A structural review of capital market operators

A STRUCTURAL REVIEW OF CAPITAL MARKET INTRODUCTION Let me first start by commending the Securities & Exchange Commission and the Central Bank of Nigeria under the vision 2020 work done in time passed under the Money & Capital Markets Committee in its bold accomplishment of ending the concept of universal banking and hence, the final separation of commercial and merchant/investment banking However, this major accomplishment has led to a major financial exclusion of the key players in this very important intermediation sector of the economy FMD DISCUSSION PAPER We are not investment banks – we call ourselves that but, we are not There are two types of intermediation; • Bank based intermediation and • Capital market based intermediation – • In Nigeria, only bank based intermediation works - Our inability to provide a full platter of services to our clients and fulfill our role as intermediaries is a testimony… Why? capital market based intermediation is cut out of the wholesale funding markets hence, no ability to fund any part of the capital market business, it has no repo markets for liquidity, and therefore (except for commercial bank treasuries) generally has inefficient sales & trading operations or maturity transformation activities There is therefore no real added value from a liquidity stand point, as the equity trading business is generally also mainly brokerage hence, market making which is meant to significantly increase liquidity is highly inefficient FMD DISCUSSION PAPER We are not investment banks – we call ourselves that but, we are not….cont’d Even from the corporate finance origination stand point; • Underwriting financing (if you can get it) is extremely high, • No ability to execute bought deals for sell down, • No real leverage at the client’s table - lack of balance sheet generally (application to stand-alone institutions) FMD DISCUSSION PAPER We are not investment banks – we call ourselves that but, we are not… cont’d The question is: •How long can these businesses continue to mal-function due to their inability to operate as intermediaries across the financial markets with No wholesale funding access? •As is, capital market operators currently operate in “silos” with no access to the money markets and therefore totally cut off from the life blood or base liquidity of all financial markets FMD DISCUSSION PAPER NIGERIA AND MALAYSIA COMPARISON FMD DISCUSSION PAPER Malaysia and Nigeria – A factual Comparison of capital requirements - RM Current GDP/Capital 2012 Investment Bank 500,000,000.00 USD 10,432.06 0.31 Universal Broker 100,000,000.00 USD 10,432.06 Stockbroker (Broker/Market Maker ) 20,000,000.00 Issuing House Malaysian Bank Capital Requirements RM NGN $155,000,000.00 74,529,862.75 3,741,458,973.39 0.31 $31,000,000.00 14,905,972.55 748,291,794.68 USD 10,432.06 0.31 $6,200,000.00 2,981,194.51 149,658,358.94 2,000,000.00 USD 10,432.06 0.31 $620,000.00 298,119.45 14,965,835.89 NGN Current GDP/Capital 2012 NGN Investment Bank 15,000,000,000.00 $1,555.00 3,741,458,973.39 4.01x Universal Broker 1,300,000,000.00 $1,555.00 748,291,794.68 1.74x FMD DISCUSSION PAPER Malaysia and Nigeria – A factual Comparison of capital requirements - Malaysian Bank Capital Requirements Domestic Bank Current GDP/Capital 2012 RM 2,000,000,000.00 0.31 $620,000,000.00 $10,432.06 Investment Bank 500,000,000.00 0.31 $155,000,000.00 $10,432.06 Universal Broker (Marker Maker) 100,000,000.00 0.31 $31,000,000.00 $10,432.06 20,000,000.00 0.31 $6,200,000.00 $10,432.06 Issuing House 2,000,000.00 0.31 $620,000.00 $10,432.06 Nigerian Banks Capital Requirments NGN Stockbroker (Broker/Dealer) Current GDP/Capital 2012 GDP/ Capital required for current capital Capital required at current GDP levels In Local currency Domestic Bank National 25,000,000,000.00 165 $151,515,151.52 $1,555.36 $2,549.38 $92,438,425.39 15,252,340,189.76 1.64x Investment Bank 15,000,000,000.00 165 $90,909,090.91 $1,555.36 $6,118.51 $23,109,606.35 