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First published on the Milken Institute Blog website.
A key step in developing a local capital market is to develop the "buy side"-to encourage greater participation of local institutional investors such as pension funds and insurance firms. If managed well, these pools of savings can become important sources of long-term financing, including for infrastructure, which can drive socioeconomic growth.
The share of residents in East African Community (EAC) countries Kenya, Rwanda, Tanzania, and Uganda who access pension and insurance products is still small, although growing. Savings managed by local institutional investors in these countries nearly doubled in just four years, to about $19 billion by early 2016. We recently surveyed buy-side institutions in these four countries to ask how they are managing savings across asset classes and EAC countries. See the findings here.
We found that most of these investors want to further diversify their portfolios, but they are impeded largely by a lack of investable securities and risk-management products that allow them to invest in a way that meets their aims. This points to a need in these markets for more long-term investment vehicles, in particular-as well as market participants. For example, a large majority of surveyed investors showed strong interest in new vehicles such as a regional "fund of funds" that could pool their resources and manage risk by investing across diverse infrastructure projects by sector and country.
There already are clear signs that pension funds, in particular, have been diversifying their portfolios over the past decade-shifting further away from the most liquid asset classes. Surveyed pension funds hold an average of just 1 percent in cash and demand deposits across the EAC focus countries. And pension fund and insurer investments in short-term government securities typically fall well below national and even internal ceilings. Survey findings show pension funds generally hold much more in longer-term than short-term government securities. But very limited corporate bond holdings, even for pension funds, is at least partly the result of small market size and lack of product.
Our findings also show that tiny allocations so far to private equity and venture capital (PE/VC) reflect limited experience and capacity evaluating these new asset classes-more so than lack of demand or investment limits. In fact, national regulatory approaches are still evolving. Greater clarity on how regulators will treat these new asset classes may encourage more investment. While certainly not risk-free, some investment in PE/VC as part of a well-managed portfolio could help generate returns. At the same time, it will be important to boost risk-evaluation capacity among regulators, investors, and financial intermediaries.
How do national regulations affect how these investors manage their portfolios? We found that in most cases, national regulatory investment limits are not the binding constraint preventing local institutional investors in the EAC from further diversifying their portfolios. Their actual allocations to public equities and corporate bonds generally fall well below national regulatory caps. And internally set targets tend to fall well below national ceilings-as does actual investment in these securities.
Around half of investors said they invest some of their portfolio assets outside their home countries-typically in other EAC countries. How can these EAC markets draw on regional ties to attract institutional investors? Roughly half of survey participants said access to better strategies and instruments for managing foreign exchange risk would make them more likely to invest in assets across EAC borders.
We found that some investors may not be clear on the intraregional restrictions by asset class they actually face. Regulators should step up communications with investors to ensure they clearly understand both the limits and opportunities in how they invest within the EAC and across asset classes. A well-functioning buy side can reduce an economy's reliance on foreign portfolio investors, increasing its resilience to sudden capital inflows and outflows. Further progress on intraregional integration within the EAC may help mitigate some of the risks associated with cross-border investment. Limited investable securities in local capital markets strengthens the case for easing or harmonizing restrictions intraregionally. This, in turn, could improve market liquidity, deepen the EAC's capital markets, and make it easier for local institutional investors to diversify their portfolios.
Our complete survey findings are available here.
About the Author
Jim Woodsome is a Senior Research Analyst at the Milken Institute's Center for Financial Markets. In this role, he conducts research, organizes events and helps manage initiatives related to the Center's Capital Markets for Development (CM4D) program.
Let me begin by wishing you all a very happy and prosperous 2017, on behalf of all of us at the MFW4A Secretariat.
2016 was a rewarding year for MFW4A. We were proud to host the first Regional Conference on Financial Sector Development in African States Facing Fragile Situations (FCAS) in Abidjan, Cote d'Ivoire, jointly with the African Development Bank, FSD Africa, and FIRST Initiative. The conference attracted some 140 policy makers, business leaders, academics and development partners from over 30 countries, to discuss the role of the financial sector in addressing fragility. The conference has already led to several initiatives by MFW4A and our partners in the Democratic Republic of Congo, Liberia, Sierra Leone and Somalia. We expect to build on this work in 2017.
Our support to the Conférence Interafricaine des Marchés d'Assurances (CIMA), the insurance regulator for francophone Africa, helped them to secure financing of EUR 2.5 million from the Agence Française de Développement. The funding will help to expand access to insurance in a region where penetration rates are less than 2% - well below the average for the continent. We worked closely with a number of our funding partners to help define their strategies in Digital Finance and Long Term Finance. These results are a clear demonstration of how the Partnership can directly support the operations of its membership.
