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Strengthening Capital Markets in Developing Countries
By Staci WardenNovember 2014
Framing the Issues: Strengthening Capital Markets in Developing Countries
Asummaryreportbasedondiscussionsata
MilkenInstituteCenterforFinancialMarketsroundtableoncapitalmarketsdevelopmentheldMarch14,2014inWashington,D.C.
ByStaciWarden
Overview OnMarch14,2014theMilkenInstituteCenterforFinancialMarkets(CFM)hostedaworkingroundtabletitled“Framing the Issues: Strengthening Capital Markets in Developing Countries.”1 The day-long event inWashington, DC convened scholars, officials from development agencies and international financialinstitutions (IFIs), private investors, and other business and finance leaders for the purpose of betterunderstanding the importance of, and fundamental issues for, deepening capital markets in developingcountries.Thisdocumentsummarizestheresultsoftheday’sdiscussionandcapturesboththeconsensusandthedivergentviewsofroundtableparticipantsonkeyissuesforstrengtheningcapitalmarkets.2The summary is divided into five sections, each concludes with a number of policy research questionsgeneratedattheroundtable.I. CapitalMarketDevelopmentGlobally:AProgressReport–reviewstheprogressincapital-market
deepeninggloballyindevelopingcountries.II. TheFinancialMarketContext:BankingandInstitutionalInvestors–placescapitalmarketsinthe
contextofotherkeyfinancialmarketsectorsnamelythebankingsectorandthepublicbuy-side(pensionfundsandotherinstitutionalinvestors).
III. CapitalMarketDevelopment–discussesinmoredetailthenuts-and-boltsofcapital-marketdevelopment–theregulatoryenvironment,equitymarkets,andbondmarkets.
IV. InternationalandRegionalIntegrationofCapitalMarkets–outlinesthepotentialforandrisksofinternationalandregionalintegration.
V. TheRoleofInternationalFinancialInstitutionsandDevelopmentAgencies–offersrecommendationsforIFIsandotherdevelopmentorganizationsthatwanttohelp.
1CFMhostedtheroundtableaspartofitsongoingpolicyresearchinitiative,CapitalMarketsforDevelopment(CM4D).TheCM4Dprogramhopestoaddresspressingissuesofcapital-marketdevelopmentandtoidentifypracticalsolutions.2ThisroundtablewasheldundertheChathamHouserules.
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I. Capital Market Development Globally: A Progress Report Overthepasttwodecades,capitalmarketsmosteverywherehavebecomedeeperandmoresophisticated.Domesticfinancialsystemshaveundergoneadramaticchangeacrossdevelopingregionsandemergingmarkets,especiallyinChinaandIndia.China,forexample,sawfour-foldgrowthinbothequitiesandbondsandfive-foldgrowthinbankassetsfrom1990to2000.Ingeneral,SoutheastAsianmarketshaveexperiencedstrong,steadygrowth.InthePhilippinesandThailand,forexample,marketcapitalization,atlessthanathirdofGDPin2000,hasrisentoover100percentofGDP3.Vietrillionamdidnothaveanexchangein2000,buttodaytheHoChiMinhStockExchangelistsover300companies.Inaddition,duringtheperiodfrom1990to2013,internationaldebtsecuritiesoutstandingrosefrom$9billionto$147billioninSoutheastAsia.Governmentandcorporatelocal-currencyissueshavegrownfrom$165billionin2000tojustshyof$1trillionattheendof2013.LatinAmerica’scapitalmarketshavebothincreasedinsizeanddeepenedoverthepastdecade.Marketcapitalizationtheresawfour-foldgrowthinadecade,from$560billionin2000to$2.4trilliontenyearslater.WhileequitymarketsarelargerinChileandColombia,bondmarketsarelargerinMexico,BrazilandCostaRica.AccordingtostatisticsfromtheBankforInternationalSettlements(BIS),LatinAmericandebtoutstandingininternationalcurrenciesfromallissuers,bothsovereignandcorporate,hasrisenfrom$40billionin1990to$600billionin2013.Localcurrencydebtmarketsarealsogrowing.Asrecentlyas2001,localcurrencybondsoutstandingfromallissuers,governmentandcorporate,inLatinAmericastoodatlessthan$30billion.Bytheendof2013,theyhadgrownnearlyahundredfoldto$2.8trillion.InSub-SaharanAfrica,marketsarestillatanascentstageofdevelopment,buthavestartedtoattractforeigninvestorssearchingforhigherrisk-adjustedreturns.Whilefewcountriesreportreliablestatistics,marketsappeartobedeepening.Since1990,sixteennewstockexchangeshaveappearedandthemarketcapitalizationnowapproaches$1trillion.
Figure1:SizeofDomesticFinancialSystem,1990vs.2000
Source:PresentationbySergioSchmukler,WorldBankatMilkenInstituteStrengtheningCapitalMarketsinDevelopingCountries,March14,2014
Figure2:SizeofDomesticFinancialSystem,2012
3In2012marketcapitalizationasapercentageofGDPhadreached106percentinthePhilippinesand105percentinThailand,accordingtotheWorldBank’sWorldDevelopmentIndicators.
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Sources:BankforInternationalSettlements,Bloomberg,Bankscope,MilkenInstitute
Figure3:Marketcapitalizationoflistedcompanies,2000vs.2012
Source:WorldBank–WorldDevelopmentIndicators
Despitethisgrowthstory,onlyasmallnumberoffirmsindevelopingcountriesaccesscapitalmarkets.Forequitymarkets,presentedinFigure4,thenumberoffirmsraisingcapitalisrelativelyfewcomparedwiththetotalnumberoffirmsinthesecountries,andonlyinChinaandIndiahasthenumberoffirmsraisingcapitalincreasedbyanotableamount.ThenumberoffirmshasinfactdeclinedinLatinAmerica,from224inthe1990sto175inthe2000s.Thesefiguresindicatetheconcentrationofmarketsamongafewtopissuersinmanycountries,notthediffusionofcapitalaccesstoawiderrangeofparticipants.
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Figure4:Numberoflistedfirmsinequitymarkets,1990vs.2000
Source:TatianaDidierandSergioL.Schmukler,“FinancialDevelopmentinAsia:BeyondAggregateIndicators,”PolicyResearchWorkingPaperNo.6761,WorldBank,January2014
Likewise,onlyasmallnumberoffirmsindevelopingcountriesaccessbondmarkets.Forinstance,asshowninFigure5,anaverageofjust21firmsperyearissuedbondsinAsiafortheperiodbetween2000and2008.ThenumberoffirmsissuingbondsdecreasedinLatinAmerica,from30firmsinthe1990sto19firmsinthe2000s.
Figure5:Averagenumberoffirmsissuingbonds,1990vs.2000
Source:TatianaDidierandSergioL.Schmukler,“FinancialDevelopmentinAsia:BeyondAggregateIndicators,”PolicyResearchWorkingPaperNo.6761,WorldBank,January2014
II. The Financial Market Context: Banking and Institutional Investors Participantsbeganbyrecognizingthatastrongbankingsectorhashistoricallyprecededthedevelopmentofcapitalmarkets,andthatinmanydevelopingcountries,bankingsectorstabilityhasmadeenormousstridesinthepastdecade,despitetheglobalfinancialcrisis.Likewise,thepasttwodecadesofsustainedeconomicgrowthhaveledtolargerpoolsoforganizedsavingsintheformofbothpublicpensionfundsandsovereignwealthfunds.Thesetwosectorsareimportantforthediscussionofcapitalmarketdevelopment.Banksservebothasanimportantfoundationfor,butalsocompetitortocapitalmarkets,andinstitutionsofdomesticsavingsbenefitfromandcontributetothedevelopmentofdeep,liquidmarkets.
