Component 5: Trading of Shares on the JSE PDF

THE TRADING OF SHARES ON THE JSE COMPONENT 5 THE TRADING OF SHARES ON THE JSE 5.1 INTRODUCTION This component will start with a brief overview of the functioning of an open outcry market, followed by a description of the electronic trading systems o...

THE TRADING OF SHARES ON THE JSE COMPONENT 5 THE TRADING OF SHARES ON THE JSE 5.1 INTRODUCTION This component will start with a brief overview of the functioning of an open outcry market, followed by a description of the electronic trading systems of the JSE over the last few decades. This will be followed by a discussion on the main types of orders a client can give to a broker, including execution and validity constraints which can further be set on orders. A comprehensive example of continuous trading as well as the auction process will follow. Attention will be given to the matching of orders in the central order book and the determination of the auction price. The chapter will conclude with a discussion on the relevant transaction costs when a broker executes a buy (sell) order on behalf of a client. 5.2 TRADING IN AN OPEN OUTCRY SYSTEM Since the establishment of the Johannesburg Stock Exchange in 1887, shares were traded by means of an open outcry market. This implies that all the market participants (i.e. the stockbrokers buying and selling on behalf of their clients) gathered at a geographical place and then became knowledgeable about one another by calling out loud the name of the company whose shares they want to buy/sell. The following example illustrates the trading of shares during an open outcry market. Assume a potential buyer wants to buy 500 of the issued shares in Absa Ltd. In order for the purchase to take place he must trace sellers who are prepared to sell at least 500 Absa shares. Thus, there must be two parties with opposing opinions for any transactions to take place - the one feels it is a good time to sell and the other feels it is a good time to buy. These two parties are usually brought together by the JSE. The buyer selects a broker and instructs him to purchase 500 shares at the price he is prepared to pay. If there is an owner of Absa shares who wishes to sell them, he instructs his broker to sell and informs him of the price he is prepared to accept. The two brokers notify their offices at the JSE of the instructions they have received. The broker (or his dealer) will take up position more or less under the name of the company (Absa) on the price board and call out the name of the company aloud. All brokers with buy and sell orders for Absa shares will move closer and this broker, together with all other brokers, representing the total supply and demand for the specific share at that specific time, will negotiate on the floor of the exchange in an attempt to close a sale within the price confines given by their clients. If the transaction succeeds, the information is confirmed by the clearing system of the exchange and the brokers inform their clients. 1 INTRODUCTION TO INVESTMENT MANAGEMENT The seller must send his share certificate and signed transfer forms to his broker within seven business days of the transaction, who in turn forwards it to the buyer’s broker. He then sends these documents to the transfer secretary of Absa, who will make the necessary changes to the register of shareholders and send a new certificate with the buyer’s details back to the broker. If the buyer has not yet resold the shares, he will receive the certificate from his broker. The buyer must pay the amount due within seven business days after the date of the transaction to his broker, who in turn pays it over to the seller’s broker for payment to the seller. With the introduction of electronic trading in 1996, this method of trading ended. The need for a large trading floor disappeared and since 1996 stock brokers could establish their businesses all over the country as long as they are electronically connected to the JSE and if there are enough clients in that vicinity. 