With the support of our Supervisory Committee, we took steps to ensure the long term sustainability of the Partnership. The approval of a revised governance structure which fully integrates African financial sector stakeholders, public and private, was a first critical step. The ultimate objective is to expand membership and build a true partnership of all stakeholders in Africa's financial sector.
2017 will be a year of transition for the Partnership. It marks the end of MFW4A's third phase, and the beginning of its transformation into a new, more inclusive partnership, with an expanded membership. We will focus on revamping our value proposition to provide more focused, needs based services with the potential to directly impact our current and potential membership. In so doing, we hope to consolidate MFW4A's position as the leading platform for knowledge, advocacy and networking on financial sector development in Africa.
In closing, I must, on behalf of all of us at the MFW4A Secretariat, thank all our funding partners, stakeholders and supporters, for your constant support and encouragement over the years. We look forward to working together to strengthen our Partnership.
With our best wishes for a happy and prosperous 2017,
MFW4A Partnership Coordinator
What we learned from the Conference on Financial Sector Development in African States Facing Fragile Situations? - Part 119.07.2016,
Last month, leaders from the public and private sectors and development partners gathered in Abidjan to discuss the links between fragility, resilience and financial sector development in Africa. This event, a joint initiative created by the African Development Bank, the Making Finance Work for Africa Partnership (MFW4A), FSD Africa, FIRST Initiative and the Initiative for Risk Mitigation in Africa (IRMA), also provided an opportunity to explore prospects for partnerships, innovative policies and private sector-led solutions to accelerate financial sector development in fragile situations in Africa.
In this first instalment of a six-part series, Amadou Sy, Senior Fellow and Director of the African Growth Initiative, Brookings Institution, looks at some of the major takeaways of the conference.
What is fragility?
Using a "harmonized definition," the African Development Bank (AfDB), the Asian Development Bank, and the World Bank classify states as being fragile when they exhibit poor governance or when they face an unstable security situation. For practical purposes, governance is measured by the quality of policies and institutions (states with a CPIA score less than or equal to 3.2) and insecurity is assessed by the presence of United Nations or regional peace keeping operations (PKO). In sub-Saharan Africa most fragile states are also low-income countries (LICs).
While the focus of the "harmonized definition" is on institutions and insecurity, participants stressed that fragility is a multi-faceted concept. In particular, fragility implies weak state institutions, poor implementation capacity, underdeveloped legal and financial infrastructure as well as low social cohesion and the exclusion of a large share of the population from financial and other services. The nature of fragility is also fluid and fragile states face situations ranging from violent conflicts to post-conflict economic recovery. The sources of fragility go beyond poor governance, low GDP per capita, and conflicts to include vulnerability to commodity shocks and other macroeconomic shocks, and exposure to the risk of pandemics.
The need to broaden the definition of fragility was further explored with reference to a quote from President Ellen Johnson Sirleaf of Liberia "fragility is not a category of states, but a risk inherent in the development process itself". Mr. Sibry Tapsoba, Director of the Transition Support Department of the AfDB argued for a multidimensional approach, which applies a fragility lens to (i) look beyond conflict and violence; (ii) focus on inclusiveness and institutions; (iii) recognize the importance of the private sector; and (iv) recognize the presence of asymmetries in resources, policy, and capacity.
Participants also insisted on the need to go beyond the negative connotation of fragility and recognize instead that fragile states are in transition and present opportunities for human and financial sector development.
What role for financial sector development (FSD) in fragile countries?
Empirical evidence points to the positive role that financial sector development (FSD) can play in fragile countries. There is a positive correlation between financial sector and economic growth, poverty reduction, and inequality reduction. FSD can be a driver of growth through increased job creation and it can help mitigate risks through increased savings, loans, and insurance.
A key finding stressed by Ms. Emiko Todoroki, Senior Financial Sector Specialist at FIRST Initiative is that fragile countries fare worst in all macro and financial metrics, except one: the share of adults with mobile accounts. Digital financial services are offering solutions in fragile states and there is a need to understand better their role.
In the same vein, Ms. Thea Anderson, Director at Mercy Corps argued for the need to focus in on micro issues such as the role of delivery channels, payments infrastructure, insurance, and blended finance (including impact investment), and Islamic finance. As she noted, FSD is relevant even in the more volatile security situations. For instance, refugees and internally displaced persons (IDPs) can be viewed as a market segment and their financial inclusion can be kick-started with the use of functional identification (which also help comply with Know Your Customer (KYC) requirements). Mr. Paul Musoke, Director of Change Management at FSD Africa also highlighted the role of markets and market building in a difficult context. He noted the need to look for scale, sustainability, and systemic change. As markets are dynamic and not predictable, taking a systems approach can be useful. Such an approach includes asking questions such as what factors are going to play a role in the future? Who is going to pay for infrastructure? What level of development should we target?