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Thebankingsector:ComplementandcompetitorItmakessensethatthebankingsectordevelopsfirstinmostcountries.Inaweakinformationenvironment,therelationshipbetweenbankerandborrowermaybetheonlywaytoassessthecredit-worthinessoffirms.Furthermore,severalparticipantsagreed,thebankingsectorlaysanessentialfoundationforcapital-marketdevelopment,as“moneymarketsarethecornerstoneofcapitalmarkets.”Throughcreditlines,banksprovidetheliquiditytocapitalmarkets,andbankdepositsprovidean“exitdoor”toinvestors.Last,andperhapsmostimportantly,banksareactiveparticipantsincapitalmarketsonboththeassetandliabilitysidesoftheirbalancesheets.Inmanyfrontiermarkets,largebanksareoftenamongthefirsttoissuedomesticbondsortolistonlocalstockexchanges.Beyondhelpingbanksmeettheirownfinancingneeds,capitalmarketsrevealfinancialmarketinformationthatisusefultobanks.“Theimportanceofcapitalmarketsisnotnecessarilytheamountoffundingthatisraisedinthemarkets,”saidoneparticipant,“itistheinformationrevealed.Capitalmarketsrevealinformationforthebanks,andthebanksreciprocateinrenewingloansornotrenewingloansforthecapitalmarkets.”Assuch,thedevelopmentofcapitalmarketsisalsoessentialforthesustainedhealthofthebankingsector.Thedominanceofthebankingsector,however,canoftenstiflethedevelopmentofacountry’scapitalmarkets.Inmanydevelopingcountries,thegovernmentandthelargestfirmsaretheonlyeconomicactorswithaccesstobankfinancing.Asoneparticipantnoted,“Banksdominateasthesourceofcapital,andgovernmentsdominateasusersofcapital.”Asaresult,developingcountries“canhaveaverystablebankingsystem,whichconsistsofbanksjustbuyingtreasurybillsandbeingveryprofitableandverystable—butnotreallydoingtheirjobasfinancialintermediaries.”Intheprivatesector,whichisoftenhighlyconcentrated,banksprioritizeonlythelargestfirms,withneithersidebeingincentivizedthentodevelopcapitalmarketsthatcould(1)competewithbanksand(2)financethelargefirms’smaller,perhapsmoreinnovativecompetitors.Thissituationharmssmallandmedium-sizedenterprises(SMEs)thatoftenfacecollateraldemandsthatare,asoneparticipantdescribedthem,“reallyridiculous—nothingshortofridiculous.”Yetthesebusinesseshavenootherwayofraisingcapital.Participantsagreedthatgovernmentpolicy,isforthemostpart,“severelybiasedinfavorofbanks.”Forexample,intimesofeconomiccrisis,inbothadvancedanddevelopingeconomies,governmentsaremorelikelytosavesystemicallyimportantbanksfromcollapse,evenas,forinstance,corporatebondmarketsdryup.Inmostcases,“justgettingoutofthewayisoftenoneofthemostefficientstrategiesthatgovernmentscantaketodevelopcapitalmarkets,”remarkedoneparticipant.Policiessuchassubsidizedbank-depositinsuranceandthedouble-taxationofdividends,inparticular,causemarketparticipantstofavorbankfinancingoverusingcapitalmarkets.Instead,thepublicpolicygoal“shouldbetocreatealevelplayingfieldforthedevelopmentofalltypesoffinancialproducts.”Mobilizingdomesticsavings:TheroleandrequirementsoflocalpensionfundsPublicinstitutionalinvestorsplayanimportantroleincapital-marketdevelopment,notjustbecauseoftheirsize,butalsobecausetheydonotfaceexcessiveliquidityrequirements,giventheirlong-termmandateand(thus)investmenthorizon.Inparticular,roundtableparticipantsemphasizedthepotentialoflong-terminstitutionalmoneytohelpcatalyzedomesticcapital-marketdevelopmentthroughinvestingininfrastructureprojectsandthecorporatesector.“Countriesthathavehadreallybigpoolsoforganizedsavingshavehadaneasiertimebuildingcapitalmarkets,”explainedoneparticipant.“LookatChile,Colombia,Malaysia,andThailandasexamplesofdevelopingcountriesthathaveachievedagoodbalanceinthisregard.”Whiletherewassomedisagreementamongparticipantsonthequestionoftheoptimalassetallocationforpensionfundsindevelopingcountries,participantsdidagreethatthosepensionportfoliosare
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overwhelminglyconcentratedindomestic,low-risk,low-yieldsecurities.“It’sscarythatsomuchmoneyisinvestedinbankdepositsandshort-termgovernmentbonds,”saidaroundtableparticipant,“becausethey’reverylowyield.”Whilepensionfundshaveafiduciarydutytoaneconomicallydependentandvulnerablesegmentofthepopulation—whichnaturallydrivesconservatisminassetallocation—itisalsotruethatpensionfundsmustgeneratepositiverealratesofreturninordertomeettheselong-termliabilities.Insomerespects,alimitedinvestmentopportunitysetwithabiastowardshort-termgovernmentsecuritiesincreasesconcentrationrisk,andasaresultheightenstheriskofnegativetaileventsfrommacroeconomicshocks.Diversification,ofcourse,requirestheexistenceofarangeofinvestmentopportunitiesaswellasdeep,liquidcapitalmarketsthatenableinstitutionalinvestorstoaccess–andexit–thoseopportunities.Oneparticipantsummeditthus:“Pensionfundsneedlong-termlocalcurrencyinvestments,andtheyneedyieldsfromarangeofassetclassesinordertomeetthepayoutobligationstopolicyholders.”Thiscanalsomeaninternationalizinginvestmentguidelines.Domesticinstitutionalsaverscouldimprovebothyieldsandhedgelocalexposurethroughdiversificationintoothergeographies.Asoneparticipantnoted,Chinesecitizens“savingforretirementwouldoptimallyliketohavesomeoftheirexposureoutsideChina.Certainly,Chileanresidentsdonotwanttohavetodependonapensionthat’svulnerablewhencopperpricesaredown.”Participantscautioned,however,thatbecausegovernmentsoftenseepensionsavingsasanimportantsourceofbudgetaryfinance,anymovestowardinternationaldiversificationcanbeahardsell.Participantsagreedthatalackofcapacityandregulatoryburdensdrivewhatmaybeexcessiveconservatisminpensionfundinvestmentdecisions.“Inmanyofthesecountries,”saidaparticipant,“pensionfundsarejustverynewtoinvesting,andsobynaturethey’reveryconservative.”Anothernotedthat“whilethecapacityofinvestmentmanagersandseniorleadershiphascontinuedtoimprovedramaticallyinrecentyears,theboardsofdirectorshaveinmanycasessufferedfromalackoffinancialliteracyandtheabilitytoassesstherisk-versus-returnprofileofpensionfundassetallocationstrategies.”Regulatoryregimes,recognizingthelackofcapacityinmanycases,areoftenexcessivelyconservative,andthis—togetherwiththenegativepublicitythatcanarisefrominvestmentlosses—addstotheriskaversionofpensionboards.Whilemuchofthediscussionfocusedonpensionfunds,roundtableparticipantsagreedthatapublicpolicygoalfordevelopingcountriesshouldalsobetodiversifythedomesticinvestorbase.OneparticipantcitedtheexperienceofColombia,wherepensionfunds“kidnappedanddestroyed”theliquidityofthenascentcorporatebondmarket.Participantsagreedthatdevelopingcountrieswoulddowelltoputmorefocusoncommercialsavingsvehiclesforretailinvestors,suchasmutualfundsandothervehicles.Domesticsaverssufferfromfinancialrepressioninmanydevelopingcountries,andhouseholdswouldbenefitfrompooled,diversifiedvehiclesthatgivethemanoptionbeyondlocalbankaccounts.Further,asoneparticipantargued,“ifpensionfundscometounderstandthattheydominatelocalfinancing,theychargetoomuch.”Todeveloptheinstitutionalinvestorsectormorebroadly,participantsdiscussedtheimportanceofestablishinggovernmentsavingvehicles,suchassovereignwealthfunds,tomanagenaturalresourceswealth.InNigeria,forexample,theNigerianSovereignInvestmentAuthorityisincreasingtheamountofcapitalavailablefordomesticinfrastructureprojects.“EvenSenegal,whichhasnonaturalresources,”notedaparticipant,“hasstartedasovereignwealthfundbysellingpublicassets,andistryingtokick-startprivateinvestment.”Finally,governmentscanmakebetteruseofcapitalmarketsbybecominginvestorsthemselves.Anotherparticipantpointedtotheimportanceofpublicinstitutionalinvestorsin
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France,Italy,andCanadaasmodelsthatcouldbeusedbydevelopingcountries.Here,publicmoney,pooledinthecaissededépôt,seeksmarketreturns,andbecomesanadditionalsourceoffinancefordomesticborrowers.PolicyResearchQuestion! Howcanpensionmandatesbereformedtoencouragediversificationbothwithinthedomestic
economyandinternationallyinwaysthatbothbenefitspensionersanddeepenscapitalmarkets?
