With elections, greylisting, and global geopolitical turmoil as its backdrop, Sifiso Ndala, Mark Kerns and Gregory Naicker discuss the impact on the South African asset services
Moderator
Karl Loomes
Group Editor
Asset Servicing Times
Panellists
Sifiso Ndala
Head of Global Securities Solutions
Rand Merchant Bank
Mark Kerns
CEO
Adapa Advisory
Gregory Naicker
Head of CSD Services
Strate
Welcome to this Asset Servicing Times panel discussion, where we will be looking at asset servicing in South Africa.
South Africa has the largest asset servicing market on the continent, and as with the rest of the world, it is seeing global macroeconomic and geopolitical uncertainty as the backdrop to its financial markets.
Additionally, the growing complexity of financial instruments, the increase in digital assets, and an ever-shifting regulatory environment, all add to the issues facing asset servicers and custodians in the country.
Our panel will be talking about these issues and many more.
Given some of the factors previously mentioned, as well as greylisting and national politics, what would you say is the current market landscape in South Africa and do you think it is having an impact on inbound investment?
Sifiso Ndala: There have been myriad things happening in our jurisdiction in South Africa, including the greylisting.
The greylisting does not mean South Africa is closed for business though, it just means that institutions that want to deal in the country have additional compliance issues to consider. This includes enhanced due diligence, which obviously increases costs.
However, if the country does not make efforts to get off the greylisting, it might have negative sentiments on the jurisdiction, which in turn may mean that flow of liquidity might be a challenge. In turn, this may then have an impact on our credit rating.
When I think about the last 12 months, the trajectory has been fairly positive. There have been a lot of steps that institutions, and the government, have taken to implement a lot more anti-money laundering (AML) policies, in order to get the country out of the greylisting. When you consider the reasons why we got into greylisting, it was not necessarily the institutions that faulted, it was more on the fiscal side that there were some AML policies that were not properly implemented.
Looking at the bright side of things, we have seen quite a lot of partnership between the government and the private sector. There have been a number of initiatives where the private sector is partnering with the government to make sure that we put policies in place. I know there have been instances where people from the private sector have even been seconded into government, to assist in efforts to get out of the greylisting.
As I said, the trajectory is positive, but we remain extensively cautious because the 2025 deadline needs to be met, and we need to put measures in place to meet it. In addition to that, just as with half of the world, we have an election year, this year. My sentiments are that for the first time ever, we are probably going to have a coalition government, which is something that we have not really tested before.
The positive thing about this is that in the past 30 years, the country is going to experience another free and fair election. With a coalition government, from a business perspective, there is hope that the governing body would get at least between 43 and 47 per cent, which means that they will still have a large majority. As a result, there will be some consistency in the policies — especially the financial policies that have been put in place.
There are coalitions that, from a business perspective, we might not be comfortable with. But overall it will be good for the nation that we get some sort of consistency going forward.
Finally, something to consider is what we South Africans call loadshedding. Effectively, we had lots of challenges with our power, and electricity was a big issue. There have been some initiatives by the government to try and fix the problem. One of the key such moves was that the President recruited an electricity minister. This gentleman was put in place solely to focus on fixing our power issues. When he was initially appointed however, he did not have a very clear mandate. So there was a cooling period where we tried to understand exactly what his role was. There are a number of ministers that all have some influence, accountability and responsibility, with power. We effectively had three ministers that were focusing on fixing our power issues, because from an economic perspective, it slowed down activity.
Subsequent to that, the minister was given a mandate, the bulk of which was on power generation. We were expecting the worst, and at some point we were expecting the grid to totally shut down. Thankfully, we did not get to that point. The highest stage that we went through from a power perspective was stage eight officially, which means we had very limited power on a daily basis. Corporations were well prepared with large generators, and households were also able to find alternative power sources, so the country continued.
Since then, the trajectory has been quite positive.
Gregory Naicker: As a central securities depository (CSD), we are able to see the whole market in terms of impact from a greylisting perspective, so I can offer an overview in terms of how things have been playing out.
