Strategic alliances and mergers of financial exchanges: The case of the SADC

Journal of Southern African Studies

Volumn 31, Issue 1, 2005, Pages 75-93

  Okeahalam, Charles C ^a  

^a Africa Growth Holdings   (South Africa)

Author keywords

[No Author keywords available]

Indexed keywords

ECONOMIC RELATIONS; FINANCIAL MARKET; REGIONAL ECONOMY; SOUTHERN AFRICAN DEVELOPMENT COMMUNITY;

AFRICA; EASTERN HEMISPHERE; SOUTHERN AFRICA; SUB-SAHARAN AFRICA; WORLD;

EID: 17444395988     PISSN: 03057070     EISSN: None     Source Type: Journal    
DOI: 10.1080/03057070500035703     Document Type: Article

References (55)

1. See C. C. Okeahalam, 'An Analysis of the Price-Concentration Relationship in the Botswana Commercial Banking Industry', Journal of African Finance and Economic Development, 3 (1998), pp. 65-84
2. and C. C. Okeahalam, 'Costs and Efficiency in Botswana Commercial Banking', Journal for Studies in Economics and Econometrics, 23 (1999), pp. 53-72.
3. The field of market microstructure attempts to examine issues, or friction, in markets which might influence the outcomes of those markets. Some of the earliest studies on the market structure of securities markets go back to the writings of G. J. Stigler, 'Public Regulation of the Securities Markets', Journal of Business, 37 (1964), pp. 117-142 - who studied market makers
4. and H. Demsetz, 'The Cost of Transacting', Quarterly Journal of Economics, 82 (1968), pp. 33-53, which is a study of bid-ask spreads.
5. A Walrasian equilibrium refers to a situation in which all markets clear, i.e. total demand equals total supply for each good. This consistency of the actions of all agents is achieved by price movements which are arrived at because all private agents receive a price signal and assume that they will be able to exchange whatever they want in the price regime.
6. For a broad survey of the findings, see A. Madhavan, 'Market Microstructure: A Survey', Journal of Financial Markets, 3 (2000), pp. 205-258.
7. I b i d.
8. See A. Singh, 'Should Africa Promote Stock Market Capitalism?, Journal of International Development, 11 (1999), pp. 343-365.
9. Although the focus of this article is on equity securities, there has also been some debate regarding the trading infrastructure and organisation of other securities-bonds and commodities.
10. At the time they proposed to merge, the London Stock Exchange (LSE) and the Deutsche Bourse agreed to merge their clearance and settlement systems so as to establish a Europe-wide central counter party (CCP) for clearing equities. When the proposed merger of the exchanges failed, the establishment of the CCP was cancelled. This is unfortunate because both organisations estimated that the CCP would lead to savings of approximately €1 billion per year. The LCH then began merger talks with Eurex Clearing.
11. Clearstream makes a significant contribution to Deutsche Bourse's profits and the decision to keep its own settlement system, given the plans to merge with the LSE, seems to be well considered. The Deutsche Bourse Company was floated on 5 February 2001 - becoming the first big stock exchange operator to float. It was 23 times oversubscribed, climbed 10 per cent on the pre-floatation price, and ended the first day of trading with a market capitalisation of DM4 billion.
12. For more on this, see C. Detken and P. Hartmann, who have developed a series of measures to analyse the significance of the euro on European and international capital markets. C. Detken and P. Hartmann, 'The Euro and International Capital Markets', International Finance, 3, 1 (2000), pp. 53-94.
13. M. Pagano, 'Trading Volume and Asset Liquidity', Quarterly Journal of Economics, 104 (1989), pp. 255-274
14. and D. Easley and M. O'Hara, 'Time and the Process of Security Price Adjustment', Journal of Finance, 47, 2 (1992), pp. 577-605.
15. The Deutsche Aktieninstitut represents the interests of Germany's listed companies. See R. von Rosen, 'Clearing Up Europe's Exchanges', Financial Times, 9 February 2001.
16. C. Pirrong, 'The Organisation of Financial Exchange Markets: Theory and Evidence', Journal of Financial Markets, 2 (1999), pp. 329-357.
17. For details on this, see K. J. Cohen, S. F. Maier, R. A. Schwartz and D. K. Whitcom, The Microstructure of Securities Markets (Englewood Cliffs, NJ, Prentice Hall, 1986).
18. The best-known functioning examples of economic integration in the SADC are the Common Monetary (Rand) Area (CMA) which is comprised of Lesotho, Namibia, South Africa and Swaziland, and the Southern African Customs Union (SACU), which comprises all of the aforesaid countries as well as Botswana. For a discussion of integration and trade in the SADC region, see 'Focus on SADC Trade Protocol', Enterprise Magazine (2001).