5.3 ELECTRONIC TRADING With the open outcry market, only a limited number of shares could be traded daily as the system required substantial administration and misunderstandings between brokers developed quite easily. Therefore, the JSE switched to a system of continuous screen trading (computer based trading of shares) known as the JET system (Johannesburg Equities Trading system). According to the JET system, all requests by clients to purchase/sell shares are imported via their stockbrokers into the computer system and then the computer program will immediately couple all the executable requests (i.e. where the buyer and seller agree on the price) and execute the transactions. The requests that cannot be executed immediately will remain on the order book as passive transactions. In spite of all the improvements of the JET system, the software became insufficient. This, along with the greater co-operation between the JSE and the LSE (London Stock Exchange) led to the implementation of the London trading system in 2002, known as JSE SETS (Stock Exchange Trading System). According to the JSE SETS system, trading is done in a twofold manner. Firstly, there are auctions during certain times of the day. During an auction all bids and offers will accumulate for a certain time period, say 10 minutes, after which the opportunity to enter requests will close. The software will then determine the price at which the maximum number of shares will be traded. Currently the opening and closing prices are determined through an opening and closing Auction. There is also a daily intraday Auction at 12:00. Over and above the three daily auction periods, further intraday auctions can take place any time during the day. At all other times, trading is done on a continuous basis (as described under the JET system). The JSE has undertaken significant technological upgrades over the years in order to consistently update the trading system. Upgrading of the trading system is necessary to increase the trading speed and consequently the trading volumes of the exchange. In April 2007, the JSE SETS system was 2  THE TRADING OF SHARES ON THE JSE replaced by the JSE TradElect system, resulting in a significant increase in trading volumes. TradElect was licenced from the London Stock Exchange and it was maintained and operated by the London bourse. Therefore, the trading platform of the JSE was situated in London. In July 2013, the JSE implemented a new trading platform in the equity market namely the Millennium Exchange. The change from the TradElect to the Millennium Exchange platform resulted in the relocation of the JSE’s trading system from London to Johannesburg. The move back to Johannesburg has allowed enhanced operational efficiency and ensuring trading optimisation for market participants. With the new trading platform, trades can now be executed up to 400 times faster than under the TradElect system. The change, therefore, allows for increased market liquidity. Trading with the Millennium Exchange takes place in a twofold manner, similar to trading under the JSE SETS system. There are three auctions during a trading day and at all other times, trading is done on a continuous basis. Before explaining the functioning of auctions and continuous trading it is, however, important to take cognisance of the different types of orders that brokers can execute on behalf of their clients. The next section will discuss the different types of orders that clients can give to their brokers. 5.4 ORDERS TO BROKERS Three basic types of orders that clients can give to their brokers are a market order, a limit order and a stop order. Execution and validity constraints can, furthermore, be set on market and limit orders. 5.4.1 THE MARKET ORDER A market order is the simplest instruction that a client can give to his broker. With a market order, the client only specifies the volume of shares that must be purchased or sold in a specific company. No price is specified. The broker will then endeavour to purchase/sell the shares at the best possible price (the current market price). A market order (submitted during the continuous trading session) will be matched with orders on the contra side of the order book until it is fully filled. The following example illustrates the execution of a market order. Assume the following (sell) orders appear on the supply side of the order book: 1 000 shares available at 160c 2 300 shares available at 165c. If a market order is entered to purchase 2 000 shares, the client will receive 1 000 shares at 160c and 1 000 at 165c. The first 1 000 was purchased at the best price and the second 1 000 at the next best price. 