Joseph Stiglitz, Nobel laureate in economics and a friend to Nigeria, places great emphasis on the role of capital markets for developing economies like ours. He reminds us thus: “If capital is at the heart of capitalism, then well-functioning capital markets are at the heart of a well-functioning capitalist economy.” Resuscitation and restructuring of the capital market is therefore sine qua non so that the market for long-term funds can be fluidly channelled toward the projects, sectors and companies which will help us unravel the developmental challenges of infrastructure deficits, economic development, unemployment, etc. We have sought to highlight specific thrusts for action which will help us all join hands as firms, investors (retail and institutional), clients, regulators, banks, government, etc., to bring about recovery and sustained development of the capital market.
Economic structure and growth
Revised 2010 and Q4 GDP estimates suggest that earlier estimates for Q4 2011 were optimistic at 8.68 percent. New estimate shows that the economy grew by 7.68 percent compared to 8.36 percent in Q4, 2010. It is also lower than the forecast of 8.46 percent. Growth in all quarters of 2010 is higher than that of 2011. The slowdown is traceable to the slowdown in investment in the oil and gas sector. The impact of sustained monetary tightening is a major source of decline in growth in 2011.
Nigerian capital market overview
The market depth is quite shallow considering the statistics: only 247 securities listed as at April 18, 2012, made up of 200 companies (including 12 ASeM securities), 25 federal government bonds, 9 state government bonds, 10 corporate bonds, 3 preference shares, and total market (equity/bond) capitalization of about N9.5 trillion ($63.4 billion).
Meanwhile, only the telecom sector can add an estimated N3.5 trillion to the market capitalization by listing the top three companies.
Market development – equity market
The Nigerian equities market lost 16.31 percent in 2011 but started this year on a slightly positive note. Sustained retail-investor apathy, systemic liquidity crunch and impressive return on alternative assets classes are largely responsible for the loss in 2011. Considering above and largely optimistic outlook for the economy, equity valuations remain impressive. Q1 corporate results, benefit expectations and positioning could keep the market relatively stable in Q2. The high inflation expectations suggest the possibility of further rise in interest rates and more pressure on ECM as currently constituted. Comparative low yield of the market amongst other asset classes could keep the market low in the short- to medium-term.
Market development - debt market
Yield declined across tenor compared to February; and even December 2011 at the shorter end of the market. The curve inversion is still obvious. 5-yr, 7-yr and 10-yr bonds currently trade at or below 15.5 percent. The decline in yield accompanied the hold on MPR by the MPC recently, a sign that rates may come down soon. The marginal yield on the new issue 10-yr bond in February closed at 16.16 percent. The yield on the Nigeria 10-yr Eurobond improved to 5.6 percent in March, suggesting increasing demand and positive outlook for the economy globally. Funds continue to flow into the market as market capitalisation rises. The outlook for the bond market is mixed as the potential for sharp decline in yield is rising. Government plans to issue N794.4 billion in 2012 to fund budget gap.
The Need is clear
Equity capital markets and debt capital markets are central to development. As we seek to aid ailing sectors like manufacturing and deepen fragmented sectors such as agriculture, we must note that capital markets facilitate the reconciliation of national savings and investment flows and therefore play a crucial role in the real sector of the economy. Beyond this, more sophistication will be engendered via a resuscitated market to insure the healthy development of credit risk transfer instruments and institutions, including hedge funds.
Whilst there is a momentum that has seen us grow GDP impressively despite global economic upheaval, it is essential that we in Nigeria fully capitalize on this unusual moment ahead of the downturn which the likes of the World Bank, IMF and Institute of International Finance warn may lie ahead in 2012-2013.
This year, international analysts such as those from the Institute of International Finance expect capital flows to sub-Saharan Africa to reduce slightly but remain robust compared to the more significant slowdowns expected for Brazil and India and notable cut-backs for a previously stellar performer like Brazil. In their view, strengthening capital markets in this context reinforces sound economic management practice that will strengthen public debt management and aid market discipline in domestic finance; strengthen the investor base and improve regulation and consistency of treatment of institutional, foreign, and other investors; develop financial derivatives such as repos and swaps, as well as asset-backed securities markets, improving access by foreigners to domestic hedging services. This of course must be matched by suitable regulation of equity derivatives markets, as well as increased market surveillance and improved risk management at every level; bring trading, settlement, custody, and delivery mechanisms up to world standards, where necessary through regional linkages, and opening up to global investment in these services.
