African exchanges, though varying widely in terms of liquidity, ease of listing and ease of trading, are growing by leaps and bounds. From North to South, continental Africa now boasts some eighteen securities exchanges, eleven of which began operations in the past twelve years. In the same period total market capitalization of Sub-Saharan Africa (excluding South Africa) has increased from just over USD5bn in 1990 to nearly USD75bn in 1999.
African exchanges vary widely in terms of operational history, number of companies listed, capitalization and transaction volume and liquidity. Nevertheless, they were all created with the same core goals in mind:
- Increasing the savings rate of the working population, through the offering of a variety of securities accessible to as many people as possible;
- Increasing the flow of foreign direct investment into long-established or recently introduced companies through the ease and access provided by modern market systems;
- Improving corporate governance through increased transparency and access.
The growth in market capitalization in Africa is remarkable in its generality. It is no longer restricted to specific regions such as the Maghreb or to the more advanced economies such as South Africa. It is a general trend with broad penetration across political and economic boundaries. For example, starting from the North, the Moroccan economy evolves in a political environment that has not seen much change, while the venerable Casablanca exchange has experienced rapid growth through the Government's focus on privatization over the past ten years. Conversely, South Africa experienced dramatic political changes with the end of apartheid and yet its well developed and recognized exchange has shown great stability as an institution.
The growth in African exchanges has also been characterized by innovation. South Africa for example was one of the first emerging markets countries to use extensive asset swaps in order to accelerate foreign investment in its exchange. Similarly, the francophone countries of West Africa have created the world's first regional exchange, the Bourse Regionale des Valeurs Mobilieres (BRVM- Regional Stock Exchange).
The BRVM regrouped eight French-speaking members of the West African Economic and Monetary Union (UEMOA) in 1998 in the world's first regional stock exchange. It is innovative in economic and technical terms. On the economic side, the countries that formed it recognized the value of consolidating efforts to develop a common hub for capital markets development in their geographical zone. On the technical side, they have been innovative in using the most modern electronic and satellite communications equipment, enabling it to maintain performance despite the under-developed communications infrastructure in the individual countries comprising the exchange.
Not all of African exchanges are immune from political fall-out however. The Zimbabwe Stock Exchange, established in 1896 and a star performer among the emerging markets stock exchanges in 1996 and 1997, saw its turnover and its capitalization flounder since 1998, due in great part to the loss of confidence brought about by the present regime's political and economic policies. The Zimbabwe exchange is an example of how a smaller country can go it alone in developing an exchange, and in ruining it as well.
In spite of their variety in size and trading history, the African securities exchanges share some common characteristics, both positive and negative. On the positive side is their comparative youth, assuring access to the most modern technical equipment and assistance and regulatory advice. In addition, because of their colonial history, most of the legal and accounting concepts familiar to Western investors are well established, thus providing foreign investors with a familiar frame of reference. On the negative side is the lack of liquidity in shares trading, the almost non-existance of commercial paper markets, the low savings rate and supply of good quality shares.
The comparative youth of several of the African securities exchanges is an asset in that it enables the exchanges to use the best state-of-the art technology to facilitate and secure transactions. To cope with a dramatic increase in new listings that resulted from the privatization of many state-owned companies, or to start a newborn exchange, the latest state-of-the art computerized technology is a necessity, all the more so as it helps overcome the lack of communications infrastructure and trained personnel common in African countries.
Satellite communications, automated matching and settlement of buy and sell orders, automated inscription of dematerialized securities in the books of the brokers or direct investors, are essential tools for an efficient and fast-working securities exchange. Modern technology also allows internet brokers to set up systems that will be accessible from treasury departments of corporations and from individuals' homes and offices, thereby increasing the number of actors on the market and the trading volume.
Partnership agreements between nascent or developing exchanges with major exchanges of the industrialized world, that will benefit the former by making them more visible and allowing dual exchange listings for major companies, also require flawless communication systems.
The constant evolution of the information technology allows for a permanent adaptation of communications and trading tools to the needs of a given securities exchange. Outsourcing the functioning of the system lowers the starting costs substantially, converting a capital expense into an operating cost, and will also produce savings over time, by permitting exchange authorities to upgrade their systems without incurring renewed capital costs.
