Being the Keynote Presentation by Olufemi AWOYEMI, mni, FIoD, FCA, FCTI, FCIB, Chairman/Founder of Proshare LLC, at the Legislative Retreat and Engagement on the Investment and Securities Bill 2021, organized by NESG, serving as the Secretariat of the National Assembly Business Environment Roundtable (NASSBER) which held at Ibom Hotels and Resort, Uyo, Akwa Ibom State on September 22nd to 25th 2022.
Fully functioning capital markets work by pooling savings, which can be channelled as capital to fund local business growth (or government projects) and generate jobs, while simultaneously offering the public an opportunity to invest in returns-bearing assets.
Thus, capital markets are important because they supplement the financing of the economy, allocate risk, and support economic growth. They also serve as an essential organized system for the free flow of capital raised through debt or equity.
Despite the intermediation and developmental role of capital markets, the Nigerian Capital Market is however buffeted by a variety of issues that require synthesis – these include regulatory mandate/focus and infrastructure, market incentives and barriers, fit-for-purpose exchanges that deliver market integrity, and an industry-wide need for good governance culture.
The resolution of these issues will define the market’s complexion, shape and its participants’ character in years to come. The dark underbelly of the market needs to be brought to light to ensure that the market’s future is not scarred by today’s self-interested institutional and personal maneuvering. It needs to be highlighted that participants will come and go, but the market will remain. As an engine of efficient capital intermediation, the market must always be the best version of itself, untainted by hucksters and hustlers.
So, as we are gathered for the legislative retreat on the Investment and Securities Bill, 2022; the importance of the capital market to the economy, and the need for a legislative framework that is adaptable to market infrastructure levels is not in doubt. We must consider it a given to enable our regulation keep up with practices.
What the market looks forward to, and the nation deserves from the eminent experts, heads of regulatory agencies and distinguished legislators interrogating the proposed reform provisions in the Bill, is the WILL to catalyze the development of the capital market by establishing a nexus with the economy. It will only do this by being forward-looking, bold and imaginative; not acting from memory.
To achieve this, may I crave your indulgence to draw your attention to why the much-needed uncomfortable conversations, must be had.
The Global Economy and Investments: Recession Fears and the broader Impact of Inflation on the Global Financial Market
The anticipation of a global economic recovery in 2022 was tied to the expectation that several sizeable economic stimulus packages adopted in 2021 by governments globally would permeate through several economies following the complete removal of lockdowns and travel restrictions. Supply chains that had buckled due to higher shipping costs last year were expected to be restored fully in 2022. These aspirations did not hold. Following the Russian invasion of Ukraine in February, geopolitical tensions destroyed infrastructure, increased trade restrictions around the Black Sea, increased insurance costs, and, most importantly, sent energy prices soaring.
At the same time, the US and some other major economies began to dial back their bond purchase programmes and prepared for monetary policy normalization, an action required to address unusually high inflation levels. In 2021, the Global Equity Index (GEI) rose under the accommodative monetary policy that held sway in many advanced economies (see illustration 1 below).
Illustration 1: Global Equity Index & FDI 2016 – 2021
The geopolitical tension in Ukraine induced a spike in energy and food prices, further worsening inflation, thereby heightening the need for a more aggressive rate hike. Global macroeconomic fundamentals continued to deteriorate, and with the prospect of developed markets edging closer to a recession, global equity funds have continued to record outflows. For instance, in the week through August 24, 2022, US$5.1bn flowed away from global equities. The trend continued in September.
Conversely, as the interest rate changed in 2022, the 10-year US treasury notes yield, which stood at 1.5% at the end of 2021, rose to 3% in May 2022, causing many investors to consider fixed-income securities as a better investment alternative. The expectation that the Fed would extend its hawkish stance with another 75bp hike in rates in its September 2022 meeting has sent the US Treasury 10-year yield back above 3%, closing the month higher by 55bps – markets are inferring that the Fed’s hiking cycle is only going to get more aggressive.
Emerging & Frontier Markets: The Pressure of Capital Flow Reversal Triggering Domestic Inflation
Cross-border portfolio investment halted in many emerging markets and some advanced economies in March 2022 when the Federal Open Market Committee in the US decided to raise the rates by 25bp, the first increase since 2018. Before, investors had considered the relatively high yield environment in emerging markets attractive. According to Financial Times, in the first three weeks of 2021, Emerging markets attracted $17bn. Still, as the year wound up, portfolio flows to emerging markets began to slow as investors started to bet on tighter US monetary policy and weaker EM currencies. The trend has persisted throughout 2022. While the more advanced economies have liquidity buffers from the fiscal spending from previous years, the same cannot be said about emerging markets, as the fear of recession has informed caution in raising rates amidst higher energy and food prices. With the spread closed out, capital flow reversals became imminent (see illustration 2 below).
