CHALLENGES FACING AFRICAN CAPITAL MARKETS

1. CHALLENGES FACING AFRICAN CAPITAL MARKETS PRESENTED BY SUNIL BENIMADHU CHIEF EXECUTIVE THE STOCK EXCHANGE OF MAURITIUS (UNECA FORUM �Johannesburg, October 27-29, 2003 Organized by UNECA in partnership with Rand Merchant Bank) Ladies and Gentlemen, I would like to extend my sincere thanks to UNECA and Rand Merchant Bank for having invited me to participate in this forum. Ladies and Gentlemen, I would like to extend my sincere thanks to UNECA and Rand Merchant Bank for having invited me to participate in this forum.

2. 2 Presentation Outline Key changes that have underpinned the evolutionary path of the stock exchange and capital markets industries worldwide African Stock Exchange Situation What are the challenges ahead? Potential solutions to challenges My presentation will focus on the following key issues: I will, first, undertake an assessment of the key changes which have underpinned the evolutionary path of the Stock Exchange and capital markets industries worldwide in recent years. I will, then, look at how African Stock Exchanges have fared in this environment of change and what have been their key contributions to African economies. I will, finally, end with an analysis of the key challenges facing African Stock Exchanges and come up with some possible solutions to these challenges. My presentation will focus on the following key issues: I will, first, undertake an assessment of the key changes which have underpinned the evolutionary path of the Stock Exchange and capital markets industries worldwide in recent years. I will, then, look at how African Stock Exchanges have fared in this environment of change and what have been their key contributions to African economies. I will, finally, end with an analysis of the key challenges facing African Stock Exchanges and come up with some possible solutions to these challenges.

3. 3 Key Changes to the Stock Exchange industry Globalisation and internationalization of the stock exchange industry Demutualisation of Stock Exchanges Merger, Alliances and Consolidation of Exchanges Growing reliance of Exchanges on technology-led initiatives (Internet trading and extension of trading hours) Greater focus on the need for better and sounder regulation Harmonization and improvement of Clearing and Settlement Practices Proliferation of new financial products In my view, the key changes that have underpinned the evolutionary path of the Stock Exchange industry worldwide in recent years can be summarised as follows: First, with the advent of spectacular technological and telecommunication progress during the last two decades, capital markets and the Stock Exchange industry worldwide have gone global. Secondly, globalisation has pressured Stock Exchanges to review their hitherto close-knit and club-like structures to adopt a demutualised structure. Third, heightened competition resulting from globalisation has led to a wave of strategic alliances, mergers and consolidation among stock exchanges, as they scramble to reduce trading costs and offer investors a variety of financial instruments, ranging from equities to sophisticated derivative instruments from a singular trading platform. A fourth important change relates to the greater use of technology-led initiatives by exchanges to respond to the growing exigencies and sophistication of investors and listed companies for real-time and interactive market information. We have also witnessed a major overhaul of the regulatory framework and substantial improvements in terms of clearing and settlement of stock exchange transactions. The last major change, in my view, relates to the proliferation of new financial products namely in the derivative segments of the markets.In my view, the key changes that have underpinned the evolutionary path of the Stock Exchange industry worldwide in recent years can be summarised as follows: First, with the advent of spectacular technological and telecommunication progress during the last two decades, capital markets and the Stock Exchange industry worldwide have gone global. Secondly, globalisation has pressured Stock Exchanges to review their hitherto close-knit and club-like structures to adopt a demutualised structure. Third, heightened competition resulting from globalisation has led to a wave of strategic alliances, mergers and consolidation among stock exchanges, as they scramble to reduce trading costs and offer investors a variety of financial instruments, ranging from equities to sophisticated derivative instruments from a singular trading platform. A fourth important change relates to the greater use of technology-led initiatives by exchanges to respond to the growing exigencies and sophistication of investors and listed companies for real-time and interactive market information. We have also witnessed a major overhaul of the regulatory framework and substantial improvements in terms of clearing and settlement of stock exchange transactions. The last major change, in my view, relates to the proliferation of new financial products namely in the derivative segments of the markets.

