(THISDAY) Eromosele Abiodun writes that with balance sheets large enough to guarantee trade on designated equities on a continuous basis, the 10 market makers unveiled by the Nigerian Stock Exchange (NSE) recently may help to revitalise the stock market. Since August 2009 when the Central Bank of Nigeria (CBN) intervened in five troubled banks following huge non-performing loans as a result of massive exposure to the stock market, the Nigerian equities market has never been the same.As a matter of fact, five days after the intervention, all major market indices declined massively, erasing investors' worth by a whopping N519 billion. Despite the fact that  some  major exchanges around the world have since recovered and others making steady recovery  from the global financial crisis of 2008, the Nigerian market has been  struggling between red and green.Efforts by the Securities and Exchange Commission (SEC) and the Nigerian Stock Exchange (NSE) to revive investors' confidence have not yielded any reasonable fruits. But all that is about to change with the recent introduction of market makers who are expected to  have balance sheets large enough to guarantee trade on designated securities on a continuous basis.

NSE's Efforts

While announcing the Market Makers, the Chief Executive Officer (CEO) of the NSE, Mr. Oscar Onyeama, said it was a major landmark. "This is a great milestone and a major step in the direction of turning the market round to have liquidity and depth back into the market. We will continue to move forward on this," he said. The 10 stockbroking firms, which were selected from a list of 20 that applied include: Stanbic IBTC; Renaissance Capital Limited; Future View Securities Limited; Vetiva Capital Limited; ESS/Dunn Loren Merrifield, WSTC Financial Services Limited; Capital Bancorp Limited; FBN Securities Limited; Greenwich Securities Limited and CSL Stockbrokers Limited.

"The companies selected went through a very rigorous process and met the minimum net capital requirement of N570 million. We also examined their compliance history and looked into their operational capabilities including their technology and processes, "he added. According to him, the firms were taken through trainings, debated the appropriate market structure to be used while the exchange further went through the approval of the SEC in the selection process. The 10 market makers were also allowed to the select a basket of quoted companies in which they would provide the desired level of liquidity via a draw.

Stakeholders' Reaction

Thrilled with the introduction of market makers to the NSE market, stakeholders told THISDAY that the effort would take the market close to where it was in 2008 and called on investors to take advantage of the opportunity to increase their stake in the market. Stockbrokers who spoke to THISDAY believed the positive  trend noticed in the market last week, would persist adding that the recent news that banks have excellent first quarter results would  help sustain the trend.

The Managing Director and Chief Executive Officer of Cowry Assets Limited, Mr. Johnson Chukwu, said the current low price of the highly capitalised stocks in the market should provide impetus for the growth in the market as shown in their improved performance in relation to the previous years in terms of turnover, earnings and corporate actions. "However, note that the market evolves in cycles thereby giving opportunities for selective buys. Meanwhile, given the positive role the market makers are expected to play in the market, investors should hold a medium to long term view in stocks that have good fundamentals in the equities in order to ensure the safety of their investments, "he said.

On his part the Managing Director and Chief Executive Officer of Vintage Wealth Partners Limited, Mr. Idowu Ogedengbe, said the introduction of market makers on the Nigerian Bourse, which was long overdue, should help to enhance trading activities and the liquidity of most of the stocks quoted on the Nigerian Stock Exchange (NSE). This, he stressed, however depended on the expected restoration of investor confidence and increase in mandates from institutional investors, pension fund managers, offshore endowment fund and portfolio managers. "Equally critical for the success of market making in the equities market is the ease and cost at which market makers will be able to borrow shares in order to meet client purchase mandates when they do not have the shares in their inventory. "It is also important that the infrastructures, structures and processes necessary for the effective running and monitoring of the new regime are first put in place. The risk management protocol and crisis recovery mechanism among the operators should be well monitored and supervised by the regulators to prevent another crash in the market due to undue exposures by the operators," he said.

Understanding Market Makers

Market makers provide liquidity to securities through provision of bid and offer prices in the trading system of a stock exchange. They ensure a fair and orderly market in their securities of responsibility and assist in the effective functioning of the overall market. Also, a market maker is a special type of broker whose function it is  to "make" the market for a particular stock. The market maker will hold a certain number of stock or shares in his or her inventory for the express purpose of being able to sell them to the person bidding to purchase them, or will add to his or her inventory by purchasing stocks from a seller offering the shares for sale. In some cases, the market maker may just match up the buyer and seller of the shares.

