Abstract
This Selected Issues paper analyzes the challenges that the Republic of Slovenia will face in the coming years. It examines the efficiency of the Slovene banking sector in the European Union context. The paper analyzes indicators of bank efficiency by comparing performance indicators for banks in Slovenia, the European Monetary Union, and new member states. It presents results from cross-country econometric estimates of banking sector cost efficiency. The paper also discusses results from estimates of cross-country banking sector contestability, and the determinants of efficiency and contestability.
IV. Issues with Capital Market Development in Slovenia24
Summary
Slovene capital markets remain less developed than their EU peers, and financial market integration with the EU is only starting. The supply of investment instruments and the investor base are narrow, while infrastructure is gradually being integrated with EU markets.
Deeper capital markets and greater financial integration with the EU would foster growth and financial stability by providing financing alternatives for companies, especially for SMEs, new or leveraged domestic enterprises, and would help diversify risks and accumulate pension savings.
To develop capital markets, Slovenia should follow a hybrid strategy that removes obstacles to deeper integration with EU capital markets and constraints on domestic market development to meet local needs.
A. Introduction
62. The Slovene financial sector is less developed than that of countries in Europe with similar incomes. Despite strong credit growth in recent years, bank assets, at 40 percent of the EMU average in 2005, are well below those in EMU peers. Intermediation in Slovenia relies mostly on the banking system with established lending relationships. The development of the non-bank financial sector is even more behind EMU peers - their assets, at about 20 percent of EU average, were half of those in Portugal. Integration with EU markets is also only beginning.
Financial System by Assets, 2005
(Percent of GDP, EMU=100; end of period)
Financial System by Assets, 2005
(Percent of GDP, EMU=100; end of period)
| Slovenia | Portugal | Spain | Greece | EMU | |
|---|---|---|---|---|---|
| Total assets of credit institutions | 39 | 86 | 84 | 55 | 100 |
| Total investment of insurance corporat | 21 | 63 | 52 | 14 | 100 |
| Total assets of pension funds | 26 | 125 | 81 | 0 | 100 |
| Total assets of investment funds | 14 | 42 | 44 | 21 | 100 |
Financial System by Assets, 2005
(Percent of GDP, EMU=100; end of period)
| Slovenia | Portugal | Spain | Greece | EMU | |
|---|---|---|---|---|---|
| Total assets of credit institutions | 39 | 86 | 84 | 55 | 100 |
| Total investment of insurance corporat | 21 | 63 | 52 | 14 | 100 |
| Total assets of pension funds | 26 | 125 | 81 | 0 | 100 |
| Total assets of investment funds | 14 | 42 | 44 | 21 | 100 |
63. Capital market development would enhance growth potential and reduce vulnerabilities. A number of studies have pointed out that greater reliance on capital markets can improve access to finance by new and innovative enterprises.25 This is important in Slovenia that has to compete by increasing productivity and technological upgrading of production. By improving access to equity, a more diversified financial system can also reduce vulnerabilities, for example, from high reliance on debt financing in Slovenia.
64. Capital market development can also contribute to financial stability. More diversified and liquid markets could attract investments from Slovene institutional investors that currently prefer to invest abroad. International integration can enable all types of investors, including retail investors, to maintain a diversified global portfolio and better manage risks. A broader investor base could enable companies to raise capital from the local market at lower costs, and banks can develop alternative sources of revenue from investment services. More open financial markets would also increase transparency and accountability. This would support the overall stability of the financial system.
65. EU integration and euro adoption are both an opportunity and challenge for capital market development for a small country like Slovenia. With the removal of currency risk and the adoption of EU directives, the scale and scope of Slovenia’s financial integration with the EU is set to deepen. This can bring sizeable benefits for Slovenia by overcoming the problems with the small domestic market. At the same time, it will complicate capital market development at home by greater competition and pressure to find niche markets with a local comparative advantage. Slovenia’s situation is therefore indicative for many other smaller emerging countries that move towards integration with an established market, such as the other new EU member states.