III. Capital Market Development Fordomesticgovernments,capitalmarketdevelopmentbeginswitha“firstpillar,”macroeconomicstability,andastronglegalandregulatoryframework.4Thegovernment’srolebeginswithpromotingtheruleoflaw,protectingthephysicalsecurityofcitizensandvisitors,andestablishingasound,independentjudicialsystem.“Oneshouldnotexpecttohavedevelopedcapitalmarketsinacountrywheretheexpectedprofitabilityoflong-termprojectswilllikelybenegativelyimpactedbyvolatilityinthemacroeconomicenvironment,”explainedoneoftheroundtablemembers.Nominalinterestrates,inparticular,mustcomedowntoreasonable,stablelevelsbeforefirmscanissuelong-termdebt.“Ifinterestratesinagivencountryare20percent,”thisparticipantadded,“therearejustnotmanycompaniesthathaveabusinessmodelwheretheycanborrowatthoseratesandinvestattractively.”Second,asdiscussed,ahealthybankingsectorislikelyneededbeforecapitalmarketscandevelop.Third,capitalmarketsneedgoodmarketrulesandregulations.But,havinggoodlawsis,initself,notsufficient;afourthpillarisstronginstitutionalcapacitytoimplementexistinglawsandcreatereformswhenneeded.Asoneparticipantsaid,“ifcountrieshaveweakjudicialsystems,eveniftheyhavetheperfectlydesignedbankruptcylaw,[theexistenceofthat]lawwillnotallowfortheorderlyrestructuringofafirmindistress,orachangeinmanagement.”Anothersaid,“it’snotjustabouthavingregulation,buthavingtheexpertisetoenforceit.”Thissectionlooksinmoredetailattheproblemsandpolicyideasforimprovingtheregulatoryenvironmentingeneralandfordevelopingequityandbondmarketsinparticular.Regulatoryenvironment:OverbearingandoverlyvagueRegulationthatcreatesanenablingenvironmentcanhaveanimportantimpactonthepaceofmarketdevelopment.Asanexample,oneparticipantpointedtothecontrastingapproachoftworegulatorsinIndia.TheStockExchangeBoardofIndia,whichregulatesthepublicequitymarket,hasadaptedmorereadilytotheneedsandincentivesofmarketparticipants,spurringanexpansionoflistingsandrapidgrowthinmarketcapitalization.Meanwhile,thecountry’scentralbank,theReserveBankofIndia,hasmorerigidlyregulatedthecorporatebondmarket,likelyslowingitsdevelopment.Unfortunately,inmanydevelopingcountries,regulatoryregimesarecostly,time-consuming,uncertain,andineffectiveand/orcorrupt.Roundtableparticipantsdiscussedeachoftheseconcerns.First,regulatorycompliancecanbeexpensiveforcompanies,especiallythoseseekingtoraisecapital;tomarketintermediaries;andtoinvestors.Registration,licensure,andunderwritingandlegalfees,
4Forafulltreatmentofallpillars,seeroundtableparticipantLilianaRojas-Suarez,“Towardstrongandstablecapitalmarketsinemergingmarketeconomies,”BISPaperNo.75,January2014,availableathttp://www.bis.org/publ/bppdf/bispap75c.pdf(accessedOctober22,2014).
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especiallywhenpairedwithpoliciesthatsubsidizecommercialbankfinancing,inhibitthedevelopmentofcapitalmarkets.Thoughanecdotalevidenceabounds,participantsnotedthatthereisalackofsystematic,cross-countryempiricaldataonthefinancialcostsforcapitalmarketparticipantsindevelopingcountries.Oneparticipantsuggestedthatthecollectionandpublicationofdataonthesecostswouldbeaworthwhileresearcheffort.Inadditiontofinancialcosts,burdensomeregulatorycompliancemeanslosttimeforcompanies.Longapprovalprocessesmeanthattheyoftencannotaccesscapitalwhentheyneedittoexpandandinvest.Tediousandtime-consumingpaperworkcanalsodelaymarketactivityor,duetostrainedcapacity,preventsomecompaniesfromparticipatingincapitalmarketsatall.Participantsagreedthatreducingthecomplexityandlengthofapprovalprocessesoughttobeapolicypriority.AparticipantpointedtoKenyaasapositiveexample;therethesecuritiescommissionhasreducedthenumberofdaysneededforapprovalforacorporatebondissuancefrom240to70.Ironically,whileregulatoryregimescanbeareoverlycomplexanddemandinginsomeaspects,indevelopingcountries,theyarealsotoouncertain,lackingclear“rulesofthegame”andahistoryofcaseprecedent.Developingcountriescanoftenlackabankruptcycode,propertyrightsprotections,orclearrightsforminorityshareholders,allofwhichdeterinvestorsfromenteringthemarket.Andregulatorsoftenhavenostandardsforalternativefinancialproducts,includingcommoditiesderivativesorsecuritization.Acountry’sspeedinadoptingclearandconciseregulationscanbeanimportantaspectofattractingforeigndirectinvestment(FDI).Twoprivate-sectorparticipantsnotedtheirownexperienceinEastAfrica,wheretheyneededregulatorstowritenewpublicpolicybeforetheforeignerscouldmakeinvestments.“You’rewaitingforthemtocomeuptospeed,whichisreallyquiteachallenge,”explainedoneofthem,“becauseyou’reburningcapitalwhilethey’retryingtofigureoutwhetherthey’regoingtolicenseyou,orhowthey’regoingtodealwithyou.”Inthiscase,RwandaactedmorequicklythanKenya,sothefirmbaseditsoperationsthere.Finally,theregulatoryenvironmentcanbeineffectiveduetoalackofcapacityand/orcorruption.Policymakersmaydesignrulesthatfavorelitesorotherdomesticactors,andbureaucratsoftenarbitrarilyimposefees.Roundtableparticipantsdiscussedvarioussolutionstotheproblemsofcapacityandeffectiveness.Forinstance,aninternationalauthorityorregionalbodycouldassumetheresponsibilitytodesignandenforceregulatorystandards,ortherecouldbearoleforinternationalconsultantsinregulatingmarkets,wherebygovernmentscouldmaintaintheirownsovereigntywhilehiringindependentregulators.Mostparticipants,however,wereskepticalthatpolicymakerswouldadoptanarrangementthatcedestraditionalmechanismsofsovereignauthoritytoexternalactors.Inimprovingtheregulatoryenvironmentmoregenerally,participantssawpromiseinthepossibilityofself-regulationthroughtheadoptionofinternationalbestpractices.TheypointedtothepositiveinfluenceoftheInternationalOrganizationofSecuritiesCommissions(IOSCO)inincreasingfinancialliteracyandregulatorycapacityindevelopingcountries.Accordingtoseveralparticipants,avaluablepursuitwouldbestrengtheningIOSCOandworkingtoensurethatitsglobalbenchmarkstakeintoaccountthelimitedresourcesofdevelopingcountries,andtheirvulnerabilitytoexternalshocks.BuildingequityandbondmarketsFordevelopingcountries,equity-marketdevelopmentisfaraheadofthatofcorporatebondmarkets.Thisisdueinlargeparttothedifficultyinacquiringthecreditskillsandestablishingthecreditculturenecessarytoparticipateasinvestorsinbondmarkets.Butatleastoneparticipantnotedsomeironyinthis:“Ifinditsomewhatillogicalthatyoucouldhaveanextremelyrobustequitymarket,whichis
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absolutelythemostsubordinatedlayerofthecapitalstructure,butthenhaveacompleteabsenceofahigh-yieldmarket,whichoffersbetterinvestorprotection.”Inanyevent,theroundtablediscussionofthesemarketsreflectedthisdynamic.Themoreoptimisticdiscussiononbuildingequitymarketsfocusedontheneedforattractingmoreissuers,thedemutualizationofexchanges,andtheroleofSMEexchanges.Indiscussingcorporatebondmarkets,participantsfocusedmostlyonconstraints.
EquitymarketsPublicequitymarketsindevelopingcountrieshaveexpandedinrecentyears,butinmanycountriesthemarketsremainshallowandaremadeupofonlyafewsectors,particularlybanksandtelecoms.Moreover,familyfirms,whichrepresentalargeproportionoftheprivateeconomyinmanycountries,areoftenuninterestedorunabletoraiseequityfinancethroughpublicmarkets.Thesefirmsmaynotwanttodilutecontrolorundergothescrutinythatcomeswiththedisclosuresrequiredofpubliccompanies.Howcanmoreissuersbedrawntothesemarkets?Participantsdiscussedseveralideas.Perhapsmostimportant,governmentscangivemomentumtopublicmarketsbylisting,orpartiallylisting,state-ownedenterprises(SOEs).Thiscouldprovidemuchneededcapitalizationinmanycases,butparticipantsnotedthatpolicymakersareoftenreluctanttolistSOEsforreasonssimilartothoseoffamilyfirms:Theydonotwanttocedecontrol.Andasisoftenpointedout,SOEsareoftenruntomaximizepoliticalvalue,ratherthanfinancialvalue.ParticipantspointedtotheUKandPoland,however,asgoodexamplesofprivatizationthatdidcatalyzethedevelopmentofequitymarkets.Inadditiontoalackofissuers,nascentmarketssufferfromalackofqualified,interestedintermediaries.Insomecountries,regulatoryrequirements(suchasmulti-yearcommitments)deterbanksfromplayingafacilitatingroleasmarketmakers.IntermediariesarecriticalforSMElistingsinparticular.SMEs“reallyneedsomebodylikeamarketmakerornomadorsponsor.Whateveryouwanttocallthem,youneedsomebodytodotheduediligenceandtoprovidesomemorePRforsmallercompanies.”Iftherightintermediarieswereinplace,whatshouldanSMEexchangelooklike?First,oneparticipantargued,theSMEexchangemustbeconnectedtothemainstockmarket.Otherwise,“thecompaniesthatdowellwillgraduateandmoveontothemainexchange,leavingtheSMEexchangewithalargeproportionofpoorperformers,tothedetrimentoftheexchange’sreputationasadesirableplatformforvisibilityandmarketing.If,ontheotherhand,theSMEandthemainexchangearelinked,therewillbeincentivestomakeeachplatformwork.”Second,accordingtothesameparticipant,“inthecaseofSMEs,thejobofanexchangeisnotsimplytolistandtrade.TheyneedtodoalotmoreintermsofprovidingotherservicestoSMEs.”Theseservicesshouldincludefinancialmarketeducationandassistancewithinvestorrelations.ByofferingtheseservicescollectivelytolistedSMEs,exchangescouldimprovemarketefficiencyby(1)removingtheneedforeverySMEtospendfinancialandhumancapitalontheseservices,and(2)presentingmorestandardizedinvestmentopportunitiestoinvestors.Privatemarketscanalsoplayacrucialroleinfinancingprivateenterprisedirectly,aswellasindevelopingpublicmarkets.Severalparticipantssuggestedthatpromotingavibrantprivateequitymarketthatfeedsintothedevelopmentofpublicequitymarketsoughttobeapolicypriority.Inthisscenario,privateequityfirmswouldidentifyhigh-growthcompaniesina
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developingcountry,performduediligence,andinvestinimprovingmanagementandoperations,thushelpingthefirmsdeveloptothepointwheretheyarereadyforpublicofferings.Then,whenfirmsaremoreestablished,thestockexchangecanofferanexitfortheseinvestors.OneparticipantdrewattentiontotheexampleofNASDAQDubaiasacautionarytale,however.Liquidityislowandprivateequityfirmsarehavingtroublesellingshares,evenafterlistingcompanies.Suchstoriesdiscouragefutureparticipationinthesemarkets,because“exchangesneedsuccessstoriesformarketstogetgoing.”Last,participantsagreedthattheexchangesthemselvesshouldbecomepubliccompanies.Thatis,exchangesshouldmovetowarddemutualization.Thedemutualizationprocessmaybeslow,asmarketsarenascentandsometimesdependonthegovernmenttocontinueoperations,butinthelongerterm,demutualizationwillhavepositivebenefits,inthatitstrengthenscorporategovernanceoftheexchange(byremovingconflictsofinterestamongleadership)andmakestheexchangemoreresponsivetomarketforces.Demutualizedexchangesarealsomorelikelytooffernewproducts,suchasexchangetradedfunds(ETFs)thatcandrawretailinvestmenttotheexchange.Moreover,throughaninitialpublicoffering(IPO)andsubsequentofferings,demutualizedexchangesarebetterabletoraisecapitaltomakeimportantinvestmentsinnewtechnologyandmarketinfrastructure.Vestedinterests,however,canmakedemutualizationpoliticallydifficult.