3 INTRODUCTION TO INVESTMENT MANAGEMENT 5.4.2 THE LIMIT ORDER With a limit order, the client specifies the volume of shares to be traded as well as the price limit. In the case of a buy (sell) limit order, the specified price indicates the highest (lowest) price the client is willing to pay (accept) for the shares. The transactions are always executed at the price limit or better. An order to sell at 600c will imply that the broker will try to sell at 600c or more. If the order cannot be executed in full, the remaining un-executable volume of shares will remain as a passive order in the order book until executed. Assume the following (sell) orders appear on the supply side of the order book: 1 000 shares available at 160c 2 300 shares available at 165c. If a limit order is entered to purchase 2 000 shares at 160c, only 1 000 shares will be purchased at 160c (this is all the shares that are available at the specified price of 160c – the client is not willing to pay a higher price than 160c). The rest of the order will remain on the demand (buy) side of the order book as a passive order to purchase 1 000 shares at 160c. 5.4.3 THE STOP ORDER A stop order is a market order to buy or sell shares when the price of a share reaches a specified price level (stop price). Once the stop price is reached, the order will be entered in the order book and be treated similar to a regular new market order. Similar to the stop order, a stop limit order can also be applied. In this case, once the stop price is reached, the order will be entered in the order book and will be treated similar to a regular new limit order. Stop orders can be used to protect a profit or to limit a loss (also referred to as a stop-loss order). Firstly, a stop order can be used to protect a profit. Let’s assume a person purchases a share at 500c and the price gradually increases to 600c. The person is now uncertain whether there will be further price increases, but also does not want to sell the share unnecessarily, as there might still be further price increases. He then gives his broker a stop order to sell at say 580c (stop price), implying that the broker must only sell, should the price drop to 580c. If the price continues to increase to say 650c, the order will not be executed. If the price, however, drops to 580c (the stop price), then the order will be entered into the order book as a market order and the share can be sold for 580c. Therefore, the client still makes a profit of 80c (580 – 500) per share. present MP 600 stop order @ 580 purchase @ 500 With electronic trading, an elementary program is available to assist the broker with this task. A certain percentage-decline is set, say 10% (instead of an amount such as 20c). As soon as the price declines by 10% (instead of 4  THE TRADING OF SHARES ON THE JSE continuing to rise), the program is triggered to automatically place the shares on the order book to sell. Secondly, a stop loss order can be utilised to limit a loss. Let’s assume a person purchases a share at 500c in the expectation that the price will increase. However, to play safe, the person immediately places a stop loss order with his broker to sell, should the price drop to 480c (stop price). If the share price increases from 500c, the order will not be executed. If the price, however, drops to the stop price of 480c, the order will be entered into the order book as a market order and the share will be sold at 480c. The investor will, therefore, limit his loss to 20c per share plus the transaction costs. With electronic trading, the margin is set at a certain percentage rather than at a certain amount such as 20c. An elementary computer program follows the share prices and as soon as the percentage decline appears, the program will automatically place the shares on the order book to sell. 5.4.4 A BEAR TRANSACTION (SHORT SALES) A highly speculative order that is sometimes given to brokers by their clients is the bear sale (short sale). During the traditional bear transaction, a person sold shares that he does not possess, in the hope that the price of the shares will drop, so that he can purchase the required number of shares at a lower price in order to deliver to the person to whom he originally sold the shares. This was possible as certain transactions took up to a month to settle. However, should the price of the shares increase after the person (bear) had sold them, then he still has to purchase the shares as he must deliver them. The prerequisites for a bear transaction have changed with the implementation of electronic trading. If a person wants to execute a bear transaction, he must negotiate beforehand with a “loan agent” (loan desk) to acquire (borrow) the necessary shares. Normally a loan agent is a CSDP (Central Securities Depository Participant). Most of the CSDP’s are banks. The bear must be certain that the required shares are reserved for him at the CSDP. Now he can sell the shares via his stockbroker. The bear will receive his money for the sale on day T plus 3. In the meantime, the bear must purchase the required shares so that he can hand them back to the loan agent from whom he borrowed. If the price has dropped since he sold, then he can purchase the shares at a lower price and make a profit. However, if the price should increase since the sales transaction, then the bear will suffer a loss. Over and above the broker’s and other costs connected with the buying and selling of the shares, the bear will also have to pay a “loan fee” to the loan agent. This fee is a function of the volatility of the price of the shares that were borrowed. The bear will also have to provide the necessary security (guarantee) to the loan agent for the shares that he borrows. Due to the complexity of stop orders and more specifically, bear transactions, this book will only focus on the execution of market orders and limit orders. 