Illustration 2: Inflation and Interest rates in Emerging Market Economies (EMEs)
The Current State of the Nigerian Economy & Key Indicators for the Markets
The turn of the year 2021 saw domestic inflation return to an upward trajectory. The geopolitical tension in Ukraine further worsened this. By August, Iinflation had risen to a 17-year high of 20.52%, up 354 basis points from the 16.98% recorded FY 2021. Analysts attribute the surge in inflation to a global hike in energy and food prices and a steady devaluation of the naira.
The Economy managed an expansion with GDP growth at 3.32% in H1 2022, following a better-than-expected Q1 2022 growth of 3.11% and a 3.54% growth in Q2 2022. However, this is below the long-term growth potential of the country.
Considering the two macroeconomic indicators above, the Monetary Policy Committee (MPC) hiked the Monetary Policy Rate (MPR) by 250 basis points from 11.5% at the beginning of 2022 to 14.0% in July. Afterward, the Purchasing Managers Index (PMI) declined slightly by 310 basis points from 55.4 as of July 2021 to 52.30 in August 2022. However, it remained above the 50-index points threshold, indicating modest growth.
Foreign reserves decreased from US$ 40.52bn as of 2021 to US$ 39.18bn as of August 2022 as NNPC remittances have reduced drastically and CBN’s effort to maintain the official rate as exchange rate levels further declined by -23.68% from N570/US$1 recorded as of January 2021 to N705/US$1 in September 2022 (see illustration3 below)
Illustration 3: Snapshot of the Nigerian Economy
The State of the Market & Key Developments or Change Triggers
The Nigerian Capital Market is a growth harbinger, given its role in capital formation. According to the Investment and Securities Act (ISA 2007), the Securities and Exchange Commission (SEC) regulates the Capital Market, ensuring effective compliance with laid down guidelines and promoting global best practices. Analysts have argued that the SEC has laid much more emphasis on revenue generation and veered off its primary role of promoting capital formation and intermediation (see illustration 4 below).
Illustration 4: The Roles of the Securities and Exchange Commission (SEC)
The Capital Market is limited in the variety of instruments available to investors, and experts have argued that this is because the capital market is not representative of the Nigerian Economy. The Market Capitalization to GDP ratio (of the NGX), which stood at 29.7% in December 2007, has declined to 18%, showing that key players in growth sectors in the Nigerian Economy do not have their securities listed on the capital market. Taken together, however, the market capitalization of the three major exchanges, namely FMDQ Group ($45.64bn), NGX($74.14bn) and NASD($1.19bn), amounted as of December 2021 to US$120.9bn less than 50% of the Country’s US$ 400bn GDP in 2021 (see illustration 5 below).
Illustration 5: Comparing the Size of the Nigerian Capital Market and the Economy (2021)
According to the Securities and Exchange (SEC) 2015-2025 Master Plan Report on the Nigeria Capital Market, the country needs to make a few reviews and action plans. The Report stated that the Nigerian Capital Market is not big enough to source funds for elaborate long-term projects. An example of a project the Nigerian capital market could have facilitated is the US$2.52bn budget for the Privatization of the Energy and Power Sector. Companies that presented bids ought to have been in the local capital market five years before the acquisition.
In economies with more sophisticated capital markets, the situation is different. The ratio of market capitalization to GDP in the USA is 151% as of June 2022, while the long-term average market capitalization to GDP is 82.55%, the situation in the United Kingdom (UK) is similar. As of December 2021, market capitalization as a percent of GDP was 106.4%, with an all-time high of 130.8%. The South African case further typifies the argument for a more vibrant capital market. Market capitalization of the Johannesburg Stock Exchange (JSE) as a proportion of South Africa’s GDP in 2021 was 329.3%.
The Nigerian Capital Market also faces the following challenges:
1) Lack of collaboration between stakeholders
Regulators and stakeholders have operated in silos, leading to over-regulation on the one hand and resentment on the part of the operators. The Capital market can only expand with effective cooperation between the exchange and the regulatory body. Operators must be assured of the SEC’s interest in broadening and deepening the market. Operators and Investors become concerned when these financial institutions don’t work together effectively.