BondmarketsManyofthethemesdiscussedforbuildingequitymarketsalsopertaintobuildingbondmarkets.Again,participantsagreedthatthelegalandregulatoryenvironmentisfundamental.Unlikeinequitymarkets,bondmarketdevelopmentisprimarilyaboutdevelopingprimaryissuancemarkets.Asoneparticipantargued,indevelopingcountries,“corporatebondmarketsdonotneedalotofliquidity,asmostinstitutionalinvestors…arelonger-terminvestors.”Whilethelackofliquidityinsecondarymarketsisobviouslyinpartwhatdrivesbuy-and-holdstrategies,forthemostpart,participantsfeltthattargetingthedevelopmentofprimarybondmarketsisthesensiblepolicypriority.Forbondmarketdevelopment,participantsspentmuchtimediscussingthenecessity—anddifficulty—ofbuildingthecapacitytoconductcreditanalysis.Theyagreedthatthemostglaringneedswereincreditassessmentanddevelopingacreditassessmentcapabilitybeyondthebankingsector.“Typicallyinvestorslacktheskillsrequiredtodoacreditassessmentinthesecountries,”saidoneparticipant,“becausethey’veneverhadto.”Companiescanlackthefinancialliteracytounderstandtheissuanceprocessandtheadvantagesofparticipatingincapitalmarkets.Thislackofknowledgepushesmarketparticipantstowardthemorefamiliaroptionofbankfinancing.Participantsagreedthatgovernments,aseconomicactors,haveacrucialroletoplayinbondmarketdevelopmentthroughtheirtreasuryfunctionasprimaryissuers.Governmentscanoftenborrowmorecheaplyabroadthaninlocalcurrency,buttheydosoattheexpenseofthelocalcorporateandbankingsectorsinmanyinstances.Localcurrency-denominatedsovereignpaperisessentialtomarketdevelopmentasitservesasabenchmarkforbankandcorporatecouponrates.Tobuildalocalcurrencyyieldcurve,governmentsmustraisemoneyonaregularbasis,andatarangeofmaturities.Opportunisticfinancingmightbemoreefficient,butregularissuance,thatthemarketcanrelyon,isrequiredforbuildingayieldcurveandforyieldcompressionforprivate-sectorborrowers.Asaresult,participantsagreed,regularissuanceonthepartofgovernmentfinanceministries,augmentedbySOEissuance,isacriticalbuildingblockforenablingbroadercommercialissuance.OneparticipantpointedtoSingaporeasan
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exampleofthisstrategy,whereSingaporeAirlinesandDBSBank,bothsubsidiariesofthegovernment-ownedTemasekHoldings,haveissuedbondsinlocalmarkets.
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Oneoftheimportantpointsraisedduringtheroundtablewasthatallfourpillarsmentionedabovearelikelyrequiredbeforecapitalmarketscandeepensignificantly.Theyreinforceoneanother,andweaknessinoneunderminesthestrengthoftheothers.Inlightofthisinterconnectedness,capital-marketdevelopmentrequiresasenseofcommonpurposethroughoutthewholeofgovernment,drivenbypoliticalwillfromthetoplevelsofnationalleadership.Politicalwill,andaclearroadmapthatoutlinesthesequencingofreforms,enablesacoordinatedeffortacrossagencies.SeveralparticipantspointedtotheMalaysiancapital-marketplanningprocessasasuccessfulexampleofcombiningpoliticalleadershipwithaclear,practicalroadmap.ParticipantsalsopointedtoPolandasanexampleofimplementingmanyofthemostimportantfeaturesofacapital-marketsdevelopmentstrategy.Inparticular,Polandembracedtheconceptofbuildingoutitsowntreasuryissuanceinordertolengthenthelocalyieldcurve.TheMinistryofFinancealsoestablishedaprimarydealersystemforgovernmentsecuritiesauctions,madeearlyinvestmentsincreatingasoundmarketinfrastructure,andbuiltawell-functioningstockexchange.Polandusedprivatizationsto“buildanequityculture,”followingtheexampleoftheUnitedKingdom.Inparallel,Polandinvitedforeignbanksintotheeconomy.Whiletheparticipationofforeignbanksindevelopingeconomiescanbecontentious,oneparticipantarguedthatinPolandforeignbankshavehadapositiveimpact.Theybroughtstrongbalancesheets,betterfinancialproducts,betterriskmanagement,anddeepfinancialknowledge–allofwhichimmediatelystrengthenedthedomesticfinancialsystem,leadingtosustainedgrowthoverthelasttwodecades.Last,thePolishGovernmenttookactivestepstocourtforeigncapital,includingconductingroadshowswhere“theywouldgoouttoprominentfinancialcentersandsellthePolishstoryasitdevelopedovertheyears.”
PolicyResearchQuestions! Whatarethecharacteristicsofthosecountries(and/ortheirpolicyenvironments),thathave
beensuccessfulindevelopingcapitalmarkets?Arethesecharacteristicsconsistentacrossdevelopingregions?Ifnot,whataccountsforvariations?
! Whatistherightleveloffinancialsectordevelopmentfortheeconomicsizeanddevelopment
ofaparticularcountry?Whatothercountryassets(human,cultural,legal,geographicetc.)arethemostimportantdeterminantsofpotentialfor,andrightstrategiesforpursuing,capitalmarketdevelopment?
! Whatistherightsequencingofcapitalmarketinnovations?Whatkindofplanningprocess
shouldbeundertaken?Whataretherightbenchmarks?Aretherepoliticaleconomymodelsthatbestenableexecution?
! Whatarethecostsassociatedwithissuingbondsand/orlistingonequityexchangesin
developingcountries?Howcanwemakecross-countrycomparisonsanddelivertheminawaytobehelpfultogovernmentstomakeimprovements.
! Whatistherelationshipbetweenarobustprivateequitymarketandthedevelopmentof
publicstockexchanges?Whatarethebestpoliciestocreatefeedermarketstobroadpublicownership?