66. This study recommends a hybrid strategy for capital market development in Slovenia. The study first takes stock of the current state of development of Slovene capital markets. It then develops a hybrid approach to capital market development that deepens the integration with European capital markets while preserving a local market segment that is tailored to the needs of domestic issuers.
B. State of Development of the Slovene Capital Markets
67. Key indicators of market development show that Slovene capital markets remain underdeveloped in terms of relative and absolute size. Despite recent growth in market capitalization, equity turnover has remained low. While the number of outstanding bonds point to a considerable market size, most bonds are illiquid. Despite a deregulation of investment restrictions and a pension reform, assets under management of pension and mutual funds and insurance companies are low.
Capital Market Key Indicators
Capital Market Key Indicators
| Slovenia | EU | |
|---|---|---|
| Equity market capitalization (in percent of GDP), end-2006 | 42.1 | 82.8 |
| Equity market turnover ratio, end-2005 (in percent) | 9.1 | 90.8 |
| Outstanding domestic bonds (in percent of GDP), end-2005 | 22.4 | 88.1 |
| Assets under management (in percent of GDP), end-2005 | 20.6 | 115.3 |
Capital Market Key Indicators
| Slovenia | EU | |
|---|---|---|
| Equity market capitalization (in percent of GDP), end-2006 | 42.1 | 82.8 |
| Equity market turnover ratio, end-2005 (in percent) | 9.1 | 90.8 |
| Outstanding domestic bonds (in percent of GDP), end-2005 | 22.4 | 88.1 |
| Assets under management (in percent of GDP), end-2005 | 20.6 | 115.3 |
Capital market size and volume
68. Equity market capitalization doubled last year, but trading remains thin. Rising stock prices, capital increases, and a listing of a large enterprise (Telekom Slovenije) boosted equity market capitalization to 42 percent of GDP in 2006. Although this makes Slovenia’s equity market comparable to Germany in relative terms, liquidity is thin by EU standards, pointing to low market activity.
Equity Market Capitalization, end-2005
(In percent of GDP)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Sources: EMDB; Belgrade Stock Exchange; Bratislava Stock Exchange; Ministry of Finance, Macedonia and WEO.Equity Market Capitalization, end-2005
(In percent of GDP)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Sources: EMDB; Belgrade Stock Exchange; Bratislava Stock Exchange; Ministry of Finance, Macedonia and WEO.Equity Market Capitalization, end-2005
(In percent of GDP)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Sources: EMDB; Belgrade Stock Exchange; Bratislava Stock Exchange; Ministry of Finance, Macedonia and WEO.
Equity Turnover Ratios, end-2005
(In percent)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: EMDBEquity Turnover Ratios, end-2005
(In percent)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: EMDBEquity Turnover Ratios, end-2005
(In percent)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: EMDB69. Most trading takes place off market, thereby reducing transparency and market information. About one-third of the total trading volume, and 41 percent of equity trading took place off-market (“unofficial market”) in 2005. Furthermore, block trades (large transactions that are bilaterally negotiated) accounted for another 16 percent of total trading volume, and 27 percent of equity trading in 2005. These practices have made regular trading volumes at the Ljubljana Stock Exchange (LJSE) small and relatively illiquid. The dominance of these negotiated deals differentiates the LJSE from more established stock exchanges, which usually have a smaller share of negotiated deals and require more timely reporting.
Negotiated Deals
(Percent of total value traded, 2006)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: FESE, staff estimates.Negotiated Deals
(Percent of total value traded, 2006)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: FESE, staff estimates.Negotiated Deals
(Percent of total value traded, 2006)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: FESE, staff estimates.70. The relative size of the local bond market is similar to that in the other new EU member states, but smaller than that of EU peers. The amount of outstanding bonds stood at 22 percent of GDP in 2005. Three quarters of the total consists of government bonds, while the rest are mostly bonds issued by local banks.