2) Trust Deficit in Fund Managers
The genuineness of fund managers and their tendency to offer the wrong financial advice in a bid to create a market or sell securities and earn commission also features in the catalogue of the challenges facing the capital market. Necessarily, the regulation of operators must ensure a high level of integrity and compliance with the rules of due diligence. The Fund Managers’ Association of Nigeria (FMAN) must engender good Fund management practice among practitioners.
3) High cost of Transaction and Double taxation
Market operators are burdened with several taxes, including the 10% withholding taxes paid to the government, Value Added Tax(VAT), and regulatory duties paid by operators. Economists note that the multiple charges can be disruptive and have led to a deadweight loss where the market is clearing at a sub-optimal equilibrium. To lower the high cost of transactions on the market and increase investor appeal, the federal government should offer a tax holiday on all stock market transactions.
4) Outmoded set of guidelines in a Changing World
With the rapid development of infrastructure and products, global capital markets are becoming more active. Older, more sophisticated exchanges use consolidation as a strategy to maintain their competitiveness. As a result, the growth of the capital market needs to be understood in the context of regional market integration. The bilateral MoU signed in 2002 has served as a vehicle for cooperation between the SECs of Ghana and Nigeria on various subjects. The Nigerian and Ghanaian Exchanges are the top stock exchanges in Anglophone West Africa. Other Exchanges trade securities, such as exchange-traded funds (ETFs) and futures contracts on commodities.
Other tradeable instruments that have plugged market gaps include asset-backed securities (ABS), mortgage-backed securities (MBS), real estate investment trusts (REITs), and ethical or halal capital markets instruments and hedge funds.
5) Technology and Market Infrastructure
A constant technological upgrade is pivotal to determining the time to market as it simplifies and accelerates the process. Capital market regulators need to bring in the technology that can transform operations and allows for innovation
Other Challenges facing the Capital Market include:
- Lack of Integration of Securities Settlement
- Ownership and Operational Control
- International Participation
- Banking/Capital Market Financing
- Operational Capacity
- Regulatory Framework
- Investor Protection
- Legal Framework
- Development of the Bond Market
- Enhanced Corporate Governance
- Market Research and Innovative Instruments
- Ratings Culture
Imperatives for a Fit-for-Purpose Capital Market needed for Sovereign Economic Growth & Development.
One major imperative for creating an ideal capital market is the implementation of the existing plans and policy programmes for the market.
The Capital Market Master Plan 2015-2025 was a programme meant to culminate in the deepening of the Nigerian capital market. The programme entered its implementation phase in 2016, at which point the Capital Market Implementation Committee (CAMMIC) comprised 12 distinguished professionals and stakeholders, while the Capital Market Project Management Team CMPMT acted as the committee’s secretariat. The over 100 initiatives in the Masterplan were classified into SEC-led initiatives that a working group supervised, while the Market-led initiatives were managed by technical committees (see illustration 6 below).
Illustration 6: The Implementation Architecture of the Capital Market Masterplan 2015-2025
The Master Plan was the collective aspiration of the capital market community, requiring a concerted effort at implementation. The plan focused on driving initiatives targeted at the breadth and depth of its activities but is yet to meet lofty goals.
Market professionals have argued that the Securities and Exchange Commission (SEC), Capital Market Masterplan Implementation Committee, and other stakeholders must address grey areas like the dematerialization of share certificates, e- Dividend mandates, facilitation of access to alternative investments like Sukuk and Specialized Funds, review of CAMA and ongoing review of the Investment and Securities Act (ISA), enhancing the commodities eco-system, design of a National Savings Strategy among others. The proper implementation of the plan would promote greater Investor confidence, which is critical to the market’s growth, and increase domestic and foreign investor participation.
Steps must be taken to encourage complete dematerialization of certificates, direct cash settlement, recapitalization of CMOs, e-Dividend Mandate Management System, National Savings Strategy must also be employed to grow domestic risk capital formation, the Roadmap on Enhancing Commodities Trading Ecosystem, Establishment of the West African Securities Regulators Association (WASRA) to encourage the integration of capital markets in West Africa, among others.
