Cover Story : Capital Gains
Capital markets are playing a growing role in development and global economic integration.

When Emaar the Economic City held its initial public offering in Saudi Arabia in July, a record 10 million Saudis, or approximately half the national population, subscribed to the issue. More than 30% of the applications were made using automatic teller machines.

Capital markets are helping to democratize emerging markets and raise capital for companies that want to expand. They are also helping to create market economies in the Middle East, Africa, Asia and elsewhere that can reap the benefits of globalization.

The $680 million proceeds of the Saudi IPO will be used toward the development of the $26.6 billion King Abdullah Economic City, or KAEC, to be built on the kingdom’s Red Sea coast north of Jeddah. Saudi British Bank (SABB) was the lead underwriter of the IPO, with Riyad Bank and National Commercial Bank as sub-underwriters. HSBC was the financial adviser.

Demographics are spurring a trend toward economic liberalization, as swelling youth populations create pressure on governments to provide gainful employment. The KAEC project alone is expected to create 500,000 jobs for Saudi citizens.
The development of regional capital markets not only benefits domestic economies by creating risk-sharing opportunities and a new vehicle for savings but also builds support among the people for market reforms, corporate governance and transparency, says Todd Moss, a senior fellow at the Washington, DC-based Center for Global Development, a not-for-profit think tank that focuses on reducing global poverty and inequality.

“Companies that list their shares must comply with accounting standards,” Moss says. “If a growing family business wants to take on additional investors, it will have to open up its books.” The effects are enhanced if foreign investors are involved, he says. “International investors demand even stronger standards, which they are used to in their home market,” he notes.

Capital markets are a key way of linking into international networks, Moss says. They also influence the way governments conduct their business and subject them to scrutiny. “If you don’t have a credit rating, and many poor African countries don’t, then you don’t have to worry about maintaining it,” he says. “If you do have a rating, you have more at stake.”
The 15 stock markets in sub-Saharan Africa are forging links with the JSE securities exchange in Johannesburg and are working to harmonize listing requirements. Meanwhile, exchanges in Uganda, Kenya and Tanzania are also working together to create another regional hub. East African Breweries, the first company in the region to reach $1 billion in market capitalization, is listed on exchanges in all three countries.

“There are two main ways that capital gets distributed: through banks and the markets,” says Marc Chandler, global head of currency strategy at Brown Brothers Harriman in New York. Most developing countries rely more on banks, which tend to be extremely conservative and make binary decisions. “Either you get the loan or you don’t,” he says. “In contrast, the markets have capital for everyone, even companies that are bankrupt, and only the terms are dickered over.”

One of the criticisms of developing countries in Asia, according to Chandler, is that they haven’t done enough to develop their markets. As a result, they are unable to absorb the vast savings and export earnings, which means that capital must be exported, he says. Meanwhile, sub-investment-grade companies from developing Asia have flocked to the United States and Europe to raise funds.

The excess savings in the Middle East is even greater due to the flood of petrodollars, Chandler says. Many oil-exporting countries have large Muslim populations and impose restrictions on paying interest or trading in futures and options. This has discouraged the development of domestic capital markets. However, the recent surge in Islamic financing is removing some of these impediments.

“It is in the US economic and geo-strategic interests for there to be deep and broad Islamic capital markets,” Chandler says. “They promote economic development and thus foster stability. They help to integrate the region and its people into the world economy, giving them a greater stake in the world’s prosperity,” he says.

Chandler says the US should consider issuing a dollar-denominated Sharia-compliant financial instrument. “It would signal respect for Islamic law and people and would recognize the limitations of military and political strategies,” he says. Such an instrument would also appeal to fund managers of socially responsible investments, who may be attracted to the high ethical standards that Sharia demands, he adds.

The International Finance Corporation, or IFC, the private-sector lending arm of the World Bank Group, is helping to develop capital markets in emerging economies by issuing bonds in local currencies as part of the funding of the organization’s operations. John Borthwick, IFC’s deputy treasurer for funding, says the ultimate beneficiaries of efficient local capital markets are the companies that are able to issue debt denominated in their own currency. “Over time, domestic securities markets will lower the cost of capital for local businesses,” he says. “What’s more important, these companies should not be forced to finance their operations with foreign-currency-denominated borrowings.” One lesson of the Asian financial crisis of the late 1990s is the need for companies to avoid currency risk by seeking domestic sources of finance.

IFC has $15 billion of debt outstanding in 16 different currencies, including eight emerging market currencies, and has issued securities in 35 different currencies. It swaps most of its bond issues into variable-rate dollar-denominated debt. In October 2005 IFC became the first nonresident institution to issue yuan-denominated “panda bonds” in China’s capital markets. The 10-year bonds were placed with institutional investors. China International Capital and CITIC Securities were joint lead managers. “One issue doesn’t make a world of difference in a highly regulated environment such as exists in China,” Borthwick says. “But there is no question that such issues help to develop the domestic financial sector and local capital markets.”

In recent years, IFC has opened new debt markets in Colombia, Morocco and Peru with its borrowing operations. It also launched the first Islamic bond by a supranational in Malaysia in December 2004. The three-year ringgit-denominated bonds were heavily oversubscribed. HSBC Bank Malaysia and Commerce International Merchant Bankers were the joint lead managers.

“We may return to Peru, Malaysia and China with future local-currency bond issues,” Borthwick says. IFC has been hoping for some time to issue baht-denominated bonds in Thailand, but market conditions have not been right. The coup in September could delay further issuance in baht. IFC also has been ready to issue rupee bonds in India for some time but has been dissuaded because the market for swapping into dollars does not work efficiently.

The European Bank for Reconstruction and Development, or EBRD, is helping to establish market economies in formerly communist countries in eastern Europe and central Asia. In Russia the EBRD issued five-year, floating-rate, ruble-denominated bonds in May 2005. It helped the National Currency Association create a money market index similar to Libor, known as the Moscow Prime Offered Rate, or MosPrime. The EBRD’s first local-currency loan was in Hungarian forints in 1994. The bank has also made loans in the Bulgarian, Czech, Kazakh, Polish and Slovak currencies.

The European Investment Bank, or EIB, the EU’s long-term financing institution, issued its first floating-rate note in the Bulgarian lev in September 2006. Its first Bulgarian issue was a five-year fixed note in 2004. The floating-rate note bears a coupon linked to the three-month Sofidor, the interbank lending rate. Austria-based RZB Group was the sole lead manager for the issue, which was jointly arranged by Raiffeisen Zentralbank Österreich and Raiffeisenbank (Bulgaria).


Gordon Platt
 

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