Outstanding Domestic Bonds, end-2005
(In percent of GDP)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Sources: BIS; Local authorities; Deutsche Bank; Fitch Polska; Cbonds; Erste Bank and WEO.Outstanding Domestic Bonds, end-2005
(In percent of GDP)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Sources: BIS; Local authorities; Deutsche Bank; Fitch Polska; Cbonds; Erste Bank and WEO.Outstanding Domestic Bonds, end-2005
(In percent of GDP)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Sources: BIS; Local authorities; Deutsche Bank; Fitch Polska; Cbonds; Erste Bank and WEO.71. The dominance of bank finance and competition from EU sources have complicated bond market development. Alternative sources of funding for corporates, mostly from banks that refinance in the EU, is abundant. This makes bond finance more expensive than loan financing for non-financial corporations. Furthermore, despite recent efforts to develop a special local market (the “TUVL”), government bond issuance is set to migrate to the euro market that can finance larger volumes with lower spreads (Box 1). This is a good example of problems faced by small economies in capital market development with greater international integration.
The Rise and the Fall of TUVL
An over-the-counter trading platform for government bills and bonds, named the “TUVL”, was created in Slovenia in September 2005 to increase market liquidity and transparency. To promote trading, the issuer assumed the trading cost, and clearing costs were negotiated to be less than 10 percent of the normal fee levied.
OTC Trading
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: Bank of SloveniaOTC Trading
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: Bank of SloveniaOTC Trading
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: Bank of SloveniaThe initiative helped to concentrate the formerly fragmented trading activity and greatly reduced trading costs. Trading volume increased by eight times in the first month of operation and the average trade size doubled. Pre- and post-trade transparency improved as market maker quotes were accessible through a public web page maintained by the LJSE.
While the creation of the TUVL is a good example of how a concerted initiative can boost liquidity and transparency of the trading activity, it also points to the difficulties of capital market development in small countries with increasing international financial integration. Trading volumes at the TUVL declined recently when issuance activity migrated to the euro government bond market (using the pan-European MTS trading platform). Although this will cease local trading, the adoption of MTS brings significant advantages, such as better access to foreign investors and the possibility to implement the MTS repo facility. Given that the initial investments in the TUVL infrastructure did not pay off, this case also illustrates the need to develop a long-term strategy for capital market development.
72. Trading in other financial instruments, such as derivatives or structured products, is virtually nonexistent. Repurchase transactions (“repos”) are conducted mostly outside Slovenia, which is more cost efficient and less cumbersome. For similar reasons, securities borrowing and lending transactions are rare, and there have been no issues of asset backed securities (ABS). With regard to derivatives, some currency and interest rate products are traded over the counter and a few exchange traded funds (ETFs) are listed at the LJSE.
73. The EU integration process has started. Until recently, bank loans from abroad were the main source of integration with EU financial markets. However, compliance with EU directives, such as for investment services (“ISD”) and collective investments (“UCITS”), set off a process that ultimately will lessen the importance of national borders. After Slovenia lifted the investment restrictions on mutual funds, the share of foreign securities in domestic portfolios increased substantially. At the same time, funds domiciled elsewhere in Europe have been launched in Slovenia, and currently outnumber domestic funds. Certificates on the local stock exchange index have also been listed in Frankfurt and Vienna. This has attracted the attention of international investors and improved liquidity, as selling the certificate requires the issuer to hedge on the local market.
Issuer and investor base
74. The supply of investable instruments has been limited due to the small market size and reliance on other sources of finance. The number of issuers of bonds or stocks has been low, partly because of the limited number of sizable companies in Slovenia and the absence of listings from abroad. The government still holds important stakes in many financial and other enterprises and, apart from Telekom Slovenije recently, has not actively pursued their listing on the stock exchange. Privatizations, which in some countries have helped create an investor base, have mostly been conducted by private placements instead of public offerings at the stock exchange.
75. Despite recent growth, the investor base remains small and concentrated. Compared to EU peers, the institutional investor base is shallow. However, the investment fund industry is growing strongly. Since the relaxation of foreign investment restrictions in 2001, private savings are increasingly channeled into mutual funds. Direct participation of retail investors has remained low given the absence of discount brokerage services. Foreign investors are increasingly present (as inward investment in securities has grown to 12 percent of all Slovene securities) and contribute to trading liquidity at LJSE: As active market participants, foreign investors have a 2.3 times higher turnover ratio than domestic investors. Therefore, foreigners provide liquidity and contribute disproportionately to price formation.