John Lipsky, when with the IMF, held that a more variegated market is central to making emerging economies more liquid, sounder and more resilient. Nigeria must now seek to take advantage of improved economic fundamentals and the resiliently liquid international finance markets to help restructure balance sheets (especially regarding systematically important sectors such as banking and insurance) via deepened local capital markets. Despite the markets turmoil, international investors are increasingly prepared to be seen purchasing securities denominated in local currency – with attendant support for our naira. The strategy now must be to turn the sometimes over-exuberant “search for yield” in an environment of low interest rates and considerable liquidity to a committed focus on value for all concerned.
The federal government will see a commitment to a revived market rewarded via enhanced employment platforms, better-structured, higher public revenue streams and improving tax collection (and better tax regime). The facts below will be boosted by the resuscitation of the market: public share issues, plausible mass privatisation through programmes such as voucher schemes, and employee buy-outs, listings and the like to strengthen the nation’s entrepreneurial base, especially regarding the SMEs which are crucial to sustainable development.
Market situation
Nigeria is a unique country that has had more stockbroking firms (at a stage over 250) than quoted stocks. The Nigerian equities market has gone from representing a comparative 38.8 percent of Nigeria’s GDP in 2008 (at the market’s high) to a meagre 6.8 percent today. The intent 3-4 years ago had been to boost the nearly 40 percent comparative to a more competitive 100 percent so as to match middle income economies’ markets like South Africa’s. Today’s reality reminds us just how far off kilter we are.
Over the last 3 years, most of these practitioners have found themselves looking in from outside a vastly shrunk market (current total equity market cap of N6.63 trillion is back to July 2006 levels and posits that a staggering half or 50 percent of wealth has been wiped out) which sees the top 5-10 firms controlling more than half of market trading activity. This is an unwholesome and definitely unsustainable situation.
As a series of sanitisation moves sweep the financial services sector, there is an urgent need for palliatives to prop up the scores of firms which are teetering on the edge of closure with hundreds of professionals facing an onerous labour market which is choc-a-bloc with professionals from other sectors. In the last few months to the end of 2011, the market lost over N1.4 trillion in market capitalization, losses we believe were driven by the soft global economy, including debt crises in the United States of America and European Union (EU accounts for 22 percent of foreign portfolio investment into Nigeria); the Nigerian banking crisis (including nationalization of 3 banks in August); concerns about the security situation in the country; and rising interest rates which is encouraging investors to shift to fixed income instruments.
Investor confidence is low and this is evinced by a virtual wiping out of the retail segment of the market. This explains to a large extent why the handful of stockbroking firms which have a catchment of institutional clientele virtually run the market as oligopoly. In addition to a retreat by local mom-and-pop investors, international investors (which, according to the Nigeria Stock Exchange CEO, hold up to 40 percent of free float equities on the market) also folded back portfolios and have stayed largely away to obviate risks in the face of the global markets turmoil. Most problematic, though, is the underweight portfolios of institutional investors (fund managers from insurance companies, corporate and government treasurers and, most significantly, the pension fund administrators – who should be investing 25 percent or over N600 billion of their N2.4 trillion war chests in the market (other emerging economies have considerably higher proportion of pension AUM invested in equities), but only have under a quarter of a trillion or N250 billion committed – have dampened enthusiasm from other sectors. From historic volatility patterns, an extra N300-N350 billion of market liquidity could trigger multiplier effects of up to 50 percent increments in market value.
Nigeria pension fund industry vs. emerging market peers
According to the Organization for Economic Co-operation and Development (OECD), real net returns by Nigeria’s pension industry was (11.9) percent in 2010. However, PENCOM data indicates (0.16) percent, a much lower negative real return than our OECD source. This is nonetheless a poor performance when compared to the recovery in other developed and emerging market countries, evidenced by the impressive growth in pension AUMs.
Analysts note that significantly reduced interest by domestic institutional investors has ceded over 70.0 percent of trading to foreign investors leading to dull and uninspiring activities on the bourse. Average daily value traded dropped from N3.4 billion in Q1 2011 to N2.7 billion in Q2 2011, and further to N1.9 billion from July to date, meaning a drop of 45 percent in investor activity within 2011 alone. Set against the N3.03 billion daily trade average of 2010, the N2.4 billion trend for the whole of 2011 reminds us of just how dire the level of market confidence is currently – especially considering the fact that 2010 was merely a tenuous period of recovery itself.
Lessons from the crisis
One major lesson we have learnt from the global credit crunch is that a free market cannot regulate itself. On the global front, with particular reference to the US, the meltdown was caused by complex and poorly underwritten home loans unsuitable to the borrower. In Nigeria, we had thought we were insulated from the global crisis and in many ways slow to act; hence, the failure of risk managers and regulators to ask and provide answers to some critical questions that led to the bubble that burst in the nation’s stock market. Nevertheless, the common thread running through both economies is that highly leveraged, largely unregulated financial instruments and inadequate risk disclosures magnified the crisis. The resulting crisis of confidence has led to reduced credibility in the financial system, gridlocked credit markets, liquidity squeeze, locked up capital and depletion of shareholders’ wealth.
