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1. Nigerian Capital Market at Crossroads; Working Towards a New Normal

The Chartered Institute of Stockbrokers in the Face of Honour

The Chartered Institute of Stockbrokers (CIS) was in the eye of a storm in 2022 as it pushed the agenda for a unified capital market training framework under a proposed Chartered Institute of Securities and Investments (CISI). Connoisseurs of free markets and free market economists have balked at the prospect of a professional monopoly and insist that fixing what is not broken is a poor use of time and opportunities. The Institute in the year conferred honourary fellowships on individuals it considered distinguished and worthy of recognition. 

In itself, this was commendable, except the choice of some beneficiaries appeared to have been informed by the politics of influence (towards a CISI Charter) rather than rewarding professional contributions or industry support.

The honorary fellowships, it is believed, are designed to recognize individuals that have made significant contributions to the securities industry or have shown support for the Institute’s goals and objectives. Recipients are awarded certificates and can use the designation "Honorary Fellow of the Chartered Institute of Stockbrokers" (HFCIS). Over the years, the body has awarded honorary fellowships to business leaders and past heads of state or presidents of the country (see illustration 4 below). 

Illustration 4:

Understandably, some industry players have questioned the profile of recent award recipients, observing that only a few seem to have made any notable impact on the capital market thereby negating the purpose of the awards. Analysts believe that the body could do better in evaluating prospective awardees.   

The CSCS Ownership Play Board: Market Development Beyond Monopoly Games

The capital market saw clever professional and political manoeuvring in 2022 as the nation’s largest fixed-income trading platform, the FMDQ, showed up to the table to throw its hat into the ring as it expressed its intention to increase its shareholding in the country’s premier market clearing and settlement platform, the CSCS. The fixed income financial market infrastructure’s (FMI’s) pursuit of additional equity in the CSCS started in December 2021. According to media reports, the deal, under regulatory approval, would see the FMDQ Group part with US$48.2m or roughly N20bn (at the autonomous market exchange rate) to acquire 21.6% of the CSCS. However, Proshare’s independent investigations indicate that the FMDQ may already own more than a 10% stake in the Clearing and Settlement company, thereby if approved, the additional 21.6% stake would bring the FMDQ interest in CSCS to over 30%. Given that the SEC has instructed the NGX to reduce its equity stake in the CSCS to 35% as reflected in the regulatory statutes, both the NGX and FMDQ would have a joint controlling interest in the settlement infrastructure. Does this raise concerns about a market duopoly? Maybe.

Dominant ownership of the CSCS by NGX and FMDQ would create an ownership duopoly distinct from a market duopoly. The structure would support internal checks and balances on both SROs. Further, the dominant ownership of the FMI by the country's two largest capital market asset exchanges would help grow the integration of the settlement arrangements of the market and would help scale up operations through digitalization.

Analysts think that strong equities and fixed income exchanges on the board of the CSCS would create self-regulatory checks by the competing entities, which would be good for the market. The market would be a beneficiary of the latent rivalry as it produces in-built operating and governance stabilizers. The larger presence of the FMDQ on the board of the CSCS would dilute the dominant influence of the NGX, and allow for a smoother playing field for other market participants. 

According to earlier publicly available documents NGX was the largest CSCS shareholder with a 29.16% stake. Five CBN-regulated Deposit Money Banks (DMBs) owned about 18% - Access (7.5%), UBA (5.37%), Fidelity (3.75%), Citibank (1%), GTB (0.3%), while FMDQ sought to acquire part of the holdings of Artemis (16.6%) and Leadway Insurance (16.29%).

Considering the history of FMDQ and NGX, analysts believe that there may be a revolving door between both SROs. A board dominated by the NGX and FMDQ would be one under the strong influence of related parties, however, this does not vitiate the added value of a stronger FMDQ presence on the CSCS board (see illustration 5 below)

Illustration 5:

The acquisition of a greater FMDQ stake in CSCS is expected to support faster digitalization of the clearing house’s operations. 