Lastly, Mr. Cedric Mousset, Lead Financial Sector Specialist, World Bank reminded the audience that governance remains a key dimension of fragility. Weak governance in fragile countries exposes them to a higher risk of non-compliance with regulations such as anti-money laundering and combating the financing of terrorism (AML-CFT) regulation. Improving governance, although it may be a slow process, is needed to support FSD. Measures to support political stability, improve the business and macroeconomic environment, ensure legal security, and build capacity remain important.
You can download all the presentations on the conference website.
You can also view a selection of photos here.
For more information, please contact:
Pierre Valere Nketcha Nana
How should Rwanda develop its capital markets? This was the subject of a three-day roundtable discussion held last October in Rubavu, Rwanda. The roundtable was organized by the Rwanda Capital Market Authority (CMA) and the Milken Institute's Center for Financial Markets (CFM), with support from FSD Africa. Highlights from that discussion, including points of consensus and debate, are captured in the Milken Institute's new publication, "Framing the Issues: Developing Capital Markets in Rwanda."
Over the past decade, Rwanda has made considerable progress in achieving rapid economic growth and reducing poverty, supported by sound macroeconomic policies. Its business-friendly environment is now among the best in Africa. The government and its international development partners view deepening and diversifying the domestic financial system as essential to Rwanda's goal of transitioning to middle-income status.
Last year, the Rwanda Ministry of Finance and Economic Planning gave the CMA a mandate to produce a 10-year Capital-Market Master Plan (CMMP) to guide reforms to develop Rwanda's capital markets. An overarching goal will be to deepen capital markets so that they intermediate long-term finance for private-sector-led growth and meet the country's infrastructure and other socioeconomic needs.
The October strategic planning roundtable kick-started the process of mapping out capital-market reforms. The event gathered policymakers, regulators, issuers, investors, and capital-market experts from around the world, including senior officials from the government of Rwanda. The roundtable provided an off-the-record forum for frank and in-depth discussion about the opportunities and challenges Rwanda's capital-market stakeholders face, as well as how they can prioritize and sequence reforms. Participants also heard firsthand how other developing countries mapped out and launched their own capital-market reforms.
The roundtable covered core questions that will inform the drafting of Rwanda's Capital-Market Master Plan, including:
- How should Rwanda develop its investor base, both domestically and regionally? What are innovative ways to mobilize household savings?
- Can other nonbank financing sources-such as private equity, financial leasing, and even crowdfunding-help "incubate" firms for future listings?
- How can Rwanda strike the right balance in accessing needed foreign-portfolio investment while guarding against risks of overreliance on this investment?
- How can capital markets in Rwanda and its East African Community partners take a regional approach to attracting new listings?
- Should the stock exchange target small and medium-sized enterprises (SMEs) in its outreach for new listings-and, if so, how?
- What can Rwanda learn from other countries about the process of planning and implementing capital-market reforms?
Roundtable participants strongly agreed that an immediate and ongoing priority is for Rwanda to develop a pipeline of prospective listings. Targeted outreach -including education and technical assistance - is critical to increasing the number of firms willing to list. Cultivating a high-growth-potential corporate base could also serve as an incubator for future listings, as would developing the local venture capital and private equity markets.
Lessons shared by participants from other emerging markets underscored the importance of sequencing and developing capital markets to complement the banking sector, not compete with it. As an economy grows and becomes more complex, firms and households require a wider range of financial services - from banks as well as other financial intermediaries. Once larger firms begin to rely more on capital markets for longer-term financing, banks may increase lending further down the credit spectrum, to SMEs and households.
Well-functioning, appropriately regulated local and intraregional institutional investors are vital to developing a stable investor base. Several participants flagged the need to mobilize small savers across EAC markets, perhaps through a regional fund, which also would advance financial inclusion. The role of non-EAC foreign investors was more heavily debated, however - particularly the degree to which bond issuers should rely on foreign capital.
Regionalization emerged as a key cross-cutting issue. More cross-border listings and cross-border investment across the EAC's securities exchanges could help overcome local capital markets' impediments such as illiquidity, low market capitalization, and few listings. Greater cooperation across EAC capital markets in developing and sharing market infrastructure and intermediation services could unlock significant economies of scale. Throughout the roundtable, participants returned to the point that capital-market development should not be done for its own sake, but to spur growth of a diversified, inclusive economy that creates decent jobs and improves living standards. And, while best practices exist, there is no one-size-fits-all approach to developing capital markets.
This blog post was originally published on the Milken Institute's blog website.
About the Authors
Jacqueline Irving is a Director in the Center for Financial Markets at the Milken Institute. Previously, she was a senior economist at US Treasury, responsible for the migrant remittances and financial inclusion portfolio and a U.S. government delegate to the G20's technical working group on remittances.
