The Need for More Competition and Liquidity in Africa’s Equity Capital Markets

The Need for More Competition and Liquidity in Africa’s Equity Capital Markets

Image credit – PwC 2017 Africa Capital Markets Watch

Note: This article only looks at domestic companies that are listed within their country of operation, i.e. organisations that are cross listed are only counted in their country of origin.

There is wide variation in the size and accessibility of securities exchanges across Africa however, data shows that a considerable majority of the continent’s largest stock markets are characterised by a small number of large firms accounting for disproportionately high shares of market capitalization (or market cap) and share trade value. This article looks at some of the key indicators that relate to equity capital market structure and development among the largest and most active securities exchanges on the continent, on a country by country basis[1].

South Africa sticks out as an outlier with a market cap of over USD 450 billion, as of 22 October 2018, that dwarfs that of the other African nations illustrated in Chart 1 with more than double their combined worth. In terms of the number of actively trading securities, Nigeria, Egypt and South Africa have over 200 while the rest of the countries depicted have below 100.

Advisory 11-11-min

The ratio of market cap to GDP is a generally used to assess whether a country’s stock market is overvalued or undervalued by contrasting current ratios with historical averages. In this context, however, the ratio is more useful as an indicator of the proportion of companies within a country that are private versus publicly listed where a higher market cap to GDP ratio suggests the presence of more public companies relative to private, all else being equal. In Chart 2 we see that the more developed equity capital markets on the continent had market cap to GDP ratios well below the global level in 2017, with South Africa being the glaring exception, which might be indicative of economies that have relatively lower percentages of firms that are listed.

Advisory Second Chart

Prevalence of High Market Concentrations

Market concentration in a securities exchange, the degree to which aspects of the market are controlled by its biggest institutions, is indicative of competition within the space and has important implications. Chart 3a illustrates the proportion of domestic market cap held by the top five largest listed companies (horizontal axis) against the proportion of the value of stocks traded originating from the five highest trading equities as a proportion of total value traded (vertical axis) during the year to 22 October 2018, while the size of the bubble represents the turnover ratio which is defined as the value of transactions in a year divided by end-of-year market cap.

High market concentration in securities exchanges is important for a number of reasons. From a macroeconomic perspective, a highly concentrated market poses risks because any negative shock to a single dominant firm is more likely to negatively impact the entire stock exchange and thus the economy. From an investor’s perspective, holding shares that are illiquid implies higher transaction costs when selling them which might incentivise investment into larger, more liquid companies thereby exacerbating market concentration. A less concentrated securities exchange, and thus more competitive, allows investors to redirect investments at lower costs and with greater ease which incentivises companies to improve their performance in order to attract and retain shareholders. The turnover ratio is important because it is an indicator of market depth, the ability of an exchange to absorb large trade flows without significantly affecting prices and the higher it is the more effective the capital allocation process becomes while minimising the risk of destabilising the market.

The majority of securities exchanges in Africa are highly concentrated with low liquidity levels. Firstly, the trend that emerges among the bubbles in Chart 3a indicates a positive correlation between the two measures of concentration in that nations with high concentrations of market cap are likely to also have high concentration in the value of stocks traded and vice versa. Only three countries in the chart – South Africa, Tunisia and Egypt – have levels below 50.0% across both measures of market concentration while the other ten countries under review have over half of the value of their traded stocks and market cap originating from the five most prominent domestically listed organisations. The highest market concentrations are seen in Zambia, Namibia and Tanzania which is largely due them having very few, under 30, actively trading equities. Another key takeaway is that countries that exhibit lower concentration levels, and therefore have more competitive securities exchanges, tend to have higher turnover ratios and are therefore more liquid.

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Spotlight on Kenya

Kenya finds itself uniquely positioned in this realm, having relatively high levels of market concentration while maintaining a comparatively high turnover ratio. This is even more pronounced when carrying out this analysis for the single largest publicly-listed domestic firm as seen in Chart 3b. Kenya has over 60 domestic listed companies that are actively trading. The largest by market cap, Safaricom, accounts for a hefty 45.3% of the total market cap, the highest among the countries being analysed, while it makes up over a third of the value of shares traded over the course of a year[1]. For comparison, Egypt is at the opposite end of the market concentration spectrum and its dominant equivalent to Safaricom (as of when the data was collected), Commercial International Bank (CIB), accounts for only 13.1% of market cap and 8.2% of the value of transactions.

Safaricom is a leading player in its business operations boasting 65.4% of mobile subscriptions and 78.3% of the value of mobile money transaction in the second quarter of 2018[2] so it is no wonder that it carries considerable weight in the stock exchange. However, it is imperative that a less concentrated and more liquid securities exchange be encouraged in Kenya, and the same holds true for the majority of African exchanges, in order to give investors more options, encourage competition between listed organisations for shareholders and mitigate the macro-level risks posed by the contagion of a negative shock to one of the few companies that dominate the stock market.

Advisory Second Last Chart

Advisory Last Chart

Source: Bloomberg, StratLink Africa

Outlook: What can developed capital markets do for Sub-Saharan Africa?

Between 2015 and 2016, StratLink Africa undertook due diligence on a fund whose core business is accelerating development of capital markets in Africa through stirring local currency bond issuances. This due diligence covered eleven economies and focused on the factors that impede bond issuance by corporates and determining whether added investment by the fund could help unlock greater possibilities in local capital markets. Our assessment paved the way for a USD 10.0 million investment by a development finance institution in the fund, monies which are expected to be deployed in helping to crowd-in private activity in bond markets that are considerably dominated by government issuance. This lends credence to our belief that developed capital markets would inject much needed impetus in private sector development in the continent. With Small and Medium Enterprises accounting for 80% of all jobs created in sub-Saharan Africa, there is urgent need to widen access to and participation in capital markets by these businesses. Already, there is evidence that countries in the region are taking cognizance of this and adopting remedial measures. The roll out of the Growth Enterprise Market Segment, targeting mid-sized companies, at the Nairobi Securities Exchange in 2013 is a good case in point alongside the Alternative Securities Market at the Nigeria Stock Exchange. Attracting new listings is undoubtedly a key component of addressing high market concentration characteristics of stock exchanges in the region.

[1] As of 22 Oct 2018.

[2] Communications Authority of Kenya

 

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