The real reasons the JSE is shrinking

Paul Miller is nothing if not obsessive.  

The CEO of mining consultancy AmaranthCX, a one-time MD of Keaton Energy  and a former corporate finance whizz at Nedbank, he has spent the past few years delving into exactly why the JSE isn’t seeing the sort of listings flood that the likes of Australia have enjoyed.  

Since 2013 the Australian Stock Exchange has grown from 2,181 companies to 2,289 today. South Africa, by contrast, is a much sadder story: the market has shed about 20% of its companies over the past decade, from 394 down to  about 313. 

“I’ve been an approved sponsor on the JSE, I’ve done the regulatory stuff for listings, and the common red herrings were irritating me,” Miller tells the FM. 

The standard excuse for companies fleeing the JSE is that the exchange is “too expensive” and the regulations too onerous; that private equity is the preferred option to raise capital; that these shifts are “cyclical”; and that the country’s limping economy means nothing much is happening anyway.  

This is all “BS”, says Miller. “Of course [the regulations] are onerous and it does cost money, but on a benchmark basis against other stock exchanges that have been able to attract listings, the JSE is actually cheap.” 

Calling this the “shallowest and the laziest analysis” possible, Miller says the JSE has, in fact, tried many things to stem the tide — including a small companies exchange known as AltX, opening the gates for dual listings from overseas, and allowing real estate investment trusts (Reits) to list.

“Those are all initiatives by the JSE — each of which, in its own right, was successful; none of which was able to change the trajectory,” he says. 

As for the “existential fight to the death” between private capital and public capital, that’s also nonsense, he argues.  

“The statistics in South Africa in no way support that argument. Our venture capital association has about R12bn in assets under management and Asisa [the Association of Savings & Investment South Africa, representing the big asset managers] members have about R120bn in private equity, and you know where they’ve invested that R120bn: in renewable energy projects with National Treasury guarantees.” 

In other words, these renewable projects alone dwarf the money going into private equity.

Where firms such as Allan Gray and Ninety One have previously argued the JSE’s big shrink owes much to market cycles, Miller is dubious. “It’s not a cycle if you’ve gone from 800 to 300 listings over 20 years — it’s a structural decline,” he says.  

This is the crux of his argument: “The problem is not about delistings — it’s not even about listings so much — the problem is primary capital raising.” 

Yet, it seems churlish to dismiss these explanations for the JSE’s shrinking as entirely invalid. 

Fatima Vawda, CEO of investment firm 27four, expects the JSE will continue to shrink. “Times have changed,” she tells the FM. “There are now multiple sources of alternative funding solutions. We are following the global trend where over the past decade we have seen a rise in private markets and a decline in new listings. Companies can source capital from private equity and venture capital players more easily than they could before.”

It’s not a cycle if you’ve gone from 800 to 300 listings over 20 years — it’s a structural decline

—  Paul Miller

And it would be wrong to entirely dismiss the argument that complying with the regulations can be costly for smaller companies. 

“This can discourage them from going public [as does the] increased scrutiny from investors, analysts, and the media,” she says. And, she adds, South Africa is “not exactly screaming out as an attractive investment destination for global investors”.

It’s true that the moribund economy, and a government that seems intrinsically hostile to private capital, has much to answer for. But, says Miller, “there had to be something else about it, and that’s the journey I went down”.  

A 1992 plan that went wrong ...  

Miller started with an exhaustive analysis of the 195 listings that have taken place on the JSE since 2010. He found that the last time the JSE experienced a true public offer (where anyone who applies for shares in a new offer has an equal chance of getting shares) was 2012.  

It’s an astounding statistic. The vast majority of recent  listings have been mostly technical — unbundlings, rather — in the same way that Zeda was spun out of Barloworld, Premier Foods was spun out of Brait, CA Sales came out of PSG and, further back, South32 was spun out of BHP Billiton. 

Even the Reits listing boom a decade ago was largely a placement affair — where capital was already committed by big institutions — rather than a flurry of new kids on the block, raising money from whoever had cash. 

