South African trading in single- stock futures fell to its lowest level in at least four years after the Johannesburg Stock Exchange forced brokers and banks to move to electronic platforms, cutting the profit they make from buying and selling contracts.
Trading has dropped 19 percent in the first eight months of this year from a year earlier to 35 million contracts, the fewest since at least 2007 when data on the JSE Ltd.’s website began. The value of trades totaled 141 billion rand ($19 billion) through the end of August, down from 174 billion rand in the same period last year and more than the 137 billion rand in 2009, the data show.
The switch in December cut fees by 75 to 80 percent for Johannesburg-based Nedbank Capital, a unit of South Africa’s fourth-largest bank, said Eugene van Rensburg, head of prime services. Macquarie Group Ltd. (MQG), Australia’s largest investment bank, exited the on-screen market in July because of falling fees and reduced trading, said Graham Crawford, chief operating officer at its Derivatives and DeltaOne unit in Cape Town.
“It’s unsustainable at current volumes,” said Van Rensburg, who sits on the JSE’s derivatives advisory committee.
The JSE is following bourses from Brazil to India in turning to cheaper and more transparent trading to help lure investors after it slipped to fourth place from the top three years ago for the number of contracts traded in the World Federation of Exchanges. Europe’s oldest options exchange, Euronext Amsterdam, moved to electronic trading in 2002 while NYSE Euronext (NYX) runs a combination of electronic and floor trades.
‘Purely Price Taker’
“If you look at the prices between bid and offer, there is not a lot left for the market makers and execution providers,” said Macquarie’s Crawford. “We are making prices off screen, but will not pursue products where we view our role as purely a price taker.”
The JSE operates Africa’s largest stock and bond markets. Equity derivatives accounted for 9 percent of the exchange’s 1.26 billion rand of revenue last year. The JSE said it also plans to introduce electronic trading for stock options.
Some market participants resisted the move to on-screen trading because of the cut in fees and the need to increase investment in computer systems, said Allan Thomson, the head of derivatives at the JSE.
“We had a big reduction in the single-stock futures market,” said Thomson. “In the long term, we’re not particularly worried.”
The fall in trading volumes also followed the financial market crisis in 2008 and a significant drop in smaller, riskier shares, Thomson said. Trade in larger shares has helped support the value of contracts traded.
The exchange is talking to international bourses to help boost foreign participation in the JSE’s single-stock futures by giving them direct market access, said Magnus de Wet, manager of the JSE’s derivatives specialist trading division who is leading the project. The JSE has licensing agreements in place with CME Group Inc. (CME), the Chicago-based derivatives exchange, for trade in commodity derivatives, financial contracts whose value is based on underlying assets including metals and corn.
BM&FBovespa SA (BVMF3), operator of Brazil’s stock, futures and commodities exchanges, in September 2008 agreed to trade products through CME’s electronic platform.
In India, the start of electronic trading in 1994 virtually eliminated the traditional market makers, who bought and sold stocks when no one else would. The Securities and Exchange Board of India says bourses will be allowed to offer reduced fees, cash payments or shares in the exchanges to brokers who take on the role of market making. The National Stock Exchange of India Ltd. has more than 90 percent of the country’s futures and options market.
Some South African brokers have shifted to so-called contracts for difference, over-the-counter products that allow investors to bet on securities without owning them, said John Vorster, head of online initiatives at Johannesburg-based PSG Online, a unit of investment holding company PSG Group Ltd. (PSG)
“Liquidity is a problem” for single-stock futures trading, said Vorster. “Our clients are retail clients and they depend on liquidity.”
Trading may improve as investors become more comfortable with the new platform, he said. PSG Online trades CFDs and single-stock futures, he said.
“There’s no doubt we have lost some liquidity to CFDs,” said the JSE’s Thomson. The drop-off was evident at the beginning of the year when the JSE’s single-stock futures central order book slipped to about 50,000 orders a day. They subsequently rose to a peak of about 4 million a day when futures contracts were closed in June, he said.
“You need to have a market in which you can actually see the market and are able to trade at the press of a button; that’s a massive positive development,” David Shapiro, a director at Sasfin Securities Ltd., said by phone from Johannesburg. “I don’t think people who deal in the CFD market fully understand the risks. It is an unregulated market.”
The move to the electronic platform has eroded the relationship between counterparties, such as brokers and hedge funds and the large banks that provide liquidity, said Richard Swain, head of listed products at the equity derivatives unit of Investec Securities in Johannesburg.
Over-the-counter trading guaranteed “efficient and competitive pricing because you had that relationship in place,” he said. The brokerage boosted CFD trades this year.
“This regulation has put us right back to square one from a liquidity provider’s perspective,” Swain said. “It takes a lot of time to wean people off their relationship and to go on screen.”
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