African countries have been receiving technical assistance in various fields for decades, and subsidized technical assistance required to set-up or manage securities exchanges has been widely available. In the same way as the Eastern European economies in transition were helped, African countries wishing to develop or set-up securities exchanges were able to tap important technical assistance resources, most often using grant funds at no cost.
International financial institutions such as the International Finance Corporation of the World Bank and various bodies of experts belonging to national securities exchanges of industrialized countries have provided important assistance with a view to building the legislative, regulatory, and accounting basis for the proper running of securities exchanges. They have also provided extensive technological assistance, again taking advantage of the latest developments in information technology applied to financial markets.
Securities laws and enforcement
Most of the African countries that set up securities exchanges over the past decade did not have modern legal and regulatory regimes governing securities trading and settlement. Consequently, the majority of the countries establishing new exchanges have established new legal and regulatory regimes using the most modern terminology and technique.
Not only is it indispensable to have a proper legislative and regulatory environment to operate securities exchanges, but it can bring about major changes in the way local companies are run. Rules on accounts auditing, disclosure and reporting to regulatory authorities as well as shareholders, prohibition of dealing on insider's information are essential to building confidence in the market.
Enforcement is no less important, and regulators must be trained and given adequate means to perform a real and productive work. As mentioned above, technical assistance in those fields is a useful means to get a good start or an updating of legislation and training of personnel.
In any country, however, creating an efficient regulatory system for securities exchanges is a difficult goal to achieve and maintain. In the case of nascent or developing exchanges, any mishap that would be seen as an isolated and minor event in a major developed market can kill the confidence in the entire system, with lasting ill effects.
Although some are better than others, most of the smaller African exchanges lack the trained manpower and experience to adequately police the modern regulatory regimes they have adopted. Consequently, enforcement actions are rare and abuses are not uncommon.
When the legal, technical and operational structures are in place, any African securities exchange, national or regional, can function as any other exchange in more developed countries. There remain fundamental shortcomings, however, due to the structural problems inherent in the least developed economies in the world. Identifying and addressing these structural problems will eventually have a beneficial impact on the African exchanges.
Insufficient savings rate and how to increase it
It is no surprise that in countries where a large portion of the population lives on less than a dollar a day, the savings rate is often non-existent and at best very low. In fact, for large segments of the Sub-Saharan African population, speaking of capital formation and securities exchanges may sound pointless and even surrealistic in light of their dire economic and political condition.
War, political unrest and oppression, endemic disease and grinding poverty are huge obstacles and symptomatic of immature political systems. They are also enormous obstacles to efforts to foster general economic and social development, and to the process of capital formation specifically that exchanges represent. The growth of African exchanges over the past decade is particularly remarkable when viewed in this light.
Moreover, this growth is particularly important as well regulated securities markets can accelerate the process of political and structural reform. For example, a public utilities privatization program usually aims at improving the state's financial position, and at providing a better service to clients and consumers of the utilities involved, such as telecommunications services or electricity production and distribution. If the equity of such privatized companies is totally or partially sold to the public through the stock exchange, the utilities' managing company will be made, and will feel, more accountable to consumers that are its shareholders too. And the feeling by the shareholder's population that they own a piece of a company that they can relate to in their daily life is a strong incentive to capital formation.
Likewise, pension funds can play a major role in countries where a general pay-as-you-go retirement system is not viable due to demographic and economic constraints. As the popularity and success of recently implemented private pension fund systems in Latin America demonstrate, salaried workers that never owned shares or bonds in the past like the idea of having a portion of their monthly salary withheld and immediately invested in mutual funds that they know are well regulated. They can relate to their growing savings much more concretely and easily through their account statements than to a much more abstract system of contributing to a system that does not inform them of their account status until retirement.
So not only does a nascent private pension system provide funding for the state (Treasury bond issues) and for private corporations (bond and stock issues), it contributes to the formation of capital by the public. Progressively, through concrete and vivid personal experience, the public accesses an economic and financial universe that offers an individualization of property through a common set of rules. It is a universe that provides for the protection of property rights on intangible assets such as securities at an individual level. They thus realize that the future reward in the form of a pension is worth the immediate sacrifice of purchasing power through their savings effort and they accept it because they trust the collective system of rules designed to protect individuals' future well being.
