Tutorial for 2022 Promotion Exam
Capital Market - Concepts, Definitions and
Market Infrastructures
January 13, 2022
Mahmud Muhtar
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Outline
1. Demutualisation
10. Spread
2. Commodities Trading Ecosystem
11. Short Selling
3. Dematerialisation
12. Margin Lending
4. Bull/Bear Market
13. Securities Lending
5. Arbitrage
14. Pump and Dump
6. Book Runner
15. Peer to Peer Lending
7. Bid/Ask
16. Financial Market Infrastructures
8. Blue-chip
17. Information Services and Technology
9. Haircut
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Concept of Demutualisation
Demutualization is a process by which a member-owned company legally changes its
structure in order to become a profit-making company owned by shareholders.
In a demutualization process, members may receive structured compensation or
ownership conversion rights in the form of shares in the new for-profit company. Also,
the trading rights that members have are separated from ownership.
Demutualization will, therefore, enable the company to conduct its business activities as
a profit-making entity. It would also mean a change in operational structure and
leadership.
In the mutual membership model, a broker seeking to trade on the exchange first has to
be approved as a member. Typically, only members of the Exchange will be allowed to
trade.
Where a broker resigns its membership of the Exchange, the broker loses its rights to
trade on the Exchange. Demutualisation therefore separates these roles so that an entity
will no longer need to be a member or even a shareholder to be granted trading rights.
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Demutualisation Trend Across the Globe
Starting in the early 1990s, stock exchanges around the world began to
demutualise — starting the process of converting exchanges from non-profit,
member-owned organisations to for-profit, investor- owned corporations.
This phenomenon has been pioneered in Europe with Stockholmsborsen
becoming the first for-profit exchange in 1993 and listing in 1998.
The Stockholm Stock Exchange (now Nasdaq) became the first exchange to
demutualize.
By 2020, it was no longer a trend – it was deemed the norm for exchanges both
small and large to demutualize and is viewed as an essential part of developing
the capital market in a nation.
Currently, at least two thirds of members of the World Federation of Exchanges
are demutualised including London Stock Exchange Group Plc, Deutsche Boerse
AG, Hong Kong Exchanges and Clearing Corp., Japan Exchange Group, Nasdaq,
CBOE, CME Group, ICE, Australian Securities Exchange, the Johannesburg Stock
Exchange, Bursa Malaysia, and the Philippines Stock Exchange.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Benefits of Demutualisation
Provides access to capital;
Allows investor participation;
Improves organizational efficiency and effectiveness;
Results in improved market quality and liquidity;
Improves corporate governance, transparency and
accountability;
• Improves performance of the exchange, including the
ability to compete globally.
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Demutualisation of the Nigerian Stock
Exchange
In line with Demutualization plan of the Nigerian Stock Exchange, a new
non-operating holding company, the Nigerian Exchange Group PLC,
has been created with three subsidiaries as follows:
1. Nigerian Exchange Limited (NGX Limited), the operating exchange;
2. NGX Regulation Limited (NGX REGCO), the independent regulation
company; and
3. NGX Real Estate Limited (NGX RELCO), the real estate company.
Nigerian Exchange Group PLC has been listed on NGX Limited and is
currently trading as a listed company.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Commodities Trading Ecosystem
Commodity Trading Ecosystem can be defined as the environment within which commodities
trading takes place and directly or indirectly, affects activities and development of the
commodities market and the Exchanges.
The ecosystem is comprised of various elements, which are integral to the architecture of
the market and vital to the smooth and efficient functioning of a commodity market or
exchanges.
Developing a roadmap for a vibrant Commodities Trading Ecosystem is one of the key
recommendations of the Nigerian Capital Market Master Plan (2015-2025), which has been
assigned to a Technical Committee to undertake. The work of the committee has been
ongoing and the committee provides periodic update, particular during the quarterly Capital
Market Committee meetings.
The ecosystem encompasses all spheres of the commodity trading environment such as its
operations, products traded, infrastructure, logistics, traders/brokers, commodities, etc.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Components of Commodity Trading Ecosystem
1. Legal and regulatory framework
2. Products/commodities
3. Grading and standardisation
4. Warehouse and warehouse receipt
5. Physical infrastructure
6. Operators, other participants and stakeholders
7. Logistics
8. Delivery mechanism, clearing and settlement.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Participants in the Commodity Trading
Ecosystem
An organized commodities market consists of multiple players that form the
agricultural value chain.
They include commodity exchanges, farmers, merchants, aggregators,
processors/producers, commodity market operators, warehouse operators,
collateral managers, banks, insurance companies, clearing houses, and logistic
companies.
It is important to organize this market to enhance its efficiency, growth and
competitiveness which will better position it to play a strong enabling role in
food security, employment generation and economic diversification.
