Efforts by many developing countries to establish reliable domestic capital markets have played an important role in attracting foreign capital. This section reviews recent measures adopted to improve the institutional setting of those markets, to harmonize regulations, and to broaden investor bases at home and abroad. It also reviews recent changes in regulations in creditor countries affecting the access of developing countries to international capital markets.
Reform of Regulatory Structures
Over the last year, many emerging market countries have taken steps to improve the quality of regulation in their capital markets. Mexico introduced thoroughgoing reforms in 1993. New measures strengthened the supervisory authority of the Comisión Nacional de Valores, improved the institutional structure of the stock market, and formalized automated trading. Uruguay is taking similar steps to regulate its capital markets and create an independent securities regulator, which will take over functions currently exercised by the central bank. In February 1994, Poland introduced a new securities law to govern the over-the-counter securities market.
Russia has some 80 small stock exchanges dispersed throughout the country, and most trading is conducted over the counter. In a recent survey, about half of the country’s privatized enterprises envisaged raising capital with new share issues in 1994 (and from July 1, 1994, all shares are to be sold for cash rather than vouchers). The country’s recently formed Commission on Securities and Stock Exchanges is now responsible for unifying all state agencies under a single entity and developing regulations. The Commission is currently drafting legislation to create a single independent regulatory body that will have jurisdiction over such matters as disclosure requirements and clearing and settlement systems.
Following an overhaul of China’s regulatory framework in early 1993, a number of further revisions were made over the last year. A permanent National Securities Law, however, has yet to be ratified by the People’s Congress.33 In an effort to restrict the rising incidence of informal curb markets, the authorities have made it mandatory for all shares to be issued and traded through state-run securities firms. Following the closure of a large black market exchange, Chengdu, in southwestern China’s Sichuan province, is currently seeking to establish China’s third stock exchange after Shenzhen and Shanghai. Efforts to increase the listings and quality of “B” shares, and thereby to attract more foreign investors, are being taken across the exchanges. The Shenzhen Stock Exchange, for example, recently introduced a number of measures aimed at improving disclosure, regulation, and accounting standards applying to “B” shares.
Many countries over the last year have taken actions to improve disclosure, listing, and accounting standards, which make local capital markets more transparent and promote investor confidence. Introduced in December 1993, Venezuela’s Comisión Nacional de Valores issued regulations to harmonize the financial statements of companies listed on the country’s stock exchanges and to clarify the responsibilities of auditors in the preparation of financial reports. Peru’s Bolsa de Valores de Lima now requires that all listed companies disclose complete financial information for parent companies. In Malaysia, all listed companies now have to establish audit committees, which review internal accounting controls, supervise external financial reporting, and assure accurate financial disclosure.
Deficiencies in investor protection can seriously undermine investor confidence in emerging markets.34 As markets mature and develop in sophistication, countries have increasingly recognized the need, in particular, to improve the enforcement of measures to limit and oversee insider trading. From the beginning of 1994, for example, the Securities Board of India (SEBI) has introduced a series of legislative measures specifically aimed at tightening investor protection. These include regulating all transactions between clients and brokers and permitting the SEBI to inspect the books of debenture trusts. The SEBI has also been empowered to prosecute companies whose prospectuses misrepresent the facts. Further plans include requiring disclosure on a continuous basis and improving transparency through screen-based trading and internationally acceptable custodial and depository services. In Malaysia, the Kuala Lumpur Stock Exchange recently introduced new minimum standards of conduct for member brokerage firms to ensure equal opportunities and information for all clients. Peru introduced a new insider trading law at the end of 1993 that specifically forbade the use of preferential information. In Chile, insider trading was more clearly defined and made punishable by law in January 1994. Plans by Chile’s Superintendencia de Valores y Seguros to improve market surveillance, including the expansion of electronic monitoring capacity, will strengthen enforcement. Similar changes to Mexico’s National Securities Law late in 1993 included much stricter legislative criteria and penalties on the misuse of insider information. Finally, Poland’s new securities law, among other things, establishes strict penalties for securities offenses, including the falsifying of information in prospectuses.