Definitely from a foreign investment perspective, greylisting has impacted us. Consider in the context of asset managers, or any institution investing into a foreign destination, they have specific mandates they need to comply with, in order to protect investors that they look after. So we have seen a drop in foreign investment, or the number of foreign investors into South Africa — that is natural. Any greylisted country would see the same thing, and in South Africa I believe it is the lowest in 10 years. That is just because of the greylisting.
But with any negative scenario, there is always an opportunity behind it. What we have seen come out of it as an opportunity, is that we are one of the companies in South Africa that is engaging with the government to try and solve transparency issues. Consider the public markets, where there is a lot of transparency around who owns what, from an investor perspective, but the government has a big problem. They do not know who owns what in the private sector.
You have got to complete the loop, because the combination of both is actually what they need to solve for. We are helping the government in terms of digitising the private sector, so that we can enable them to have transparency around ownership. That is big, not just for South Africa, but globally, in terms of private sector ownership. That is one of the big opportunities that has come out of this, which will take our market forward.
Once you have transparency, then there can be enforcement. Regulations are hard to enforce if the beneficial owner is unknown.
On the power issue, one of the biggest things the government has done is removing restrictions for the private market, or private players to enter the space. Previously our power utility was managed by one entity. But now they have taken away those restrictions, the private sector can now operate in that space.
In Cape Town, for example, there is 100 hectares of land that is owned by a private company, and they have put up a million solar panels, pushing all that power back into the grid. The private sector is helping tremendously, which is why we have seen the stabilisation of the grid over the last few months. It is because the private sector has been more fully involved.
Also, households have managed to create a lot of power within their own environments.
This is all because we are the tip of Africa, and the sun is for free. So we have got a lot of what you could call ‘energy resources’, and are able to create value for not only private homes, but also for the economy and the capital markets as a whole.
One important point to note is that we are seeing a move away from public platforms for listings, into the private sector. Traditionally the exchange used to be the marketplace for raising capital, but it is no longer the place now. You can raise capital at any point.
We have seen a lot of things from the greylisting that has caused us to think a little bit differently about our capital markets, which is positive, because we are forced to think differently.
The players in the market have started to think differently, about how to attract new business, how to look at customers differently, how to look at foreign investors differently, so that the assets are protected in any space.
Mark Kerns: I concur with both Sifiso and Greg’s comments. I have been doing business in and out of Africa for over 25 years, and there is no doubt that in that 25 years, this has been one of the most challenging periods that I can recall. Regarding the trajectory, however, I would agree with Sifiso that it is positive.
If we ask how do you address this from an investment destination point of view, I think people are thinking laterally, about how to progress from this point. Obviously, the outcome of the election is an important factor domestically, as well as how that might impact international sentiment. It is important to note that South Africa is a very sophisticated market.
It is very liquid, and there are plenty of fantastic investment opportunities, whether in the public or the private markets.
You have got a very strong domestic environment from an asset management, wealth management and pension perspective. It is very mature, diverse, and is heavily invested in the domestic market as well — the infrastructure is strong.
There is a path moving forward. Would people like to see that accelerated? Of course. Would we like to see greater levels of foreign inbound investment across the board, not just in securities, but in broader projects? Of course.
How do regulatory frameworks like the Financial Advisory and Intermediary Services Act (FAIS) and the Collective Investment Schemes Control Act (CISCA), impact asset servicing in South Africa, particularly in terms of compliance requirements and oversight?
Kerns: One of the things that characterises South Africa is that it is a well regulated market, and, frankly, it has been for a long time. Many of the legal principles have foundations in UK law. So in the unit trust market, for example, the concept of trustee, trustee duties, and regulation that supports the role of the trustee, and indeed, the whole value chain, is very mature as it relates to the securities markets.
From an exchange point of view and from a settlement point of view, it is very heavily regulated, with various oversight across the whole process. From a regulatory point of view, the market is extremely solid, with strong principles that can continue to be built on.
To comment on the points that Greg made around transparency, broader investment products, and private markets, obviously as you develop the market, there will be a need for regulation to support that. Digital assets, for example, is an area where regulation needs to be developed to support how the investment markets are changing, but the foundation and principles are very strong.
Naicker: As the CSD in South Africa, we are predominantly regulated under the Financial Markets Act. Under the financial markets act, the level of scrutiny and governance from a regulatory perspective is significant, because we are what would be defined as a market infrastructure and a systemically important financial institution. This comes with a lot of regulation by default.