19. Michie defines economic competence as 'the ability to identify, expand and exploit business opportunities' and states that it 'is unevenly distributed among firms (asymmetric capabilities)'. He goes on to state that 'when new generic technologies become available, providing vastly expanded and different technological and commercial opportunities, the bounded and different visions ... of managers due to varying knowledge bases, imply that firms may differ greatly in their perception of these opportunities' (J. Michie, 'The Internationalisation of the Innovation Process', International Journal of the Economics of Business, 5, 3 (1998), pp. 261-277).
20. This was one of the reasons that the LuSE in Zambia was established in 1993.
21. In South Africa, the electronic Johannesburg Equities Trading (JET) system began operating on 8 March 1996, and Share Transactions Totally Electronic (STRATE) - the electronic settlement system - started operating on 30 July 2000. It is designed to comply with the G30 recommendations on the contractual agreed settlement day, rolling settlement (initially T + 5 moving to T + 3), gross settlement without aggregation or netting. Furthermore, the JSE has de-materialised all JSE-listed share scrip and is developing capacity to use the same trading system as the LSE.
22. Some studies illustrate that US companies report negative abnormal returns around international listings; see, for example, J. S. Howe and K. Kelm, 'The Stock Price Impacts of Overseas Listings', Financial Management, 16 (1987), pp. 51-56.
23. (G. Alexander, C. S. Eun and S. Janakiramanan,'International Listings and Stock Returns: Some Empirical Evidence', Journal of Financial and Quantitative Analysis, 23 (1988), pp. 135-151).
24. The Anglo-American conglomerate has increased its shareholdings in De Beers, the leading diamond producer, to a controlling stake. Given that Anglo-American is now listed on the LSE, this has removed De Beers as a primary listed counter from the JSE. Investec investment bank has also moved its primary listing to the LSE.
25. 'Counters' is an old financial market term used for the representation of a financial instrument which represents a firm listed on an exchange. The expression was particularly relevant in the days when the values attributable to relevant parties in trades were manually counted and an actual bearer instrument was exchanged.
26. Carmody makes the same point and emphasises the significance of this trend by stating that 'The globalisation strategies of South African conglomerates have gone further than those of other transnationals worldwide.' P. Carmody, 'Between Globalisation and (Post) Apartheid: the Political Economy of Restructuring in South Africa', Journal of Southern African Studies, 28, 2 (2002), pp. 255-275.
27. The IFSA is the trade and governing body of the 54 major exchanges in the world. The JSE is the only financial exchange in Africa that has qualified for membership of the IFSA.
28. The Salomon Smith Barney Guide to World Equity Markets ranks the ISE twentieth by capitalisation, but it is ranked lower by liquidity. Figures from the same source for 1999 give the NYSE, NASDAQ and LSE a market capitalisation of US$12,296.1 billion, US$5,204.6 billion and US $8,765.9 billion, respectively.
29. Several factors can cause market segmentation: high transaction costs such as tax duty, exchange controls, tax policies and lack of clarity and enforcement of legal frameworks. Furthermore, in theory, assets can be classified according to their level of liquidity. Usually there is a liquidity preference, in that of two or more assets, with the same nominal value, the one with the lowest transaction costs and highest liquidity will carry the lower investment risk and will thus - in an efficient market - trade at a premium to the other assets or securities. If the methods and principles of exchange are well documented and adhered to, financial securities should have low transaction costs given that their properties can be transparently defined and their costs of delivery can be kept low in relation to their value.
30. The theoretical reasoning is that in a perfectly integrated capital market, investors would have the same opportunity set for all domestic and foreign securities. Yet in a segmented market the expected rate of return on a security would differ from the expected rate of return on a security with the same beta (diversifiable portfolio risk) after adjusting for exchange and tax rates. For example, research findings suggest that, where capital markets are relatively segmented, international listings may be a way of overcoming the disadvantages. The issue of market segmentation versus integration has been widely researched - see Cohen, Maier, Schwartz and Whitcom, The Microstructure of Securities Markets.
31. In addition, Jefferis and Okeahalam and Okeahalam and Jefferis have illustrated that the SADC exchanges are not integrated. They also find that the JSE has a relatively low level of integration with the major equity markets LSE, NYSE and Tokyo Stock Exchange (TSE). Of the three markets, the JSE is most integrated with the LSE. (K. R. Jefferis and C. C. Okeahalam, 'International Stock Market Linkages in Southern Africa', South African Journal of Accounting Research, 13, 2 (1999), pp. 27-52.