Steps also continue to be taken to improve clearance and settlement procedures in emerging markets as well as to enhance overall trading systems. The efficiency of such systems can help to promote rapid market development, and several countries are moving toward fully electronic systems. Well-developed procedures help to ensure effective surveillance and regulatory control, promote investor confidence, and facilitate cross-border securities transactions. Chile, for example, has recently established a centralized clearing house and depository, which was expected to be fully operational for equity-fixed income and money market trading by the end of 1994. Venezuela is presently formulating plans for a similar depository. Currently, the custodial function is decentralized, with asset titles held by the transfer agent, brokerage house, custodian bank, or final investors. Over the last year, Mexico’s national securities depository (S.D. Indeval) has been authorized to provide simultaneous payment and securities delivery, as well as direct securities clearance services in ADR-related operations. These modifications are specifically aimed at providing efficient trading and liquidation, and overcoming differences in settlement periods across international markets. Having commenced electronic trading in 1991, Singapore’s stock exchange is expected to have a completely electronic settlement system this year. As part of Indonesia’s plans to improve settlement procedures and strengthen enforcement capabilities, Jakarta’s stock exchange intends to replace manual trading with computerized trading in mid-1994. During 1994, Hungary established a fully operational clearing house and share depository, which has reduced settlement time.
Expanding the Investor Base
Several countries have established new securities markets where none previously existed. At the beginning of 1994, Zambia formalized a securities regulatory regime, with oversight power invested in a Securities and Exchange Commission. This permitted the opening of the country’s first stock exchange, which commenced operations in Lusaka in February. Nepal also opened its first stock exchange in January 1994, and 62 firms listed their shares. Nicaragua is expected to open a securities exchange, which will be the prime vehicle for the privatization of state assets.
In an effort to provide smaller companies with easier access to investable funds, a number of countries have recently established second-tier markets characterized by less stringent listing and disclosure requirements. This has the benefit of providing a phased movement to full public listing; it also assists in longer-term efforts to deepen markets. Recent changes to Mexico’s Securities Law, for example, defined a second market with more lenient regulatory and disclosure requirements. Similarly, Brazil released draft regulations in February 1994 for a special over-the-counter market to handle smaller companies. In the Czech Republic, while listed companies on the Prague Stock Exchange must provide quarterly as well as annual financial reports and are required to promptly report substantive events affecting the value of their shares, unlisted but tradable companies face more lenient disclosure requirements.
Many developing countries with advancing capital markets have also expanded their efforts to widen the product range of assets available and to liberalize investors’ access. Colombia recently modified rules to allow small and medium-sized investors access to securitized bond issues. In tandem, new legislation permitted both the state oil company and other public sector entities to issue securitized debt related to infrastructure projects; securitization of real estate assets has also been allowed. Under Venezuela’s new banking law, banks can now diversify into securities other than traditional instruments like certificates of deposit. Thailand recently relaxed its restrictions on provident funds to enable them to invest in unsecured instruments. Similarly, Chile has permitted pension funds to invest in nonrated company shares, derivatives, and foreign securities; securitized paper has also been expanded to include home mortgages.
The creation of credit rating agencies can also help to expand the investor base by standardizing and improving the quality of available information. Several countries, therefore, allow foreign credit agencies to participate in joint ventures in their domestic markets to help develop credit criteria that conform to international standards. Over the last year, a number of countries have also introduced domestic rating agencies. Chile recently modified the role of the National Ratings Commission (NRC) to preclude it from making its own evaluations but to extend its authority to oversee the work of private agencies. Peru recently set up a risk classification commission to develop a credit rating system in line with international standards. Under the current stock market code and new legislation relating to recently formed pension funds, the Peruvian authorities have specified that all institutional investors must operate within such a system. In early 1994, Venezuela’s CNV established regulations for new credit risk agencies, the first of which opened in March. Colombia also opened its first risk-rating agency (under foreign ownership) in late 1993.