From a FAIS and a CISCA perspective, both pieces of regulation have been fit for purpose for a very long time. Considering the growth of the market in South Africa, there is quite a strong savings industry. That comes out of corporate employment. Employed people are mandated that they must contribute to a pension fund or provident fund, etc. That has helped the savings industry, and it has become a culture within South Africa. The market is about 3.2 trillion from an assets under management perspective.
If we look globally, what we are seeing is mutual funds, as a team, are coming under the auspices of the CSD banner from a security type perspective. One of our intentions in South Africa is definitely to look at that, from a very simple perspective. How do we create further risk reduction? How do we further optimise? Can we give cash incentives back to the market from the way that we price so that we can democratise the savings environment a little bit more?
If the savings culture is driven through the corporate employment structure, but you are an entrepreneur, for example, and you want to save, there should be a process within the environment. We should create that ability for investors to create a broader economical savings culture.
Considering the South African economy, the country has a population around 60 million, with a working class of probably about 25 million, but there are only about 2 million that are actually saving through the structures. We have to ask, how can you create scale, and how can you democratise savings in a way that will allow all South African citizens, including those not in the corporate environment, such as entrepreneurs, a channel.
We are working with regulators to see how we can enable the current pieces of legislation to evolve. If we create this culture, then you reduce the dependency of people on the government, from a social perspective, and in terms of looking after people once they retire. If you do not have this done quite early in a person’s life, the impact is on the government, and then the impact is on the taxpayers, because they have to contribute towards making sure that once a person reaches retirement age, then they will have to help pay for people past that time.
We have to think about it carefully, in terms of the way our regulations and our legal structure is put together. From a government perspective, I do know that they are looking at it holistically, asking how we can harmonise across security types, because equities, money markets, mutual funds, and bonds, are under different pieces of legislation. But it is actually the same thing. Arguably it is we, as capital market practitioners, that have contributed towards this disparity.
It has worked for 36 years — the market has grown quite nicely. But if you have to think about the next 50 years, and where we want South Africa to be, or where we want the capital markets to be, you have to have a long term vision in terms of how you structure regulation. You have one chance to get it right, or then it sits there for 20 years.
Ndala: Just to make two points, to supplement what my colleagues are saying.
I fully agree with what they have said. Looking at this through the lens of the private sector, usually when we speak about regulation, it is one of those things that we are not very comfortable with, because we feel like our hands are being tied, and that we can not run a business the way you want to.
But if you think about it at its core, why regulations are there, it is to protect the end investor. You think about that nurse, or the school teacher, or the policeman, that works very hard for 30 or 35 years, hoping that at the end of their retirement they can get something to live off, you have to have guardrails in place that protect that person that is going to depend on these funds.
Secondly, it is important as a private sector, that asset managers and custodians like ourselves, need to partner with regulators so that we make sure that the environment is stable for us to do business, and is conducive for all the different stakeholders and the rest of the ecosystem, to do what it needs to do.
How are custodians adapting their custody services to accommodate asset owners and asset managers with diverse investment strategies and global portfolios?
Ndala: As a custodian, it is very important to consider the changing needs of our clients. We constantly have to adjust ourselves and be amenable to the changing landscape. Mark spoke earlier about digital assets, and that is a good example. There are new asset classes coming on board, and we need to be able to cater for that.
Even our systems need to cater for the changing environment for our clients, our processes or regulation. In my organisation, it is very important for us to be close to our clients, and to understand what they need, but also to understand that we are part of a bigger ecosystem. We can not look at it solely as a custodian, we have to consider the various other stakeholders that are involved, because it is a whole ecosystem. Then we can ask, what is our niche? What is our value within this ecosystem?
As an example, what we have seen — especially from our global custodians and the bigger players — is that they are creating solutions out of multiple products that they have. They will have online platforms where they will display multiple solutions, of which one would be a custody offering. But then clients will also have the liberty and the leverage of creating their own solutions among these platforms. They will have a fund admin on it, they will have a custodian on it, they will have securities lending on it, and they can create for themselves a proper solution that they need.