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Benefits of Commodity Ecosystem
1. Create economic diversification
2. Create employment and raise the living standard of the farming and mining communities
3. Foster financial inclusion of small holder farmers and miners
4. Make investment in commodities more attractive
5. Create liquidity and facilitate price discovery, which further encourages commodity trading
6. Promote the development of derivatives market with commodities as the underlaying
instruments
7. Provide reliable price benchmark for non-exchange traded markets such as the OTC market
8. Ensure exported commodities meet minimum quality and standard through traceability.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Recommendations on Enhancing the
Ecosystem
1. Good enabling business environment
2. Development of warehouses
3. Grading and certification
4. Provision of improved extension services
5. Introduction of flagship commodities
6. Strategic purchases through the exchange
7. Discounted payment to farmers on insurance
8. Logistics
9. Integration of major players in the commodities exchanges
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Dematerialisation
Dematerialisation simply means the conversion of
physical (paper) certificates into electronic book entry
form with a Central Securities Depository such as the
CSCS or FMDQ Depository.
Dematerialisation of share certificates is one of the key
initiatives of the Capital Market Master Plan (20152025), which has since been accomplished.
As at 2016, it was reported that over 97.4% of share
certificates was dematerialized.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Benefits of Dematerialisation
1. Eliminates problems associated with holding paper
certificates including theft, loss, cloning, destruction,
abuse by issuers/registrars and loss of investment value
2. Promotes efficiency, liquidity and transparency
3. An international best practice
4. Depositories such as the CSCS and FMDQ Depository
act as depositories, holding certificates in electronic
form for investors.
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Bull/Bear Market
A Bull Market is the condition of a financial market in which prices are rising or are
expected to rise. The U.S. SEC defines a bull market as a period of time when there is a
market rise of 20% or more in broad-based market index for at least two months.
Although the concept of bull market commonly applies to equities market, it actually
extends to anything that is traded, such as bonds, real estate, currencies, and
commodities.
Bull markets are characterized by optimism, investor confidence, and expectations that
strong results would continue for an extended period of time.
Bull markets generally take place when the economy is doing well and there is an
established correlation between the bull markets and the performances of other
economic indicators such as the GDP, employment rate, etc.
On the other hand, Bear Market is the opposite of the bull market.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Arbitrage
Arbitrage is the practice of buying a security in one market and at the
same time selling it in another market at a higher price, thereby allowing
investors to profit from the difference in the price per share.
The difference in exchange rates between two or more currencies is a
major attraction to arbitrage when trading in stocks that are dually listed
in different jurisdictions.
Arbitrage is also facilitated by the level of efficiency of a market. In other
words, the efficiency level of a market gives traders and investors the
opportunity to take advantage of price discrepancies.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Book Runner, Bid/Ask, Spread
Book Runner - refers to a Lead Issuing House/Underwriter that is responsible for coordinating
the issuance of new securities. A Book Runner is in charge of bidding the shares of a company to
the public and overseeing the process. The Book Runner is equally in charge of the books
associated with the process.
Bid/Ask – this is also called Bid/Offer, which simply means a two-way price quotation that
indicates the best potential price at which a security can be sold and bought at a given point in
time. The Bid represents the maximum price that a buyer is willing to pay for a unit of security,
while the Ask represents the minimum price that a seller is willing to take for that same security.
Spread - A spread can have several meanings in finance. Generally, the spread refers to the
difference between two prices, rates, or yields. In one of the most common definitions, the spread
is the gap between the bid and the ask prices of a security or asset, like a stock, bond or
commodity. This is known as a bid-ask spread.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Blue-chip, Haircut
Blue-chip – A blue chip refers to an established, stable, and well-recognized entity. Blue-chip
stocks are seen as relatively safer investments, with a proven track record of success and stable
growth. They are highly liquid and have a large market capitalisation in relation to the total market
capitalisation. They have stable debt-to-equity ratios and high returns on equity and assets. Many
blue chip companies have long records of paying stable or rising dividends. Example of blue chip
stocks on NGX are Dangote Cement PLC, MTN Nigeria Communications PLC, FBN Holdings PLC,
Seplat Energy PLC, Access Bank Holdings PLC, Nestle Nigeria PLC, Zenith Bank PLC, Nigerian
Breweries PLC, etc.
Haircut – In finance generally, the word ’’Haircut’’ is mostly used in relation to the difference
between the market value of an asset and the amount that can be used as collateral for a loan.
There is a difference between these values because market prices change over time, and the
lender factors this fluctuation into their valuation and analysis for risk mitigation.