32. K. R. Jefferis and C. C. Okeahalam, 'The Impact of Economic Fundamentals on Stock Markets in Southern Africa', Development Southern Africa, 17, 1 (2000), pp. 23-51.
33. C. C. Okeahalam and K. R. Jefferis, 'An Analysis of the Differential Information Hypothesis on the Botswana and Zimbabwe Stock Markets', The Investment Analysis Journal, 49 (1999), pp. 39-40.
34. and C. C. Okeahalam and K. R. Jefferis, 'An Event Study of the Botswana, Zimbabwe and Johannesburg Stock Markets', South African Journal of Business Management, 30, 4 (2000), pp. 131-140).
35. A study currently being carried out examines the trading and operational costs of exchanges in the SADC region using econometric and stochastic frontier analysis.
36. See H. Bessimbinder, 'Trade Execution Costs on NASDAQ and the NYSE: a Post-Reform Comparison', Journal of Financial and Quantitative Analysis, 34 (1999), pp. 387-407
37. and H. Bessimbinder and H. M. Kaufman, 'A Comparison of Trade Execution Costs for NYSE and NASDAQ Listed Stocks', Journal of Financial and Quantitative Analysis, 32 (1997), pp. 287-310.
38. The evidence as to which type of financial exchange market mechanism structure provides the lowest cost of capital for a firm is mixed. Small firms prefer dealer markets and larger firms prefer auction markets. Dealer markets usually have larger bid-ask spreads, which would be expected to increase the cost of capital. However higher spreads also give dealers an incentive to make a market in a particular stock. See P. Clyde, P. Schultz and M. Zaman, 'Trading Costs and Exchange De-listings: the Case of Firms that Voluntarily Switch from the American Stock Exchange to the NASDAQ', Journal of Finance, 52 (1998), pp. 2,103-2,112.
39. J. H. Harris and P. H. Schultz, 'The Trading Profits of SOES Bandits', Journal of Financial Economics, 50 (1998), pp. 39-62.
40. For a detailed discussion on this issue, see P. Young and T. Heys, Capital Market Revolution: The Future of Markets in an Online World (Harlow, Pearson Education/Financial Times Prentice Hall, 1999).
41. Furthermore, the title of the article by John Langton, Chief Executive of the International Securities Market Association (ISMA), 'Notice to Stock Exchange Members: Dining Room Closed. Silicon Chips Being in Basement. All Welcome', International Finance, 3, 1 (1999), pp. 161-166, nicely sums up the state of play and trend of industrial organisation of trading activity on financial exchanges.
42. It has been shown that trading on the NASDAQ is more costly than trading on the NYSE even after the reforms of the early 1990s. The main reason for this is that dealers on the NASDAQ tacitly collude, by avoiding odd eighths of a dollar bid-ask quotes and maintaining 1/8 quotes even though there is not necessarily a link between quoted spreads and traders' actual execution costs. See H. Bessimbinder and H. M. Kaufman, 'A Comparison of Trade Execution Costs for NYSE and NASDAQ Listed Stocks, Journal of Financial and Quantitative Analysis, 32 (1997), pp. 287-310.
43. and W. Christie and P. Shultz, 'Why Do NASDAQ Market Makers Avoid Odd Eighth Quotes?', Journal of Finance, 49 (1994), pp. 1,813-1,840.
44. If more data are collected and a frontier analysis is carried out, it is likely that we would observe that most of the exchanges lie far from the efficiency frontier. A frontier analysis is a performance measurement technique that can be used for evaluating the relative efficiency of organisations. A detailed study needs to be conducted to examine just how efficient each exchange is and whether or not a merger of trading, clearing and settlement systems will (as I suspect) improve the overall level of efficiency. This is an area for future research. Such a study calls for a comparison of the costs of trading, settlement and clearing on each of the exchanges. In addition, there is a need to calculate the administrative and operational costs of trading, settlement and clearing on each of the exchanges. This can then be compared with the costs of trading under a unified and harmonised trading settling and clearing regime using the already established JET and STRATE systems.
45. Given that existing trading arrangements are subject to choice, Kirilenko endogenises the choice of trading arrangements and uses emerging foreign exchange markets, which exhibit a wide range of trading arrangements, to illustrate that if the design of a trading ... 'arrangement affects trading outcomes, then rational, strategically-acting agents will opt for the arrangement that facilitates trading and leads to price discovery'. A. A. Kirilenko, 'On the Endogeneity of Trading Arrangements', Journal of Financial Markets, 3 (2000), pp. 287-314.