Custodians need to understand the ecosystem, they have to understand the client’s needs, and they have to understand how they touch on their niche within this environment. Then clients will be able to pay, and be very happy to pay, for the service.
Kerns: I agree with Sifiso’s comments — the important thing is, what are you delivering to the end client? South African custodians are very familiar with dealing with the international banks, which is largely about asset safekeeping, it is about settlement, it is about foreign exchange, and all other things associated with that inbound investment. There is copious experience in the market in dealing with the international community.
Likewise, there is a lot of experience dealing with domestic institutional investors and asset owners. But the demands of those markets have expanded over time. As Sifiso articulated, at one point, custody was the product. Now, the demand on custody banks is to act as a trustee and provide custody. Clients want to invest in broader Africa and they want to invest globally. They have demand for accounting valuation, performance, risk, ESG services — the markets have developed into private assets, alternatives, etc.
There is a requirement from an end customers perspective, to support them across that value chain. In terms of where the market is on that value chain, different organisations will be at different places in terms of how they are dealing with that value chain. Sifiso makes a very important point, that that value chain does not need to be completed by the bank all on its own.
Because of the complexities of service delivery, the cost associated with it, essentially demands that you work with partners, or you work with other internal groups within your own organisation. The target is — what does the client require from a full value chain perspective, and how do we deliver against that value chain?
That target is pretty clear, but different organisations are at different stages of how they are delivering that, which is a function of where the organisation comes from, how they have built their business, the nature and profile of their client base, etc.
The other thing which I think is very important at this time from a South Africa point of view, is that the levels of global investment are higher than they have ever been. Over time, there has been a relaxation as to how much can be invested offshore. It was kept to quite low levels at one point, to manage a foreign exchange risk, repatriation, etc. But those numbers over time have increased, and asset owners and asset managers in many cases, are up against those thresholds.
Because everything that goes global is leaving South Africa, it is important from a security services point of view, that you can support that entire value chain, including the global component, where there is a demand for people to invest overseas for diversification reasons. But supporting those assets, and being able to do that in partnership, and manage that whole value chain, is a critically important issue for the security services market. This will also be the case in other African markets, as demand for international exposure has increased.
Naicker: Innovation can happen from the back as well. We have been working with our custodian banks, to diversify our markets into a few places in the local market. It is around any trade venue that we want to bring into the market, because our custodian is an extended part of our value chain, in terms of the way custody is offered to an end client.
We want to bring in new security types, trust and mutual funds, as I mentioned, it is a big focus for us. The derivatives market is a big focus for us from an OTC perspective. Lots of our custodians are banks, and we want to create a digital platform for them.
The big thing for me is, and Mark alluded to it, is that you have to look at value prop to a client from a one-stop-shop perspective, because the foreign component is becoming more important. Our listed companies are trading at a p/e ratio of six. To buy stock in South Africa right now is cheap. Asset managers, from a foreign investment perspective, are moving a lot of investment offshore.
From a RMB perspective, the conversation will be: how does RMB service the client through a one stop shop, through the central depository, in a way that they can access the global markets. From the very high level research that I have done on this, if for example you take seven hops into the foreign market, going through market infrastructure, you have three into the foreign market, and then that makes a big difference for how RMB can service its client in this context.
There are lots of good things that will come out of it. I think the number is now five trillion sitting offshore, and that is a significant portion that we would like back in the local market, so that we can get value from a settlement perspective and from an asset servicing perspective.
How would you characterise the fund administration business in South Africa, and do you think it is a growing opportunity?
Kerns: One of the things that is not well understood internationally, is that South Africa is one of the most mature markets from a mid and back office outsourcing point of view. But there was a period when a number of the large asset managers in South Africa took the decision to ring fence their mid and back offices, and create separate entities that would support them as a group, but also open them up to be able to provide third-party administration for other organisations. The market in that sense has been providing those services, and providing outsourcing solutions for fund administration, for 25 years in some instances. Over that period there have been various acquisitions, and other activities, and the introduction of services from the international banks in that space. This means the markets have changed, but the market is mature in terms of fund administration.
In terms of that changing landscape, there is a lot of activity around how funded administration is being done. In the instances where fund administration is being done in-house with an asset manager, it is now very much in the minority from a pure scale point of view. Most of that has been outsourced to a third party, who is either a resident domestically, or is an international bank who is providing the services through their offshore operating model.
That said, from a value chain point of view, being able to support a client from an end-to-end perspective, creates an opportunity to provide fund administration as part of your overall service offering, whether you do it internally, whether you do it with an internal partner organisation, or whether you do it with a third party, but having that capability is an opportunity to be considered.
The other thing worth noting is the greater the demand there is for new products, for alternative products, then the greater the opportunity there is for fund administration services. It is a critical part of the value chain. The question of how you do it, is where the strategic consideration needs to have lots of thought, because fund administration is a scale activity, and the costs associated with it are not insignificant.
This means doing it in an efficient manner, internally or with a partner, and how you commercialise that, are a very important series of questions, but it is a critical function in the value chain. It needs to be catered for in that value chain in an appropriate way.
The other thing I would say, is that from a domestic market point of view, the market has done an exceptional job in terms of dealing with a multiplicity of products. As Greg said, this sector has got a very mature savings market, and that mature savings market has led to many different types of funds, classes, sub funds, and very complex structures, that the fund administration community in South Africa has done an exceptional job in servicing.
Given the depths of the life and pensions markets, this trajectory is only going to continue, which again means it is important to determine where it fits in the value chain and ask how do we execute against it? For those providers or fund administration in the domestic market, their challenge is building scale, looking at broader diversification. A number of those factors are important strategically, for them to continue to grow a franchise. This is how you commercialise your operation. There is a client delivery, but there is also understanding the economics and how you commercialise it, and how you make these activities profitable.
Naicker: What I have noticed in the fund administration space, is that there has been an evolution out of pure fund administration — let us call it capability — over the last few years, that has now started tagging on certain capabilities that are traditionally executed by a custodian or transfer agent in the mutual fund space, or other capabilities that they have now latched on to fund administration.
For me, that is an area that we need to be aware of. Sifiso for example, from a RMB perspective, is licensed by Strate under a specific regulatory framework, and they need to comply with that. If I have a look at some of the fund administrators in the current market, and if I look at some of their capabilities, it is a duplication of what Sifiso does. This raises the question, under what regulatory framework do they work? It ties back with FAIS and CISCA.
We have to ask the question of if there is regulatory arbitrage, between certain functions in the market, that have evolved for a specific need. As Mark alluded to, the fund administration business has grown per product and per client type, but through that evolution, have they taken on certain functions that do not quite fit within the FAIS regulatory framework, but fit under the CSD framework, and should be regulated? You can see how it automatically starts creating blurry regulatory lines.
Where I see this is in the mutual fund space, where fund administrators have evolved to become transfer agents, and now offer a suite of functions as an outsourced arrangement. But when I look at the regulations that they need to comply with, and then I look at the services from a custody settlement and administration perspective, that Strate needs to comply with for this, and for all security types, there is definitely regulatory arbitrage.
We are very cognizant about it, but our ecosystem is becoming more cognizant about it right now. The unintended consequence of something like this, if left too long without being addressed, is that investors are going to be paying lots of costs through the tiers, ultimately to the end investor, who is a client of RMB, from a banking perspective, or Standard Bank from a banking perspective.
We need to think about that ecosystem in terms of roles, capabilities, and the market structure. Because if you are not, in your role, in the right regulation, then the cost of the industry is just going to increase on a regular basis. An example of this is our saving industry, which is mandated. But think about it if it was not mandated, and if you had the choice not to invest into your pension fund, but take that contribution and invest it somewhere else — I do not think it would be successful.
That was my only observation around fund administration, is that I think it has evolved over the years to where, maybe, there is certain duplication, and where it may be, not quite aligned to the regulatory framework that it was born under.
Ndala: I 100 per cent agree with Mark’s sentiments. Responding to Greg’s observation, it is then important to define the collaboration between the different administrators and the various other stakeholders in this market, to avoid that duplication. Definitely, some of those funds can be allocated towards other funds that they can invest in, instead of paying their party providers.