3,813,085,047.44 3.93x Domestic Islamic Bank (National) 10,000,000,000.00 165 $60,606,060.61 $1,555.36 $1,019.75 $92,438,425.39 15,252,340,189.76 0.66x 1,300,000,000.00 165 $7,878,787.88 $1,555.36 $2,651.35 $4,621,921.27 762,617,009.49 1.70x Market Maker (Fixed Income & Equities)+Broker Dealer FMD DISCUSSION PAPER Malaysia and Nigeria – A factual Comparison of capital requirements - Malaysian Bank Capital Requirements RM Current GDP/Capital 2005 RM NGN Investment Bank 500,000,000.00 $5,553.94 0.38 $190,000,000.00 139,990,709.30 7,027,646,049.11 Universal Broker 100,000,000.00 $5,553.94 0.38 $38,000,000.00 27,998,141.86 1,405,529,209.82 20,000,000.00 $5,553.94 0.38 $7,600,000.00 5,599,628.37 281,105,841.96 2,000,000.00 $5,553.94 0.38 $760,000.00 559,962.84 28,110,584.20 Stockbroker (Broker/Market Maker ) Issuing House Current GDP/Capital 2012 NGN Investment Bank Market Maker (Fixed Income & Equities)+Broker Dealer NGN 15,000,000,000.00 $1,555.00 7,027,646,049.11 2.13x 1,300,000,000.00 $1,555.00 1,405,529,209.82 0.92x FMD DISCUSSION PAPER Malaysia and Nigeria – A Comparison –Key Takeaways • The new SEC capital requirements are adequate for the current size of the economy ` BUT • The capital requirements for a Merchant Bank by CBN is clearly in excess for the size of our economy FMD DISCUSSION PAPER 10 WHAT SHOULD A FINANCIAL MARKET DEALER LICENCE HOLDER BE ALLOWED TO DO? SOURCE OF FUNDS - Therefore the assets it can hold should be as follows:- Treasury Bills Treasury Certificates Negotiable certificates of deposits Bankers Acceptance Commercial Paper Asset Backed Commercial Paper Asset Backed and Mortgage Backed Securities Corporate Bonds and Notes Federal Government Bonds State and Municipal Bonds Equities for NOT more than days (Trading Purposes ONLY) Any other securities that may be from time to time approved by the CBN/SEC/NSE FMD DISCUSSION PAPER 38 PROPOSED CAPITAL COMPUTATION Beginning in 2008, many observers remarked that the 2004 change to the United States SEC's net capital rule permitted investment banks to increase their leverage and this played a central role in the financial crisis of 2007-2009 This position appears to have been first described by Lee A Pickard, Director of the SEC's Division of Market Regulation (the former name of the current Division of Trading and Markets) at the time the SEC's uniform net capital rule was adopted in 1975 In an August 8, 2008, commentary, Mr Pickard wrote that before the 2004 rule change, broker-dealers were limited in the amount of debt they could incur, to a ratio of about 12 times their net capital, but that they operated at significantly lower ratios FMD DISCUSSION PAPER 39 PROPOSED CAPITAL COMPUTATION He concluded that, if they had been subject to the net capital rule as it existed before the 2004 rule change, broker-dealers would not have been able to incur their high debt levels without first having increased their capital bases.[10]  In what became a widely cited September 18, 2008, New York Sun article (the "2008 NY Sun Article"), Mr Pickard was quoted as stating the SEC's 2004 rule change was the primary reason large losses were incurred at investment banks FMD DISCUSSION PAPER 40 PROPOSED CAPITAL COMPUTATION In late 2008 and early 2009, prominent scholars such as Alan Blinder, John Coffee, Niall Ferguson, and Joseph Stiglitz explained (1) the old net capital rule limited investment bank leverage (defined as the ratio of debt to equity) to 12 (or 15) to and (2) following the 2004 rule change, which relaxed or eliminated this restriction, investment bank leverage increased dramatically to 30 and even 40 to or more The investment bank leverage cited by these scholars was the leverage reported by the Consolidated Supervised Entity Holding Companies in their financial repoPrts filed with the SEC.