46. Stamp Duty (SD) is a tax levied on the purchaser of assets bought in paper form. The UK rate is 0.5 per cent (1.5 per cent on the creation of depository receipts) of the consideration value rounded up to the next 50 pence. The liability arises on the settlement date. The UK Treasury was able to reduce the stamp duty because it was quite clear that an average cost pricing strategy would derive greater revenue and was the more profit-maximising strategy for the LSE, the government and the regulatory authorities than a marginal cost-pricing approach. The liquidity which extra trading activity brings further highlights the accuracy of this strategy. It also highlights a major dilemma with which many of the exchanges in the SADC region are currently faced. Stamp Duty Reserve Tax (SDRT) is a tax levied on the purchaser of assets bought in paperless form, i.e. via CREST. The UK rate is 0.5 per cent (1.5 per cent on the creation of depository receipts) of the consideration value rounded to the nearest penny. The liability arises on the trade date. Although the rates of SD and SDRT are the same, there can be advantages to paperless trading as a result of the difference in the rounding up of the consideration value.
47. The two other explanations which have been put forward by research findings are that a quote-driven dealer market structure may be less efficient in providing liquidity for stocks than an order-driven market. Second, higher trading costs on the quote-driven market might be the result of special features inherent in such a market, which make it possible for market makers to maintain very competitive bid-ask spreads. See Christie and Schultz, 'Why Do NASDAQ Market Makers Avoid Odd Eighth Quotes?', pp. 1,813-1,840.
48. See G. Gaudet and S. W. Salant, 'Towards a Theory of Horizontal Mergers', in G. Norman, and M. Ia Manna (eds), The New Industrial Economics (Aldershot, UK, Edward Elgar Press, 1992).
49. Indeed, in the event-studies literature of financial economics, it has been illustrated that the market discounts the share price of firms that have paid too much or are perceived to have made a bad merger or takeover deal. None of the SADC financial exchanges is, as yet, a public listed company and so it is difficult to obtain a market estimate of the merger. However, it is clear that all the exchanges will have an idea of what is in their best interests, that is, what is a good deal. For a recent study of such findings of this method applied to the banking sector, see E. J. Kane, 'Incentives for Banking Mega-Mergers: What Motives Might Regulators Infer from Event Study Evidence?', Journal of Money, Credit and Banking, 32, 3 (2000), pp. 671-701.
50. Trade Point Exchange is currently being developed as a market response (or protest) by a number of major banks, such as ABN Amro, Credite Suisse First Boston, Deutsche Bank, JP Morgan, and Merrill Lynch, to the difficulties which the established exchanges have had in reaching agreement on merging quickly.
51. In dealer markets (for example, in Namibia and South Africa) liquidity providers have total flexibility to bargain on the price with their customers (investors). In limit order markets (Zambia), they are restricted to convex schedules: they cannot sell the first share at a higher price than the second. Furthermore, in limit order markets, arriving at a unique equilibrium entails efficient risk sharing and competitive spreads. Floor traders (for example in Botswana, Mauritius and Tanzania) basically respond to the liquidity demand conveyed by brokers and as a result, in floor markets risk sharing is inefficient and spreads are large. In dealer markets, risk sharing can be efficient, however bid-ask spreads also tend to be large. See B. Bais, T. Foucault and F. Salanie, 'Floor Dealer Markets and Limit Order Markets', Journal of Financial Markets, 1, 4 (1998), pp. 253-284.
52. In February 2001 the JSE announced that it had agreed to a strategic alliance with the LSE.
53. In most of the SADC countries, the financial exchange also houses offices for clearing, settling and compliance and monitoring. Each country has a different set of rules regarding the way in which this has to be carried out - although, as noted earlier, Namibia has adopted the JSE rules as part of the dual listing agreement. Each SADC exchange also has a set of documentation that it presents to companies, traders and investors wishing to list and trade on its exchange. Some exchanges have a marketing arm. These costs can all be pooled and shared.
54. See D. Simon, 'Trading Spaces: Imagining and Positioning the "New" South Africa within the Regional and Global Economies', International Affairs, 77, 2 (2001), pp. 377-405.
55. Business Day, 29 August 2003 and The Sunday Times, 31 August 2003. Both quoted the following statement by the Botswana Stock Exchange - which accused the JSE of 'trying to force regional exchanges into a South African dominated bourse to boost its own trading volumes and revenues'.