Miller argues the genesis of South Africa’s present plight is a series of reforms that stemmed from the Jacobs committee of 1992 (officially titled the “Report of the Committee of Investigation into the Promotion of Equal Competition for Funds in Financial Markets”). 

This report was the “scaffolding” on which most of our current financial regulation rests; it was the basis of the Financial Advisory & Intermediary Services Act and the Financial Markets Act. It was supposed to lead to a flourishing of new listings and primary capital raisings. Instead, says Miller, the opposite happened, “and nobody has gone back to hold themselves accountable to the original objectives”. 

It’s not as if there isn’t money to be put to work. If you take South Africa’s insurance assets, bank assets, the R3-trillion in the mighty collective investment schemes industry, along with the R2.5-trillion of the Public Investment Corp (PIC), there’s probably about R9-trillion to direct to companies in South Africa’s investment ecosystem.  

But, says Miller, “we still can’t raise primary capital for a mine or a citrus estate. So we need to understand why primary capital raisings are not happening”. 

In his view there are six main reasons. 

 1. Changes to the stockbroking business model

In 1996 the stockbroking industry was deregulated from earning 1% on every trade made. Stock exchanges made huge investments in technology and brokers got squeezed on fees. Then a new UK market rule came along (the Markets in Financial Instruments Directive), which meant people couldn’t direct trades to a broker in return for research — so the number of analysts plummeted, and research-based stockbroking “went out the window”.  

The result is that, today, most traditional stockbrokers are licensed wealth managers. In practice, says Miller, it means “you can’t phone up your broker and talk about a stock that’s not on their approved list because, to get a stock onto their approved list, they’ve got to demonstrate that they’ve applied an investment process ... and the way compliance managers interpret that is, you’ve got to write a report and submit it to a committee for approval”.

It’s an expensive exercise and it means, in reality, that safety in large caps prevails.

The guy on the other end of the phone will say: ‘I can’t even talk to you about that, it’ll never get on our approved list’

—  Paul Miller

“You can’t phone your broker and say ‘I want to talk about Alphamin Resources’ — the guy on the other end of the phone will say: ‘I can’t even talk to you about that, it’ll never get on our approved list.’ The fact that it’s the world’s richest tin mine in North Kivu has nothing to do with it. The fact is that, at the time of listing on the JSE, it was a R2bn market cap looking to raise R500m, which was too small. It didn’t justify writing a 60-page report.”  

One the country’s most experienced stockbrokers is David Shapiro, now a portfolio manager at Sasfin Securities. “Admittedly, the idea is to protect some sucker from some dodgy pump-and-dumper,” he tells the FM. “The outcome, though, is that we have more people in compliance than we have portfolio managers.”

2. The rise of the independent financial adviser 

The savings industry has developed in such a way that independent financial advisers are intrinsically tied to large institutions, whose platforms they use for their clients.  

Miller argues that this is a “travesty — wrong on every level” because, while these advisers are notionally independent, in practice, they’re not. It means that savers’ money is funnelled towards the majors — usually taking one’s “risk profile” (age, for example) into account.  

Shapiro agrees. “You’ll be astonished by how few savers know what they hold. Not only do they not know what they hold but they have no idea how their investments have performed,” he says. 

Advisers and salesmen, says Shapiro, “have no underlying feel for the market. They carry with them a house view embodied in a PowerPoint presentation with lots of charts that bedazzle and bamboozle their clients. The clients have absolutely no idea what they’re buying. Instead, they buy the ‘reputation’ of the institution.”

You’ll be astonished by how few savers know what they hold. Not only do they not know what they hold but they have no idea how their investments have performed

—  David Shapiro

3. Discrimination in tax policies  

Then there’s tax.  In 2001, South Africa introduced capital gains tax (CGT).  

Miller says the asset management industry successfully argued for an exemption on collective investment schemes (CIS) paying capital gains on trades. In the end, unit trust owners only paid CGT when they sold, but this clearly favoured CIS above individual trading accounts. 

Practically, say you have R1m to invest: if you put that into a share trading account and you’re an active trader, your trades will be taxed as income at your marginal tax rate. If you don’t trade regularly, you’ll just pay CGT in the year you incur it.  

