The Future of Domestic Capital Markets in Developing Countries

The Future of Domestic Capital Markets in Developing Countries

ROBERT E. LITAN
MICHAEL POMERLEANO
V. SUNDARARAJAN
Copyright Date: 2003
Pages: 400
https://www.jstor.org/stable/10.7864/j.ctt12814q
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    The Future of Domestic Capital Markets in Developing Countries
    Book Description:

    The Future of Domestic Capital Markets in Developing Countries addresses the challenges that countries face as they develop and strengthen capital markets. Based on input from the world's most prominent capital market experts and leading policymakers in developing countries, this volume represents the latest thinking in capital market development. It captures the views of a global gathering of experts, with perspectives from developing and developed countries, from all regions of the world, from the public and private sector.

    This volume should be of interest to senior financial sector policymakers from developed and developing countries in securities and exchange commissions, regulators, central banks, ministries of finance, and monetary authorities; private sector executives in stock exchanges, bond markets, venture capital markets, and investment funds; and researchers and academicians with an interest in capital market development in emerging markets. What are the key factors threatening the development and survival of stock exchanges in developing countries? What domestic strategies are needed to protect the future of local markets? Should exchanges consider linkages or alliances? Merging with, or buying up, other exchanges? Demutualization? The volume provides practical guidance on strategies such as nurturing issuers, improving rules and institutions, addressing regulatory challenges, and sequencing reforms. The contributors address a variety of country experiences, and suggest steps that policymakers and practitioners in emerging markets can take to promote an orderly transition toward efficient, well-regulated, and accessible capital markets.

    Contributors include Reena Aggarwal (Georgetown University), Alexander S. Berg (World Bank), Alan Cameron (Sydney Futures Exchange), Olivier Fremond (PSACG), Amar Gill (Credit Lyonnais Securities Asia), Gerd Hausler (IMF), Jack Glen (International Finance Corporation), Peter Blair Henry (Stanford University Graduate School of Business), Patricia Jackson (Bank of England), Ruben Lee (Oxford Finance Group), Robert Litan (Brookings Institution), Clemente Luis del Valle (Securities and Exchange Commission of Colombia), Sanket Mohapatra (Columbia University), Alberto Musalem (World Bank), Dilip Kumar Ratha (World Bank), Ajit Singh (University of Cambridge), Philip Suttle (DECPG), V. Sundararajan (IMF), Thierry Tressel (IMF), Philip Turner (Bank for International Settlements), and Piero Ugolini (IMF).

    eISBN: 978-0-8157-9610-7
    Subjects: Business, Finance

Table of Contents

  1. Front Matter
    (pp. I-IV)
  2. Table of Contents
    (pp. v-viii)
  3. Foreword
    (pp. IX-X)
    Strobe Talbott, Cesare Calari and Stefan Ingves

    Limited access to capital presents a critical challenge to growth and stability. Well-functioning markets ensure that corporations efficiently mobilize capital for growth and that markets price risk well, so that valuable projects will be financed. Most important, countries that do not have access to equity capital face higher costs of capital, often leading to segmentation of markets. In this context, the World Bank, International Monetary Fund, and Brookings Institution organized a global conference focusing on the future of domestic capital markets in developing countries. Participants addressed the challenges that developing and developed country markets face from globalization, technological changes, and...

  4. 1 Introduction
    (pp. 1-18)
    ROBERT E. LITAN, MICHAEL POMERLEANO and V. SUNDARARAJAN

    It is now well understood that economic development requires healthy growth of a nation’s financial sector. Initially, nations tend to channel their savings and investment primarily, if not almost exclusively, through banks. But over time, savers in search of higher returns and firms seeking capital provide the foundation for the development of capital markets. Here, too, a sequence is evident: first, the issuance and trading of bills and bonds of national governments, followed by the issuance and trading of bonds and equities of publicly held corporations.

    Capital markets cannot function effectively, however, unless a number of elements are in place....

  5. PART ONE Capital Market Development around the World

    • 2 Trends in Developing-Country Capital Markets around the World
      (pp. 21-44)
      GERD HÄUSLER, DONALD J. MATHIESON and JORGE ROLDOS

      One of the key structural changes in a growing number of emerging markets has been the rapid development of local securities markets since the mid-1990s. This change has reflected both policy efforts by the authorities in major emerging markets and trends in global financial markets. In this paper, we review some of the trends in the development of local markets as well as some key policy issues, as reported in several of the International Monetary Fund’s Global Financial Stability Reports.¹

      The efforts to develop local securities markets have been motivated by a number of considerations, especially the desire to provide...