4. 4 Effects of changes: Major shift in investors� behaviour, informational flows and institutional set-up Investors (retail and institutional) have already developed global portfolios which they trade around the world and round the clock Investors (retail and institutional) have ways and means to cross borders at the click of a mouse Stock Exchange order books are readily available on the internet on a real-time basis Exchanges are providing different and multiple accesses to their trading platform. Globalisation The effects of globalisation of stock exchanges are best epitomised by the changes that they have brought to investors� behaviour. Globalisation has led to a major shift in investors� behaviour worldwide. Thanks to technology and the advent of automated trading systems everywhere, investors, whether retail or institutional, have developed global portfolios and are in a position to follow markets on a real-time basis round the clock from the comforts of their home, at the click of a mouse. Exchanges, today are providing different types of participants different types of access to their trading platforms.Globalisation The effects of globalisation of stock exchanges are best epitomised by the changes that they have brought to investors� behaviour. Globalisation has led to a major shift in investors� behaviour worldwide. Thanks to technology and the advent of automated trading systems everywhere, investors, whether retail or institutional, have developed global portfolios and are in a position to follow markets on a real-time basis round the clock from the comforts of their home, at the click of a mouse. Exchanges, today are providing different types of participants different types of access to their trading platforms.

5. 5 THE AFRICAN SITUATION Statistical data on stock market development Contribution of stock markets to African economies Key challenges facing African stock markets Solutions to these challenges THE AFRICAN SITUATION How have African Stock Exchanges fared in this environment of change and how are they positioning themselves? The second part of my presentation focuses on 4 major issues related to stock market development in the region in recent years. It first presents a few important statistics of stock market development on the African continent. It then looks at the main contributions of stock markets to African economies. It thirdly, highlights the key challenges that African stock markets are confronted to. It concludes with the presentation of solutions for African Stock Exchanges to meet these challenges.THE AFRICAN SITUATION How have African Stock Exchanges fared in this environment of change and how are they positioning themselves? The second part of my presentation focuses on 4 major issues related to stock market development in the region in recent years. It first presents a few important statistics of stock market development on the African continent. It then looks at the main contributions of stock markets to African economies. It thirdly, highlights the key challenges that African stock markets are confronted to. It concludes with the presentation of solutions for African Stock Exchanges to meet these challenges.

6. 6 Statistical Data on African Stock Markets (Ex South Africa)

7. 7 Contribution of Stock Markets to African economies Facilitated the privatization process Diversified the financial services sector Provided listed companies with a platform to raise long-term capital Offered investors� alternative investment opportunities Acted as a barometer of overall macro- economic performance What have been the main contributions of stock markets to African economies? Without the creation and existence of stock markets, the privatization process underway in Africa in the wake of the IMF and World Bank inspired structural adjustment programmes would have been more difficult. In fact, stock market greatly facilitates the privatization process by providing investors entry and exit routes. Secondly, financial systems in African economies have for long periods of time revolved essentially around the Banking sector. Over-reliance on one type of institution reduces competition, fosters collusion and results in an inefficient allocation of financial resources across the business spectrum. Capital raising to finance development activities has also been another important contribution. Through the establishment of stock markets, the array of financial products available to investors in Africa has also increased. Although Africa is still lagging behind in terms of the breadth of financial products available, we have certainly made progress. Stock Markets in Africa also tend to act as a barometer of over-all macro-economic performance. Although our markets do not yet display the degree of efficiency observable in bigger markets or in markets with a longer history, I believe that market movements over time tend to reflect investor sentiment, the general macro-economic situation, interest rate policy etc� What have been the main contributions of stock markets to African economies? Without the creation and existence of stock markets, the privatization process underway in Africa in the wake of the IMF and World Bank inspired structural adjustment programmes would have been more difficult. In fact, stock market greatly facilitates the privatization process by providing investors entry and exit routes. Secondly, financial systems in African economies have for long periods of time revolved essentially around the Banking sector. Over-reliance on one type of institution reduces competition, fosters collusion and results in an inefficient allocation of financial resources across the business spectrum. Capital raising to finance development activities has also been another important contribution. Through the establishment of stock markets, the array of financial products available to investors in Africa has also increased. Although Africa is still lagging behind in terms of the breadth of financial products available, we have certainly made progress. Stock Markets in Africa also tend to act as a barometer of over-all macro-economic performance. Although our markets do not yet display the degree of efficiency observable in bigger markets or in markets with a longer history, I believe that market movements over time tend to reflect investor sentiment, the general macro-economic situation, interest rate policy etc�

8. 8 Contribution of Stock Markets to African economies Attracted foreign capital flows and increased the level of foreign exchange reserves Sensitized market operators about the importance of Corporate Governance Rendered companies more accountable to shareholders Set the stage for a gradual alignment of local business practices and standards with international best practice 6) The inflow of foreign portfolio flows to Africa has been quite substantial during the last decade. 7) Stock markets have also corporate governance issues to the forefront of listed companies and market operators� concerns. 8) Finally, I think stock markets have created an enabling environment for a gradual alignment of local business practices and standards with international best practice. 6) The inflow of foreign portfolio flows to Africa has been quite substantial during the last decade. 7) Stock markets have also corporate governance issues to the forefront of listed companies and market operators� concerns. 8) Finally, I think stock markets have created an enabling environment for a gradual alignment of local business practices and standards with international best practice.

9. 9 Factors constraining the development of African Stock Markets: Political and macro-economic set-up. Political instability and internal strife High volatility in GDP Growth Macro-economic uncertainties Lack of medium-term visibility on the macro-economic front. Having discussed about the importance and key contributions of stock markets to African economies, I would now like to reflect on the main constraints and challenges facing African stock markets and analyze some of the solutions to these challenges. Two types of constraints have hampered the development of stock markets in Africa: The first one relates to the political and macro-economic set-up and the second type concerns stock market specific factors. Political instability and internal strife have strongly affected stock market evolution in Africa. Cote d�Ivoire is a case in point. A Another macro-issue related to the relative volatility in GDP growth, which prevents investors from having a clear-cut visibility of the macro environment two or three years down the road. Investors, generally, are ready to put with diversifiable risks, but they are unwilling to look at markets characterised by political and macro-uncertainties.Having discussed about the importance and key contributions of stock markets to African economies, I would now like to reflect on the main constraints and challenges facing African stock markets and analyze some of the solutions to these challenges. Two types of constraints have hampered the development of stock markets in Africa: The first one relates to the political and macro-economic set-up and the second type concerns stock market specific factors. Political instability and internal strife have strongly affected stock market evolution in Africa. Cote d�Ivoire is a case in point. A Another macro-issue related to the relative volatility in GDP growth, which prevents investors from having a clear-cut visibility of the macro environment two or three years down the road. Investors, generally, are ready to put with diversifiable risks, but they are unwilling to look at markets characterised by political and macro-uncertainties.

10. 10 Factors constraining the development of African Stock Markets: Stock Market Specific Factors Liquidity issues Absence of an active and well developed domestic investor base Manual Trading and Settlement infrastructure Issues of efficiency and real-time availability of market information Corporate Governance practices of Listed Companies Among the market specific issues, I think the key challenge for African stock markets is liquidity. A look at the following table emphasises the point I want to make. Part of the liquidity problem is attributable to the absence of an active and well-developed domestic investor base. (refer to next slide) Another factor which has stifled stock market development in African markets relates to the absence of a strong and active domestic investor base, led by institutional investors such as pension funds and insurance companies. Instead of taking a leadership role in the development of stock market activities and in fostering the implementation of good corporate governance practices by listed companies, big institutional investors, have rather taken a back-seat role and hardly acted as the drivers of the market, as such is the case in developed markets and in some of the better-known emerging markets. On the contrary, local institutional investors tend to act as followers, whose investment decisions are often based on foreign investors� decisions. Clearing and Settlement as well as trading infrastructure is also lagging behind on African markets. Out of the 19 Stock Exchanges, only six ensure automated clearing and settlement of transactions and strict delivery versus payment. As regards trading infrastructure, most African markets still operate manual trading systems which in, many cases, have outlived the initial stages of stock market development. Among the market specific issues, I think the key challenge for African stock markets is liquidity. A look at the following table emphasises the point I want to make. Part of the liquidity problem is attributable to the absence of an active and well-developed domestic investor base. (refer to next slide) Another factor which has stifled stock market development in African markets relates to the absence of a strong and active domestic investor base, led by institutional investors such as pension funds and insurance companies. Instead of taking a leadership role in the development of stock market activities and in fostering the implementation of good corporate governance practices by listed companies, big institutional investors, have rather taken a back-seat role and hardly acted as the drivers of the market, as such is the case in developed markets and in some of the better-known emerging markets. On the contrary, local institutional investors tend to act as followers, whose investment decisions are often based on foreign investors� decisions. Clearing and Settlement as well as trading infrastructure is also lagging behind on African markets. Out of the 19 Stock Exchanges, only six ensure automated clearing and settlement of transactions and strict delivery versus payment. As regards trading infrastructure, most African markets still operate manual trading systems which in, many cases, have outlived the initial stages of stock market development.