Assets under Management, 2005
(percent of GDP)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: OECD, Securities Market Agency, Insruance Supervision Agency, and staff estimates.Assets under Management, 2005
(percent of GDP)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: OECD, Securities Market Agency, Insruance Supervision Agency, and staff estimates.Assets under Management, 2005
(percent of GDP)
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: OECD, Securities Market Agency, Insruance Supervision Agency, and staff estimates.76. The small share of the free float reduces trading liquidity. There is a strong positive relationship between free float and stock market turnover. In Slovenia, the free float capitalization of the prime market (the most liquid segment at the LJSE), at 61 percent of the total capitalization, is relatively low compared to, for example, the DAX (88 percent).26 This points to a concentration of ownership in many Slovene companies. For 18 smaller companies, for which data is available, the free float stands at only 35 percent.
Free Float and Turnover of Stocks traded at LJSE
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: LJSE, and staff calculations.Free Float and Turnover of Stocks traded at LJSE
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: LJSE, and staff calculations.Free Float and Turnover of Stocks traded at LJSE
Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A004
Source: LJSE, and staff calculations.77. Given the limited demand and supply of securities, capital is not raised by initial public offerings (IPOs). With the small number of potential buyers, companies consider an IPO to be too expensive vis-à-vis a private sale. Larger issuers would need to consider listing abroad given that the onshore market does not offer sufficient absorptive capacity. Since listing in an illiquid market does not bring the benefits of deep capital markets, corporations prefer to remain unlisted given the direct and indirect costs of compliance with the stock exchange’s transparency rules. Thus, the limited supply and demand of investable securities has become self-reinforcing.
Infrastructure and regulation
78. The only organized market for securities trading in Slovenia is the LJSE. The LJSE offers trading of equities, bonds, and investment funds. Order book trading is conducted through a trading system called BTS, while block trades are negotiated bilaterally and reported to BTS once a day. The large over-the-counter (OTC) market (“unofficial market”), which accounts for one third of the overall trading activity, does not use any specific trading infrastructure. However, some investors, such as investment funds, are restricted from engaging in off-market trading.
Trade Volume in 2006
Trade Volume in 2006
| Total trade | Type of market | |||||
|---|---|---|---|---|---|---|
| volume | Order book | Block trades | TUVL | Off-market | Total | |
| (EUR bln) | (percent) | |||||
| Equities | 2.46 | 32.6 | 26.5 | n/a | 40.9 | 100.0 |
| Other securities | 2.65 | 7.3 | 6.2 | 66.7 | 19.9 | 100.0 |
| Total | 5.10 | 19.5 | 15.9 | 34.6 | 30.0 | 100.0 |
Trade Volume in 2006
| Total trade | Type of market | |||||
|---|---|---|---|---|---|---|
| volume | Order book | Block trades | TUVL | Off-market | Total | |
| (EUR bln) | (percent) | |||||
| Equities | 2.46 | 32.6 | 26.5 | n/a | 40.9 | 100.0 |
| Other securities | 2.65 | 7.3 | 6.2 | 66.7 | 19.9 | 100.0 |
| Total | 5.10 | 19.5 | 15.9 | 34.6 | 30.0 | 100.0 |
79. Slovenia’s one clearing and depository house has relatively high settlement costs. Post-trade services are handled by Centralna klirinško depotna družba (KDD), the central securities depository (CSD) in Slovenia. Given the relatively high fixed cost in the business and small volumes, settlement costs in Slovenia are higher than in other national CSD in Europe or in the US.
Operating income per transaction
(in euro)
1/ No netting is conducted.
Operating income per transaction
(in euro)
| Slovenia | EU average | US | ||
|---|---|---|---|---|
| via CSD | via ICSD | |||
| Post-netting | 3.80/1 | 2.98 | 5.14 | 2.77 |
| Pre-netting | 3.80 | 1.49 | 2.86 | 0.46 |
1/ No netting is conducted.
Operating income per transaction
(in euro)
| Slovenia | EU average | US | ||
|---|---|---|---|---|
| via CSD | via ICSD | |||
| Post-netting | 3.80/1 | 2.98 | 5.14 | 2.77 |
| Pre-netting | 3.80 | 1.49 | 2.86 | 0.46 |
1/ No netting is conducted.