The world over, Financial Market Infrastructures (FMIs) and self-regulatory organizations (SROs) have embraced a digital future to benefit from cost efficiency, speed, and ease of transaction completion. Market observers and stakeholders differ on what constitutes the most pressing need for Distributed Ledger Technology (DLT).  In a recent survey conducted by Sophus Consulting, one in four respondents identified speed as the primary reason for digital ledger technology (DLT) adoption. Another reason is the technology’s discrete security features. The modernization of payment platforms is catching on and this has implications for the business of Clearing would be done in the future.

Internal economies of scale can be achieved as a result of the FMDQ deal, as the cost of capital expenditure could be spread over a larger number of transactions, thereby reducing the average unit cost of transactions. Other fixed costs could be amortized over larger transaction numbers.

The bigger benefits of a potential scaled-up FMDQ ownership of the CSCS are in the form of external economies. The share acquisition could create positive externalities for the entire industry. For instance, the volume of data available at a giant depositary would be of benefit to smaller operators. This creates outcomes that are preferable for the entire industry (see illustration 6 below)

Illustration 6:

Despite these positive expectations, it must be noted that an alternative school of thought has identified four (4) potential pitfalls in the FMDQ equity acquisition proposal, namely:

1. CBN's Indirect Control of the Depository;
2. Possibility of Concentrated Ownership & Control;
3. The Rise of a Monopoly; and
4. FMDQ's Financial Market Infrastructure (FMI) power. 

CBN's Direct and Indirect Influence over the Depository

FMDQ proposes to acquire a 21.61% stake in CSCS. Some analysts have expressed concern about the burgeoning influence of the CBN (and the financial institutions it regulates) on the CSCS. Currently, the CBN owns a 15.4% stake in FMDQ, which hands the apex bank substantial influence on the operations and policies of the FMDQ. If the stake of other CBN-regulated banks is considered, the stake of the CBN (direct and indirect) rises to 63.67% (see illustration 7 below)

Illustration 7: 

The NGX and FMDQ are competing parties despite their cross-equity ownership. In Proshare’s opinion, a potential FMDQ acquisition of 21.6% shareholding in CSCS is not anti-competitive. Analysts believe that monopoly considerations do not exist as the market's pricing mechanism is sufficiently monitored and regulated. The SEC would not allow such monopoly pricing. The regulatory framework and laws ensure that any financial market infrastructure’s (FMI’s) fee-for-service pricing is within best global practices.   

Given the context and legal framework around the clearance required for the FMDQ acquisition of 21.6% equity in CSCS, it is our opinion that a clearance should be granted in line with the economic, technical, and legal context advanced. However, such a negative Clearance by the FCCPC should be subject to verifying information submitted by FMDQ on its interest in the CSCS. 

The New Digital Assets Rules - Who is in Charge SEC or CBN?

The innovation of the digital age has caused a paradigm shift in every aspect of our lives. In the financial market, these innovations have brought about the emergence of a digital asset market such as Bitcoins and non-fungible tokens (NFT). The recent sudden rise in trading has made the Securities and Exchange Commission (SEC) issue guidelines on their issuance and custody in the country. 

The Rules on Issuance, Public Offers, and Custody of Digital Assets issued on May 13th, 2022, appear to be a completion of the regulator’s three-pronged approach to creating a regulatory framework in the crypto market.  The new guideline classified a digital asset as a digital token that represents assets such as a debt or equity claim on the issuer. These rules and regulations legalize digital assets such as cryptocurrencies concerning the fulfillment of all requirements set by the SEC (see illustration 8 below).

Illustration 8: 

The newly issued rules slightly negate the previous CBN circular that prohibited financial institutions under its regulatory control from engaging in payment for transactions involving cryptocurrency and virtual assets. Even with the new rules by SEC, the CBN is yet to revoke its ban on financial institutions facilitating cryptocurrency transactions, which suggests that crypto transactions are still prohibited in Nigeria. This situation justifies the assumption that the CBN seems to have superior power in the regulation of the crypto sector than the SEC, which is a primary regulator overseeing securities offers, sales, and investment activities including crypto-assets.  

Issues/Challenges Around the NGX Demutualization

The demutualization of the Nigerian Stock Exchange (now NGX) unlocked previously imprisoned opportunities for capital mobilization from the investing public. One of the major challenges the then NSE encountered was with the Companies and Allied Matters Act (2020). The Act only allowed the conversion of private companies into public companies and vice versa while preventing the conversion of companies limited by guarantee (like the then NSE) into public companies. 

