SINGAPORE (Apr 30): To hear some old-time brokers talk about the state of the local stock market, one might think that the Singapore Exchange is operating a moribund business. Yet, SGX recently reported its highest quarterly revenue since it was listed back in 2000, and its highest quarterly net profit in a decade.

For 3QFY2018 ended March 30, SGX posted a 21% y-o-y rise in net profit to $100.5 million on a 10% y-o-y increase in revenue to $222.2 million. Much of that strong performance was driven by SGX’s thriving derivatives business rather than traditional stock trading by the retail investors from which remisiers used to make a good living. SGX’s revenue from derivatives increased 20.4% y-o-y to $90.5 million, which was 40.7% of its total revenue. On the other hand, revenue from securities trading and clearing rose 11.6% y-o-y to $61.7 million, which was 27.8% of its total revenue for the quarter.

The other segments of its revenue were issuer services (up 7.9% y-o-y to $20.5 million); post trade services (down 10.8% to $25.6 million); and market and data connectivity (down 2.2% to $23.9 million).

Not all of SGX’s revenue from securities trading and clearing was driven by stock trading, though. SGX notes that its securities daily average value (SDAV) increased 17% y-o-y to $1.5 billion in 3QFY2018, with total traded value for the quarter rising 15% y-o-y to $89.9 billion. The traded value of equities (including real estate investment trusts and business trusts) grew 13% y-o-y to $83.7 billion. The traded value of other products — which includes warrants, exchange-traded funds (ETFs), daily leverage certificates, debt securities and American depository receipts — increased by a much stronger 37% y-o-y to $6.2 billion.

These numbers shine a light on what remisiers have been complaining about: Retail investor participation in the market is not what it used to be back in the 1990s. Some of SGX’s past decisions could well have contributed to this. Notably, in 2011, it did away with lunch breaks, which some remisiers complained made it harder for them to find the time to share trading ideas and market gossip with their clients. The same year, SGX narrowed the bid-ask spread, which brokers complained reduced the incentive for their clients to take a quick punt on a stock. Last year, SGX restored lunch breaks and widened the bid-ask spread from half a cent to one cent for stocks priced between $1 and $1.99.

However, it is also clear that investors have more choices now when it comes to investing their money. What is the point of taking calls from a broker with a hot tip when one can invest in an expertly managed fund? Or, obtain broad exposure to the market through an ETF? These trends are channeling investor funds towards the larger stocks in the market, reducing turnover velocity in the market, and weighing on the valuations of mid-sized and small-cap stocks. That, in turn, may have spurred delistings and weighed on new listings in recent years, and further reduced retail investor participation in a vicious circle of sorts.

SGX seems none the worse for wear, though. Its derivatives business has grown strongly in recent years, helping to support its revenue and earnings in the face of waning securities trading. And, even if many remisiers still do not believe it, a cyclical upturn in securities trading now appears to be unfolding. With all its cylinders firing at the same time, SGX could well report more record-breaking revenue and earnings in the quarters ahead.

There are risks, of course. SGX potentially faces competition in the derivatives space from the likes of Intercontinental Exchange, which opened a derivatives exchange in Singapore in 2015. A third player, Asia Pacific Exchange, received regulatory approval to operate in Singapore earlier this year. As it is, SGX’s average fees per derivative contract have been declining, according to a December 2017 report by Maybank Kim Eng Research. SGX has also been lowering its securities clearing fees to spur liquidity. A longer-term risk is shifting technology, which could force SGX to make massive capital investments to stay in the game, or render it altogether irrelevant.

Ironically, lacklustre retail investor participation in the market and a generally lower penchant for risk taking might be holding back shares in SGX. According to a Maybank Kim Eng report this past week, SGX is forecast to generate a return on equity of 35.5% and its stock is trading at 7.3 times its estimated 2018 book value. Its arch nemesis <strong>Hong Kong Exchanges and Clearing</strong> is generating an ROE of only 27.5% but trading at 8.2 times book value.

If the local market were as vibrant as that of Hong Kong, perhaps shares in SGX would be more highly valued. Clearly, shareholders of SGX should join remisiers in hoping that retail participation in the local market picks up in 2018.

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