In another description, a haircut can be regarded as a reduction in an amount of money, such as
the price of a share or bond or even salary and allowances.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Securities Lending
Securities Lending is the market practice of temporarily transferring securities, for a
fee, from their holder to another party, with the borrower agreeing to return the
securities to the lender either on-demand or at the end of the agreed loan term. This
practice usually requires the borrower to collateralize the transaction with cash or other
securities of a value equal to or greater than that of the lent securities, in order to
protect the lender against counterparty credit risk.
Securities lending was introduced by NGX in 2012 as a liquidity programme with the
intention of enhancing market liquidity. It plays an important role in deepening the
market, which in turn reduces the cost of trading and promotes price discovery. Global
Master Securities Lending Agreement (GMSLA) and its Nigerian Addendum is the
standard contract document that binds lender and borrower in a Securities Lending
arrangement.
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Margin Lending
Margin Lending is a type of investment loan that allows a broker or his client to borrow money to
invest in securities, using existing securities or cash as collateral for the loan. On the other hand,
margin trading means the buying and selling of securities by a broker for themselves or for their
clients through margin lending. Recall the role played by margin lending in Nigeria, leading to the
2008 financial crises.
These existing assets are used to calculate the clients’ Loan to Value Ratio (LVR), which determines
how much a client can borrow, and once the borrowing limit is established, the client has to use
available funds to make further purchases.
Interest on a margin loan is calculated daily, using mark to market; but how it is paid depends on
the loan. Some margin loans allow interest to be paid in advance.
Some of the benefits are diversification of portfolio, potential tax advantages, etc, while some of
the risks associated with it are market risks, interest rate changes, margin calls, etc.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Peer to Peer Lending
Peer-to-peer (P2P) Lending is a form of fintech that allows people to lend or borrow
money from one another without going through a bank or any financial institution. P2P
lending uses websites or apps to connect borrowers directly to investors and the
sites/apps set the rates and terms and enables the transactions.
P2P lenders are individual investors who seek to get a better return on their cash savings
than they would ordinarily get from a bank savings account or other forms of money
market instruments such as commercial papers or certificate of deposit. On the other
hand, the P2P borrowers seek an alternative to traditional banks or a lower interest rate.
The default rates for P2P loans are much higher than those in traditional financial
institutions. Example of P2P fintech are Piggyvest, etc.
In terms of risk, P2P lending is riskier than a savings account or other money market
instruments, but the interest rates are often much higher. This is because people who
invest in a P2P lending sites/apps assume most of the risk, which is normally assumed by
banks or other financial institutions.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Short Selling
In line with the Rulebook of NGX and the current market practice, short selling, or
“shorting,” is the practice of selling securities that the seller does not currently own, and
subsequently repurchasing them. Where a broker sells securities short, it must borrow
those securities in order to fulfil its settlement obligation in the securities settlement
system.
The main motivation in short selling is the hope that the broker will make a profit from a
decline in the price of the assets between their sale and repurchase period. In this
circumstance, the broker will pay less to buy the assets than it received when selling
them. However, the broker will incur a loss if the price of the assets rises, as he will
have to buy them at a higher price than he sold them.
Short selling is a legitimate trading practice on NGX, provided that, prior to initiating a
trade on a security, that security has been borrowed and is in the account of the seller.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Pump and Dump
Pump-and-dump is a form of market malpractice whereby the perpetrators
attempt to lift the price of a security through fake recommendations,
which are based on false, misleading or exaggerated statements. The
perpetrators already have an established position in the company's
security and will sell their positions after the hype has led to a higher
share price.
Pump-and-dump just like many other market manipulation practices is a
violation of the security laws, and in particular, the ISA 2007 and the
Commission’s Rules and Regulations.
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Financial Market Infrastructure
According to Committee on Payment and Settlement
Systems/Technical
Committee
of
the
International
Organisation of Securities Commissions (CPSS/IOSCO), a
Financial Market Infrastructure (FMI) is defined as a
multilateral system among participating institutions, including
the operator of the system, used for the purposes of clearing,
settling, or recording payments, securities, derivatives, or
other financial transactions.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Categories of Financial Market Infrastructures
Exchanges/Other
Trading Venues ATS
Central
Counterparties
Central Securities
Depositories
Securities
Settlement
Systems
Trade
Repositories
Payment Systems
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Functions of Financial Market Infrastructures
FMIs provide participants with centralized clearing, settlement, and recording of
financial transactions among themselves or between each of them and a central
party to allow for greater efficiency and reduced costs and risks;
Through the centralization of specific activities, FMIs also allow participants to
manage their risks more efficiently and effectively, and, in some instances,
eliminate certain risks;
FMIs can also promote increased transparency in particular markets. Some FMIs
are critical to helping central banks conduct monetary policy and maintain
financial stability.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Key Risks in Financial Market Infrastructures
Systemic risk
Legal risk
Credit risk
Liquidity risk
General business risk
Custody and investment risks
Operational risks
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Categories of FMIs - An Exchange
Operate
trading
platform
Acts as
SelfRegulatory
Organisation
Provides
avenue for
Listing
Executes
orders
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Disseminate
information
Over-the-Counter Market
An over-the-counter (OTC) market is a decentralized
market in which market participants trade stocks,
commodities, currencies, or other instruments directly and
bilaterally - between two parties and without a central
exchange or broker.
