South Africa: Greater market harmonisation proposed by the FSCA's draft Conduct Standard and Directive for Exchanges

Background

The JSE is South Africa’s oldest stock exchange and has been joined by four new exchanges over the last five years, namely ARX, A2X, 4AX, and the Equity Express Securities Exchange. The FSCA asserts that an increase in the number of exchanges in the South African market involving the same authorised users has the potential to create market fragmentation and this could lead to market conclusion and arbitrage if no comprehensive framework and rules supporting market quality are introduced. To this end, the FSCA proposes to implement through the Conduct Standard a policy that defines circumstances and issues in which exchanges should interoperate or cooperate to ensure a sound, fair, efficient and transparent equity market; and through the Directive, the harmonisation of listing requirements across exchanges with dual listed securities. We set out below the key proposals contained in the current drafts of the Conduct Standard and the Directive.

The Conduct Standard

The Conduct Standard is to be promulgated in terms of section 106 of the Financial Sector Regulations Act, 2017 and section 17(2A) of the Financial Markets Act, 2012 (the
FMA), although a date for such promulgation has not yet been published.

Cooperative arrangements

In terms of paragraph 2 of the Conduct Standard, exchanges which have dual authorised users and dual listed securities must enter into a cooperative arrangement with each other. “Cooperative arrangement” is defined in the Conduct Standard as “an arrangement between exchanges to cooperate with each another and which regulates the specific subject matters prescribed in the Conduct Standard”. More specifically, a cooperative arrangement is an attempt by the FSCA to ensure mutual cooperation and information sharing between exchanges that have the same authorised users or where the same securities are listed on more than one exchange.

Based on the draft Conduct Standard, it is broadly expected that a cooperative arrangement will provide for, among other things, the alignment of market operations requirements and those relating to instances of extreme price movements for harmonised automated pre- and post-trade volatility controls; the alignment between the exchanges’ rules and listing requirements; dispute resolution mechanisms concerning disputes relating to the cooperative arrangement; and the manner in which price sensitive information will be disseminated simultaneously by all exchanges.

One of the key effects of this Conduct Standard is that although the additional administrative duties are placed directly on the exchanges, the obligation imposed by the Conduct Standard may have an indirect effect on authorised users. For example, an exchange may not admit an authorised user of another exchange unless a cooperative arrangement has been entered into between the exchanges. This may have a limiting effect on dual authorised users who wish to be admitted on two exchanges but are prevented from doing so because a cooperative arrangement has not yet been reached between the exchanges. It would also appear that dual authorised users have no control over the process or the timeline of the conclusion of a cooperative arrangement. Paragraph 2.3 provides that exchanges with dual authorised users and dual listed securities will need to provide the FSCA with a compliance report on the progress of the conclusion of cooperative arrangements or proposed steps to comply with this requirement within 90 days of the commencement date of the Conduct Standard.

Additional requirements for exchange rules

Paragraph 3 of the Conduct Standard prescribes additional requirements with which the exchange rules must comply.

Essentially, these additional requirements concern themselves with: (i) risk management measures; (ii) minimum capital adequacy requirements; (iii) clearing and settlement processes and settlement assurance models; (iv) authorised user default; and (v) best execution, each of which will be discussed briefly below.

Risk management measures

Coordinated approaches across exchanges with dual listed securities or dual authorised users are proposed to be implemented into the rules of such exchanges to ensure that risks associated with different settlement cycles, technology and assurance models are mitigated. There is also a specific focus on managing the probability of failed trades, which may impact the stability and soundness of the South African financial markets. Exchanges are required to ensure that its authorised users implement an effective process and employ adequate resources for the determination, measurement, management and disclosure of such risks.

Minimum capital adequacy requirements

Authorised users are required to maintain adequate financial resources (currently proposed to be the higher of an amount sufficient to meet an authorised user’s fixed expenditure or ZAR500,000) to meet their business commitments and to withstand all the risks to which the business is subjected.