The demutualization saddled the exchange with the responsibility of being both a regulator and issuer which would make operations a bit more complex. Since the demutualized exchange is also listed on its exchange for trading, the responsibility might result in a plausible conflict of interest. To avoid such occurrences, the NGX established an independent regulatory company to regulate its market activity. The regulatory Chinese walls represent market best practice but leave slivers of concern about the potential for the barriers to be breached, creating a regulatory nightmare.  The consideration of the potential for regulatory failure forms the basis for further interrogation of the demutualization goals of the NGX in a forthcoming Proshare report in H2 2023.

The New CISI Bill: Matters Arising

The new CISI bill aims to properly capture the scope of a stockbroker, the functions of the institute, and the securities that a stockbroker can deal in. The scope of the stockbroker ranges from securities dealing, fund and portfolio management, asset management, investment management, corporate finance, and other related fields. The passage of the bill will promote the regulation of training and certification of core capital market operators which will discourage the multiple fake operators in the country. With the new bill effectively defining the duties and streamlining the eligibility of a stockbroker (standardization of training and certification) to the Chartered Institute of Stockbrokers (CIS) only, the bill will drive the registration of all professionals in the securities business and prevent the current duplication of roles among different professional bodies. The new bill seeks to further deepen the existing Chartered Institute of Stockbrokers Act No. 105 of 1992 which recognized the CIS as the only body of professionals legally empowered to train and certify professionals in securities and investments. Analysts noticed the bill contains an additional part that focuses on the regulation of Commodity Exchanges and Warehouse Receipts, which will ease the development of the entire gamut of the commodities ecosystem. 

Prominently, the bill prohibits ponzi/pyramid schemes and other illegal investments with a punishment of a jail term of not less than 10 years for promoters of such schemes. The punishment should slightly address the rising online fraudulent investment in the country. 

New approaches to address systemic risk will be deployed under the bill. The approaches cut across monitoring, managing, and mitigating systemic risks with access to relevant information from both financial sector regulatory authorities and government agencies. To smooth out the complexity of identification, a legal entity identifier will be used for proper monitoring of systemic risks.

Some industry players seem to oppose the new bill. The Association of Corporate and Individual Investment Adviser (CIIA) believes that the capital market does not need a new law to enforce discipline amongst its market operators as the current ISA 29 of 2007 already serves that purpose. They envisage that the proposed bill will create an unwieldy structure of conflicting career pursuits in the market which is a bid to legislate a monopoly into existence. Furthermore, the uniformity of the professionals will not address the issue of low trust in the market as specified in the bill but only enforcement actions can. 

The SEC’s Unsettling Revenue Drive

Market Operators and trade groups have previously queried the funding structure of the Security and Exchange Commission (SEC). Over the years, the SEC generates funds from fees (registration and transaction), penalties/ fines, and subventions from the government. The subvention received is known for its inadequacy which makes the regulator highly dependent on fees and penalties from market operators. The comment exhaled from the point of view that the regulatory body should be independently operated. They think that the fees received from market operators can obscure the effectiveness of the regulator and should only rely on the government, fines, and registration fees for funding the SEC. The regulator charges a commission of 0.3% on each transaction while the registration fee varies based on the transaction description (see illustration 9 below).  

Illustration 9:

One school of thought raises the scenario of illegal investments where the SEC has received transaction fees, and the body could be said to be an accomplice in crime, as a beneficiary of income from the proceeds of criminal activity. The school argues that the SEC is meant to develop and regulate the capital market in a dynamic, fair, and efficient way to contribute to the nation’s economic development, so being cut in such a web lessens the potency of its authorities. 

A second school disagrees with this position and argues that as long as the SEC was not aware of the crime being committed as of when it received fees on market activities it could not be said to be an accomplice (see illustration 10 below).  

Illustration 10:

Proshare analysts have concluded that if markets must grow, they must be able and prepared to deal with uncomfortable truths. Markets are tangentially like human beings.  If stress does not break them, then it will make them. Nigeria’s capital market is facing a poly-crisis of human, technological, and infrastructural issues. A set of solutions will come, but it will require time, intelligence, and tact. A difficult combination to see in periods of uncertainty.