The quiet Technology Revolution in South African Trading

Merlin Rajah, Head of Equities Electronic Product at Absa Corporate and Investment Banking believes that South Africa is the most exciting emerging market for electronic trading right now – as he explains the vital connection between the right tech and international investment.

Technology is often not the first thing that springs to mind when the international community thinks
of Africa, however it is no longer possible to dismiss the entire continent on these grounds. One could
certainly argue that, although the county has the status of an emerging economy, South Africa’s
trading infrastructure is more comparable with its far more developed counterparts.

Of course, interest in South Africa from global hedge funds and asset managers has increased over the
past twelve months, as investment and trading flow has been redirected away from Russia’s
sanctioned markets to other emerging markets such as South Africa.

But even before this global shift in international politics, South Africa was proving itself to be a market
to watch. The country has taken advantage over the years of its position as a policy-taker rather than
policymaker, to look at what has worked globally, and then select the parts that are most appropriate
for its own conditions.

In just one obvious example, the Johannesburg Stock Exchange (JSE) has replicated much of what the
London Stock Exchange (LSE) has done in London in terms of technology, to the point where it has
implemented similar trading technology. Quants and high-frequency traders have made their home
in Johannesburg with colocation sites, evening the playing field for market participants of all kinds.
Over the past few years, our global client base has been telling us that international investors are
looking for electronic access to the markets throughout the continent. This again is something that
the South African ecosystem is ideally placed to provide.

Kenya stands ready for electronic trading, largely because the Nairobi Securities Exchange operates
on the same technology stack as the JSE, albeit a few versions behind. The trading system in Namibia
is also hosted by the JSE, suggesting that the Namibia Stock Exchange (NSX) is also an ideal venue for
electronic trading, if it can embrace direct market access and the benefits. South Africa is the gateway
to a vast array of opportunities for savvy brokers, asset managers and investors.

The critical role of technology
Expanding electronic trading through the continent certainly has its appeal. If we are to
grow these and other African markets – like Ghana and Egypt – we will need to encourage
international investors to come to Africa. We also need to take these African markets overseas.
That the JSE enjoys an underlying compatibility with European and UK electronic trading systems is a
key part of this development. There’s a familiarity here – as well as time zone compatibility – that adds to South Africa’s appeal as a trading destination.

What’s more – the landscape within South Africa itself is changing. Although the JSE has enjoyed a
unique position in the South African ecosystem for many years, that is no longer the case. Dark pools
have arrived, and a directly competing second exchange, A2X, is already making waves. More than
100 instruments are listed on the exchange. It has a reputation for using the most sophisticated
technology coupled with favourable pricing, and has gained between five and ten percent of total
trading volumes across several highly liquid counters.

In fact, 2023 looks set to become the year of the smart router in South Africa, as A2X beds in and offers a credible and cost-effective competition to the JSE. Direct Market Access (DMA) into A2X and best execution overall will become features in South Africa, just as they are in more developed markets –as will enabling technologies needed for Transaction Cost Analysis (TCA) and handling clearing and
settlement.

That too puts a premium on high-quality technology. Brokerages and exchange members who have
the algorithms and the speed to satisfy international traders are likely to do well. Proximity is king –
provided a broker or bank has the technology to support it.

Here however, scalability is likely to be an issue. Not all firms in South Africa have a technology team
of sufficient size or capability to develop the tools that international players demand. While third
parties may step into this gap, it is unlikely that they will have the level of local expertise and
experience – or the necessary responsiveness to deliver new solutions in a timely fashion.

Nonetheless, tools like Absa’s own low latency switch, bespoke algorithms and smart order router,
are attracting positive attention and even admiration from major banks looking into South Africa’s
markets.

Overcoming barriers
This is where international players will need to do their due diligence. The South African ecosystem is
thriving, but some participants will struggle with the new technology demands and the changing needs of a multi-exchange environment. 

They will also need an insightful guide to the peculiarities of the South African system. Market
fragmentation offers numerous benefits in terms of competition, but the country’s liquidity position
is fragile and the JSE, having dominated for so long, needs to update both its market structure issues
and its regulations to ensure that new liquidity pools do not dry up – or cause existing Issuers to turn
back to New York, Frankfurt or London for their listing.

In recent years, the JSE has made the right noises about making the necessary changes and kicked off
several initiatives to review legacy rules and regulations. We can hope that the arrival of new and
sophisticated competition, and a recent spate of delisting’s from the JSE, will cause it to accelerate the
pace of change and to look again at how price formation, valuations, market making, and growth in
general have been hampered by legacy processes, cost structures and internal systems.

Coming full circle, the good news is that the JSE has a history of looking to developed markets to learn
essential lessons about what works and what doesn’t. With the pace of change picking up in South
Africa, and the technology-led electronic trading revolution very firmly under way, there is every
reason to believe it will be making the necessary moves to create a more even and functional playing
field – for itself, its members, and for the international investment community.