Several countries have made it easier for foreign brokers to operate in domestic markets, often in partnership with domestic companies. Such measures potentially have the virtues of facilitating the transfer of valuable information technology and of providing a useful degree of comfort for new foreign investors. In an effort to enhance market competition, the Security and Exchange Commission in Taiwan Province of China reduced capital requirements for foreign brokerage firms and brought them into line with domestic houses.35 In April 1994, Thailand allowed foreign brokerage firms to purchase up to 49 percent of the shares of Thai securities firms. In March 1994, Russia granted the first securities license to a foreign-owned investment institution. Similarly, Poland is scheduled to allow foreign brokers to set up offices.
In the course of market development, a greater variety of instruments become available to investors. This allows them to diversify their portfolio and hedge possible risks more effectively. Derivative instruments, including futures, options, and warrants, greatly enhance flexibility. To make effective use of such instruments, however, markets need adequate liquidity in underlying assets. Well-functioning regulatory structures and clearing-and-settlement systems also are essential. Without adequate liquidity and regulatory oversight, the premature introduction of such instruments can increase the risk of destabilizing fledgling domestic securities markets and undermining the local banking system. With such factors in mind, Taiwan Province of China is currently in the final phase of a three-stage program to establish a domestic futures market; operations are scheduled to begin in late 1994. Thailand recently commissioned a feasibility study on the establishment of a similar market; the study is aimed particularly at specifying necessary regulatory structures, capital adequacy requirements, and product ranges. Hong Kong is expected to open an options market in late 1994 in line with continuing efforts to expand the availability of financial derivatives. Likewise, in October 1993, Mexico approved the trading of inflation-linked options based on government securities linked to the consumer price index. Finally, in February 1994, Venezuela issued regulations to govern new markets for options and futures.
During the past few years, countries have been cooperating more intensively on capital market regulatory issues. Such efforts tend to accelerate as domestic markets become more mature. Countries with relatively advanced markets commonly see greater integration as a way of improving their global competitive positions. Regulatory harmonization, however, can also strengthen emerging markets.36
A recent study by the Development Committee of the International Organization of Securities Commission surveyed securities regulatory commissions of 23 developing countries and found that nearly all were moving toward harmonizing procedures, regulatory requirements, and accounting standards.37 Many are also removing restrictions on the sale of local securities abroad and foreign securities in local markets. On the basis of this survey, three goals were set: (1) to promote the provision of reliable information on changes and improvements in international regulatory procedures and accounting standards; (2) to stimulate the interest of members in lifting restrictions on the placement of local securities in foreign markets and foreign securities in local markets; and (3) to organize regional associations that will help overcome difficulties commonly faced in emerging markets.
Consistent with the latter goal, a number of countries in Latin America passed legislation over the last year providing for the approval of cross-border listings with nearby countries. The Mercosur group of countries (Argentina, Brazil, Paraguay, and Uruguay), for example, had passed legislation by early 1994 to allow the trading of stocks and bonds across one another’s markets. Colombia recently approved the listing of foreign companies on its domestic market, provided certain listing and disclosure requirements were met. It also broadened the scope for domestic companies to make public offerings abroad. Separately, Argentina is considering granting Mexican companies access to its local capital market. Mexico’s new National Securities Market Law established an international trading section on the Mexican exchange and allowed a recently created central depository institute (Indeval) to serve as custodian for foreign securities. This enables local brokers to complete transactions in foreign securities for their clients. In an analogous effort to promote interregional investment as well as to facilitate privatization, the stock exchanges of Bahrain, Jordan, Kuwait, Oman, Morocco, and Tunisia were expected to be linked by September 1994; the Arab Monetary Fund was providing assistance. Similarly, the Hong Kong Stock Exchange announced its intention to focus on attracting equity placements by foreign countries (particularly China).