But in a CIS, the manager doesn’t get taxed on trading revenue or income — it’s always a deferred capital gain until right at the end. It means that between an identical portfolio in a stockbroking account, or one in a unit trust, the CIS will outperform on tax benefits alone. 

4. Mismatched liquidity 

Miller argues that there is a liquidity mismatch in the savings industry that warrants examination. At present, every CIS is obliged to return cash to an investor on request in less than 24 hours.  

But no-one can trade out of a position in less than three days, which means every CIS keeps a bit of cash on hand to bridge this gap. In practice, it means schemes are more likely to keep money in liquid stocks — the big ones — than in illiquid shares, from which  it can take days to exit a large position.  

“Ordinarily, people’s pension savings are long-term savings, which generally can’t be accessed until a saver is at least 55 years old. But the use of CISes as building blocks has forced them into the liquid end of the stock exchange, no matter what size the CIS is,” he says. 

5. Size is everything 

Then there’s the institutionalisation of the market. Says Miller: “Because we only have 10 major institutions actually managing 90% of the money … no fund will own a position less than 1% of the fund because that’s immaterial — why do the work if it’s not going to [affect] the performance of the fund?” 

In most cases, fund manager mandates mean they are prevented from owning more than 10% of a company anyway. So the brute size of the investment industry, relative to the size of the JSE, means that certain funds are so large that even 1% of the fund is far bigger than 10% of a company.  

The impact on listings is that a company listing isn’t going to be enticing, unless the market cap exceeds R11bn. “If your market cap is outside the top 100, you’ve got no chance,” says Miller. 

6. Indexation 

The last factor in the concentration of money into the large end of the stock market is perhaps the most slippery to grasp. 

As Miller explains it: the index advisory committee of the JSE is made up of institutional investors. These committees set the rules for the composition of indices; it is official policy that the indices should reflect what is actually owned by South African investors.  

The way that principle plays out is through shareholder weightings: committees weight companies according to the proportion of their share register that is held in South Africa. 

But because South Africa is dominated by a handful of institutions, these indices are, in effect, benchmarked against the industry itself. “It’s not a measure of market performance, it’s a measure of the performance of the shares owned by the 10 largest institutions,” says Miller. Worse, “they earn performance fees measuring themselves against themselves”. 

Miller is particularly withering when it comes to the largest asset managers, such as Allan Gray, Coronation, Old Mutual, Ninety One and Sanlam.  Of these, about 10 manage about 90% of all assets under management, if you include the PIC. While they have the financial clout to plough capital into nascent and maturing companies, instead they favour the most liquid, biggest-cap stocks on the JSE.  

Describing them as a “rent-seeking lobby group”, Miller says “every single pension and savings policy guru earns their money by working for those 10 institutions; every lawyer, every lobbyist, every regulatory specialist. You either work for the South African Reserve Bank, the Treasury or the 10, or Asisa itself.” 

So, he concludes, is it any surprise that the regulations then come out favouring precisely those institutions, rather than individuals? 

‘We haven’t captured the regulators’ 

That’s some accusation — and, obviously, not a view shared by  Asisa.  

Busisa Jiya, CEO of the association, tells the FM: “Asisa has been in existence for just over 14 years, and in this time we have experienced the Treasury to be a tough and fair policymaker and definitely not a pushover. To insinuate that Asisa has the power to ‘lobby’ the Treasury to back down in favour of the industry, at the expense of the individual, is unfair.”  

The same, he says, applies to the Reserve Bank, the Prudential Authority and the Financial Sector Conduct Authority (FSCA).

Asisa and its members agree that a vibrant and active market is in everyone’s interest, there are several reasons companies have been delisting and why others are reluctant to [list]

—  Busisa Jiya

“While Asisa and its members agree that a vibrant and active market is in everyone’s interest, there are several reasons companies have been delisting and why others are reluctant to [list],” says Jiya. “The JSE is certainly aware of the need to create a more attractive environment that will encourage companies to list, and the proposed amendments to the listing requirements, released for comment in October 2022 are a step in the right direction.”

Asisa is clear that the problem of encouraging more listings is one for the JSE to solve. 

But Miller wants the JSE to use its convening power to investigate why there are so few capital raisings — and what to do about it. 