Clearing and settlement processes and settlement assurance models

Each exchange with dual listed securities or dual authorised users are required to align its rules in respect of the settlement cycles and ensure that such exchange informs and provides each other exchange with the relevant information when declaring a transaction of an authorised user as a failed trade.

Authorised user default

The exchange rules are required to provide for arrangements to manage a dual authorised user’s default and ensure that the exchanges in which such user operates coordinate their efforts, consult and share information. Such exchanges are also required to coordinate their efforts, consult and share information with the central securities depository and the participant of the defaulting user to determine whether crossexchange netting is possible. A notice declaring the dual authorised user’s default shall be prepared by an exchange and communicated to the other exchanges of which the user is a member.

Best execution

The principle of “best execution” requires dual authorised users to obtain the best possible result for a client when trading in securities on different exchanges on behalf of its client. The Conduct Standard requires the rules of an exchange to implement a policy and procedures to disclose and agree with their clients how they intend to achieve best execution.

General requirements for exchanges

Paragraph 4 of the Conduct Standard require exchanges with the same authorised users or the same listed securities to comply with a number of requirements aimed at harmonising their market operations to promote greater efficiency and transparency. These additional requirements include, among others, time synchronisation with a primary standard; revised provisions relating to informing other exchanges of trading disruptions and significant events; prevalence of reference prices across exchanges and responsibilities for corporate actions; consistent corporate action processes; alignment of suspensions and removals of securities; and coordination of efforts for the default of dual authorised users.

All exchanges and its authorised users will be required to comply with the Conduct Standard within 6 months after it comes into operation.

The Directive

The Directive is to be promulgated in terms of section 6(4)(a) of the FMA and is to be read with the Conduct Standard. The Directive requires exchanges with dual listed securities to amend or replace their listing requirements to comply with the Directive and achieve harmonisation across such exchanges. More specifically, the Directive prescribes that such exchanges implement certain listing requirements relating to: (i) accounting standards; (ii) corporate governance; (iii) continuing disclosure obligations; and (iv) price sensitive information; each of which will be briefly discussed below.

Accounting standards

An exchange must require that a South African issuer with a primary listing on that exchange prepare its financial information according to the International Financial Reporting Standards (IFRS) and foreign issuers must adopt one of the accounting standards listed in paragraph (2)(1)(b) of the Directive which includes, among others, the IFRS, various forms of Generally Acceptable Accounting Principles or any other accounting standard approved by the exchange and the FSCA.

Corporate governance

An exchange’s listing requirements must require that an issuer incorporated in terms of the Companies Act, 2008 is able to demonstrate implementation of the King Code, by applying the King Code disclosure and application regime. A foreign issuer must be required to disclose in its annual report the corporate governance requirements applicable in its country of incorporation. If an issuer or foreign issuer is noncompliant with the requirements, an exchange must require the issuer to give reasons for non-compliance and any plans to achieve compliance with the requirements.

Continuing disclosure obligations

An exchange’s listing requirements must require that precedence with regard to timing and publication of financial information is given to the primary exchange. Issuers have an ongoing obligation to disclose this information and an exchange must require that where an issuer is listed on more than one exchange, the information released under the ongoing disclosure obligation of one exchange be released on similar basis on all other exchanges. The information released by the issuers must be released promptly, must not be misleading and must be released to the public before any financial customers or interest parties.

Price sensitive information

An exchange’s listing requirements must require, in respect of the same securities listed on more than one exchange, that the requirements dealing with the obligations and timing for the public disclosure of price sensitive information, including cautionary announcements are aligned. Exchanges must agree on the minimum requirements for the release of price sensitive information relating to the distribution channel for the dissemination of price sensitive information and cautionary announcements, the format and layout of the information and announcements, location of the distribution channel, apportionment of costs relating to the distribution channel and who will be responsible for the validity of the information that will be disseminated into the market.

Next Steps

Stakeholders and interested parties may submit their comments on the Conduct Standard and/or the Directive, in writing, to the FSCA on or before 15 July 2020.