OF MARKET INTERVENTIONS AND REGULATORY EXUBERANCE

Almost a year ago I wrote an article titled “It’s Irrational Exuberance, Stupid”. In the said article, I forewarned of a stock market bubble and that the Nigerian capital market was headed for an imminent correction. What I couldn’t forecast was whether the correction would take the form of a prolonged bear run or a fast and furious crash. I got several reactions to that article. Of all them, the most interesting one came from the Nigerian Stock Exchange. Before I got to the office that Monday morning, Sola Oni, Head of Media at the exchange, called to express his concerns about my article.
His biggest worry was not my gloomy forecast; rather he was more concerned with the title. By some inexplicable interpretation, he read it to mean that I had referred to the director general of the NSE, Dr Ndi Okereke-Onyiuke, as “stupid”. Oni and I, as a matter of fact, spoke quite a number of times that day arguing vehemently over the phraseology I had used for my headline which I insisted was not insulting or rude, but a play on words. In the end, we agreed to disagree, with him promising to send a rejoinder for publication. I still await his response to date.
However, what I found most intriguing about the NSE’s reaction to my article was its lack of concern for the issues raised in the said piece. Instead its officials were losing sleep over an innocuous word. Even more worrying than the flight of fancy that had beclouded all sense of judgment of the regulator, was that the managers of the market were in denial. For some strange reason, for all their international exposure and so-called in depth knowledge of capital markets, they somehow forgot that all markets must go through cycles of booms and bursts. They honestly believed the Nigerian market would beat the odds and that the bubble would remain afloat till the end of time. How myopic they were. A bubble by its very nature can only remain afloat for so long before it reaches saturation and inevitably pops. Alternatively, the slightest prick or trigger would bring it floating down to earth.
The irony of that incident was that I was not the sole voice concerned about the fate of the capital market. Several analysts such as Bismack Rewane of Financial Derivative Limited and Bimbo Olashore of Lead Capital were certain that the unprecedented stock market bull run which started sometime in 2005 would eventually come to a halt. At every opportunity the likes of Rewane cautioned against the inevitable but no one listened. The regulators ignored the warnings because they were living in La-La Land and told anyone who cared to listen that returns in our capital market were as high as 400 per cent, thus making it an attractive investment destination.
To a great extent, the marketing effort did work. Several international hedge funds plunked billions of dollars into the Nigerian market. But were the first to make a dash for the exit when the same NSE applied an ill-conceived circuit breaker sometime in May this year to stem the downward slide of shares. Three months before that incident, the market had been on a downward spiral, and was charging towards wiping out all the gains made in the last two to three years. Unfortunately, it was a panic measure that scared international investors silly, because if officials of the exchange could intentionally stop share prices from going south, then they would stop at nothing to keep prices afloat; even going as far as creating market imperfections.
Well, the bulls did eventually screech to a grinding halt. And in the last six months, it’s been obvious that the regulators of the Nigerian capital market have been at their wits end as to how to stem the market melt down. Even the Central Bank’s postponement of the harmonised year end for banks, and its denial that it had placed an embargo on margin lending, had little impact on the market. Instead, it took a drastic intervention by the government the week before last to restore some measure of sanity to the market. But even then, the quick fix measures as announced by government should still give cause for concern. As the term ‘quick fix’ suggests, they are only temporary that can only firm up prices for a short period before they start to head south again, because the long term prognosis for the market is anything but healthy.
As it stands, the Nigerian capital market is fundamentally flawed and not structured to operate efficiently. It is for this reason that its regulators previously and continue to introduce all sorts of restrictions and apply circuit breakers certain to drive away discerning hedge funds and institutional investors that are the de facto market makers. Second, by placing a maximum downward limit of one per cent on daily price movement, the volume of trade on shares and market turnover has been unnaturally restricted. What this means is that investors with large volumes of particular shares cannot dispose of their equities in a timely manner because the market has been greatly curtailed to what extent a share price can fall on a daily basis. That is not to say that limits on the upward and downward movement of shares did not exist in the past. They did, but with more flexibility.