80. The regulatory framework is in transition, largely to comply with EU directives. Slovenia has adopted all relevant EU capital market-related Directives, most recently the Prospectus Directive by amending the Securities Market Act. By drafting a new law on financial instruments, Slovenia strives for a timely transposition of the Markets in Financial Instruments Directive (MiFID), that extends the range of investment services that firms can passport (i.e., make them transferable to any EU country).27 The directive also strives to harmonize the organization and conduct of the investment business, for example by improving transparency requirements for equity markets. Given the complexity of the issues, it remains to be seen whether the new law can accommodate the full scope of MiFID principles, and to what extent it fosters financial integration with the EU. Takeover legislation and capital gains taxation in Slovenia are in line with common practice in the EU. Important regulatory barriers exist in the pension and insurance sector, such as the minimum return requirement on investments that effectively limits risk taking.
81. Financial sector supervision is fragmented. Bank supervision is located at the central bank, the Securities Market Agency is in charge of financial market supervision, including market activity and mutual funds, and the Insurance Supervision Agency covers insurances and pension companies and funds. Consolidating the activities, as currently planned by the authorities, could help streamline administrative procedures and improve the effectiveness of capital market supervision.
C. Developing Capital Markets in Slovenia
82. Capital market development in a small country like Slovenia has to balance the objectives of local market development and deeper integration with EU markets. Slovenia already has a basic infrastructure in place, that can be used to further develop local markets for the needs of investors and issuers. Given its trade and investment links in Southeastern Europe, Slovenia may also find some niches in the region. At the same time, European financial integration is advancing rapidly, and small markets can derive large benefits from participating in this process. International integration mitigates some of the size-related obstacles, such as diversifying the investor universe, attracting trading liquidity, and enlarging the funding capacity. This means that Slovenia should develop a hybrid strategy that pursues integration with international capital markets and continues to enhance domestic capital markets.
Integrating Slovene markets with international capital markets
83. While benefits from deeper integration with foreign markets can be large, they are not without risks. Consolidation of trading and settlement venues can lead to direct cost savings for market access and trading from scale effects, which can be further enhanced by competition.28 By integrating the investor and issuer base, international markets can offer a higher degree of diversification opportunities and lower risk premia.29 From a national perspective, the main risk of financial integration is the loss of policy independence. Another risk is fragmentation of liquidity from migration to several exchanges and trade diversion, if they are not linked.30 This has happened, for example, in Latin American equity markets (de la Torre and Schmukler, 2007), but not yet in Europe (BIS, 2001, p. 21).
84. Against this background, deeper international integration in Slovenia should cover measures to globalize the investor base, integrate the infrastructure, and harmonize other regulations, taxation, and supervision. The globalization of the investor base can be achieved by removing constraints to international investors establishing presence in domestic markets, and to domestic issuers migrating to foreign markets. As with infrastructure and regulation, much of this is guided by EU regulations.
| Achievements in Slovenia | Future Actions | |
|---|---|---|
| Globalization of investor base |
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| Integration of infrastructure |
|
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| Harmonization of regulation, taxation, supervision |
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| Achievements in Slovenia | Future Actions | |
|---|---|---|
| Globalization of investor base |
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| Integration of infrastructure |
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| Harmonization of regulation, taxation, supervision |
|
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85. Further globalization of the investor base requires measures to develop the local capital market and to lower costs of cross-border transactions. Despite recent progress, the limited supply of investment instruments is reducing the attractiveness of Slovenia for foreign portfolio investors. To increase this supply, further development of local markets is needed (see following section). At the same time, Slovene institutional investors have difficulty in competing with larger counterparts in the rest of Europe due high costs of setting up market presence abroad. These costs can potentially be reduced by achieving scale effects and the gradual decrease in costs from cross-border competition. Market participants also note that the existing legislation entails some indirect barriers to foreign participation in local markets that should be further studied.