[13] FMD DISCUSSION PAPER 41 PROPOSED CAPITAL COMPUTATION  As noted from the last financial crisis, having excessive capital does not make an institution immune to an insolvency, bankruptcy or liquidity crisis  We therefore advocate for a rather medium level of capital requirement as a head start but with a very strict and much improved monitoring/reporting/regulation on the amount of leverage currently applied by the firm, the assets, tenors, funding, governance structure, market values, asset concentrations etc  Firms should be mandated to have very robust risk management systems and high level risk management personnel FMD DISCUSSION PAPER 42 PROPOSED CAPITAL COMPUTATION FMD DISCUSSION PAPER 43 Credit rating Maximum Leverage Maximum Assets 30,000,000,000.00 Est Returns AAA 12,000,000,000.00 12.75% 40.00% AA 7,200,000,000.00 13.50% 24.00% A 6,000,000,000.00 14.50% 20.00% BBB 3,000,000,000.00 16.00% 10.00% N/R 1,800,000,000.00 20.00% 6.00% 2,000,000,000.00 14.01% 100.00% Capital Credit protection BBB Credit rating Mainly Equities Maximum buckets 4,212,000,000.00 Funding Costs 10.00% 3,000,000,000.00 Net Spread( turnover not included 4.04% 1,212,000,000.00 MD CEO: Loss % of capital MD CEO: Number of Days held 111.10% 7.09% Single Obligor Limit Single Obligator Amount Capital protection Coverage AAA 25.00% 3,000,000,000.00 2,000,000,000.00 67% AA 20.00% 1,440,000,000.00 2,000,000,000.00 139% A 15.00% 900,000,000.00 2,000,000,000.00 222% BBB 12.50% 375,000,000.00 2,000,000,000.00 533% N/R 2.50% 45,000,000.00 2,000,000,000.00 4444% FMD DISCUSSION PAPER MD CEO: Maximum Loss per day 10% 18,427,950.00 0.92% 44 OTHER REASONS FOR A LOWER CAPITAL THRESHOLD      Non deposit taking institution Does not trade currencies Cannot advance loans as risk assets (illiquidity) No trade finance business Purely institutional funding FMD DISCUSSION PAPER 45 OTHER REASONS FOR A LOWER CAPITAL THRESHOLD FINALLY, The financial market dealer licence is intended to serve as a stepping stone for issuing houses, underwriters, broker/dealers, market makers etc to one day become fully fledged Merchant Bank This also allows for financial inclusion from the institutional level It also allows for the regulators to grow with these institutions learning from lessons where capital is still relatively small and risks are very manageable FMD DISCUSSION PAPER 46 OPTION – A TWO TIER MERCHANT BANKING LICENSE FMD DISCUSSION PAPER 47 THE CASE FOR A CREATING A TWO TIER MERCHANT BANK STRUCTURE A two tier structure is proposed as follows: 1.International Merchant Banking License • Can bid for international issues government • Can have operations offshore for the 2.National Merchant Banking License • Can only operate within Nigeria • Cannot bid for international issues FMD DISCUSSION PAPER 48 OTHER REASONS FOR A LOWER CAPITAL THRESHOLD FINALLY, Financial intermediation remains a very crucial part of the workings of any financial market Moreso, where the development of infrastructure in the economy is weak and requires a multitude of funding propositions or its middle class requires a viable primary and secondary mortgage markets to function relying on liquid financial markets FMD DISCUSSION PAPER 49 OTHER REASONS FOR A LOWER CAPITAL THRESHOLD FINALLY, We believe the case to have new institutions that are jointly regulated by SEC and CBN that can originate, distribute and trade all asset classes across the financial market spectrum is long over-due The process for achieving this has little or no hitch to current regulatory practices and will be seen by domestic and foreign observers of the Nigerian financial markets as a major step in the right direction FMD DISCUSSION PAPER 50 OTHER REASONS FOR A LOWER CAPITAL THRESHOLD FINALLY, We have shown the model to be sustainably profitable and that the risks associated can be strictly contained and managed We therefore believe that the newly created Universal Brokers or originators (Issuing Houses), distributors and traders (Financial Market Dealers) or National Merchant Banks will become major engines of growth for the development of our financial markets going forward FMD DISCUSSION PAPER 51 THANK YOU AND GOD BLESS THE FEDERAL REPUBLIC OF NIGERIA