    • 3 The Development of Domestic Markets for Government Bonds
      (pp. 45-76)
      CLEMENTE DEL VALLE and PIERO UGOLINI

      The World Bank and International Monetary Fund (IMF) agree that the development of domestic bond markets deserves high priority on the financial sector development agenda.¹ On the one hand, bond markets are essential for a country to enter a sustained phase of development driven by market-based capital allocation and greater avenues for raising debt capital. On the other hand, the role of domestic bond markets in markedly strengthening the resilience of a country’s financial system and insulating it against external shocks, contagion, and reduced access to international capital markets is tantamount. The World Bank and International Monetary Fund have dedicated...

    • 4 Bond Market Development: What Are the Policy Issues?
      (pp. 77-112)
      PHILIP TURNER

      Why should governments want to issue bonds in their own markets? The simplest reason historically is that bonds have become more attractive or feasible than other methods of finance. Under the highly regulated financial regimes prevalent before the 1980s, governments in many emerging markets could meet much of their borrowing needs by simply forcing local banks to hold government paper, usually to meet demanding reserve requirements. In many countries, inflation “financed” part of the government deficit. Foreign borrowing often seemed an attractive alternative in a world of fixed exchange rates. But such methods of financing were undermined by the progressive...

    • PANEL SUMMARY Country Experiences with Capital Market Development
      (pp. 113-122)

      Clemente Del Valle, chair of the panel and chairman of Colombia’s Securities and Exchange Commission, initiated the discussion by commenting that financial systems in most developing countries are fundamentally banking systems and that developing-country governments now recognize the need for capital markets. Yet despite this understanding, developing countries confront many problems as they attempt to cultivate their domestic capital market. The financial culture is so focused on banking that an investor base fails to develop and grow, as would-be investors are not accustomed to evaluating and buying securities. Many countries consequently lack the strong intermediaries and brokers that are keys...

  6. PART TWO Integrated Supervision

    • 5 Market Discipline and Financial Stability
      (pp. 125-152)
      GLENN HOGGARTH, PATRICIA JACKSON and ERLEND NIER

      This paper contributes to understanding the role that capital markets play in fostering financial stability by considering the channels through which the markets, including debt and equity markets, can exert discipline on banks. In particular, it explores whether market discipline is effective in influencing bank behavior.

      Effective market discipline depends on a number of important elements. The market must have the information to be able to assess the riskiness of the banks relative to capital. Market participants must be at risk of loss if the banks fail, or they will not act on the information.¹ For the threat of market...

    • 6 Supervision at the Micro Level: Do Disclosure-Based Regimes Work?
      (pp. 153-178)
      ALAN CAMERON

      My background is as a former practitioner of regulation, now subject to regulation, rather than as an academic, but in recent years, since giving up the active practice of regulation, I have been fortunate to observe very closely capital market regimes in both developed and emerging markets. This experience has convinced me that disclosure-based regulation remains the preferred regulatory approach for developing markets to adopt as quickly as possible, despite the perceptions of its recent failings in developed markets. But developing markets do need to understand its full ramifications—namely, that the credible threat of enforcement is needed to ensure that...

    • 7 Domestic Capital Market Reform and Access to Global Finance: Making Markets Work
      (pp. 179-214)
      PETER BLAIR HENRY and PETER LOMBARD LORENTZEN

      Over a decade ago, Robert Lucas asked the following question: Why doesn’t capital flow from rich to poor countries? His point was simple. Poor countries have lower capital-to-labor ratios than do rich ones. Under standard neoclassical assumptions, the rate of return to capital in poor countries should be higher than in the developed world, attracting capital until risk-adjusted rates of return are equalized. In other words, market pressures should lead to a positive net transfer of resources to less-developed countries, thus boosting their growth rates. Lucas encouraged us to think about the obstacles that prevent this flow from occurring. (Lucas...

