White Paper Accelerating Capital Markets Development In Emerging .

Rather than providing an exhaustive list of all challenges andsolutions uncovered, the two case studies are structuredaround three shared objectives for improving the efficiencyand effectiveness of capital markets in emerging economies:1. Create additional investment opportunities byencouraging increased issuer participation through (a)optimized issuance processes and procedures and (b)economic policies that encourage tapping into capitalmarkets.2. Broaden the investor base by improving the investorvalue proposition via (a) reforms that encourage bothforeign and domestic investments, (b) tax regimesthat align with financial development objectives, (c)strengthened regulatory and legal frameworks thatprotect investors, and (4) strong corporate governanceframeworks.3. Improve market access and efficiency by (a)improving data collection and dissemination, (b)enhancing competitiveness of the market infrastructureand the financial intermediation industry, and (c)developing and growing standard types of products andtransactions (e.g. repurchase agreements, securitieslending and equity derivatives).This White Paper offers a practical set of recommendations(Figure 1) in four action categories for policy-makersnavigating the corporate bond market developmentprocess. It provides an overview of those markets,establishing the key role they play in the financial system andoverall economic development, and highlights the numerouschallenges and extensive effort involved in developing them.The White Paper outlines recommended policy actions forovercoming some of the key challenges and acceleratingcorporate bond market development, highlighting selectactions that are potentially the most impactful.The White Paper’s recommendations are grouped into thefollowing action categories:A. Encourage greater issuer participation: How tominimize the obstacles for issuers to the market and therelative costs to participate in itB. Improve the investor value proposition: Howemerging markets can encourage the development of adomestic savings pool and lower actual and perceivedrisks of participating in the market for domestic andinternational investorsC. Enhance market efficiency and transparency: Howto enhance market infrastructure and intermediaryactivities to lower the burden and costs associated withparticipating in the market, and to match supply anddemand more effectivelyD. Attract global interest: How to establish a nationaldirection for market development and improve thedomestic market’s attractiveness relative to globalmarketsSource: Oliver WymanBackgroundThese four categories mirror the three common objectivesthat group the case studies’ challenges and solutions. In theframework of the objectives, namely (1) to create additionalinvestment opportunities, (2) to broaden the investor baseand (3) to improve market access and efficiency, the actioncategory “attract global interest” is touched upon in both thesecond and third objectives.In 2014, the Forum established the Accelerating CapitalMarkets Development in Emerging Economies initiative, withthe aim of encouraging a dialogue that could create newknowledge and aggregate best practices across emergingeconomies. From 2014 to 2015, the initiative exploredhow to make the process for developing and deepeningcorporate bond markets more effective and efficient,culminating in the initiative’s first report, AcceleratingEmerging Capital Markets Development: Corporate BondMarkets, published in April 2015.Country Case Studies5

Figure 1: Case study action categories, recommendations and outcomesAction categoryKey recommendationsKey outcomesA. Encouragegreater issuerparticipation1. Limit market distortions that bias against corporate bond markets– Expand access to anduse of corporate bond2. Optimize the issuance process and costs– Streamline issuance processes– Expand issuance options to cater to a diverse set of corporations– Harmonize the regional issuance frameworkB. Improve theinvestor valueproposition1. Introduce reforms to encourage domestic long-term savings– Encourage an investment culture through education– Provide incentive for or mandate private domestic savings2. Strengthen the regulatory and legal framework to offer credibleinvestor protection– Lower the cost offinancing– Improve efficiency andtime to market– Grow the size of thelocal capital pool– Improve market certaintyand investor confidencein entering the market– Improve recovery rates– Develop an effective and efficient process for settling disputes– Strengthen the insolvency regime3. Establish a strong corporate governance frameworkC. Enhance marketefficiency andtransparency1. Improve information availability and accuracy– Establish robust accounting and reporting standards– Improve collection and assimilation of market data2. Enhance the competitiveness of market infrastructure andintermediaries– Minimize fragmentation in market infrastructure– Ensure market infrastructure is competitively positioned– Improve the ability ofmarket participants toassess the market’scosts and benefits– Match capital supplywith demand moreeffectively– Increase secondarymarket liquidity– Develop a sophisticated and competitive environment for financialintermediationD. Attract globalinterest1. Form and communicate a clear strategy for developing capitalmarkets2. Implement a tax regime aligned with financial developmentobjectives3. Position country to be included in global indices and portfoliosSources: World Economic Forum; Oliver Wyman6Accelerating Capital Markets Development in Emerging Economies– Increase exposure in theglobal emerging marketportfolio– Be better positionedto serve as a financialcentre

