensuring the smooth unimpeded functioning of an independent capital markets regulatory function is of paramount importance.
(vi) Draft Amendments to PenCom Investment Regulations
Globally, pension funds have played invaluable roles in the rapid maturing of capital markets. However, existing statutes in the country limit pension fund administrators (PFA) equity holdings to 25% of each portfolio. This cap therefore restrains the extent to which the activity of PFAs on the market could drive growth.
For context, the latest available numbers for the pension industry indicates that PFAs have 9% of assets invested in equities, 51% in government securities and 26% in money market instruments. On the other hand, the sector’s total assets amounted to N2.45tn (US$15.6bn) as at end-2011, and are growing roughly by 20% annually. Despite these salutary numbers, only about five million workers in Nigeria are registered in contributory pension schemes, which points to the large potential upside for the sector.
Accordingly, one aim of the proposed amendments to the PFAs’ investment rules is to deepen and widen eligible assets into which PFAs can put this huge pool of cash. The amendments propose different fund structures, which are distinguished by the exposure to variable income instruments. Depending on the fund, the ceiling for equities would range from 10% to 50% of the total.
In addition, the draft would permit investment for the first time, inter alia, in interest free (Sharia compliant) products, infrastructure funds, private equity funds, and asset and mortgage backed securities.
On the whole, then, there is a strong incentive to expedite action on the enactment of the necessary statutes to have these changes in place in the near term.
(vii)Revitalisation Of Secondary Market Bond Trading
As part of its efforts to boost trading volumes, the NSE recently appointed 10 market makers, each with responsibility for a basket of listed equities. Ideally, this should improve liquidity, perhaps even for the second tier stocks. However, market makers may provide liquidity only to the extent that they can also borrow stock to meet client orders. They could transform the secondary market in bonds. The impressive market capitalisation of listed bonds conceals the fact that trading is overwhelmingly on an over-the-counter basis.
(viii) Reactivation of the Abuja Stock Exchange
This will add breadth to the market, while at the same time improving the market’s price discovery process.
(ix) Towards A More Investor-Friendly Exchange
A critical requirement for the capital market’s success is that it should offer investors ease of use and access. To a considerable extent, the change of regime at the top management of the exchange in August 2010 has had a beneficial effect on market sentiment. In the same vein, the scrapping of the one-year mandatory holding period for foreign investors in Federal Government bonds and treasury bills, effective July 2011, was a modest positive. Furthermore, the NSE has eased some listing requirements including reducing the required track record for a company wanting to list from five to three years.
(x) Design and Deployment of new Listings
An understanding of the reasons why a company would want to list on the Nigerian capital market is essential to the proper design of a reform programme. As with Dangote Cement in 2010, companies have their (different) reasons for listings. Most often, they list because it suits their purposes and not because some constitutional authority demands it. In this sense, efforts by the National Assembly to compel the oil majors and the main telecoms operators to list on the NSE might be counter-productive. The exchange would have benefited more if the Federal Government had made the award of a telecommunication license in 2001 conditional upon a public listing on the bourse. Current arguments in favour of a compulsory listing of the telcos shares are weakened because they are clearly driven by the success of the licenses.
If our ultimate aim is to get the capital markets working in the larger interest of the economy, better instead to have a lot of trading taking place in the listed equities than to compel the additional listing of equities whose free float might further constrain trading. No less important in this regard, is the need to have the exchange become a more accurate mirror of the structure of the economy. It is noteworthy that the NSE’s outlook shows that services, healthcare, ICT and conglomerates accounted for just 1% each of market capitalisation at end-2011, and construction/real estate for only 2%. Financial services and consumer goods each comprised 31% of the total, and industrial goods (notably cement) 29%.