    • 8 Capital Market Development and Nurturing the IPO Market
      (pp. 215-232)
      REENA AGGARWAL

      Strong securities markets are necessary for the economic growth and development of any country. Efficient raising of capital and allocation of financial resources is an integral part of economic development. Recent literature documents the direct link between capital market development and economic growth. It also documents the essential role played by capital markets in improving corporate governance, disclosure standards, transparency in the marketplace, and accounting standards.¹ The optimal amount of transparency and regulation leads to market credibility and results in market growth. A sound regulatory framework is the cornerstone of vibrant financial markets. However, global competition is the force that...

    • 9 Managing Risks in Financial Market Development: The Role of Sequencing
      (pp. 233-272)
      CEM KARACADAG, V. SUNDARARAJAN and JENNIFER ELLIOTT

      Domestic financial markets are a critical pillar of a market-based economy. They can mobilize and intermediate savings, allocate risk, absorb external financial shocks, and foster good governance through market-based incentives. As such, they contribute to more stable investment financing, higher economic growth, lower macroeconomic volatility, and greater financial stability. The development of local financial markets also reduces the risks associated with excessive reliance on foreign capital, including currency and maturity mismatches.¹ Key, but heretofore largely unanswered, questions concern the optimal path and sequencing of reforms to develop domestic financial markets and how these reforms should be coordinated with capital account...

    • PANEL SUMMARY Does Integrated Supervision Work in Emerging Markets?
      (pp. 273-280)

      Alan Cameron, chair of the panel, deputy chairman of the Sydney Futures Exchange, and a consultant with Dawson Waldron, asked the panel to discuss the use of integrated supervision in developing countries as a response to the growing complexity of the financial industry from conglomeration, globalization, and the blurring of distinct financial industries. The United Kingdom is the most prominent country to use integrated supervision, but such regulation has long been the model in Scandinavia and Singapore as well.

      Daochi Tong, deputy director general of the Department of Listed Companies Supervision in China’s Securities Regulatory Commission, observed that China’s financial...

  7. PART THREE Securities Trading

    • 10 Changing Market Structures, Demutualization, and the Future of Securities Trading
      (pp. 283-304)
      RUBEN LEE

      It is widely recognized that the pressures of competition, globalization, and technological change are threatening the development, and in some instances the very survival, of many developing capital markets. This chapter examines some options for responding to these pressures that are open to policymakers with regard to their trading infrastructure and exchanges, and also provides some practical comments on how to decide which of these policies to follow.

      The chapter is divided into six sections. The first section briefly identifies the key factors threatening the development and survival of securities exchanges in developing markets. The next four sections analyze different...

    • 11 Corporate Governance Issues and Returns in Emerging Markets
      (pp. 305-316)
      AMAR GILL

      This paper shares my views on corporate governance in emerging markets, focusing on Asia, the region covered by my company. CLSA, a subsidiary of the French banking group Credit Lyonnais, has produced its fourth report on corporate governance. We issued our first report in 2000, just after the financial crisis hit Asia, in response to the belief of our clients—international fund mangers—that this was a key area of concern for emerging markets in Asia. We have since issued a report each year, scoring the companies we cover, as well as markets, for macro determinants on corporate governance.¹

      In this paper...

    • 12 Capital Structures and Control Rights: Patterns, Trade-offs, and Policy Implications
      (pp. 317-346)
      OLIVIER FRÉMOND and MIERTA CAPAUL

      Capital structures and voting arrangements define how control is distributed among shareholders in the corporation. Capital structures may consist of a single class of shares where every share has one vote or several classes of shares with different voting rights. This chapter contributes to the one share, one vote debate by showing that “one size does not fit all” and that effective reform of corporate governance must take into account a country’s ownership structure, enforcement capacity, specific policy objectives, and idiosyncratic constraints of the political economy.

      The chapter is organized as follows. From a corporate governance perspective, countries can be...

    • 13 Identifying Vulnerabilities, Promoting Financial Stability, and Other Challenges
      (pp. 347-364)
      PATRICK K. CONROY and ARNE B. PETERSEN

      The international community has attached increasing importance to identifying vulnerabilities in the financial architecture, finding solutions to address these potential risks, and focusing on other developmental needs. In particular, the Asian financial crisis of 1997 and subsequent, well-publicized market events have highlighted the need to strengthen the functioning of markets and promote financial stability. More subtle actions, primarily concerning efficiency of markets, have also been at work to shore up financial supervisory regimes and promote cross-border financial activity.