The following conditions are required for successfullyimplementing the recommendations:–Macro-fundamentals have been established and/or are being addressed. These include sustainedmacroeconomic and political stability, capital accountliberalization, the fundamental rule of law, a stronginstitutional framework and a sound banking system.–The government is committed to the corporatebond market development process. Governmentsponsorship has supported successful examples ofdeveloping emerging-market corporate bond markets.–The government’s policy actions are communicatedclearly and applied consistently. While investorsare able to account for known market risks and priceaccordingly, unpredictability of doing business in acountry dissuades them from entering altogether.Furthermore, ongoing partnership and dialogue with privatesector market participants is important for an effectivemarket development process. Policy-makers should bereactive to the market and adapt as needed if unintendedconsequences of new regulations or reforms appear toadversely affect market participants.Methodology for market selectionThe Forum employed a two-step selection method (Figure2) to determine where to focus its efforts over the pastyear. To create a shortlist of potential target countries,three criteria ensured a high likelihood of impact: (a) thesize of the country’s economy, (b) the need for furtherdevelopment of capital markets and (c) the commitmentof local policy-makers to capital market development.Ultimately, collaborations were launched in Colombia andIndonesia given the Forum’s strong relationships and localpolicy-makers’ high level of interest shown in the Forum’sinitiative. Next, as the topic of capital market development isvery broad, each country had a specific area of focus withincapital markets development. Working with local policymakers, the Forum decided to concentrate on developmentof Colombia’s equity market and Indonesia’s corporate bondmarket, based on the following three criteria: (1) the size ofthe opportunity to accelerate capital markets development,(B) the potential for near-term progress and (C) the potentialto be additive to ongoing public- and private-sectorinitiatives. The country case studies include additional detailsrelevant to the topic selection.Figure 2: Two-step method for selecting countriesFigure 2: Two-step method for selecting countriesStep 1: Country selection criteriaStep 2: Topic selection criteriaAASize of opportunity toaccelerate capitalmarkets developmentSize of country’seconomyCountryofinterestBCCommitment oflocal policymakers to capitalmarketdevelopmentNeed for furtherdevelopment ofcapital markets1.2.ColombiaIndonesiaBPotential for nearterm progress1.2.Area offocusCAdditive toongoing publicand private-sectorinitiativesEquity market developmentCorporate bond market developmentSource: World Economic ForumCountry Case Studies7

