Boosting economy through market integration

Barring any unforeseen circumstances, the capital markets of countries in the West African sub-region will be integrated by the first quarter of 2016. The Chairman, Nigeria Securities and Exchange Commission, Suleyman Ndanusa at the opening session of the fifth meeting of the West African Capital Markets Integration Council (WACMIC) held recently in Abuja said significant achievement had been recorded in two out of the three phases required for capital market integration.

Until December 1977, when it became known as the Nigerian Stock Exchange, with branches established in some of the major commercial cities of the country, the Nigerian capital market had little economic significance to the economy and companies listed on the exchange hardly had any foreign portfolio investor interest nor Nigerian corporations in a position to list on foreign stock exchanges.

The reasons for this, may, however, be attributed to weak financial regulatory regimes; failure to implement international financial standards; poor institutions and laws, poor enforcement mechanisms; weak economies and bad governance.

Indeed, a different picture is emerging today and the Nigerian capital market has witnessed unprecedented growth. In the last three to four years, net portfolio inflows have been on the rise again.

In 2010, net portfolio investment flows to sub-Saharan African countries amounted to about half a billion U.S. dollars.

With the development, Africa has been dubbed a ‘second generation emerging market’ or what is now best known as a ‘frontier market’ by foreign portfolio investors.

The term “frontier markets” is commonly used to describe a subset of emerging markets that have small financial sectors and/or have low yearly turnover and liquidity, but nonetheless demonstrate a relative openness to and accessibility for foreign investors.

They are generally in the early stages of financial market development and Nigeria, according to the IMF, is one of the African countries included in this list of ‘frontier markets’.

The main attraction of frontier equity markets for investors is that they may offer high, long-term returns and low correlations with other markets.

At the same time, frontier market short and medium-term securities typically have higher yields than in more developed emerging countries.

Ghana was the first African country to raise $750m in its first sovereign bond issue in 2007. The bond, which was for a tenure of ten years with a coupon rate of 8.5 per cent per annum, is the first in Sub-Saharan Africa and at the time of closure was more than four times oversubscribed.

Foreign portfolio investors began to seek alternative investment opportunities away from advanced markets where the recent financial crisis began.

They thus turned to Africa and found that returns on investments were higher relative to returns from investments in advanced markets.

These investors also saw African investment as an opportunity for risk diversification away from their investments in advanced and emerging markets especially as growth trends in these African markets are not synchronized with advanced economies.

Also, as a number of African countries, since the past one to two decades, have recorded positive growth, foreign investors have since been interested in opportunities to partake in the countries’ growth prospects.

The interest of foreign portfolio investors in Nigeria is not surprising as it has the second largest capital market in sub-Saharan Africa after South Africa.

Nigeria is also of particular interest as South Africa has growth trends which are heavily synchronized with advanced economies due to the linkages its markets have with advanced markets.

This is the reason why the recent financial crisis affected South Africa the most in comparison to other sub-Saharan African countries. As such, Nigeria is set to be next in line as the most attractive destination for foreign portfolio investment in Africa.

The political stability witnessed in Nigeria for nearly two decades has fostered economic growth and engendered confidence in investors seeking opportunities to do profitable business.

As SMEs grow, so too has the middle class which has also created more opportunities for investors to do business. Also, the financial regulatory environment is stronger than it used to be and the Nigerian SEC, in particular, appears to be taking a more proactive and zero tolerance approach to market abuse and mialfeasance although a lot still needs to be done with regard to strengthening financial disclosure and strengthening the enforcement of financial regulation.
Examples of foreign portfolio investments in Africa, with Nigeria being a strong player, include Nigeria’s Guaranty Trust Bank plc (GTB) five-year Eurobond issued to raise $350m in January 2007. The demand for this bond was high and this was the first time any Nigerian institution, private or public, had approached the international capital markets since the early 1990s.