In order to promote information sharing and advance toward market integration, a number of countries have recently negotiated memoranda of understanding with one another. In Latin America, all countries have signed memoranda with at least one other country, often a regional partner. In March 1994, for example, the Venezuelan and Colombian securities commissions signed a memorandum of understanding to formalize cooperation on the exchange of information about changes in regulatory and judicial issues, technical assistance, and investor protection. One purpose of the agreement is to combat money laundering. In early 1994, the London Stock Exchange and the Shanghai Securities Exchange also signed a memorandum of understanding to promote technical cooperation and lay foundations for the joint listing and trading of securities. In addition, Brazil’s Bolsa de Mercadorias and Futuros and the New York Mercantile Exchange signed a memorandum of understanding to share information on regulatory and technical issues.
Regulatory Changes in Creditor Countries
In November 1993, the U.S. Securities and Exchange Commission (SEC) adopted measures to simplify the listing of foreign companies in U.S. markets. The new measures include recognition of international accounting standards, easier registration procedures, and reducing the required reporting history from three years to 12 months. They also narrow the size requirement for a public flotation from $300 million to $75 million. Over the last year, the SEC has also assigned “recognized custodian status” to a number of emerging markets. This allows the foreign custodian to handle securities deposited by American investors, which simplifies clearance and settlement procedures. To a large extent, this recognition reflects improvements in the institutional environment in several developing countries, including Mexico and Thailand. In a similar vein, during the last year, the SEC accorded “ready market status” to Mexican Government debt instruments denominated in pesos, including treasury certificates (Cetes), inflation-adjusted bonds (Adjustabonos), and long-term instruments (Bondes). This modification allows U.S. securities firms to assign only a 7 percent capital charge against the asset, in contrast to the 100 percent charge required previously.
In analogous moves, the Australian Stock Exchange recently proposed to establish a separate “Asian market” trading board in order to attract listings from China and other Asian countries. At present, around 14 Chinese companies have expressed an interest along with a number of firms from Korea, Malaysia, and Singapore. It is expected that by the end of 1994 up to 10 companies could be listed. Asian companies intending to list would have to comply with the same requirements that apply to domestic firms, including abiding by international auditing standards and submitting semiannual reports.
Over the past several years, nearly all creditor countries have modified their provisioning requirements for commercial banks in light of the improving prospects of many developing countries.38 Although this trend in part reflects the stronger capitalization of creditor banks, it is also based on the enhanced creditworthiness of certain indebted countries. Sound macroeconomic policies, the effective restructuring of existing commercial bank debt, and the restoration of access to the international capital markets, all underlay the trend.
Provisioning requirements now tend to be much more responsive to variations in creditworthiness. For example, changes introduced by Belgium and Switzerland in 1993 replaced flat cover ratios of 60 percent and 65 percent, respectively, with a graded system that assesses debt-servicing capacity and a range of macro-economic and political factors. In most countries, average provisioning to cover exposure to developing countries has declined. In Japan, however, where bank provisioning is relatively low by international standards, a reduction in developing country exposure has helped to raise the average level of provisioning. In addition, an increase in provisioning by German banks over the last few years reflects proportionately higher exposure to Eastern Europe and the countries of the former Soviet Union (Table A20).
Early in 1993, the State Council Securities Policy Commission assumed chief responsibility for regulation and surveillance for China’s securities markets. Temporary regulations were introduced governing the domestic market (“A” shares and bonds) and Hong Kong flotations (“H” shares). As yet, China’s “B” shares for foreign investors, listed on the Shanghai and Shenzhen exchanges, do not necessarily receive the same level of protection. For further information of developments of China’s capital markets, see Goldstein and others (1994).
According to the IFC, of 22 emerging markets, only 6 have investor protection laws of internationally acceptable quality. See International Finance Corporation (1994b).
Foreign brokers have been allowed to operate in Taiwan Province of China since early 1993, but only one full branch has in fact opened.
For further information on the integration of capital markets in developing countries with those in the rest of the world, see Goldstein and others (1993).
For further information on regulatory practices in creditor countries as well as procedures by which developing countries may “graduate” from the need for creditor banks to make provisions, see Collyns and others (1992 and 1993).