In Nigeria, the implausible and inconceivable occurred to get us to the point of N1 trillion toxic asset levels. Companies seeking listing on the exchange successfully floated initial public offerings (IPO) which were oversubscribed, though the entire process was flawed by lack of transparency and thin disclosure levels to the investing public. In the aftermath of the global financial crisis, the subject of how much regulation is required is greatly debated. Modern free market‘s school of thought argued that too much regulatory oversight was a socialist inclination. However, with taxpayers’ bearing the financial burden of the recent bailout of financial institutions, a review into just how much regulation we need to maintain stability is imperative.
Market intervention expectations
Generic intervention expectations
Market interventions during the extant global markets turmoil has taken different guises regarding size, scope, sophistication, etc., depending on the segment targeted and the nature of the germane practitioners. The following are the proposed measures that would act as catalyst for rejuvenating the market:
Harmonisation and possible merger of the regulatory framework: With the insurance and pension funds both playing the role of mobilising long-term capital in the economy, we strongly admire the Chilean model, which brings the pension and insurance industries under one regulator.
Risk management should be at the heart of the business function: Rather than view risk management as a support function, it should be upgraded to the heart of the business and then evolve into a competitive differentiator.
Fuller and more transparent disclosure level: We strongly support increased transparency, including all efforts to make financial products easily understood by both consumers and investors. The poor disclosure levels and abuse of insider information in the Nigerian market prosper price manipulation, round-tripping, and often trigger panicky sell-offs. The abuse of insider information currently operates as the norm rather than the exception. Overhaul our regulations so they are comprehensive and free of gaps: Regulatory oversight and strict enforcement at all levels of government can stop harmful products and practices from escaping through the cracks.
The independence of regulatory watchdogs is non-negotiable: Standard-setters have to rebuild their independence and this should commence with the staffing of regulatory bodies. Human capacity development should be a pre-requisite and continuous. This independence should be institutionalised through appropriate legislations.
Credible credit database: As Nigeria adopts global trends in finance such as consumer financing and credit card business, we must recognise the risks that the lack of a credible creditors’ database poses to the entire financial system.
Pre-emptive not reactionary: New regulations must be forward thinking and must provide adequate cover for all foreseeable risks.
Combined communication campaign by SEC, NSE, CBN and FMoF: The SEC, NSE, CBN and FMoF should embark on a massive communication campaign and dialogue with stakeholders in the capital markets working in conjunction with the market operators and their professional associations or bodies such as AIHN, ASHON and CIS.
Expectations from CBN
Forbearance and debt cancellation: A large number of stockbrokers are currently under heavy debt burden occasioned by the diminution in the value of securities they are holding due to price crash and high interest rates from banks. The proposal is for CBN or AMCON or MOFI to assume a minimum of 50 percent of the facilities the stockbroking houses are currently carrying. AMCON should be encouraged to assume a large amount of the debts owed by the stockbroking firms in line with what was done for the banks.
Intervention fund: The CBN in conjunction with the Federal Ministry of Finance should create or avail an intervention fund of N250 billion to stockbrokers at single digit interest rate. The availability of these funds would lead to an upsurge in trading activities on the Nigerian Stock Exchange.
Ensuring a low interest rate environment: The high cost of borrowing is a challenge to the equity market as investors are unable to access the needed liquidity for investing. Even the supposed alternative investment in fixed income instruments is only beneficial if the interest rate environment is stable due to the requirement for marking to market. Therefore, a stable and low interest environment that can stimulate economic activities and direct liquidity to the capital market is desirable.
Expectations from the federal government
Taxation: We believe that the government should consider reducing or altogether eliminating taxes on brokerage transactions. It is apparent that a burden of taxation as high as 12 percent is quite significant in the context of the margins brokers make on institutional trades which range from 0.25 percent-0.5 percent of the value of the transaction. Institutional investors account for 90 percent of the average daily volumes traded on the Exchange.
Sovereign Wealth Fund (SWF): The benefits of an SWF to the Nigerian economy cannot be overemphasized, which is why other oil economies around the globe have long embraced the idea. Foreign portfolio investors have proven volatile and lack sufficient faith and understanding of the Nigerian markets. The SWF can help create stability in the markets and deepen investors’ confidence. It will also allay the fears of sceptics who argue that the Nigerian market may not be able to absorb equity listings of major corporations from Telco’s and oil and gas companies.
Persuade PenCom and PFAs: PenCom should be encouraged to persuade PFAs to increase their investment in equities from the current less than 10 percent to up to 20 percent, since the Act permits them to invest up to 25 percent of their investible funds in equities. PFAs are the biggest buy-side institutions in the Nigerian market and their asset pool is the biggest in terms of long-term capital. However, short-term money market instruments currently take precedence. This pool should be guided properly into the capital formation process to ensure long-term stability of the market.