Third, the share buy-back scheme is a huge mistake that should be revisited immediately irrespective of the nod given the Attorney General to amend the existing provisions under the Companies and Allied Matters Act. The government must be aware that when companies go to the market to raise funds through public offers, they indicate in their prospectus handed to investors that there are reasons they are raising the necessary capital. In the case of banks and insurers, the most common reasons adduced are to expand their branches networks, invest in new ICT infrastructure, and what have you.
By permitting quoted companies to buy back their shares, those shares will automatically be cancelled and the capital of the company restructured. The bigger evil is that even if the companies are so liquid and in a position to buy back their shares, the biggest losers will be investors who will most likely be selling their shares at prices below which they were bought, be it through the secondary market or during a public offer – and this is tantamount to investor fraud. Companies with nothing better to do with their cash, should be encouraged to pay their shareholders special dividends to shore up confidence, and not permitted to buy back their shares.
Moreover, in the case of banks, which account for 65 per cent of market capitalisation, it has been an open secret that they have been acting in concert with stock brokers that have been used as conduits to extend facilities to investors who in turn purchase the banks’ shares and those of other quoted companies. However, the shares remain in the possession (or are warehoused) of the brokers. Under the share buy back scheme these stock brokers will simply sell the shares back to banks at a gain to the financial institutions (banks), but at a loss to shareholders who borrowed money to invest in the shares.
Essentially, the share buy back scheme completely alienates retail investors who have the most to lose under the arrangement. The very notion that such a bizarre arrangement was even tabled for consideration is symptomatic of the calibre of people managing the market. This in itself is in dire need of an overhaul, starting from the management of the NSE to Securities and Exchange Commission. A lot of these so-called managers, I believe, have outlived their uses and lack the capacity to lead the market on to the next growth phase.
But this does not in any way suggest that market interventions to stem massive losses are not necessary. They are, and have been known to occur in all parts of the world, even in the most mature markets. They must, nonetheless, be orderly and subtle as opposed to being overt, which is what happened two weeks ago. The restriction placed on downward price movements is unnatural and has the potential of making discerning investors, especially foreigners, weary of the Nigerian market. It is obvious that the 16-man presidential advisory panel set up to restore confidence in the market has its work cut out. Fortunately, the opportunity still exists for the panel to introduce measures that can improve the long term prospects of the Nigerian capital market.
For instance, the National Pension Commission (Pencom) can be persuaded to relax the restrictions imposed on the asset portfolios of pension fund administrators which currently places a limit of 25 per cent on investment in equities. In other markets, regulators attempting to stem a systemic fall in asset prices have been known to relax liquidity requirements imposed on pensions and insurers so they are compelled not to dump their shares. When this happens, they scramble to buy up shares; and in the process push up prices and help to spur the herd instinct of retail investors. In the case of Nigeria, since the government still owes Pencom, and by extension, fund administrators trillions of naira in legacy debts, it can simply ask the CBN to lend it (Pencom) funds against future contributions to help lift the market. As unfunded contributions trickle in over time, they can be used to offset the monies lent by the CBN.
Another measure that could be considered is the imposition of a capital gains tax to curb the tendency by investors, especially institutional investors, to dump their shares at the slight increase in prices. Once enthusiasm is dampened, investors will be forced to hold their shares for longer periods before they sell. Even the coffers of government will stand to benefit from such an arrangement.
The big problem with Nigeria is that there has always been a disconnect between the government’s fiscal policies, the Central Bank’s monetary policies and the regulatory regime in the capital market. Each segment prefers to operate independently of each other and only acts in concert after the fact, and not before the fact. In the almighty US markets regulators move instantly to stem systemic crashes by subtly increasing liquidity and persuading brokers to buy up shares in overnight and day trading. Instances have been recorded in US markets, where shares are falling drastically this second, only for them to rally sufficiently hours later to recover the losses made the same day. When that happens, market intervention by the regulators was handled surreptitiously and never openly admitted.
Here we wait for six months for investors’ portfolios to get almost completely wiped out before we start to paw at the surface in a feeble attempt to protect them. Yet we pride ourselves on being an emerging market. But I think it’s high time we faced the truth. Nigeria is nothing more than a frontier market.

THIS PIECE WAS WRITTEN BY IJEOMA NWOGWUGWU.