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IV. International and Regional Integration of Capital Markets Oneofthemostseriouschallengesfacingthedevelopmentoflong-termfinancingoptionsinmanydevelopingcountriesisthesizeoftheireconomies.EvenwhencountrieslikeRwandamakeimpressivegainsinimprovingregulationsandtheeaseofdoingbusiness,theystillmustattainacertainminimumeconomicsizebeforetheycanattractinvestment,particularlyfrominstitutionalinvestors.Asacorollary,developingcountrieshaveverylimited,ifany,abilitytoissue“safeassets,”thosesecuritiesthatofferreasonablepricestabilityandliquidity.Asaresult,duringdownturns,investorstendtorunfromassetsinemergingandfrontiermarkets,andinvestinthesecuritiesissuedbytheworld’sadvancedandstableeconomies.Thisexacerbatestheproblemfordevelopingcountries.Ascapitalleaves,pricevolatilityincreasesintheshortterm;andinthelongerterm,firmsfacegreaterdifficultyinfinancingtheirgrowthandoperationalactivities,slowingtherealeconomy.Slowergrowth,ofcourse,makesitmoredifficulttoattractglobalinvestmentflows,andthedownwardspiralcontinues.Discussionwaswide-ranging,buttherewasgeneralagreementthatdeep,liquidcapitalmarketsareafundamentalrequirementofa“safeasset”environment.Thediscussiononinternationalintegrationaskedfundamentalquestionsaboutthebenefitsandrequirementsforattractinginvestmentandfinancialintermediaryservicesfromabroad.Oneparticipantemphasizedthedifferencebetweentheprovisionoffinancialservicesperseandthedeliveryofthoseservicesbyalocalprovider.Technologyincreasinglyenableslocalactorstoaccessfinancialservicesinternationally,mitigatingcapacityconstraintstomarketdevelopment,aswellaspotentiallyenablingdevelopingcountriesto“leapfrogdifferentstagesoffinancial-sectordevelopmentthroughimportinganarrayofbankingandcapitalmarketservices.”Thus,importingfinancialservicesmightbetherightpolicychoiceforresourceandcapacity-strappedgovernments.Ontheotherhand,policymakerswillbemotivatedbythedesiretomaintainsovereigntyandtoavoiddependenceonforeigncounterpartstodeliverservicestocitizens.“Oneofthenegatives[ofimportingfinancialservices]isthatifgovernmentsrelyoncommercialinstitutionsfromcountriesfromabroad,theyarereallyatthemercyofspecificinterests,”explainedaparticipant.“Wewouldhavetofigureouthowtoensurethatcontinuityifamarketplayerinanothercountrydecidesthatitisnolongerworththeirwhiletocontinueservicingagivenmarket.”Recommendationstoimportfinancialservicesfromabroadmustrecognizetheseconsiderations,thegroupagreed;yetdespitetheseconcernsoversovereigntyissues,participantsconcurredthatitworththinkingmorecarefullyabouttherelativebenefitsofopeningdomesticmarketstointernationalparticipation.Afundamentalquestionforgloballyintegratedcapitalmarketsistheadvisability(andability)ofmeetingglobalstandardsorbenchmarksforregulation,operationalpractices,andotherareas.Severalparticipantsarguedthatdevelopingcountriesshouldaspiretoglobalbenchmarks.“Investorspreferinternationalstandards,”saidone,“andcountriesthatcomeuptospeedwithglobalbestpracticescouldachieveanadvantageovertheirpeersinattractingFDI.”However,internationalstandardsmaybeaninappropriategoalfordevelopingcountries,giventhattheserequirehighlevelsoftechnologicalandregulatorycapacity.Moreover,theyaredesignedformuchlarger,faster,moreliquidmarkets.Someparticipantsaskedwhetherdevelopingcountriesmightbebetterservedtoexpendtheirlimitedfinancialandhumancapitalonotherpriorities.Morefundamentally,severalparticipantssuggestedthatdevelopingcountriesmaywishtoreservetherighttomaintainsomelevelofprotectionistpoliciesinordertodeveloplocalmarketswithoutthedisruptivestopsandstartsofforeignportfolioflows.Participantsagreedthattheglobalstandard-settingprocessshouldbedemocratizedsoastobetteraddresstheneedsandconstraintsofthemorelimitedcapitalmarketsindevelopingcountries.
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Roundtableparticipantsdiscussedanumberofmoregranular,technicalideasbywhichdevelopingcountriescouldtakeadvantageofinternationalcapitalmarkets.First,developinggovernmentscouldprovidebetterandmorereadilyaccessibledatatointernationalinvestors.Asoneparticipantnoted,onlyahandfulofcountriesinAfricaandLatinAmericareporttotheBankforInternationalSettlements(BIS),soitisverydifficulttounderstandparticularmonetaryenvironments.Second,thesegovernmentsshouldconsiderissuingsovereigndebtinlargeenoughsizetobeincludedininternationalfixed-incomeindexes,suchasCiti’sWorldGovernmentBondIndex(WGBI)orJPMorgan’sEmergingMarketBondIndex(EMBI).“Whetheraparticularcountry’sinstrumentsareincertainindexeshistoricallyhasbeenextremelyimportantintermsofboththeperceptionandtheliquidityofthoseinstruments,”saidoneparticipant,notingthat“thereismorethan$2trillioninpassivefundsthatfollowcertainindexes.”Finally,governmentsindevelopingcountriesshouldconsiderthebenefitsofmakingtheircurrencieseuro-clearable.Beingclearableinglobalcurrenciesreducescostsandriskforlarge,globalinvestors.“Mexicohasperformedwellrelativetoitspeers,”observedaparticipant,“inpartbecausetheMexicanpesoistheonlyLatinAmericancurrencythatisEuroclearable.”RegionalcapitalmarketsintegrationParticipantsdiscussedthepotentialforregionalintegrationofcapitalmarkets,andtheassociatedrisks.Regionalintegrationcantaketheformoffullmonetaryunion,suchastheWestAfricanEconomicandMonetaryUnion(WAEMU),oraloosersystembasedonharmonizationandmutualacceptanceoflocalstandardswithinaregion,ashasbeenattemptedinEastAsia.Theharmonizationofstandardsis,ofcourse,animportantfirststepandprerequisiteforfurtherfinancial-marketintegration.Thebenefitsofregionalintegrationincludealargermarketandbetterdiversificationofopportunitiesforinvestors;greateraccesstosavingsforborrowers;andcostsavingsforregulators,marketinstitutions,andmarketintermediaries.Theseefficienciescomewitheconomiesofscale.Inaddition,awell-integratedregioncandomoretoattractinternationallong-terminvestment,includingformuch-neededregionalinfrastructureprojects.TheWAEMU,inparticular,isasuccessfulexampleofdevelopingliquidmarketsingovernmentsecurities,withregionalinstitutions.“WAEMUhaseightcountrieswiththesamecurrencyandonecentralbank,”notedoneoftheparticipants,“andtheyhavebuiltaboomingregionaltreasurybillmarket.Anybankorotherinvestorinoneoftheeightcountriescanpurchasesecuritiesissuedbyanyothergovernment,andithasbeenworkingwell.”Yetdespitethissuccess,theWAEMUhasmadelittleprogressindevelopingacorporatebondmarket.Inparticular,public-sectorpensionsmightbenefitfromregionalintegration.ANigerianfundmightbemorewillingtoinvestinKenyaninfrastructure,forexample,thaninanequivalenttypeofassetinEurope.Regionalinstitutionalfundmanagerswouldlikelyhavebetterknowledgeofand/ormightmoreeasilydoduediligenceoninvestmentsintheirownregion.Inaddition,thoseinvestmentswouldhaveapotentiallygreaterdirectandindirectpositiveeconomicspillovertothehomecountry.Butparticipantsalsoraisedconcernsaboutthemeritsofintegrationeffortsinlightoftheheavycostsofbothfinancialandpoliticalcapital.First,asoneparticipantremarked,forbothlargefirmsandSMEs,“itisnotclearthatintegrationamongequalswillachievemuchmoreontopofwhatcountriesalreadyhave.”Largefirmsusuallyhaveadequatefinancingdomestically,andthefewlargefirmsthatdowishtoraisecapitalinternationallyarelikelytodosothroughinternationalfinancialcenters.SMEs,ontheotherhand,arelikelytofacethesamebarrierstobankfinancingandthesame,limitedaccesstocapitalthattheyexperienceintheirowncountry.Second,participantsnotedthattherecanbeasymmetricbenefitsandrisksassociatedwithregionalintegration.Regionalintegrationcanbenefitonecountryattheexpenseoftheothers,andthelargestbeneficiaryislikelytobethemostadvancedeconomyinthe
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region.“Whereisthemoneyreallygoingtoflow,giventhatliquiditybegetsliquidity?”askedoneoftheroundtableparticipants.Inpartforthesereasons,participantswerealsoquicktohighlightthepoliticaldifficultiesofregionalintegration.Althoughnoteverycountryneedstobuilditsownstockmarket,forexample,oneparticipantnotedthat“politically,politiciansineverycountryseemtowantastockmarket.”Electedofficialsenjoytheprestigethatcomesfromlaunchinglarge-scalenationalprojects.Likenationalairlinesorlargedams,astockexchangecanbeperceivedasasymbolofnationalprogress.Oneparticipantalsonotedthatthosecountriesthathavepursuedaregionalapproachhaveoftenhadtointernationalize.“InAsiatheyestablishedaregionalclearingplatform,aswellasaregionalratingssystem,buttheymovedtoaninternationalclearingplatformshortlythereafterandsawregionalratingsagenciesacquiredbyinternationalfirms.”Anotherpersonarguedthat“regionalintegrationalmostseemslikelastcentury.We’reinaworldofthecloudandtheInternet.Whydoesitmatterthatthecountriesarenexttoeachother?”Onebenefitofpursuinganagendaofregionalintegrationmaysimplybewhatoccursintheprocessofdoingso:thebenefitsofknowledgetransferandpeerpressure.Asoneparticipantargued,“oneofthemostimportantbenefitsofregionalfinancialintegrationisnotnecessarilytohavemorefirmslistedinthemarket,butthefactthatregionalinitiativescreateavenueforknowledgetransferandmomentumfordomesticreformefforts.”Inotherwords,thecompetitionandpositivepeerpressureofintegrationeffortspushescountriestoreformmorequicklythantheymightotherwise.PointingtothePacificAllianceofChile,Colombia,Peru,andMexico,thesameparticipantarguedthatregionaleffortshavealsoproducedalarger,morereadilyaccessiblesetofdataonmarketactivitiesinthesecountries,bothbringingtolightinefficienciesandalertinginvestorstoopportunities.PolicyResearchQuestions! Whataretheopportunitiesandrisksfordevelopingcountriestoimportorotherwiseaccess
financialservicesfromabroadasopposedtodevelopinglocalinstitutionalprovidersforthoseservices?Whataretherisks?Whatshouldbethedecisioncriteria?Howcantechnologyfacilitatewideraccesstosuchserviceswhenlocalprovidersarenotavailable?