Expectations from the SEC
Encourage share buyback: Quoted companies should be encouraged to embark on share buyback to reduce the stock of outstanding shares currently traded on the Exchange. The laws can be reviewed to encourage the companies to act accordingly.
Encourage new listings: SEC should persuade major corporations, both domestic and multinationals, to list on the NSE using moral suasion and other incentives such as those tied to tax and excise waivers or coordinated actions with other regulators or government MDAs such as FIRS, PenCom, CBN, etc.
Enhancing capacity of domestic institutional investor base: For sustainable funds to come from institutional money managers/ collective investment schemes, some intervention will also be required. We suggest that the minimum subscription amount for both non-sovereign debt and equity transactions should be significantly raised such that only qualified HNIs and institutional investors can directly access the market. The rationale behind this is to encourage use of licensed asset managers which should build the industry viz assets under managements, with stricter rules for asset management licenses in force.
Privatization and subsequent listing: Privatized companies should be encouraged to list so as to attract other privately-owned enterprises to list on the market. Subsequent sale of shares of privatized companies should be carried out through the use of licensed stock exchanges.
SEC should also do the following: begin quarterly investment seminars across the country to increase investor education and elevate aggregate informed investments; increase oversight functions of the capital markets and act as a conflict resolution agency; encourage the creation of alternate markets such as over-the-counter platforms and commodity exchange markets to help deepen the market and increase investors’ appetite and activity; increase human capacity and remuneration at the apex regulatory in order to up the game in the market and increase efficiency; ensure companies and markets adhere to timely disclosure requirements; and set and implement rules to encourage a client-interest focused environment.
Expectations from the Nigerian Stock Exchange
Listing requirements should include investor relations desks in offices of firms so investors could access company information. This would ensure active and informed investments. This sort of trades tends to be more long-term rather than knee-jerk trades which tend to be herd-like and short-term in nature. NSE should also relax liquidity requirements to encourage more firms to come to the market; fast-track provision of liquidity backbone for market making firms to hedge against failure of this project (We support the recent moves by the management of the NSE to increase the daily price movement band from 5 percent to 10 percent and steam-roll the market making process. We also would like to see flexibility in policy formation.); promote investor-company interactions which would assist in reducing the “agency problem” and boost investor confidence and transparency; and encourage creation of alternative investable assets such as derivatives, REITS and MBS.
Expectations from the brokers/dealers
Brokers/dealers should act in the best interest of clients by preserving the confidentiality of information communicated by clients and not engage in practices designed to distort prices or artificially inflate trading volume with the intent to mislead market participants; encourage best practice amongst fellow stockbroking houses; act in a professional and ethical manner at all times; communicate with clients in a timely and accurate manner; uphold the applicable rules governing capital markets; refrain from seeking and trading on insider information; educate and discourage investors on over-reliance on dividend and bonus declaration as an evidence of good performance/prospect. This puts unnecessary pressures on corporations and may make them to invest in risky ventures and to engage in sharp practices in order to show short-term profits.
Expectations from the domestic investors
Investors should continually seek investor-company interactions, through AGMs and analyst forums. They should be encouraged to listen to companies’ presentations and ask questions on the strategic direction of the companies so as to make informed investment decisions.
Investors should also try to gain the knowledge of market and company-specific developments by following sell-side analyst recommendations. It is very important for them to self-educate themselves by asking questions whenever possible and read up investments journals and other available information for better understanding of how the market works.
Conclusions
Nigeria’s challenges remain formidable – a country with poverty rate (according to the Nigeria Poverty Profile 2010 Report recently released by the NBS) of nearly 61 percent or a staggering 100 million citizens should not be tardy in implementing programmes to enhance the relatively sophisticated facets of its financial system such as capital markets. Such a strategy should be quickly implemented as feedstock to the very pressing developmental issues of food, transport and other basic necessities which need to be tackled directly.
Critics may even point to arguments that the average life expectancy of poor Nigerians may have fallen during the years since democratic rule was achieved. Simply put, obvious strategy stances such as a revitalised capital market should be a quick-win en route the thornier issues at hand. Reaching out to the target companies to list on the market will be an enhanced way to help work around the rules and regulations as well as create desired enablers that will immediately attract them. Segmentation of the companies would also help in creating the needed flexibility to negotiate listing requirements away from the one-size-fits-all approach being currently adopted.
The commitment to drive immediate initiatives at attracting big cap companies would also depend largely on efficient collaborations with other regulators – SEC, CBN, NAICOM, PENCOM, CAC, FMDA and IFRS.
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