5 INTRODUCTION TO INVESTMENT MANAGEMENT 5.4.5 EXECUTION AND VALIDITY CONSTRAINTS Both market orders and limit orders can be subject to either execution constraints or validity constraints. There are two main execution constraints that can be set on both market and limit orders. 5.4.5.1 Execute and eliminate This constraint determines that the order must be matched immediately and as completely as possible with the existing orders in the order book. Any remaining unexecuted volume will immediately be removed from the order book. These orders will therefore never appear on the order book as passive orders (the order is non-persistent). An order with an execution constraint of execute and eliminate is illustrated in the following example: Assume the following (sell) orders appear on the supply side of the order book: 1 000 shares available at 160c 2 300 shares available at 165c. If a limit order is entered to purchase 2 000 shares at 160c with the constraint “execute and eliminate”, then the client will receive 1 000 shares at 160c and the remainder of the order will be cancelled immediately as it cannot be executed immediately. 5.4.5.2 Fill or kill This constraint determines that the order must be matched immediately and in full with existing orders in the order book, or else the complete order is cancelled and never appears in the order book (the order is non-persistent). An order with an execution constraint of fill or kill is illustrated in the following example: Assume the following (sell) orders appear on the supply side of the order book: 1 000 shares available at 160c 2 300 shares available at 165c. If a limit order is entered to purchase 2 000 shares at 160c with the constraint “fill or kill”, then the complete transaction will be rejected as it is not possible to purchase the full number of 2 000 shares at 160c. Orders that are not subject to execution constraints can have validity constraints (see Table 5.1). When orders are entered into the order book, a participant can specify how long the order needs to be valid for. 6  THE TRADING OF SHARES ON THE JSE Table 5.1: Validity constraints Good for Day: Orders will expire at the end of the current trading day (23:59). Good till Date: Orders will expire at the end of a specific date; up to 90 calendar days including the present trading day. Good till Time: Orders will expire at the specified time on the current trading day. Good till Date/Time: Orders will expire on the specific date/time; up to a maximum of 90 calendar days excluding the present trading day. 5.5 EQUITY (SHARES) TRADING ACCORDING TO THE MILLENNIUM EXCHANGE SYSTEM The JSE operates an order-driven, central order book trading system with opening, intra-day and closing auctions. There are three auctions during a trading day, and at all other times, trading is done on a continuous basis. Figure 5.1 illustrates a normal trading day on the JSE. Figure 5.1: JSE trading day 08:30 – 9:00 09:00 – 16:50 16:50 – 17:00 Opening Continuous trading Closing auction auction Intraday auction (12:00) 08h30-09h00 09h00-16h50 16h50-17h00 5.5.1 CONTINUOUS TRADING An example of trading in the main order book will be illustrated. A client contacts his broker (M) with an order to sell 2 000 Absa shares at 206 cents. Through his workstation (computer), the broker accesses the main order book which may display the following: ORDER BOOK - ABSA LTD BUY SELL VOLUME PRICE (Bid) PRICE (Offer) VOLUME 5 000 206 209 5 000 3 200 205 208 9 000 10 000 204 207 1 600 Orders making up the 5 000 shares @ 206 are: Member Time placed Volume D 10:00 1 500 E 10:05 3 500 7 INTRODUCTION TO INVESTMENT MANAGEMENT The name of the member (broker) who places an order will not appear in the actual order book. On the screen, there are a number of “passive” (unexecuted) orders, i.e. original “active” orders which are unmatched or partially matched and which are waiting for possible execution. The passive orders appear in