The JSE’s head of capital markets, Valdene Reddy, tells the FM that this is already happening. 

“There are a number of initiatives happening,” she says. “But I don’t think it’s as simple and clear cut.”  

Reddy says South Africa’s market grew up with unit trusts and collective investment schemes, “so you don’t have retail investors that are as broad as some of the other developed markets”.  

But, as to whether more can be done to expand the group of retail investors, and whether the small- and mid-cap segment of the market can be expanded, she says: “Absolutely — it’s a priority focus for us.”  

That last point is critical, since the highest number of delistings have taken place among the JSE’s small- and mid-cap shares. In part, this happened because of a lack of liquidity in tightly held shares and, in other cases, buyers pitched offers to buy out and delist companies trading at bargain-basement prices.

As it is, Reddy says the entire South African market is trading at a notable discount to emerging and developed market peers. 

One of the exchange’s new initiatives is probably the antithesis of the wider public participation Miller would like to see: a plan to use the exchange to launch private placements in which stock is sold to preselected institutions and investors rather than to the broader public

And yet this does seem to be working. Launched last year, it says there are now 25 deals worth almost R5bn on the platform, as well as a pipeline of another 250-plus companies looking at doing the same thing.  

The idea is that once comfortable on the exchange, these “private” share transactions will “convert” to public transactions. But this is taking time.  

Says Reddy: “People have to do due diligences, get to know the company, take a bit more risk. But we have tried to create a marketplace to connect these parties.”  

The JSE is also working with the public sector — including the Treasury — on new incentives to channel capital through the stock market. Reddy says while “it’s difficult  for the government to give up revenue”, the upside of doing this is that you potentially spark growth in the wider economy, which benefits everyone.  

The JSE has, in fact, raised the idea of expanding South Africa’s popular tax-free savings account beyond just exchange traded funds  and money market instruments, to which it is limited right now. 

“Could we get issuers to get some incentives to grow their companies — like a different type of CGT bill? Could institutional investors put patient capital towards  a longer-term profile as companies grow in a small- and mid-cap fund? Those are the conversations we are starting to have,” says Reddy. 

Asked whether she agrees with Miller that the exchange is fated to dwindle to  100 listed large-cap companies, Reddy is philosophical.

“If you look globally, the US may have a couple of thousand listings but there are seven companies that have driven markets over the past few years. It is the nature of how capital flows,” she says. “It could very well be that there is concentration of activity in the top 100, but it doesn’t mean that small- and mid-caps can’t find a place to grow.” 

Asief Mohamed, chief investment officer of Aeon Investment Management, says this isn’t just a South African problem. “It happens in a number of developed and developing markets. What may be a bigger factor in South Africa is the low economic growth potential, excessive regulatory burden, and high cost of doing business,” he says.

Other countries are also battling to keep their stock markets relevant. For example, just 20 stocks in the US account for 90% of Wall Street’s gains this year, as the Financial Times reported this week.  

There are similar dynamics locally, where the likes of Naspers, Richemont, Glencore and other  large firms dominate trading volumes. It’s part of the reason Reddy, who was previously a derivatives trader, describes the JSE as “the hardest job I’ve ever done, but the most gratifying”. 

Describing South Africans as “the most congenitally negative people”, she says it’s her personal agenda “to make it right at a country level, because we’ll all benefit”.   

‘Salvation lies in small-cap shares’ 

Reddy has a fellow advocate in Stefano Marani, who knows exactly what it’s like to raise capital from a sceptical market. Renergen, the gas and helium prospect of which he is CEO, started out small with a R74m capital raise on the JSE’s AltX platform in 2015.  

Renergen’s market cap has since grown to R2.7bn, thanks in part to Marani’s skill as a salesman. Renergen has clearly captured public interest — though whether it can obtain the billions it needs to fulfil its ambitions remains the question.

For every R1m, the JSE’s all share employs 142 times more people than the property index, and the small-cap index employs a staggering 632 times more people than the property index

—  Stefano Marani

“I agree with Paul [Miller] that small caps are the answer. I disagree a little in that it is mainly a policy issue — as a banker of many years, I haven’t in my mind reconciled how policy is going to incentivise small businesses to list. Unless, of course, the policy he is talking about forces fund managers’ hands into specifically investing into the small-cap sector.” 