However, despite records of growth and the interest of foreign portfolio investors in the Nigerian capital market and in Nigerian debt securities, there are still numerous challenges confronting the capital market.

The main challenges include: illiquidity, a small number of companies listed on the Nigerian Stock Exchange (NSE), a dearth of domestic institutional investors and weak financial regulation and enforcement, among others.

To this effect, capital market stakeholders identified regional capital market integration as one of the solutions that would help deepen and create more efficient capital markets that would promote economic development.

Capital market integration is where a number of countries work together to form a common financial market with common rules, cross border access and increased opportunities for their citizens, investors, and stakeholders.

Director-General, Ghana Securities and Exchange Commission, Dr Adu Anane Antwi submitted that in order to sustain the current level of economic growth and attract both domestic and foreign investment in Nigeria and other West African Sub-region, there was need for the region to expand, develop and modernize its capital markets.

The Director-General, while presenting a paper titled’ ‘Integrating West African capital markets: Issues, challenges and prospects’ during the PEARL Awards yearly public lecture held in Lagos recently argued that most African stocks exchanges are however, at their early stages of development, battling with several constraints that hamper their operational growth.

He described West African stock exchanges as ‘undeveloped’, noting that such narrow and illiquid market has contributed to low level of investors’ participation in the region.

This, according to him, was evident in the low market capitalization, few listed companies, low liquidity and limited range of investment products that characterized these markets.

Antwi identified the major challenges facing these exchanges to include: political instability in some economies, high volatility in economic growth, macroeconomic uncertainty, and liquidity constraints.

Others are underdeveloped trading and clearing, settlement and depository structures, limited domestic investor base and limited market information.

“Most African stocks exchanges are however, at their early stages of development and face several constraints. Most capital markets in emerging countries like those in West Africa have been described as narrow and illiquid, and discourage investors from investing in these markets

According to him, one of the solutions that would go a long way to deepen and create more efficient capital markets is regional capital market integration.

He explained that capital market integration is where a number of countries work together to form a common financial market with common rules, cross boarder access and increased opportunities for their citizens, investors and stakeholders.

The sub region, according to him, was strategically positioned within Africa with huge customer base which when utilized would create significant domestic savings for investment to facilitate growth in the markets.

“Well-developed capital markets have played an important role in the economic development of many countries. The capital market provides funds for businesses and governments undertaking long-term projects at a competitive cost of capital. Typically banks provide short term financing which cannot be used to finance long-term projects.

“Well-developed capital markets have provided equity capital and infrastructure development capital that have strong socio-economic benefits in job and wealth creation resulting in the growth and development of the economies of these countries.

“Rapid expansion of stock exchanges in the continent has contributed to economic development in various ways. These are, among others, facilitating the privatization process, diversifying the financial services, facilitating long term capital mobilization, provision of alternative investment opportunities, attracting foreign capital inflows and serving as a signal of overall macroeconomic performance.

He added that the three major West African Stock Exchanges as at the end of December 2014 are the Nigerian Stock Exchange (NSE), the Ghana Stock Exchange (GSE) and the Bourse Régionale des Valeurs Mobilières (BRVM) in Abidjan.

He listed the benefits of capital market integration to include: strengthening the collective economic reach of WACMIC member countries, reduction in cost of capital in the region, more efficient allocation of capital, increase access to capital for enhanced industrial development

Other are: Contributions to financial stability and reduction in vulnerabilities to external shocks, enhances risk-return frontiers for investors, increase in the expertise and competitiveness, as well as deepening the financial markets amongst the member countries, strengthening local mar kets and improve liquidity and trading volumes, strengthens market regulation and investor protection, improving regulatory standards and increasing foreign capital flow in to the sub-region for enhanced economic growth.

The Executive Director of Market Operations and Technology at the Nigerian Stock Exchange (NSE), Ade Bajomo, explained that the development of a common platform for cross-border listing and trading in West Africa would create broader and deeper liquidity.