! Arethere‘shortcuts’toimprovingregulatorycapacity,throughthecreativeaccessof
outsideexperts.Istherearoleforregionalregulatorybodies?Coulda‘goodsealofapproval’approachbeusedtohelpimproveregulatorydecision-making,aswellascover’whenmakingdifficultdecisions.
! Underwhatconditionsshoulddevelopingcountriesseekfinancialintegrationwithregional
peers?Areregionalintegrationeffortsworththecostorwoulditbebetterformanydevelopingcountriestoseektointegrateinternationallyinsteadofregionally?
V. The Role of IFIs and Development Agencies Internationalfinancialinstitutions(IFIs)andbilateraldevelopmentagenciescanhaveaprofoundinfluenceoncapital-marketdevelopment,bothbecauseoftheirmandatesandbecausetheyare,themselves,importanteconomicactors.Participantsdiscussedtheirimportanceinbuildingcapacity,providingcreditenhancements,andcrowdinginprivateinvestment.
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Notsurprisingly,theimportanceoffinancialliteracyamongcompanies,investors,retailsavers,andregulatorsaroserepeatedlyduringtheroundtable,andparticipantsagreedthattheIFIscouldplayanimportantroleinbuildingbroadcapacitythroughtrainingandrelatedactivities.Asanexample,participantsreferredtoarecentprogramlaunchedbytheU.K.’sDepartmentforInternationalDevelopment(DFID),whichestablishedaneducationalexchangebetweenpolicymakersinTanzaniaandtheLondonStockExchange.Aspartoftheprogram,TanzanianofficialstraveledtoLondontovisittheexchangeandattendeducationalseminars,withsimilarplansforBritishofficialstotraveltoTanzaniatoofferon-the-groundtechnicalassistance.Moredirectly,IFIscananddofacilitatedeepermarketsbyprovidingcreditenhancementstolocalborrowers.Toestablishtheimportanceofcreditenhancements,oneparticipantexplainedthatbond-marketdevelopmentbeginswithsovereignissuance,followedinmostcasesbythelargestcompaniesinthecountrywhich“arewellknowninthecountryandaredeemedbyinvestorstobeequalifnotbetterthanthesovereign”intermsofcreditrisk.Furtherdownthecurve,theIFIscansometimes“pavetheway”byissuingdomesticcurrencybondsforspecificprojects.However,noneoftheseproductsrequiresacreditassessmentfrominvestors,and,accordingtooneparticipant,“marketstypicallystallatthispointbecauseinvestorsdonothaveexperienceincreditanalysisorwithcreditproducts.”ButtheIFIscanhelpintroduceinvestorstocreditproductsbyparticipatinginthedealandassumingsomeofthecreditrisk.“Cominginatthemezzanineorquasi-equitylevelandtakingasecond-losspositionaftertheoriginator,theIFCwillabsorbmostoftheriskofdefault,therebyimprovingthecreditratingofanissuance,”explainedaparticipant.“Investorsthenaremorelikelytoinvest,sometimesatlowerratesandlongermaturitiesthancompaniescouldotherwiseexpect.”India,Russia,andThailandaresuccessfulexamplesofthisapproach.AnotherwayfortheIFIstoprovidebroadcreditsupport,oneparticipantsuggested,istoplayaconstructiverolebycreating“liquiditybackstops”or“safe-assetsbackstops”forcountriesthatmeetcertaingoodgovernancestandardsandotherrequirements.TheIFIscanalsoplayaroleincapital-marketdevelopmentbycrowding-inprivatecapitalthroughinitiativesthattargetparticularsectorsandthroughsharingreputationalriskwithinternationalinvestors.USAID’sPowerAfricainitiative,forexample,hasworkedtochannelprivatecapitalintoAfricanenergyproductionbyidentifyingattractiveprojects,promotingthoseprojectstodomesticandinternationalinvestors,andclearingbarriersthatkeepinvestmentonthesidelines.ThroughtheCommonwealthDevelopmentCorporation,DFIDhasdirectlyinvestedinmission-drivenfundstopromoteimpactinvestingintheventurecapitalandprivateequityspaceinAfrica.TheAfricanDevelopmentBank(AfDB),throughtheAfrica50Fund,hasalsosoughttocrowd-inprivateinvestmentandfilltheregion’sinfrastructurefinancinggap.TheUSAgencyforInternationalDevelopment(USAID)alsoprovidescreditguaranteestolocalbanksinordertoencouragelendingtoSMEsthatmightbeoverlookedforfinancing,suchascompaniesownedbywomen.OneparticipantsuggestedthattheAfricanDevelopmentBankandtheotherIFIsheavilyinvestedinAfricashouldconsidersellingdowntheirownbalancesheetsinordertodrawinprivateequityandotherinvestment.“First-timeinvestors,suchaspensionfundsandotherentities,mayhaveinterestininfrastructureprojectsthathavenowmovedtothe‘operational’stage,”notedtheparticipant.Inthisway,theIFIshaveanopportunitytobundletheirloansandthensellonsmallerequitystakes($5millionor$10million)intheresultingportfolios.TheseinvestmentopportunitiescouldbeattractivetosmallerpublicandprivatepensionfundsbothinAfricaandabroadthatseekdiversification,astreamlinedinvestmentprocess,andimpact.Last,participantsobservedthatthefinancialengagementoftheIFIsandbilateraldevelopmentagenciesisimportantnotjusttomitigatefinancialrisk,butalsotocurtailreputationalrisk.First,otherinvestors
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canoutsourceinlargeparttheenvironmentalandgoodgovernanceduediligencetotheIFIs.Second,thepresenceoftheseorganizationsarguablyaddshefttoenforcementefforts.“Governmentsdon’tliketodefaultorotherwisehaveissueswiththeIFIs,”oneparticipantobserved.Whatcountsasgoodpolicyadvice?Participantsidentifiedseveralimportantconceptsthatshouldinformpolicyrecommendationsforstrengtheningcapitalmarketsinadevelopingcountrycontext.First,policyrecommendationsmustbepracticalandtailoredtothespecificconditionsineachoftheseeconomies.Broadadmonishmentstopolicymakersthatdonotincludeprescriptivepolicyideas(e.g.,arecommendationsimplytoexpandthedomesticinvestorbase,withoutarticulatingthestepstodoso)arenotuseful.Asoneparticipantphrasedit,“policyrecommendationsmustidentifyandthenaddressthe‘stickypieces’thatholdbackdevelopment.”Second,participantsagreedthatpolicyrecommendationsmusttakeintoaccounttheincentivestructuresofprivate-sectorborrowers,investors,andintermediaries.Asoneparticipantremarked,capital-marketdevelopmentcanneverbesustainableunlessinvestorsandintermediariesaremakingmoney.Policyrecommendationsthatdonottakeintoaccounttheprofitmotiveoftheprivatesectorwillnotleadtocapital-marketdevelopment,because“it’sjustnotgoingtocontinue.”Third,indesigningpolicyrecommendations,onemustkeepinmindthatreformdoesnotalwayshavetobeaboutstartinganewinitiative.Asoneparticipantsaid,“governmentsareconstantlyunderpressuretostartonthenextproject,whentheyareoftenbetterservedtoconcentrateonimprovingexistinginitiatives.”And,asmentioned,recommendationsshouldacknowledgethatthereisadistinctionbetweencreatingdomesticmarketinstitutionsandprovidingmarketservicestodomesticmarketparticipants,andthatpolicymakershaveachoicethere.Last,policyrecommendationsmustdistinguishbetween“whatistrulyaconstraintandwhatmakescountries‘developing’or‘frontier’bydefinition.”Participantsagreedthatpolicyideasthatdonotexplicitlyaccountforthelowincomelevels,thelimitedhumancapital,andthesmalleconomicsizeofmostdevelopingcountrieswillbeoflittlevaluetodomesticpolicymakers.PolicyResearchQuestions! Whatfinancialproductswouldbemostusefultotheprivatesectorindevelopingcountries
andhowcantheIFIshelpexpandaccesstothoseproducts?Whatistherightincentivestructure?