Market makers are institutions with balance sheets large enough to guarantee to trade designated securities on a continuous basis, meaning they could synchronise buy and sell transactions and promote constant liquidity in the market. That would mean domestic and foreign institutional investors could trade large blocks of shares at any time. The Managing Director and Chief Executive Officer of Emerging Capital Limited, Mr. Chidi Agbapu, told THISDAY that market makers were actually not permanent at the exchange. According to him, they are large investment companies, which buy and sell securities through an electronic network. He said: "These market makers maintain inventories and buy and sell stocks from their inventories to individual customers and other dealers. Each market maker is required to give a two-sided quote, meaning they must state a firm bid price and a firm ask price that they are willing to honour. Each security (quoted company) generally has more than one market maker, with an average of 14 market makers for each stock which provides liquidity and efficient trading. The market makers are openly competitive amongst themselves and facilitate competitive prices; as a result, individual investors generally will get the best price.

"As this competition is evident in the limited spreads between posted bids and asks, the market makers will in some instances act very much like the specialists. The NSE has traditionally been an order-driven market, meaning anybody wanting to buy or sell shares must call a broker who seeks to match the order with an investor looking to buy or sell at the same price," he said. An official of one of the recently unveiled market makers told THISDAY that "a market maker takes  no commission on the sale, but instead makes a profit from the difference between the bid and ask price." The potential seller of the stock, he added, sets the price at which the share will be sold- this is the asking price. "The potential buyer of the stock will offer or bid a price at which the stock will be purchased. These two prices are rarely equal, and the market maker will only make a trade when there is sufficient difference to yield a profit in the sale. On heavily traded stocks, in which hundreds of thousands of shares trade in a single day, the market maker can still make a handsome profit even if this difference is very small."

Giving an example of an existing market where market makers are operating, the  NASDAQ market is composed of over 300 market makers. "Since a market maker makes a profit on every sale, whether the market goes up or down, the right to be a market maker on a market like the NASDAQ is worth a great deal of money. The opportunity to become a market maker is very rare, and usually a purchased right. It is not possible, simply to decide to become a market maker and start a business as such. "To ensure an efficient and effective market, there are on average 14 market makers per stock on the NASDAQ exchange. Each market maker competes with the other market makers for each stock deal that is proposed. The intention is that, in this way, the market remains competitive and fair for everyone involved. The NYSE has dealers who fill similar roles. However, on the New York Stock Exchange, these dealers are referred to as market specialists and not market makers, though they serve the exact same purpose."

Disadvantages of   Market Making

Although market making is seen a positive move to stabilise the fortunes of the market generally, Agbapu, noted that investors might be at a disadvantage in certain cases. "However, the client's loss and the spread is the market maker firm's profit, which gets compensated for the effort of providing liquidity in a competitive market. This extra liquidity reduces transaction costs and therefore facilitates trades for the clients, who would otherwise have to accept a worse price or even not be able to trade at all. According to him, in some developed markets, most foreign exchange trading firms are market makers and so are many banks, although not in all currency markets. "Most stock exchanges operate on a matched bargain or order driven basis. In such a system there are no designated or official market makers, but market makers nevertheless exist. When a buyer's bid meets a seller's offer or vice versa, the stock exchange's matching system will decide that a deal has been executed," Agbapu said.

He disclosed that the NYSE and the American Stock Exchange (AMEX), among others, had a single exchange member, known as the "specialist," who acts as the official market maker for a given security. "In return for providing a required amount of liquidity to the security's market, taking the other side of trades when there are short-term buy-and-sell-side imbalances in customer orders, and attempting to prevent excess volatility, the specialist is granted various informational and trade execution advantages," he said. Agbapu said other exchanges employed several competing official market makers in a security adding that these market makers were required to maintain two-sided markets during exchange hours and are obligated to buy and sell at their displayed bids and offers.

"They typically do not receive the trading advantages a specialist does, but they do get some, such as the ability to naked short a stock-that is  selling it without borrowing it. In most situations, only official market makers are permitted to engage in naked short selling. On the London Stock Exchange (LSE), there are official market makers for many securities (but not for shares in the largest and most heavily traded companies, which instead use an automated system called TradElect)." Some of the LSE member firms, he explained, usually took on the obligation of always making a two-way price in each of the stocks in which they make markets. According to him, it is their prices, which are displayed on the LSE's automated quotation system, and it is with them that ordinary stockbrokers generally have to deal when buying or selling stock on behalf of their clients.