The Singapore Exchange (SGX) has achieved a 4% year-on-year increase in net profits to S$77.3 million (US$62.4 million) for the third quarter of its financial year 2011, but with its capital expenditure reaching a climax, analysts are concerned that the firm needs to see a return on its investment in technology.
Anand Swaminathan, a Credit Suisse financials analyst based in Singapore, said that the planned capital expenditure for the year of S$65 million (US$52.5 million) had been a negative surprise to the market. “So far they have spent S$44 million (US$35.5 million), with S$20million (US$16.1 million) left to spend and the run rate set to peak in June,” he said. “The S$65 million is the highest in four or five years.”
Magnus Bocker, SGX CEO, said, “Despite global uncertainties and tough market conditions, our performance was solid and strong in the quarter. We continue to expand our products and services including adding OTC clearing of foreign exchange forwards and more metal futures. Our Reach initiative achieved its first milestone when we opened the SGX Data Centre on 11 April. We look forward to offering the world's fastest trading engine and international liquidity hubs in the coming months.”
Securities market activities were largely flat over the quarter, with daily average value traded on SGX reported at S$1.7 billion (US$1.37 billion). However, derivatives average volume in March was a record of 381,451 contracts per day as the average volatility of the Nikkei225 Index was up almost fourfold, to 50% from 13% in February.
The reported profits excluded the S$12 million (US$9.68 million) of costs associated with SGX's plan to merge with the Australian Securities Exchange (ASX), a deal worth US$8.4 billion which was rejected by the Australian treasurer, Wayne Swan, on 8 April, as against Australia's national interests.
Expenses were up 18% to S$75 million (US$60.5 million) from S$63.6 million (US$51.2 million) Q3 2010, mainly attributable to technology expenses which were S$7.9 million higher (US$6.37 million) year-on-year at S$27.6 million (US$22.3 million). SGX attributed this to “our stepped-up investments: the Reach initiative (including the rental and transition expenses relating to the new SGX data centre) and the clearing of OTC financial derivatives initiative”.
“The ASX deal, Reach and OTC derivatives clearing projects were always long-term investments, and were initiated before this quarter, so taking that into account the revenues are fine,” said Anshuman Jaswal, analyst at financial markets research firm Celent.
The payback
However Swaminathan warned that returns from the initiatives must be closely monitored. “In theory, OTC clearing is a good value proposition, but it takes time to hit the bottom line,” he said. “They say they have cleared US$33bilion of contracts in the first three months of the year, but the financial impact has been minimal.”
Despite the apparent attractiveness of the clearing business, similar projects have proven unfruitful in the past. “Listing American depository receipts (ADRs) initially looked good, but it has been a sad story since the first couple of days,” said Swaminathan. “ADRs should have worked, giving access during Asian trading hours to US listed stocks when news about the firms is breaking, but SGX has still found it very difficult to get liquidity in those stocks.”
The Reach initiative is an exchange-wide technology investment, part of SGX's efforts to expand its membership, distribution network and to promote high frequency trading in SGX markets. It has included the opening of a new data centre and a co-location facility that launched as a service on 18 April.
Swaminathan says that the co-location business offers the most immediate potential returns, however there needs to be further developments for it to be attractive. “HFT in Singapore equities is not happening, it is almost zero. There have to be pricing changes to make it happen,” he said.
However sources have noted that pricing changes to positively favour HFT firms over retail investors, which make up 40% of Singapore's volumes, could prove challenging politically.
Building bridges
Following the collapse of the ASX merger, Herbie Skeete, CEO of exchange information provider Mondo Visione, believes that SGX may now look further afield. “I wouldn't be surprised if SGX tried to do something outside of Asia Pacific,” he said. “They are ambitious with a track record for being innovative. Magnus Bocker, who has been involved in Europe with exchange operator Nasdaq OMX, is a person who can build bridges.”
Any further expansion in Asia is likely to be organic, says Jaswal of Celent, suggesting SGX might even consider launching an alternative trading system, in addition to Chi-East, the joint venture it launched with Chi-X in November 2010. But he also sees the potential for the firm to work with an exchange in the western markets. “It remains to be seen but I believe there is scope for growth that way,” he said.