price/time priority. In the offices of broker M the order to sell will be transferred to the Automated Trading System - this is now an “active” order and the automated trading system will immediately try to match this order with the existing passive ones. After entering the order, the order book will (theoretically) display the following: ORDER BOOK - ABSA LTD BUY SELL VOLUME PRICE PRICE VOLUME 5 000 206 209 5 000 3 200 205 208 9 000 10 000 204 207 1 600 206 2 000 The order to sell at 206 will briefly appear in the order book as this active order will immediately be coupled with the passive purchasing orders. After matching the active order with the passive orders, the order book will display the following: ORDER BOOK - ABSA LTD BUY SELL VOLUME PRICE PRICE VOLUME 3 000 206 209 5 000 3 200 205 208 9 000 10 000 204 207 1 600 The 2 000 shares offered by broker M were sold to brokers D (1 500) and E (500). D received preference due to his time priority - his order was entered earlier than that of E. The brokers who were willing to purchase at 206 cent, received priority over those willing to buy at 205 and 204 cent. The remaining 3 000 shares that E requires will remain a passive order until it can also be executed. The respective brokers will notify their clients of the executed transaction. A further example will illustrate that the incoming active order receives price priority over the existing passive orders. Suppose the main order book is as follows: ORDER BOOK - ABSA LTD BUY SELL VOLUME PRICE PRICE VOLUME 5 000 206 209 5 000 3 200 205 208 9 000 10 000 204 207 1 600 8  THE TRADING OF SHARES ON THE JSE Orders making up the 5 000 shares @ 206 are: Member Time placed Volume D 10:00 1 500 E 10:05 3 500 Broking member N place an order to sell 10 000 shares at 204 cent. ORDER BOOK - ABSA LTD BUY SELL VOLUME PRICE PRICE VOLUME 5 000 206 209 5 000 3 200 205 208 9 000 10 000 204 207 1 600 204 10 000 The order to sell at 204 will briefly appear in the order book as this active order will immediately be coupled with the passive purchasing orders. The sales order at 204 receives price priority over the purchase order at 206 cent. After execution of the transaction, the order book will display the following: ORDER BOOK - ABSA LTD BUY SELL VOLUME PRICE PRICE VOLUME 8 200 204 209 5 000 208 9 000 207 1 600 Brokers D and E purchased 5 000 shares at 206 cents (although the 10 000 shares are being offered for sale at 204, the active order receives price priority, i.e. the shares are sold at the best possible price – the first 5 000 @ 206); the broker who wants to buy 3 200 shares at 205, will receive them; and the broker who wants to buy 10 000 shares at 204, will receive the remaining 1 800 shares on offer. The brokers willing to purchase at 206 and 205 receive price priority over the broker who wants to buy at 204 (they were willing to pay more). The remainder of the order of the broker for 10 000 shares @ 204 cents (8 200), will remain a passive order until matched with a new incoming active order. The shares sold by broker N was sold at 204 cents or better as his active order received price priority over the passive orders of the purchasing brokers. The shares of broker N was sold as follows: 5 000 shares at 206 3 200 shares at 205 1 800 shares at 204 9 INTRODUCTION TO INVESTMENT MANAGEMENT 5.5.2 THE JSE AUCTION PROCESS Three auctions can take place on a daily basis on the JSE: an opening auction, an intra-day auction and a closing auction. All three auctions follow the same process and it is used to determine a transparent opening and closing price for every share each trading day. 5.5.2.1 Various phases of the auction During each auction, there are three clearly distinguishable phases. Call Phase: Each auction will start with a call phase during which members can enter new orders, as well as adapt and/or remove existing orders from the order book. No trading is done during this phase. Only persistent orders may be entered during this phase, i.e. limit and market orders with no execution constraints. The order book is continuously updated during this phase so that the members can see in which direction the bids and offers are moving. The possible auction price and executable volume is also indicated (more on this in the section on price formation). The call phase of the opening auction is presently 30 minutes, but can be adapted as required. For the closing auction the call phase is presently 10 minutes (that can be adapted) as most of the transactions are already in the order books. For the intraday auction that starts at 12:00 the call phase is 15 minutes. Random end: The call phase