Over-the-counter markets do not have physical locations;
instead, trading is carried out electronically.
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Other Trading Venues – ATS
Alternative Trading Systems (ATS) popularly called
dark pools operate like exchanges but have no
Self-Regulatory Organisation powers. They do not
list securities and they provide little information
compared to exchanges. They are mostly used to
carry out large volume off market trades.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Central Counterparty
Interposes itself between
counter-parties
Multi-lateral netting
Assumption of risk by providing
guarantee on the fulfillment of
obligations by all parties
Clearing and settlement
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Central Securities Depositories
CSDs provide depository services
CSDs keep custody of securities either
in certificated or dematerialized form
Clearing and Settlement
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Securities Settlement Systems
They provide settlement
services
In some cases, they are
called Scripless Securities
Settlement Services (S4)
They are linked with
payment systems
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Trade Repositories
Trade repositories (TRs) centrally collect and
maintain the records of OTC derivatives. They play a
central role in enhancing the transparency of OTC
derivative markets and reducing risks to financial
stability.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Information Technology Services
Information Technology Services (ITS) refer to the structure,
development, application, execution, support, and oversight of
computer-based information systems.
IT services are used to apply technical expertise to standardize and
streamline business processes and enable organizations to optimize
and easily access information.
Information systems (IS) is an integrated set of components used for
gathering, processing, storing and communicating multiple types of
information for improved societal and organizational efficiency.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Information Technology Services and Secondary
Market
Information technology has significantly transformed securities trading
systems globally. Computerized systems have provided unique opportunities
for innovation and competition in market operations, speed and accuracy in
processing trades and risk management techniques. In addition, technology
has richly increased investor access to the market and the relevant market’s
information.
Securities exchanges have greatly automated their operations to improve
efficiency and service delivery. Computerised systems facilitate seamless
order delivery and execution. Increased trading volumes are executed with
speed and accuracy.
The entire securities trading ecosystem – trades matching, clearing and
settlement processes have been automated and seamlessly undertaken.
Similarly, SRO functions such as market surveillance, dissemination of
transaction and quotation information, registration, inspections, market data
transmission, submission and dissemination of financial information of
listed/traded companies have all been automated.
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Securities Market Surveillance Systems
Market surveillance simply means the act of monitoring trading
activities with the objective of preventing market malpractices.
The main objective of market surveillance is to preserve the
integrity of the market.
Market surveillance helps to ensure orderly markets, where
market participants are willing to participate because they feel
confident in the fairness and accuracy of transactions. Without
market surveillance, a market could become disorderly, which
would discourage investment and hamper economic growth.
Market surveillance is a primary responsibility of an exchange
and also an SRO function required to be undertaken
continuously. However, the statutory regulatory bodies also
undertake market surveillance.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Market Surveillance Systems
There are different types of market surveillance systems currently
used by market regulators. Some of the popular surveillance systems
are:
1. NASDAQ, Inc offers a market surveillance product called SMARTS
that assists regulators and market participants in monitoring
trading activities across multiple markets and asset classes;
2. Bloomberg;
3. IBM (Surveillance Insight for Financial Services);
4. Thomson Reuters - Accelus Market Surveillance;
5. SIA Eagle Surveillance Solution.
SECURITIES AND EXCHANGE COMMISSION NIGERIA
Some Features of Market Surveillance Systems
Functionalities
Alerts
Multi-assets
Large volume alert
Compatibility with different trading platforms
Suspicious orders/trades
Reports generation
Large Block Trades
Market replay tools
Marking the Close
Larger volume data storage
Orders and Trades Away from the Market
Powerful visualisation tools
Phantom Orders
Connectivity to news sources
Front Running
Initiate investigation
Unusual Volume or Large Price Movement
Comprehensive audit trail
Wash Sales and Matched Orders
Social media monitoring
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Market Surveillance
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References
1. Nigerian Exchange Limited
2. Report of the Technical Committee on Commodity Trading Ecosystem
3. Securities and Exchange Commission, Nigeria
4. U.S. SEC
5. Investopedia
6. CPSS/IOSCO – Principles for Financial Market Infrastructures
7. Random Google Searches
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