86. European integration has led to a consolidation among stock exchanges, lowering costs for trading; however, the integration of post-trading services lag behind. The consolidation among stock exchanges is expected to continue, further catalyzed by the MiFID. Apart from the common passport discussed above, the directive for an EU wide approach to market regulation could further level the playing field between regulated cash markets, unregulated cash markets, and institutions that internalize trades (i.e., match orders in house). While progress with integrating the trading infrastructure is remarkable, international integration of post-trading services is lagging behind. The currently complex and fragmented environment of clearing and settlement services, which imposes costs, risks, and inefficiencies on investors, institutions, and issuers, has recently alerted EU regulators. The EU Commission has since stepped up efforts to ensure better implementation and monitoring of existing directives in this area (the Settlement Finality Directive and the Financial Collateral Directive), and to establish a system for settlement between European clearing and depository houses (“Target2S”).
87. As a small player in the EU context, the LJSE is likely to integrate with European exchanges. LJSE has received takeover offers from various European exchanges, including OMX and the Warsaw Stock Exchange. This would benefit Slovenia by a improving access to new technology and trading facilities developed by the partner, and to a broader investor base. Using a joint trading platform under harmonized rules within the network of a pan-European exchange would immediately widen the investor base, as the existing users of this exchange could seamlessly access Slovenia’s capital market.
88. The clearing and depository agency should also continue to integrate with other markets to sustain business. After the migration of government bond trading abroad the local clearing agency (KDD) is facing stagnant business. Its settlement facility is designed for a small capital market, limiting its functionality in the European context. KDD is currently marketing its system to other small markets, such as Bosnia-Herzegovina and Angola. Other avenues for future business can include enabling foreign intermediaries to become trading and settlement members, for instance, by making the fee structure internationally competitive and establishing bilateral settlement links to large international centralized securities depositories (ICSDs).
89. Progress in adopting EU-related regulatory reforms has been remarkable, while implementation of MiFID will become key to advance integration. The Securities Market Act was amended to accommodate the EU directive on prospectuses and the directive on market abuse. The revised Takeover Act provides minority shareholder protection along the lines of the EU Takeover Directive. Double-taxation conventions are in place with relevant countries, and memoranda of understanding have been signed for cross-border supervisory cooperation. Going forward, rigorous implementation and effective enforcement of MiFID will be the key for further integration. Its transposition into national law is currently lagging behind schedule in many EU countries. Slovenia has entered the drafting stage but, as of April 2007, has not yet notified the Commission of the transposition.
Domestic capital market development
90. Local market development in Slovenia has many advantages. Given the high cost of foreign listings, better access to local equity finance can help Slovene enterprises to reduce their high reliance on debt-financing. Capital markets can also provide equity funding that, by its nature, is better compatible with long-term investment projects than bank funding, especially so for young enterprises that do not yet generate significant cash flows or service companies that lack asset collateral. Stock markets allow investors to participate in long-term projects while offering the chance to sell their stakes if needed. Likewise, the stock market opens venture capital investors a way to exit from their investments once they matured, thereby freeing capital to be invested once again. Development of new investment products such as venture capital, pension and investment funds or derivatives can also better diversify risks and funding sources.
91. Deepening the local capital market in Slovenia requires measures to enlarge the investor base and the availability of investable securities, coupled with more progress on developing infrastructure and regulations.
| Achievements in Slovenia | Future Actions | |
|---|---|---|
| Investor base |
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| Universe of investable securities |
|
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| Infrastructure |
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| Regulation and supervision |
|
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| Achievements in Slovenia | Future Actions | |
|---|---|---|
| Investor base |
|
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| Universe of investable securities |
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| Infrastructure |
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| Regulation and supervision |
|
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92. To diversify the investor base, restrictions on portfolio selection should be reduced. The removal of foreign investment restrictions in 2001 enhanced portfolio diversity by incorporating foreign securities, but additional measures are needed to allow for more flexibility with various investment products. In particular, the requirements for a minimum required return for pension funds, and restrictions on investments in the unregulated market limit portfolio selection of investable securities. By allowing, for example, the operation of funds not compliant with EU legislation (i.e., non-UCITS compliant funds) with more risky strategies (including derivative and leveraged investments) could facilitate the establishment of hedge fund products. Hedge funds contribute to widening the choice of risk-return profiles and, by pursuing active investment strategies, improve trading liquidity. Direct participation of retail investors in the market is hampered by high brokerage fees and the lack of easy-to-access internet-based brokerage services. Direct access of foreign investors is limited by the high set-up costs of local market presence, which, together with the limited investment opportunities offered, makes such an investment unattractive.
