I am a father of three, with my eldest 15 years old, and so the battlecry of “do your homework!!” is often heard throughout our house and echoing through our neighbourhood and beyond.
I felt inclined to shout the same command today after reading the news that the Zimbabwe Stock Exchange (ZSE) has entered into a deal worth about US$1,2 million with a Sri Lankan information technology firm, Millennium IT Software Ltd (MIT), to establish a central securities depository (CDS) in Zimbabwe. Has the ZSE done its homework?
The London Stock Exchange has just purchased MIT which is, in principle, good news: the LSE is a world leader. And the MIT software is pretty robust, with lots and lots of features, even if they are very costly features that need clever people to run them. But a review of how the MIT software has worked in regional markets does not bode well for Zimbabwe’s market.
- A process of engagement with all market stakeholders must be undertaken before proceeding with any particular CSD system to establish what CSD system, procedures, structure and process should be implemented for the specific and unique requirements of each market. I assume this has happened.
- Since the CDS system may (will) be a monopoly, mandatory use obligations may be placed on listed companies. Against their will. At what cost? Have Zimbabwean listed companies been consulted, or are there any plans to do so, regarding the benefits and the costs?
- Does Zimbabwe’s new securities and companies’ laws incorporate a CDS? If the CDS is not supported by legislation and broadly by the market, a tripartite alliance with listed companies, transfer secretaries and the CDS may be required. Legally this is messy. Practically this is messy.
- Is the CDS going to be adequately capitalised? In the absence of capital and legislation it may be possible that the transfer secretaries manage the registers for the CDS on behalf of listed companies. This creates a practical merry-go-round for investors because the owner of the trading data used is not the applier of the software system. In the absence of an online solution (promised by MIT in many markets but not delivered) investors suffer as does the reputation and bank balance of listed companies.
- Have the different components of the system’s functionality been costed properly? Promises of access to online account interrogation and other functionality by investors have failed to translate into reality in other markets. Why? They are too expensive (MIT is known to be expensive), the skills to manage changes don’t exist locally and the critical mass in each of these markets is not sufficient to support MIT’s fee structure.Zambia’s CDS system (sponsored initially by USAID I believe) has problems that only the listed companies and affected shareholders are aware of. There have been some serious behind-the-scenes spats between listed companies and the CDS and it is clear that systems are not 100% error-proof. There is no public acknowledgement of these issues and it appears that no resources are being applied to beef up the efficiency of the system. The predominance of manual self managed registers is growing. Not a good sign.
- Who actually bears the cost of the CDS? Unless there is buy-in from all stakeholders on how costs of the CDS are to be recovered there is a risk that costs will be borne individually by listed companies.
- What do investors think? Simple things such investors being required to receive a CSD account in hardcopy for each company in which they have invested rather than a consolidated account is important. Who suffers?: the investor, the listed company and the environment. Do investors want to pay more than they are currently paying? Absolutely not. If more costs were to be negotiated what would the basis of the motivation of this be to the listed company?
- Will the entire project be independently project managed by professionals? There are big cost and credibility issues if we get to the end and discover we’ve missed out a few key steps along the way… I guess this is handled by the US$1.2m system cost announced.
- The organisation that intends running/operating the CSD (invariably an “arm” of the exchange itself) needs to be appropriately staffed by well trained individuals with experience of IT and equity markets, using the correct hardware with the necessary backup and disaster recovery procedures etc. in place. This means appropriately staffed at the beginning and middle and end. Not just at the beginning. Anecdotal evidence from regional markets suggests that insufficient investment in human resources adds to costs, which brings me to the next point.
- MIT’s rates for maintenance and upgrades are high. Had Africa’s regulators been cooperating for the past 15 years (e.g. ASEA), there would have been ample scope for the establishment of a pan-African network of systems with steep negotiated discounts, cross subsidised by Africa’s exchanges, based on critical mass, and a dash of soft funding from something like the African Investment Climate Facility. Most MIT systems used regionally are not used to full capacity due to the high costs.
- And lastly, there is a fundamental conflict between the operations of the CDS and the manual share registrar services. In the absence of an overall agreement on the ultimate structure of the market one that is purely CDS based – conflicts will always ensure that the investor is stuck in the middle. Usually a CDS organisation is set up in which all of the market players, including banks and share transfer secretaries, exchange their interests in the businesses that they have or inject capital for an equity stake in the CDS. This aims to ensure that the overall interests of the capital markets are met. Compromises are made by each and every player for the greater good. Every player then knows that they are set to benefit from a monopoly! This co-operation is not happening in African markets. Someone should say no, and stop! Why bother if an ultimate goal cannot be defined and pursued successfully?
The inefficient application of some good ideas in some of Africa’s markets shows that no-one is regulating the regulators: the market should regulate the regulators. But in Africa it doesn’t work this way. Awareness of these issues is low amongst all players and for those that know negative public confrontation is not the way. Especially in smaller markets where established commercial relationships can be upset by any form of confrontation.
In many cases listed companies may not be aware of the risks associated with their share registrar and settlement systems. Where they are aware of the risks, I believe risk containment is handled by way of them handling their share registrars themselves. But this does not avoid bigger structural issues.
So what are a few practical pointers for Zimbabwe if the CDS system is to be effective:-
- Each investor should have ONE CDS account on which all share registrations should be recorded.
- From day one online access to the CDS account by investors should be provided. Zimbabwe has over 1million internet users. Many of them should be investors. See my blog about this.
- Qualified update of online contact details by investors should be provided. The management of contact details is one of the biggest practical problems for listed companies and investors alike.
- Service level standards for intermediaries brokers etc. should be implemented.
- Full transparency on what the actual and future costs (by way of example in other markets) are likely to be for each player.
If there is a funding gap then this should be filled in some other manner. The ZSE should not implement a system that is not wholly in the interests of the market on day one because there wasn’t the money. Starting with an incomplete system (one not addressing some of the core issues discussed herein) will lead to an incomplete less efficient system over time and make it more and more difficult for things to change as relationships (and vested interests) become more entrenched.
Investors and listed companies ultimately bear the cost. But there is a bigger picture, a national one: the efficiency of a central clearing and settlement system is ultimately reflected in the equity discount rate premium applied by investors when evaluating country risks. Raising capital in an inefficient market costs more. Investors, listed companies and economic development pay the price. The absence of publicly available appraisals of these systems means that the costs are hidden from view. For this, the equity discount premium is just that little bit higher. Caveat emptor as they say.
These issues are complex and time flies. I think that many markets realise that very little development has occurred in the past 15 years and something should be done ASAP. So there’s a rush into applying sub-optimal solutions. Which is why markets need 5 – 10 year strategies.
The ZSE should do its homework (or publish the homework it has done), engage all players and ensure that any system implemented has a chance of success measured by whether it meets the interests of investors and listed companies. This should be measured by asking the investors and listed companies. Receiving feedback and then address the issues raised in turn. It’s good, sustainable corporate governance.