Unathi Kamlana, commissioner of the Financial Sector Conduct Authority (FSCA), which this week cancelled the licence of alternative exchange ZAR X, denies the regulatory environment is hostile to small exchanges trying to compete in a space dominated by the JSE.
“We think we have a sufficiently enabling regulatory environment. There are areas we could consider further to open up and enhance, but we don't think right now what holds back the success of the additional exchanges is the rigidity of the regulatory framework.”
ZAR X launched in 2016, the first new competitor to the JSE. It was followed in short order by several other alternative exchanges, two of which are still standing.
The minimum conditions that have to be met, such as capital and liquidity requirements, are reasonable, says Kamlana.
“If you say to an entity, ‘You must have liquid financial resources which are an equivalent of six months worth of operating expenses,’ it's difficult to argue that that's not reasonable.”
ZAR X CEO Etienne Nel said the decision by the FSCA to cancel the licence was a significant setback to advancing financial inclusion.
Should smaller exchanges be given more leeway to reflect the fact that they're hosting a developing market for small- and medium-cap businesses?
They are given more leeway, says Kamlana.
“They're not expected to hold the same level of liquidity or capital as a larger financial institution. In addition to that, where there are shortcomings, whether on the quantitative side or qualitative — such as governance — side, the regulator provides a bit of space for the realisation of those requirements by smaller entities.”
Are governance requirements for small exchanges too onerous? Isn't their selling point that they have less red tape so they can be more nimble and save their clients costs and complexity?
“Absolutely, that is their competitive edge, so cut red tape by all means. But it's about how much they cut. There are things you cannot and should not compromise on because then you're putting integrity and investor protection at risk.
“Where I worry is when I see the race to the bottom where everyone wants to be as cheap as possible at whatever cost. That's not how a regulated market operates.”
There's a fine line between the regulatory framework being too rigid because it talks to the specific period when it was designed, and being as dynamic and flexible as alternative exchanges would like it to be, he says.
“The question is, when we see there are challenges how do we work with the firm to nurse it back to health.”
Did they do enough of this before suspending and then cancelling ZAR X's exchange licence?
“Without a doubt. The decision to suspend was orchestrated with the South African Reserve Bank and Prudential Authority after a series of engagements over at least a year to point out to them the challenges and give them an opportunity to come back and say how they're being addressed.”
Even when the FSCA suspended the licence in August 2021, the clear intention was to give the exchange and its shareholders (the biggest being the Public Investment Corp with 24.14%) an opportunity to assess the business model and decide what to do, he says.
You can't have an open ended environment where you can take as long as possible to reach compliance
“But you can't have an open-ended environment where you can take as long as possible to reach compliance.
“By the time we cancelled the licence it was 18 months later, so no-one can argue that there wasn't sufficient time for them to turn things around. If you're going to find new investors or make adjustments to your business model you should be able to do that if you're under strain from a regulatory perspective in 18 months.
“This was actually on the other side in terms of swinging the pendulum.”
Was the FSCA putting investors at risk by allowing ZAR X so much leeway to meet such critical capital and liquidity requirements? Fund managers had been expressing scepticism about ZAR X for a while by the time the authority pulled the plug.
“If we're to deliver on the objective of enhanced competition in this space, where you have one established player, you as a regulator have to take seriously the plan that a licenced entity communicates to you to remedy their shortcomings.”
When it was suspended in August 2021 ZAR X had seven listings.
“They're saying to you the following investors are coming, the following things are possible, give us a bit of time.”
When ZAR X still hadn't met the capital and liquidity requirements 18 months later, “we had to draw the line, and we did”, says Kamlana, who was appointed commissioner in April 2021 after 10 years at the Reserve Bank and Prudential Authority. Before that he was chief director of financial markets at the National Treasury.
How safe was it for the PIC to be investing so much government employees' pension money in ZAR X when it couldn't meet the FSCA's minimum capital and liquidity requirements?
“The PIC invests in start-up companies all the time, and at that time there was lots of potential and lots of promise in this space being opened up from a regulatory perspective and the policy objectives being articulated around competition.”
Does it raise questions for the regulator about the state investor's governance and risk management processes?
“Not in terms of this particular investment, no.”
It's not for him to comment on their other investments, he says.
A more immediate issue is the Paris-based Financial Action Task Force (FATF), which will decide on February 24 whether to greylist South Africa.
Could the FSCA have done more to ensure this does not happen?
“The things that pertained to our mandate were attended to with the kind of urgency that was required,” he says.
But what the FATF required was beyond the ability of financial sector regulators to deliver.
"This is about prosecutions and the investigative capacity of the Hawks and National Prosecuting Authority, and in spite of improvements there are gaps there that are quite significant."
Has South Africa done enough to avoid greylisitng?
“Regardless of good intentions, we haven't delivered the required outcomes in terms of the effectiveness of the criminal justice system as a deterrent to financial crime.
“I think the outcome when it is communicated by the FATF will reflect that reality.”
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