93. The supply of securities would be enlarged by listing more companies at the stock exchange. Listing of companies in which the state holds a significant stake would be a start. In particular, listing of state-dominated financial companies would greatly enhance the universe of investable securities. Implementing the current bank privatization program, that includes a secondary offering of one of the banks—as opposed to a private sale—would draw attention to the equity market and could, by using appropriate allocation rules, increase the free float. The listing of Telekom Slovenije in 2006 is a good example for how the privatization process contributes to the development of capital markets. The secondary listing of the Telekom has roughly doubled the market capitalization and added an actively traded stock that has already been incorporated in the local market indices.
94. Other measures that should be taken to enhance the supply of products are encouraging companies to present themselves for capital markets, and actively promoting the development of financial innovations, such as asset-backed securities. Weak corporate governance can make companies shy away from oversight by market participants. Recent efforts at raising corporate governance standards up to EU levels could make more companies go public. Initiatives for capital market education should complement this effort. Besides putting necessary legislation for innovative financial products in place, issuance could also be jump-started, as was done in Spain, by a concerted initiative (see Box 2). However, when considering the use of credit enhancement schemes, such as state guarantees, policy makers need to ensure that they are designed carefully to avoid fiscal contingencies, moral hazard, and reputational risks.
SME Securitization: The Spanish Case
Since late 1990’s, several European countries, including Germany and Spain, have incorporated securitization into their SME programs with some types of government guarantees. Similar efforts are also underway in other regions—for example, Singapore launched an SME Loan Access program in 2005.
The mechanics of the program can be described with the example of Spain. An originator puts SME loans to a special purpose vehicle (SPV). The Treasury commits to guarantee specific tranches issued by the relevant SPV, provided that the originator holds a minimum percentage of bank loans to SMEs in its portfolio. In return for the liquidity gained through the sale of the SME loans, the originator commits to reinvest part of this liquidity in SME financing. The scheme is supported by a master agreement that every securitization fund has signed with the Ministry of Economy.
Approximately 60 Spanish banks have participated in the scheme. In a few cases, SME portfolios from several banks have been packaged into one single securitization transaction (i.e. multiorigination). In 2004, SMEs securitization in Spain amounted to 18 percent of the total volume of securitization issuance--EUR 9 billion out of a total issuance volume of EUR 52 billion.
Principal author: Ana Carvajal (MCM-CD).
95. To improve local infrastructure, trading and settlement systems should be aligned with international standards. Listing and trading rules at LJSE are broadly in line with international practice. The demutualization of the LJSE has transformed the stock exchange into a “for profit” entity that is better positioned to cope with increasing competition. Similarly, the demutualization of KDD would put the local clearing and depository house on equal footing with competitors.
96. Order-book trade flow and transparency of trading activity could greatly be improved. More rigorous reporting requirements for off-market trades would improve transparency with regard to type, amount, and price of securities traded, as envisioned by the MiFID. Measures such as the fee structure or timely reporting requirements could also be considered to align block trading with order-book trading, or at least reduce the dominance of negotiated deals. More immediate reporting requirements, as facilitated by a trading facility for negotiated trades, could improve post-trade transparency that caters to order book trading. Creating incentives by adjusting the fee structure, or increasing the minimum size of block trades could increase the relative attractiveness of order book trades. Furthermore, promoting the presence of market makers could greatly enhance the liquidity of small and less traded stocks. The low interest of brokers to engage in making markets can be traced back to the lack of automated market maker facilities which would greatly reduce costs compared to maintaining continuous quotes manually.