! Whatisrequiredtoissueinternationallyrecognized“safeassets”?Givensmalleconomicsize
andotherproblems,aretherewaysforcountriestoissue“safer”assets.WhatrolecantheIFIsplayinthesesituations?Woulditbepossible,forexample,forIFIstocreatea“liquiditybackstop”fordevelopingcountriesthatmeetcertainstandards?
###
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Suggested Reading ! LilianaRojas-Suarez,“Towardsstrongandstablecapitalmarketsinemergingmarketeconomies,”BISPapers
No.75,BankforInternationalSettlements,January2014.! TatianaDidierandSergioL.Schmukler,“FinancialDevelopmentinAsia:BeyondAggregateIndicators,”Policy
ResearchWorkingPaper6761,TheWorldBank,January2014.
! JamesR.Barth,GerardCaprio,Jr.,andRossLevine,“BankRegulationandSupervisionin180Countriesfrom1999to2011,”NBERWorkingPaperNo.18733,NationalBureauofEconomicResearch,January2013.
! Sennogaetal.,“LeveragingCapitalMarketsforSmallandMediumEnterpriseFinancinginRwanda,”AfricanDevelopmentBank,December2012.
! IsmailDalla,“EastAsianBondMarketsin2020:Progress,ProspectsandFutureChallenges,”WorkingPaper,FungGlobalInstitute,November2012.
! RamkishenS.Rajan,“MonetaryandfinancialcooperationinAsia:takingstockofrecentongoings,”InternationalRelationsoftheAsia-Pacific,Volume8,2008.
! AugustodelaTorre,JuanCarlosGozzi,andSergioSchmulker,“CapitalMarketDevelopment:WhitherLatinAmerica?”inFinancialMarketsVolatilityandPerformanceinEmergingMarkets,editedbySebastianEdwardsandMárcioG.P.Garcia,UniversityofChicagoPress,March2008.
! BarryEichengreen,EduardoBorensztein,andUgoPanizza,“ATaleofTwoMarkets:BondMarketDevelopmentinEastAsiaandLatinAmerica,”OccasionalPaperNo.3,HongKongInstituteforMonetaryResearch,October2006.
! TatianaDidier,RossLevine,andSergioSchmukler,“CapitalMarketFinancing,FirmGrowth,andFirmSize
Distribution,”NBERWorkingPaperNo.20336.! AugustodelaTorre,AlainIze,andSergioSchmukler,"FinancialDevelopmentinLatinAmericaandthe
Caribbean:TheRoadAhead,"TheWorldBank.! TatianaDidier,andSergioSchmukler,"EmergingIssuesinFinancialDevelopment:LessonsfromLatin
America,"TheWorldBank.
Acknowledgments TheMilkenInstituteisgratefultoallparticipantsfortheirtimeandtheirinsightsduringtheroundtable,andwelookforwardtocontinuedcollaborationonthesetopicsinthefuture.ThankstoJohnSchellhaseforsignificantcontributionstothissummarypaperandtoMoutusiSaufordatacompilationandresearchassistance.
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Participant List
FramingtheIssues:StrengtheningCapitalMarketsinDevelopingCountriesAworkingroundtablehostedbytheMilkenInstituteCenterforFinancialMarkets
March14,2014
Reena Aggarwal Georgetown University
Martin Alsop
UK Department for International Development
Güler Aras
Georgetown University
Jim Barth Milken Institute
Edward Bartholomew
Inter-American Development Bank
Julian Alberto Caballero Bustos
Inter-American Development Bank
Gerard Caprio
Center for Development Economics
Williams College
Ismail Dalla Capital Market Consultant
Ernesto de la Fe Morgan Stanley
Jendayi Frazer
Africa Exchange Holdings
Sasidaran Gopalan The Hong Kong University of
Science and Technology
Daniel Gorfine Center for Financial Markets
Milken Institute
Blake Haider Latin Credit Markets
Citi
Alison Harwood World Bank Group
Diego M. Herrera
Inter-American Development Bank
Bim Hundal
Lion’s Head Global Partrillioners
Maria Soledad Martinez Peria
World Bank
Stephen Matzie USAID
Lee Meddin
International Finance Corporation
Bobby Pittman
Kupanda Capital
Apanard (Penny) Prabha Milken Institute
Ramkishen Rajan
George Mason University
Liliana Rojas-Suarez Center for Global Development
Moutusi Sau Center for Financial Markets
Milken Institute
Keith Savard Milken Institute
John Schellhase
Center for Financial Markets Milken Institute
Sergio Schmukler
World Bank
Jeannine B. Scott U.S. Angola Chamber of
Commerce
Timothy Shortley Africa Exchange Holdings
Amadou Sy
Africa Growth Initiative Brookings Institution
Don-Terry Veal
Center for Governmental Services
Auburn University
Staci Warden Center for Financial Markets
Milken Institute
Heather Wickramarachi Milken Institute
Thomas Willett
Claremont Institute for Economic Studies
Claremont Graduate University
1
About the AuthorStaciWardenistheexecutivedirectoroftheCenterforFinancialMarketsattheMilkenInstitute,wheresheleadsinitiativesonstrengtheningcapitalmarkets,accesstocapital,financialeducationandfinancial-marketssolutions,amongothers.
Formoreinformation,contact:StaciWarden
ExecutiveDirectorMilkenInstituteCenterforFinancialMarkets
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