Jim Woodsome is a Senior Associate, Program Research Analyst at the Milken Institute's Center for Financial Markets. In this role, he conducts research, organizes events and helps manage initiatives related to the Center's Capital Markets for Development (CM4D) program.
The Egyptian Exchange (EGX) is the oldest in the Middle East and North Africa region and one with a fascinating history of development, having gone through nationalisation in the 1950s and having been revitalised only in the early 1990s. The passage of the Capital Markets Law in 1992 and the introduction of the Asset Management Programme in 1994, which facilitated disposal of government stakes, were key to the revitalization of the Exchange. While the number of listed companies peaked at 1100 in 2001 with market capitalisation of $24 billion USD, the market remained illiquid and lacked transparency.
Eventually, in order to bring liquidity and improve market quality, over 800 companies were delisted by 2005 for failing to meet regulatory requirements. In an effort to bring further transparency to the market, the Egyptian regulator introduced a voluntary corporate governance code for listed companies in 2005, and some of its recommendations were eventually transcribed in the listing requirements of the EGX. Over the years, enforcement activity has grown and in 2014, the Exchange started to publish all violations on its website and through the trading terminals.
Yet, substantially improving governance practices in listed companies remains a challenge due to the low levels of participation of institutional investors in the capital market. While only 15% of market capitalisation remains in the hands of retail investors, they account for close to 80% of trading, similarly to other MENA markets. Furthermore, institutional investors, both domestic and foreign, remain rather passive unlike in developed markets where, especially following the financial crisis, the expectations and stewardship responsibilities placed on institutional investors have been growing (e.g. the Stewardship Code in the UK).
The lack of engagement by domestic investors can be explained by the type of institutional capital present in equity markets, notably state-owned pension funds and insurance companies which continue to hold sizeable stakes in the market, having "inherited" them following the nationalisation programme. Their investment decisions are delegated to investment committees composed of the executive management and board members whose investment approach is usually characterised by conservatism and scepticism of capital markets. In addition, limits for capital market investment by pension funds and insurance companies are below international standards.
On the other hand, foreign investors' passivity can be explained by a number of factors, including their relatively small stakes in listed companies - most as part of an Emerging Market Index investing - leading to a lack of incentives for them to engage. In addition, recent years have seen an outflow of foreign capital and reduced activity by foreigner investors due to political instability, as well as hurdles in profit repatriation and foreign currency scarcity. As a result, foreign institutional investment dropped to 36% of the total market capitalisation.
In a forthcoming report on exploring the participation of institutional investors in the Egyptian capital market, we put forth recommendations on encouraging institutional investors and especially sovereign investors such as pension funds and insurance companies to act in their stewardship capacity. Doing so would yield positive results both for the state as their ultimate owner, for the general public which is the beneficiary of their services, as well as for improving the quality of the governance of listed companies.
We propose obliging certain categories of institutional investors to develop voting policies and vote their shares. This was already implemented in some countries such as Chile, specifically for the pension funds, with positive results. In addition, we propose that the Egyptian Capital Market Association (ECMA) and the Egyptian Investment Management Association (EIMA) be used as a platform to introduce self-regulatory standards for institutional investors.
*The views express in this post do not represent the official views of the OECD or its member countries.
Further recommendations and analysis is presented in the study The Role of Institutional Investors in the Egyptian Capital Market.
About the Authors
Maged Shawky Sourial is the CEO of Beltone Financial Holding since 2012, and Chairman of Beltone Exchange Traded Fund Company. Mr. Sourial is the Ex-Chairman of The Egyptian Stock Exchange since July 2005 till July 2010 after being the Deputy for the chairman for almost a year. During the period of 2002 till mid 2004, he represented the Regulator (Capital Market Authority) in the board of directors of the Exchange for three years. He held the position of Senior Assistant to the Minister of Economy and Foreign Trade for Securities Markets issues for around 12 years since 1995. He holds a Masters Degree in Financial Economics from Queen Mary, University of London, United Kingdom.
Alissa Amico is responsible for overseeing OECD's work on financial markets and corporate governance in the Middle East and North Africa. Alissa joined the OECD in 2005 to establish a regional programme on private sector development in the MENA region with the relevant Ministers in the region. In this capacity, Alissa provided technical support to a number of governments in the region the design of regulatory initiatives and institution building. Alissa holds a Bachelors degree in Business Administration from the Schulich School of Business, York University (Canada) and a Masters degree in Political Economy with a specialisation in the Middle East from the London School of Economics and Political Science (UK). She is a member of the French Institute of Directors' International Commission, and was named one of the Top 100 Leaders in Europe and the Middle East by the Centre for Sustainability and Excellence in 2011 and was recognised by Columbia Law School as the Rising Star of Corporate Governance in 2014.