97. Further strengthening surveillance and enforcement will be required as the domestic market expands. The authorities recognize the need to strengthen cross-market surveillance and believe that unifying banking, financial market, and insurance supervision under one roof may be effective in improving current efforts. Furthermore, surveillance capabilities of financial markets could be stepped up. For instance, improvements in the IT infrastructure can help to detect market abuse by better monitoring trading activity. The introduction of new financial products, such as derivatives, requires developing an adequate surveillance framework, ideally supported by a derivatives law.31
98. Capital market development would also benefit from better internalization of an “equity culture.” European financial culture tends to consider market financing as more appropriate for larger companies, while bank financing is for SMEs. The banking system in Slovenia has tended to focus on providing credit to existing clients, rather than to new enterprises.32 Better acceptance of market financing could mitigate this situation by directly financing SMEs through stock markets or indirectly through enabling banks to refinance their corporate loan portfolios, possibly by asset-backed securitization. For this to happen, investors need to embrace a financial culture that provides the willingness to deal with the characteristics of SMEs, such as a more volatile business environment, higher bankruptcy rates, innovative business models, and a high share of intangible assets that are hard to evaluate.
D. Conclusions
99. Capital market development in Slovenia is best promoted by leveraging the existing local setup in an integrated European market. The size of Slovenia’s domestic market is not sufficient to become a thriving market place on its own that can deliver the benefits of a mature capital market. Therefore, a hybrid market model seems best—allowing issuers and investors to reap the benefits of the single European market while preserving a local market segment that fits the needs of domestic issuers.
100. Policymakers can help this process by taking initiatives that further improve the regulatory and supervisory framework and promote an equity culture. The following are key measures that help promote both local capital market development and international integration:
Structural issues. List state-owned companies with the option to subsequently sell a state-owned stake at the stock exchange; set incentives to foster financial innovation; and support efforts to establish international partnerships for the stock exchange and the clearing and depository house.
Regulatory issues. Fully implement MiFID as well as EU guidelines for corporate governance; and remove remaining restrictions for local investments by foreign investors as well as foreign investments by locals.
Supervisory issues. Step up surveillance and enforcement, in particular with regard to transparency in securities trading; and streamline administrative procedures.
Abbreviations and Acronyms
| ABS | Asset backed securities |
| CSD | Central Securities Depository |
| ETF | Exchange traded funds |
| ICSD | International Central Securities Depository |
| IPOs | Initial public offerings |
| ISD | Investment Services Directive |
| KDD | Centralna klirinsko depotna družba |
| LJSE | Ljubljana Stock Exchange |
| MiFID | Markets in Financial Instruments Directive |
| OTC | Over-the-counter |
| SME | Small and medium-sized enterprises |
| SPV | Special purpose vehicle |
| UCITS | Undertakings for Collective Investment in Transferable Securities |
References
Bank for International Settlements, 2001, The Implications of Electronic Trading in Financial Markets (Basel: Bank for International Settlements).
de la Torre, A., and S. Schmukler, 2007, Emerging Capital Markets and Globalization (Palo Alto, California and Washington: Stanford University Press and World Bank).
Domowitz, I., J. Glen and A. Madhavan, 1998, “International Cross-Listing and Order Flow Migration: Evidence from an Emerging Market,” Journal of Finance, Vol. 53.
Gutierrez, E., 2005, “A Framework for the Surveillance of Derivative Activities,” IMF Working Paper 05/61 (Washington: International Monetary Fund).
Hardouvelis, G.A., D. Malliaropulos, and R. Priestley, 2006, “EMU and European Stock Market Integration.” Journal of Business, Vol. 79, pp. 365 –392.
Levine, R., and S. Schmukler, 2003, “Migration, Spillovers, and Trade Diversion,” Policy Research Working Paper No. 3046 (Washington: World Bank).
Prepared by Jochen Andritzky (MCM).
See WEO (2006).
The free float is defined as all shareholdings of less than 5 percent of total market value.
An example are investment funds compliant with EU regulations that can be marketed in all EU countries.
Competition among specialists that lead to lower bid-ask spreads has been found by Domowitz and others (1998).
Hardouvelis and others (2006) show that the costs of equity capital decreased upon integration into the EMU.
See Gutierrez (2005).
Studies show that arms-length systems are better at allocating resources to new firms, technologies and activities (WEO, 2006).