I. Case Study:Colombia’s Equity MarketBackgroundLatin America’s capital markets have grown rapidly in recentyears. The total stock market capitalization has more thanquadrupled over the last decade, with Brazil, Mexico, Chileand Colombia representing the largest markets for equities.Similarly, bond markets have grown steadily across theregion, with government bonds making up the majority ofthe market.Over the past decade, the Colombian equity marketexperienced significant growth, with market capitalizationincreasing from 34% of gross domestic product (GDP)in 2005 to 73% in 2012 (Figure 3a). Driving this rapiddevelopment were strong economic growth, development ofthe private pension system, increased interest from foreigninvestors, as well as large democratization programmes thatproduced a number of landmark initial public offerings andthe development of a retail investor base.Activity in government debt and equity markets dominatesColombia’s capital markets, with the corporate bond markettrailing behind. The government bond market has flourishedsince its development in the 1990s, and is widely perceivedto be a well-functioning and liquid market. In contrast,several major obstacles impede the further developmentand growth of Colombia’s corporate bond market andequity market. Though issuances have risen in recent years,the corporate bond market remains underdeveloped, haslow liquidity and is dominated by financial-sector issues. Toaddress these and other issues, the stock exchange haslaunched an initiative to revive the market by encouragingongoing dialogue with policy-makers. As these efforts arealready under way, the Forum has focused its collaborationwith the Colombian Ministry of Finance on the developmentand deepening of the stock market.However, in the context of a challenging macroeconomicenvironment, the Colombian equity market has seen asubstantial decline in stock prices since 2012, with marketcapitalization declining to 35% of GDP in 2015 (Figure 3b).In addition, liquidity in the local market has significantlydeclined and is among the lowest among peer emergingeconomies. Colombia’s stock exchange, the Bolsa deValores de Colombia (BVC), began trading shares in 2007and experienced an average turnover ratio of only 13% in2012-2015 (Figure 4a, 4b). This lack of liquidity increasestransaction costs for market participants, preventsparticipation of certain investor types and increases risks(namely, systemic and liquidity).Figure 3a: Market capitalization of the Colombian stockexchangeIn COP TN and as a % of GDPFigure 3b: Market capitalization of key marketsAs a % of GDP1,037%1,037%Note: COP TN Colombian pesos, in trillionsSources: Bolsa de Valores de Colombia, World Federation of Exchanges, World Bank, International Monetary Fund8Accelerating Capital Markets Development in Emerging Economies

Figure 4a: Annual turnover ratio1 Colombian stockexchangeFigure 4b: Turnover ratio1 of key stock exchangesAverage of 2012-2015Measured as: annual value of share trading in the electronic order book (e.g. excludes negotiated trades and reported trades) over total marketcapitalization. Excludes trading of domestic shares in foreign exchangesSources: Bolsa de Valores de Colombia, World Federation of Exchanges1Due to these recent trends and their implications, thedepth and liquidity in Colombia’s local equity market is akey area of focus for Colombian policy-makers and marketparticipants alike. Despite measures undertaken in recentyears, further efforts must be taken to develop Colombia’sequity market in the near term.Key Challenges and OpportunitiesWithin this context, stakeholder groups discussed howthe equity market in Colombia could be further developed.Several opportunities and key challenges emerged fromthe discussion, as well as from interviews held prior to theroundtable:1. Investment opportunitiesRoundtableOn 3 December 2015, in coordination with Colombia’sMinistry of Finance and Public Credit, as well as the Unit forFinancial Regulation, the Forum hosted a private roundtablein Bogota focusing on the development and deepening ofthe Colombian equity market.01: Keynote speakerMauricio Cardenas,Minister of Financeand Public Credit ofColombia (Bogotaroundtable)The limited number of investment opportunities is a primarybarrier to deepening and developing the Colombianequity market. First, the number of issuers is low relativeto peers: as of December 2015, Colombia had only 73companies listed on its stock exchange (Figure 5a). Inaddition, Colombia’s stock market is dominated by onlya few companies, including Ecopetrol, the state-run oilcompany that accounts for nearly 45% of the total marketcapitalization. Furthermore, compared to peer economies,the Colombian equity market has a very low level of freefloat, at 29% as of 2014 (Figure 5b). A low level of free floatcan threaten the market’s liquidity and discourage investorparticipation.Efforts to attract new issuers into the market and encouragecurrently listed companies to increase the level of free floatwill be crucial to the market’s development. Several potentialopportunities include:A. Promoting issuer education01Businesses are more likely to issue stocks and/or bondsif they are educated on the processes for and advantagesof issuing financial products. The BVC’s efforts to educateissuers through the Colombia Capital programme should becontinued and expanded. In Colombia, where a substantialCountry Case Studies9