In a recent paper Marani presented to the Treasury, he set out to show how a flourishing small-cap sector could create jobs, spur growth and break the loop of poor business confidence. 

Small businesses, he argued, “tend to be less efficient with capital than big businesses as they do not have economies of scale, but [they] thrive due to other competitive advantages. Given their lack of economies of scale, they tend to employ more people, and enlist the services of more external parties.” 

This discrepancy is all the more startling when you compare the various investment outcomes offered by small-cap stocks, the JSE’s all share index and the exchange’s property index.  

As Marani explains: “For every R1m, the JSE’s all share employs 142 times more people than the property index, and the small-cap index employs a staggering 632 times more people than the property index.” 

Marani has two ideas to stimulate investment into this sector. The first would be to create the equivalent of a section 12J scheme that would grant a CGT exemption to unit trusts if they only invest in companies with a market cap of less than R2.5bn. If the company’s market cap grows from there, he suggests, “the fund may hold, but not accumulate”.

(It’s an idea with which Aeon’s Mohamed agrees, saying it could entice investors back to the stock market were Treasury to consider allowing JSE-listed companies specifically to qualify for section 12J tax benefits.)

More controversially, Marani argues that unit trusts should be forced to invest 90% of all their cash, rather than allow it to sit in money market instruments. 

Legislation to this effect, argues Marani, “would see a monthly wall of money hit the JSE small caps”.

Eventually, the pressure to deploy this money would push up small-cap valuations, and stimulate listings. 

His second suggestion is to convince the PIC to allocate 10% of the total amount invested in equities to BEE fund managers who invest in small caps based on the same rules.  

These are radical ideas, and they’d need to find a receptive ear at the Treasury, which is fighting its own battle to keep the country solvent. 

Miller, like Marani, is a prospector at heart. “The most satisfying point in my career was when I was able to raise equity capital on the JSE in 2008 and put 600 people to work on a mine where nothing had existed before, when I was MD of Keaton Energy,” he says. “We could only do that because capital markets worked for us.” 

Unsurprisingly, Miller is critical of the Treasury’s ideological leanings.

And, he says, its policy response is contradictory. “South Africa has created a lotto, which is a tax on the ignorance of poor people; we have enabled gambling on everything; we allow so-called crypto investing — and then we overregulate savers to protect them from themselves in ways which ultimately deny companies access to capital.” 

As it stands, one of the Treasury’s policy goals is to reduce the number of pension funds, for reasons of scale and cost savings, to fewer than 30. But, says Miller, “they don’t realise what a devastating impact that will have on the smaller end of the stock exchange — and they don’t seem to care.”

The Treasury hadn’t responded to the FM at the time of going to print. 

We could have 20 new mining listings if Gwede Mantashe just asked mining companies that operate here to get listed on the JSE as part of their contribution to post-Covid recovery.  But I don’t think the idea would even cross his mind

—  Paul Miller

A Jacobs committee 2.0 

It’s not as if South Africans don’t want to manage their money: just take the rise of low-cost share-trading platform EasyEquities, which now has more than 1-million active accounts.

Miller advocates an independent inquiry to look at the societal role of the market and the long-term implications of the current structure — similar to the Jacobs committee of 1992.  

“We need an all-of-society effort. [UK Prime Minister and former chancellor] Rishi Sunak lobbies to get companies to list on the LSE rather than the NYSE, for example. We could have 20 new mining listings if [mineral resources & energy minister] Gwede Mantashe just asked foreign-listed mining companies that operate here to also list on the JSE as part of their contribution to post-Covid recovery.  But I don’t think the idea would even cross his mind,” he says. 

In part, he believes, this is because the governing ANC regards JSE-listed companies, and the market, as inherently ideologically offensive — and will do nothing to help those markets flourish. 

It’s true that South Africa is already drowning in a thousand commissions that seem to go nowhere. But a stock market Codesa to thrash out a new vibrant public order and reignite the JSE? Now, that might work.