ends with a random period of 0 to 30 seconds during which it is impossible to enter new orders or adapt existing orders. The purpose of this “freeze period” is to discourage members to enter “false orders” (fictitious orders) in an effort to influence the auction price. Members run the risk of being bound by these orders. Price determination period: After the random end, the order book is frozen and the price determination algorithm is activated to determine an appropriate auction price. During this phase no transactions (orders) can be entered, adapted or be removed. The auction price is determined firstly by taking the price that will create the maximum executable volume. If the price determination algorithm identifies more than one price that will provide the same maximum executable volume, then, as a second step the price that will provide the minimum surplus for each price limit that led to the maximum executable volume, will be taken as the auction price. If there is more than one price that complies with the requirement of maximum executable volume and minimum surplus, then as a third step (phase) the market pressure of the surpluses will be taken into account. If the surplus for all possible prices are on the buy side (demand side), then the highest possible price will be taken; and if the surpluses are all on the sell side (supply side), then the lowest possible price will be taken. 10  THE TRADING OF SHARES ON THE JSE 5.5.2.2 Determination of the auction price The auction price is determined according to certain matching rules (principles). If the first matching rule is successful, the auction price will be determined according to this principle. Should the first matching rule provide more than one possible auction price, then the second rule will be applied. And so it continues to the third possible rule for price determination. a) Maximum Execution Principle: The price determination phase follows after the call phase that ended with the random end. The executable volume is determined for each price limit in the order book. The auction price is then the price that will lead to the maximum executable volume. In order to increase liquidity, market orders have priority over limit orders during the price determination process. Example: Order book at the end of the call phase: BUY SELL Volume Price Price Volume 10 000 9 550 Market 2 500 5 600 9 450 9 600 200 200 9 400 9 450 1 000 9 300 6 900 To determine the auction price the information in the order book can be rearranged. The data from the order book above will be transferred to the second, third and the fourth column (see next page). All the prices in the order book, together with the volume at each price, are ranked from the highest to the lowest price (column 2, 3 and 4). With the rearrangement of the order book, provision must be made for price increments in column 3 that do not appear in the order book, for example 9 500 and 9 350. A market order, however, is not entered as a separate line in the table. If the market order appears on the sell side of the order book, the volume at the market order will be added to the volume entered at the lowest price in the table. The reason for this is that the seller is willing to sell at any price, even if it is the lowest price. If the market order appears on the buy side of the order book, then the volume at the market order will be added to the volume entered at the highest price in the table, since the buyer is willing to purchase at any price, even at the highest price. The volumes in column 2 and 4 are then used to determine the cumulative volumes that can be bought and sold at the different price limits. In order to execute a transaction there must be a purchase order for each corresponding sales order (and vice versa). The total executable volume (auction volume – column 6) for each price limit is therefore the smallest of the cumulative buy- and sell volumes at that specific price limit. 