      Continued turmoil in a number of emerging-market economies is a poignant reminder of the overall economic and societal vulnerabilities posed by financial...

    • PANEL SUMMARY Approaches to Securities Trading
      (pp. 365-370)

      Ruben Lee, chair of the panel and managing director of Oxford Financial Group, opened the discussion by asking Emmanuel Zamble of the Bourse Regionale des Valeurs Mobiliers in West Africa why West Africa sought to create a regional exchange serving eight countries, one of the few places in the world where such a structure has been attempted. Zamble replied that the countries chose to create an exchange because the nations of the West African Monetary Union wanted to provide their citizens an opportunity to invest in their economies. They considered having eight national exchanges with linkages between them, but since...

  8. PART FOUR Private Equity

    • 14 Capital Structure, Rates of Return, and Financing Corporate Growth: Comparing Developed and Emerging Markets, 1994–2000
      (pp. 373-416)
      JACK GLEN and AJIT SINGH

      This chapter seeks to establish stylized facts and, where possible, to explain differences between emerging-market corporations and developed-market corporations with respect to accounting ratios derived from balance sheets and income statements. In addition to examining relationships among accounting variables, such as capital structure, asset structure, and return on assets, we also analyze the size distribution of corporations and the manner in which they finance corporate growth. A study of these variables for developing countries is interesting in its own right, but in order to put this into perspective, a comparison with advanced countries is particularly valuable.

      The current public interest...

    • 15 Corporate Financing Patterns and Performance in Emerging Markets
      (pp. 417-456)
      DILIP RATHA, PHILIP SUTTLE and SANKET MOHAPATRA

      The sustainability of financial flows to developing countries depends heavily on the health of the corporate sector, which has been at the center of several recent crises. Corporate borrowers now account for more than a fifth of cross-border debt flows, compared with less than 5 percent in 1990, and flows of foreign direct investment (FDI), the dominant form of external financing for developing countries, are ultimately tied to corporate performance. This study examines corporate balance sheet data for major emerging markets to document trends in, and relationships between, corporate financial structure and corporate performance in the 1990s.

      The chapter is...

    • PANEL SUMMARY The Role of Private Equity in the Development of Capital Markets
      (pp. 457-468)

      Michael Barth, chair of the panel and chief executive officer of the Netherlands Development Finance Company, initiated discussion by defining private equity as a medium- to long-term financial commitment in equity or quasi-equity in illiquid securities with the expectation that future performance of the company will generate both profits and an opportunity to divest with substantial returns. Private equity serves an important role in filling the financial gap between small companies, with sales generally of $15 million a year or less, and large, publicly tradable companies, with $250 million in annual revenue or more. Managers of private equity funds seek...

  9. PART FIVE Looking Forward

    • 16 Institutional Savings and Financial Markets: The Role of Contractual Savings Institutions
      (pp. 471-502)
      ALBERTO R. MUSALEM and THIERRY TRESSEL

      Contractual savings (the assets of pension funds and life insurance companies) have been growing at much faster rates than gross domestic product (GDP) in many developed countries (for example, the Netherlands, the United Kingdom, the United States, and Switzerland) and developing countries (for example, Chile, Malaysia, Singapore, and South Africa) over the past twenty to thirty years (see table 16-1). The institutionalization of savings by pension funds and life insurance companies is bound to develop further in the future, as demographic trends push countries to reform their pension systems in order to increase the funding ratio of mandatory pension systems...

    • PANEL SUMMARY The Future of Domestic Capital Markets in Developing Countries
      (pp. 503-514)

      Cesare Calari, chair of the panel and vice president of the World Bank’s Financial Sector Division, stated that the panel was going to revisit the model of capital market development followed by the World Bank Group and the International Finance Corporation (IFC) in the 1970s and 1980s. This model was based on relatively large middle-income countries such as Brazil, Korea, and Thailand, where the IFC worked to develop financial, regulatory, and legal infrastructure. After they attained a certain level of development, the IFC helped open these countries to foreign investment so that they could be linked with global markets. However,...

  10. Contributors
    (pp. 515-516)
  11. Index
    (pp. 517-532)