The regulator must use the updated version of the document to engage stakeholders on the current level of market development and opportunities for further capital growth; review and update the assumptions and vision of the CMMP. The revised plan, which incorporates the views and aspirations of stakeholders in the market and global best practices, should alter market direction. The revised document should provide the SEC and market participants with clarity of the vision and a road map to foster a conducive business environment and encourage innovation, investment, growth and economic expansion.
Of Chance, Time, and Opportunity
There is no time to speculate on the possible when the probable stares us in the face. We do not require reinventing the wheel when we can adopt and adapt solutions from other economies. The capital market requires urgent action to support domestic capital formation. Time is a variable we cannot control; therefore, we must use it wisely. In this light, I note the following:
- The SEC needs to see its mandate as market development rather than revenue generation. SEC’s funding structure must be revisited with the federal government (FGN) taking the position of SEC as market regulation and development catalyst and not as a revenue head for the Ministry of Finance (MoF). The SEC’s funding structure should come from FGN, penalties, fines, and registrations. It would seem a legal abnormality for the SEC to charge fees on illegal transactions (of which it was a beneficiary) and be absolved of blame when the crime is exposed. At the very least SEC would be considered an accessory to the crime since it gained material benefit from the alleged criminal transaction. I humbly leave this as a matter for legal colleagues in the market to ponder.
But while on the subject we should also take on board the broader issue of revenue or more appropriately, funding of the SEC; and issues here include the pry/sec mkt fee dichotomy, enforcement rules & need for a fee framework to eliminate discretionary application of fines, sanctions and fees to ensure it fulfils its “deterrence” remit, and not become a cost-of-doing-business, structure of govt funding, fund retention policy, etc.
- Knowing all things cannot be legislated, how can the SEC be held accountable for delivering a future-ready market that ensures its master-plan execution forms the basis of performance appraisal?
- The SEC needs to quickly develop a framework for determining the structure of centralized asset depositories in the country. The ownership structure of such Depositories must be transparent, equitable and meet best global practices. A centralized clearing and settlement system across equities, fixed income assets and commodities could introduce efficiencies that make the local markets functionally better. SEC Rule 138, which refers to a 35% limit on individual ownership of depositories, requires a review.
- Address overlap(s) amongst regulatory agencies for smoother decision and rulemaking in, and around the capital market (SEC, CBN, FCCPC, FRC, CAC). Also, rules such as the 10-Year Rule for bank Managing Director/CEOs are now past their use-by date, with the advent of the Financial Holding Company (“Holdco”) structures, which made this rule weak and unimportant. The new practice emerging is that bank MDs leave office after ten years and become GMDs of Holdcos, requiring no tenure limits to the GMD position. The recent examples are well known. Even non-bank self-regulatory organizations (SROs) have adopted this model. I think it is time to let the past go as we focus on the sunrise.
- The issue of a monopoly in professional training of capital market ‘participants’ needs to give way to a recognition of the non-monolithic nature of the service bouquet (and attendant regulatory oversight). It is an unnecessary market distraction. The bill should be rested, never to be resurrected in the form it is. Monopolies are anathema to market development, except where such monopolies establish efficiencies and externalities that are impossible without such consolidation. In the case of professional training of capital market practitioners, this is not the case.
- There is little proximity between Nigeria’s GDP and equity markets. The country’s GDP is not mirrored in the pricing of equity assets, suggesting a market weakness and opportunity. I believe there is a pressing need to support the equities market to grow faster with a wider breadth of sector coverage. The NGX’s growth board has not lived up to its potential; a way to help support this is by deliberate handholding, where off-market companies gain access to long-term capital after passing through a supervised accelerator programme. The programme takes place in layers and over phases. The goal would be to build compelling business cases of companies that have transitioned from mom-and-pop establishments to listed entities that are world-beaters.
- The scope, pace and rate of legislative changes needed to deliver the capital market required to approximate a nexus with the economy will require more than episodic encounters or annual village meetings. The shelf life of a regulation is only as good as its ability to keep up with, bring up to and anticipate business practices, trends and paradigms. It is imperative therefore that the next review of the market laws cannot wait another 10years; and the process of review through NASSBER should be considered or institutionalised to have a future-ready regulatory environment.
I thank you for your patience and wish the organizers and esteemed participants a fruitful deliberation as we take our fate in our hands, and rather than rage at the wind, we bend our sails to the direction we desire.
Opportunity is useless without preparation. I urge us all to prepare a fit-for-purpose capital market to benefit from a primed-for-change world.