Without any doubt, the design and deployment of new listings over the current plan horizon would be useful in dimensioning the outlook for the nation’s capital market. The NSE expects that there will be 20 new listings this year, compared with 34 in 2011 valued at N2.21trn (US$14.6bn). Likely candidates on the official side include minority stakes in the 18 generation and distribution companies created from the unbundling of the PHCN. Although there are worries that these transactions may well slip into 2013, there is enough on the public sector side of the budget (as it pursues its deregulation and privatisation programme) to drive
(xi) Retail Investor Education/Awareness
In the light of the lessons learned from the most recent stock market collapse, there is a strong requirement to strengthen the exchange’s investor education/awareness function, especially for retail investors.
The task in this regard is not to help retail investors choose which stocks to invest in, but to help prevent their being defrauded. In particular, a key deliverable is to bring retail investors up to scratch on the long-term nature of investments in the capital market. This will help dispel the sense that evolved on the back of the rapid price gains on the floor of the market in the period leading up to 2007 that the exchange is a source of quick, high yielding returns.
Ultimately, an institutional approach to retail investor education should help rebuild retail investor confidence, embed the current reforms, while reinforcing transparency and accountability.
A number of additional reforms recommend themselves over the medium-term. These include: the possibility of government injecting new capital into the market to provide liquidity and shoring up prices; encouraging the sovereign wealth fund to invest a certain proportion of wealth in equities quoted on the stock exchange; constituting unclaimed dividends into a trust fund; and removing the requirement to charge value added tax on capital market transactions.
Clearly, in spite of the considerable value loss that has taken place on the exchange over the last five years, and the identified impediments to growth, there is a clear and strong role for a vibrant exchange on the path to Nigeria’s development. In 2007 the ASI index peaked at over 65,000 points (currently about 22,000) and daily turnover in excess of US$100m was not uncommon. Sadly, this state of affairs was unsustainable, as it was built on retail hype, margin loans, questionable practices and ample global liquidity. Perhaps what we are witnessing currently can better be described as a market correction rather than a collapse as most commentators describe it.
Our new challenge is to build a capital market on the basis of best international practice with a wide range of assets for the investor base. In more concrete terms, the priority is to make the exchange more attractive to domestic investors. Industry data for Q1 2012 suggest that foreign investors accounted for 81% of all transactions. Bona fide market making will help this transformation of the exchange, but the essentials are a far larger regulated domestic pension industry with an investment mindset more active than hold-to-maturity.
It is also no less evident that the general outlines of an appropriate reform path have been well enunciated; and that domestically, there is adequate capacity to drive the needed change. From this vantage, the biggest challenge is to sequence the reforms properly so that the exchange in particular and the larger economy get the most value for every naira spent.
It is important also that we bear in mind that capital markets are built around strong fundamentals with respect for public trust and morality on the part of market players/stakeholders. An investor who decides to invest in the capital market does so based on what can be interpreted from the audited report made public.
Given our present balance of the sectors in the capital market that attract the interest of investors, a skew towards the services sector is immediately obvious with financial services dominating. Is this proper if the challenge is to produce tangible goods? It is expected that a market should reflect the fundamentals of an economy and its competitiveness. In this regard, the mega-listing of Dangote Cement is cheerful news and hopefully portends greater participation of the real sector in the capital markets in years to come.
Ultimately, the market needs to evolve to a level where the inevitable cycle of market bears and bulls are cushioned or less volatile and more predictable for growth and sustainability. Related to this need is how we answer the question of how to strengthen the incentives for real enterprise as against financial market arbitrage.
Effective governance within the NSE and SEC cannot be discounted as a potent barometer for guiding the market to the expected levels. There are also accounting standards issues which should now be corrected with the IFRS reporting standard.
Ultimately, the main challenge is to ensure that market’s control mechanisms are in place and strong enough to drive efficient price discovery processes. In this regard, it is heartening to note that the current focus on macro-prudential regulations is biased in favour of reinforcing coordination across regulators in the financial services industry (both domestic and internationally). It is no less important that the domestic structure of incentives is aligned in favour of value-creating economic activity. Only this way may we attain the level of diversification of the domestic economy that will reinforce whatever structural changes we agree to make as part of the process of rejuvenating the capital market for sustainable growth and global competitiveness.