Therefore, however modest the start-up and development of a securities exchange may be in an African country, it is a radical departure from the past and is therefore destined to play a major role in the slow but essential capital formation process of the country concerned. This requires, however, a very firm commitment by the government to set up an independent body of laws and law enforcement agencies that will guarantee equality of treatment, rights and obligations for all participants.
Supply and quality of securities
Unlike the major exchanges in Johannesburg, Casablanca and Cairo, most of the new African exchanges suffer from a lack of good quality securities to offer investors. Typically, most sub-Saharan exchanges will have only two or three corporations sufficiently capitalized and solid to be listed and of interest to external investors and most of these are either subsidiaries of major multinational corporations or recently privatized companies. Consequently, when offered a choice of investing in the parent on a Western exchange or a local subsidiary, fund managers choose the safer course and invest nearer to home.
Moreover, even when the parent-subsidiary choice is not on offer, many external investors find it difficult to obtain shares in the best companies on African exchanges because trading volumes are low, choices few and the best shares are held by local pension funds, banks and insurance firms that do not want to sell. With few alternative assets to buy with sales proceeds, these institutions hold onto their shares.
Breaking through the ice in these illiquid exchanges is difficult and will only change over time with close Government support. Only through the supply of quality securities will these new exchanges create needed confidence and positive expectations. Therefore it is very important that the securities exchange authorities maintain high standards for listings while heavily promoting the benefits of new listings with local companies. The country's Government should also support this effort, demonstrating its commitment to the development of a local capital market by increasing the number of companies to be privatized and marketing to the public the concept of saving through mutual funds.
Some countries in Africa have turned to the Treasury bill and bond sector to provide for a faster increase in the supply of securities. This was the case in exchanges such as Zambia and Nigeria, particularly in politically distressed periods in both countries. The key confidence element here is the soundness of the state's fiscal accounts, and its demonstrated commitment to pay its debt, whether domestic or external.
Most of the internal T-bill markets in Africa have avoided defaults, particularly in countries with their own currencies. In Francophone countries, however, where the currencies are linked to the French Franc, internal debt markets have developed more slowly and defaults have been higher, due to the inability of these countries to adopt independent monetary policies.
To attract bond buyers to internal and external debt markets, the implementation of sound macro-economic reform by the issuers is essential. A concomitant development of local capital markets will interact positively with these reforms, by providing the state with a source of local financing that could not otherwise be tapped globally. Local investors can also benefit from investment in the foreign currency denominated external debt of their governments. Investment in the external debt is a useful savings tool, acting as a currency hedge as well as providing hard currency fixed-income revenue to institutions with primarily local currency income. Such investment also contributes to balance of payments financing by returning hard currency that would otherwise remain abroad as debt service.
African countries are in many cases over-burdened with external and internal debt and yet have a difficult time attracting investors in these assets despite default rates that are comparable to other emerging market debtors in Latin America and Eastern Europe. For African countries, much of the problem lies in quasi-sovereign character of their creditors, as the majority of the tradeable debts are owed to export credit agencies that do not mark to market.
Whether it is newly issued debt or already defaulted, there are many ways in which sovereign debt can be structured to appeal to different classes of investors with varied risk appetites.
Generally speaking African governments tend to rely heavily on the advice of official creditors (including International Financial Institutions), and, upon their advice, try to have their bilateral export credit debt to sovereign creditors ("Paris Club" debt) and their commercial lenders' debt ("London Club" debt and "Trade Debt") written off to the greatest extent possible.
This tends to restrict the access of all but the largest countries to the Western capital markets. It is expected that eventually, this will change as innovative securitization techniques presently being used by banks and corporate creditors become more attractive to quasi-sovereign and sovereign creditors.
The marking to market and repackaging of these large stocks of debt owed by African countries should have the salutary effect of providing greater liquidity to the assets. As important, these securitizations should provide debt relief to the obligors at the same time that it creates surrogate yield curves for countries that presently are shut off from the international capital markets.
Once these assets are screen traded and individual countries develop track records of performing on the restructured assets, confidence will build and lead to greater participation in local debt and equity markets.
For African countries, challenges and hurdles abound on the road to capital formation. Provided they are well designed and set up, properly regulated and supported by appropriate governmental policies, securities exchanges can be a powerful tool for growing indigenous capital that will attract international capital. This virtuous circle is much to be desired and has been delayed too long.