11 INTRODUCTION TO INVESTMENT MANAGEMENT ORDER BOOK BUY SELL Cumulative Volume at PRICE Volume at Cumulative Auction volume price price volume volume 0 0 9 600 200 10 600 0 10 000 10 000 9 550 0 10 400 10 000 10 000 0 9 500 0 10 400 10 000 15 600 5 600 9 450 1 000 10 400 10 400 15 800 200 9 400 0 9 400 9 400 15 800 0 9 350 0 9 400 9 400 15 800 0 9 300 2 500 + 9 400 9 400 6 900 The auction price of 9 450 will lead to the maximum executable (auction) volume of 10 400 shares. Since there is only one price (9 450) resulting in the maximum auction volume, this price will be the final auction price. All orders entered during the auction process will now be matched, as far as possible, at the auction price of 9 450. After all the orders are executed, the order book will be as follows: BUY SELL Volume Price Price Volume 5 200 9 450 9 600 200 200 9 400 b. Minimum surplus principle: If the maximum execution principle provides more than one price that will lead to a highest executable volume, then the next principle, namely the minimum surplus, will be brought into the equation. The auction price is then the price with the maximum executable volume that also leads to the smallest surplus for each price limit. Example: Order book at the end of the call phase: BUY SELL Volume Price Price Volume 10 000 9 550 Market 2 500 5 600 9 450 9 600 200 200 9 400 9 400 1 000 9 300 6 900 To determine the auction price the information in the order book can be rearranged as follows: 12  THE TRADING OF SHARES ON THE JSE ORDER BOOK BUY SELL Cumulative Volume PRICE Volume at Cumulative Auction Auction volume at price price volume volume surplus 0 0 9 600 200 10 600 0 10 000 10 000 9 550 0 10 400 10 000 10 000 0 9 500 0 10 400 10 000 15 600 5 600 9 450 0 10 400 10 400 5 200 15 800 200 9 400 1 000 10 400 10 400 5 400 15 800 0 9 350 0 9 400 9 400 15 800 0 9 300 2 500 + 9 400 9 400 6 900 According to the rearrangement of the order book there are two prices that will provide the same maximum auction volume, namely 9 450 and 9 400 (see column 6). The principle of minimum surplus will now be activated. The auction surplus is now calculated for the two prices that provided the same maximum auction volume. The auction surplus is determined by the difference between the two cumulative volume columns. Therefore, if matching takes place at 9 450c, then an unmatched volume of 5 200 shares will remain on the buy side, because the cumulative volume on the buy side is higher. The minimum surplus principal states that the auction price will be the price that results in the maximum auction volume that furthermore leads to the smallest surplus. As the price of 9 450 provides the minimum auction surplus (5 200 vs 5 400), this will be the final auction price. All orders entered during the auction process will now be matched, as far as possible, at the auction price of 9 450. After all the transactions are executed, the order book will be as follows: BUY SELL Volume Price Price Volume 5 200 9 450 9 600 200 200 9 400 c. Market pressure principle: If after application of the maximum execution principle and the minimum surplus principle there is still more than one possible auction price, then the market pressure principle will be applied. Market pressure functions as follows: (1) The auction price is equal to the highest acceptable price if the surplus for all relevant price limits is on the purchase side (surplus of demand). (2) The auction price is equal to the lowest acceptable price if the surplus for all relevant price limits is on the sell side (surplus of supply). 13 INTRODUCTION TO INVESTMENT MANAGEMENT Example: Order book at the end of the call phase: BUY SELL Volume Price Price Volume 10 000 9 550 Market 2 500 5 600 9 500 9 600 200 1 000 9 400 9 400 1 000 9 300 6 900 To determine the auction price the information in the order book can be rearranged as follows: ORDER BOOK BUY SELL Cumulative Volume PRICE Volume at Cumulative Auction Auction volume at price price volume volume surplus 0 0 9 600 200 10 600 0 10 000 10 000 9 550 0 10 400 10 000 15 600 5 600 9 500 0 10 400 10 400 5 200 15 600 0 9 450 0 10 400 10 400 5 200 16 600 1 000 9 400 1 000 10 400 10 400 6 200 16 600 0 9 350 0 9 400 9 400 16 600 0 9 300 2 500 + 9 400 9 400 6 900 According to the rearrangement of the order book there are three prices (9 500; 9 450; 9 400) that will result in the same maximum auction volume. Consequently, the minimum surpluses must be determined for these three different price limits. Two of the three prices (9 500 and 9 450) provide the same maximum auction volume as well as the same minimum surplus. The surpluses in both cases are on the buy side (demand) of the order book, therefore this market pressure will most probably cause the price to rise immediately after the auction. To represent this pressure the pricing algorithm will select the highest of the two prices (9 500) as the auction price. [If the surplus was on the sell side of the order book, the remaining sell pressure is likely to cause the price to decrease after the auction. In that case, the lowest price (of the two prices) will be taken as the auction price.] All orders entered during the auction process will now be matched, as far as possible, at the auction price of 9 500. After all the transactions are executed, the order book will be as follows: BUY SELL Volume Price Price Volume 5 200 9 500 9 600 200 1 000 9 400 After the opening auction process, the JSE will continue trading on a continuous basis. 