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12. 12 Factors constraining the development of African Stock Markets: Stock Market Specific Factors Protection of Minority Shareholders� rights Accounting and Disclosure standards Fragmented nature of financial services sector Transmission mechanism Market depth and breadth Another constraining factor relates to the over-concentration of stock market activities on equities. An analysis of daily trading figures shows that on an average trading day more than 95 % of trading volumes are equity-related. Investors are not exposed to a wide array of investment instruments and cannot easily switch between instruments in the course of the normal re-rating of financial instruments observable on some sophisticated markets. Another constraining factor relates to the over-concentration of stock market activities on equities. An analysis of daily trading figures shows that on an average trading day more than 95 % of trading volumes are equity-related. Investors are not exposed to a wide array of investment instruments and cannot easily switch between instruments in the course of the normal re-rating of financial instruments observable on some sophisticated markets.

13. 13 Proposed Solutions Promote political stability and improve macro-economic visibility Increase available free-float Professionalise asset-management business and privatize the management of public funds Turnover ratios should be increased gradually and a target of at least 25% should be aimed at to ensure that the pricing of securities reflect market forces. To increase turnover ratios, the free-float available on the markets has to be increased substantially. In many African stock markets, the free-float lies within the 10-25% range, which is very low by international standards. Turnover ratios should be increased gradually and a target of at least 25% should be aimed at to ensure that the pricing of securities reflect market forces. To increase turnover ratios, the free-float available on the markets has to be increased substantially. In many African stock markets, the free-float lies within the 10-25% range, which is very low by international standards.

14. 14 Proposed Solutions Implement modern CDS and trading systems Foster dynamic trading by providing real-time and interactive market information flows Enhance disclosure standards and Corporate Governance

15. 15 Proposed Solutions: Strategic issues Lift Exchange Control Promote cross-linking of markets Harmonize operational, regulatory and technical infrastructure Promote real integration of internal financial systems. The solution to the problems of small, illiquid markets, besides the implementation of the above-mentioned micro-measures, lies in the cross-linking of markets. Cross-linking, coupled with the lifting of exchange control, can, if well marketed, become a powerful engine of market development in small markets on the African continent and in the SADC region. Cross-linking will enable an integration of small market while preserving the national identity of each market. It will enable investors of a particular region to have access to stocks from other markets of the same region, thereby increasing both the number of players and the number of scrips available. Both demand-side and supply-side problems can be overcome, enabling stock markets on the continent and within the SADC region to play a more meaningful role to the process of economic development. The solution to the problems of small, illiquid markets, besides the implementation of the above-mentioned micro-measures, lies in the cross-linking of markets. Cross-linking, coupled with the lifting of exchange control, can, if well marketed, become a powerful engine of market development in small markets on the African continent and in the SADC region. Cross-linking will enable an integration of small market while preserving the national identity of each market. It will enable investors of a particular region to have access to stocks from other markets of the same region, thereby increasing both the number of players and the number of scrips available. Both demand-side and supply-side problems can be overcome, enabling stock markets on the continent and within the SADC region to play a more meaningful role to the process of economic development.

16. 16 CONCLUSION CONCLUSION: Stock exchanges in Africa and within SADC have made some important strides in recent years, but have still not yet reached the real take-off stage. The future of these exchanges, in an environment characterised by intense competition from well-established financial centres, will depend upon their ability to overcome some of the above-mentioned constraints through the implementation of appropriate market-specific measures and the setting up of an a stock exchange infrastructure conducive to cross-linking of stock markets. CONCLUSION: Stock exchanges in Africa and within SADC have made some important strides in recent years, but have still not yet reached the real take-off stage. The future of these exchanges, in an environment characterised by intense competition from well-established financial centres, will depend upon their ability to overcome some of the above-mentioned constraints through the implementation of appropriate market-specific measures and the setting up of an a stock exchange infrastructure conducive to cross-linking of stock markets.

17. 17 THANK YOU Thank YouThank You