But this can only happen when there is an opportunity to collaborate, and an opportunity to look at those overlaps, and then seeing how we can maximise it, so the value chain that Mark is talking about, is properly applied for the end investor. It does bring a lot of opportunity for the market players to play very nicely with each other.
We have seen South Africa is very rich from a skills perspective. We have seen lots of internationals coming to find skills within SA, broadly and in general, but particularly trying to find some of those skills that are becoming scarcer and scarcer in other places. The evolution of this particular offering has been great for us, because it has brought about skills development for many of the people. Greg spoke about unemployment earlier, and so these skills do assist.
With the rise of digital assets and decentralised finance, what role will the market infrastructure and asset servicing providers play in facilitating the custody, administration, and the trading of these assets, and what challenges do they face in ensuring regulatory compliance and investor protection?
Naicker: We need to look at investors in a very different light. If you look at the traditional investors into the current local market, or into the global markets, they have a very specific and defined strategy. One could be a saving strategy, for example, another could be for wealth and growth etc.
There is around US$1.9 trillion invested in bitcoin. If I had to look at the target market, it is for investors that are looking for instant gratification. There are no investors in this sitting on a Bitcoin investment for more than 12 months, especially given how volatile prices are.
If I think about our policymakers, the national treasury issue retail bonds, and greater than 70 per cent of those investments are held by people over the age of 70 years. Another 20 per cent is held by those between 50 and 70. They are worried about how to raise capital, and how to attract new investors into those types of structures.
It is a big consideration for us to think about from a tokenised asset perspective, from a decentralised perspective, and we need to think about it in the context of the traditional roles that we play: what is the role of the CSD? What is the role of the custodian? We need to think about a vision greater than 20 years, so that we can keep investors within our local market.
It raises the question, what is the alternative? They are going to go to platforms that offer the services that may not be as highly regulated as we are. We need to look at the new generation of investors, in the context of, how do we bring them into our environment from a value prop perspective. Another key point to note is that the new investors of the world want to be able to have a one-touch capability, to be able to get instant gratification, and invest using their smartphone.
Ndala: I agree, regulation is going to be a catalyst. I remember five years ago when we were speaking about this topic, the sentiment was often that ‘there is a solution looking for a problem’.
I still maintain that the regulators are going to need to be quick enough to meet up, because regulation is going to be very important in this space. Once that has been established, and it has been set in place with a level of consistency, then we are going to see a lot of ramping up of these assets.
Another important thing is that the regulator is going to need to employ a lot of investment into education. There are a lot of acronyms, there are lots of things that we do not really know, so there is a need to skill-up the end investor.
Kerns: As a firm, we have done quite a lot of work in this space for clients. Frankly, this is an unstoppable train. I get exceptionally frustrated when I talk to certain counterparties that think this is just not going to happen. People get somewhat fixated about particular coins, but the principle of the technology has the ability to transform how capital markets operate.
As Greg says, the demand for those products is significant, and it has largely been driven by retail, but over time, you have seen more institutional demand. In recent weeks, we have seen the launch of Bitcoin ETFs, which have attracted billions of inbound investment. The tokenisation of assets is the area that the banks are particularly excited about, as well as the tokenisation of traditional assets.
If you tokenise an existing asset, what is the real benefit of that? There are benefits from a settlement point of view, the value chain is very different, the stakeholder engagement is different.
The need for an alignment between securities, digital assets, and tokenised assets, is critical, whether it is with integrated regulation or separate regulation, but many markets are focused on that — including South Africa. But the principles around this are not going away.
From an Africa point of view, and a South Africa perspective, the exciting opportunity here, in my view, is the tokenisation of real assets. South Africa has lots of real assets — agricultural assets, mineral assets, etc. These are seen in listings, usually in the form of major corporations and so forth, but these are the kinds of things that can potentially be tokenised, to bring new products to market and to take African products to international markets.
From a banking point of view, it causes a challenge, because there is an investment required in infrastructure for digital assets. But the return on that investment is not easy to grasp. An investment needs to be made, so you have to do it, but how you do it, the timing of how you do it, and when you are likely to see revenue from it, is the challenge that the market is facing.
As Greg said, everybody needs to determine what our role is in that chain, and if we are accountable to the existing chain, what do we need to do to make sure we are in the digital asset chain?