14  THE TRADING OF SHARES ON THE JSE All share transactions (auctions or continuous trading) have to be executed via a stock brokering firm. There are various transaction costs that have to be considered when shares are purchased or sold. The final part of this chapter will focus specifically on the different costs relevant to a share transaction. 5.6 THE COST OF A SHARE TRANSACTION As mentioned in Component 2, one of the requirements for a continuous market is that the cost of trading shares (transaction costs) must be so small that it will not have a substantial effect on the buy/sell decision. In the past, the transaction costs of share transactions were kept very low, but due to the application of minimum tariffs, it has become quite expensive for small investors. The costs of a share transaction are the following: 5.6.1 BROKERAGE During each transaction, be it a purchase or sales transaction, the broker will charge his client a commission which is expressed as a percentage of the transaction amount (the number of shares multiplied with the market price). In the past fixed scales were prescribed for the stockbrokers, for example 1,4% on the first R5 000, then 1,1% on the following R5 000 and so on up to 0,21% on the amount above R1,5 million. Brokers are no longer bound to charge the prescribed commission and the client can now negotiate with the broker on the rate of the commission. There are brokers who prefer to charge a flat rate like 0,50% on all transactions, whereas other brokers might charge brokerage fees on a sliding scale where the percentage brokerage fee decreases as the amount of the investment increases. However, the small investor is not in a strong negotiating position and will therefore have to pay the commission charged by the broker. Furthermore, brokers tend to charge a certain minimum tariff per transaction as brokerage. A minimum tariff implies that the brokerage fee cannot be less than the stated minimum fee. This fee usually varies between R90 to R230 and differs from broker to broker. In order to simplify calculations, a brokerage fee of 0,75% and a minimum tariff of R150 will be used in all examples and questions relating to transaction costs. 15 INTRODUCTION TO INVESTMENT MANAGEMENT 5.6.2 STRATE SETTLEMENT COST This transaction fee covers the electronic settlement of share transactions through Strate, which is the electronic settlement authority in South Africa. The cost amounts to: Transaction amount Strate fee < R116 116 R6,72 R116 116 – R1 867 868 0,005787% of transaction amount > R1 867 868 R108,10 5.6.3 INVESTOR PROTECTION LEVY This levy is used by the JSE to monitor transactions on the market to ensure that they have not been executed based on insider information. The levy amounts to 0,00031% of the transaction amount. 5.6.4 VALUE ADDED TAX (VAT) The government requires that the broker must charge VAT on his brokerage, the Strate settlement cost and the investor protection levy, at the current rate of 15% and that this must be paid over to the state. 5.6.5 SECURITIES TRANSFER TAX (STT) Securities transfer tax (STT) applies to the purchase and transfer of securities and this tax is levied at a rate of 0,25% on the transaction amount. Only during a purchase transaction, the state will charge this tax, therefore, only the buyer of a transaction will pay STT. 5.7 AN EXAMPLE OF A SHARE TRANSACTION INCLUDING TRANSACTION COSTS Below an example is provided of the different costs relevant to a share transaction (for the buyer and the seller): Susan sells 5 000 Santax shares via her broker to Peter (via his broker) at 920c per share. The amount that Susan will receive from her broker and that Peter will have to pay his broker is calculated as follows: 16  THE TRADING OF SHARES ON THE JSE Seller (Susan) Transaction amount (5 000 x 920c) R46 000,00 Minus total transaction costs: (404,64) Brokerage (R46 000 x 0,75%) 345,00 Strate settlement cost 6,72 Investor protection levy (R46 000 x 0,00031%) 0,14 351,86 VAT (351,86 x 15%) 52,78 Total value of transaction for the seller R45 595,36 (Total amount that Susan will receive) Purchaser (Peter) Transaction amount (5 000 x 920c) R46 000,00 Plus total transaction costs: 519,64 Brokerage (R46 000 x 0,75%) 345,00 Strate settlement cost 6,72 Investor protection levy (R46 000 x 0,00031%) 0,14 351,86 VAT (R351,86 x 15%) 52,78 STT (R46 000 x 0,25%) 115,00 Total value of the transaction for the buyer R46 519,64 (Amount that Peter must pay) 17