Figure 5a: Number of companies listed in LatAmexchanges1As of December 2015Figure 5b: Average free float ratioAs of 2014Includes domestic and foreign companies listed on domestic exchangesSources: Bolsa de Valores de Colombia, World Federation of Exchanges, Credit Suisse Research, Capital IQ1percentage of businesses have been family-owned or runfor generations, issuer education is particularly importantbecause family-business owners may be reluctant to tapinto capital markets due to fear of increased reportingrequirements and cession of control over their companyto outside investors. Once these business owners fullyunderstand the disclosure and reporting requirements,and the options for maintaining greater control of theircompanies (e.g. issuing preferred shares), they may decidethat the benefits of issuance outweigh the drawbacks. Inaddition, developing the family office sector could providenew alternatives for wealth generation once a familybusiness has been listed, reducing reluctance of thesebusinesses to tap into the equity market.China, Hong Kong, South Africa). Second, they couldencourage and provide incentives for large companiesthat are already issuing bonds to also issue stocks, giventhat they already largely comply with various reportingrequirements. Lastly, many of Colombia’s flagship issuancesover the last decade were “democratizations” targeted tothe mass retail market. This approach to issuance had theunintended consequence of increasing costs for issuers.Thus, this approach should be reconsidered and someissuances could instead be targeted primarily to professionalinvestors, which can then offer those securities to the retailmarket.B. Addressing the burden and cost of issuance versusbank fundingDespite significant efforts to improve corporate governancestandards of both listed companies and potential issuers,some challenges remain which may be limiting willingnessto invest in the market. In particular, strengthened protectionof minority shareholder rights is needed for issuers to attractinterest from a broad set of local and foreign investors.Many Colombian businesses have received funding fromthe country’s robust banking market. Few have accessedthe local capital markets because bank loans are frequentlymore attractive economically and less burdensome thanissuances. In order to attract more issuances, policymakers could consider a number of changes. First, theyshould continue to explore opportunities for acceleratingthe approval process for the issuance of securities. Inparticular, policy-makers could further simplify requirementsand reduce costs in the small and medium-sized enterprise(SME) market to create a market that competes withtraditional bank loans for smaller businesses. Manycountries have successfully created specific marketsegments for SMEs within their main exchanges, withrelaxed listing and disclosure requirements and lower costs(e.g. South Korea, Malaysia, Thailand, Singapore, India,10Accelerating Capital Markets Development in Emerging EconomiesC. Improving corporate governance2. Investor baseWhile Colombia has made significant progress in developinga local investor base (Figure 6), potential exists to increasethe pools of domestic capital available for deployment. Themandatory Colombian private pension system accounts forthe bulk of assets under management (AUM) in Colombia.The equity market could benefit from a larger and broaderinvestment base and, specifically, from additional shorterterm investors with more speculative strategy.

Figure 6: Asset allocation in Colombia by type of local institutional investorFigure6: AssetColombiaby type of local institutional investor1% of totalAuM,allocationas of julyin2015% of total AuM, as of July 20151AuMCOP Higher riskModerateVoluntarypensions3Mandatory pensions (by fund type)Other2Foreign (FI EQ)Local EQLocal FINote: FI Foreign investment; EQ Equity1. As of September 2015 for collective investment funds2. For mandatory and voluntary pension funds, “Other” includes private equity, derivatives and deposits; for collective investment funds, “Other” includes non-rated debt, real estate and specialized fundsNote:FI voluntaryForeignpensioninvestment;EQ byEquity3. Includesfunds managedpension fund administrators, trusts and insurance companiesprivate equity2015funds andmanagingpublic resourcesunder Decree 15251. 4.AsExcludesof Septemberfor fundscollectiveinvestmentfunds5. Includes life and non-life insurance2. Sources:For mandatoryand voluntary“Other” includes private equity, derivatives and deposits; for collective investment funds, “Other” includes11SuperintendenciaFinanciera depensionColombia, funds,Carteras Colectivasnon-rated debt, real estate and specialized funds3. Includes voluntary pension funds managed by pension fund administrators, trusts and insurance companies4. Excludes private equity funds and funds managing public resources under Decree 15255. Includes life and non-life insuranceSources: Superintendencia Financiera de Colombia, Carteras ColectivasThe following approaches, categorized by investor segment,could broaden the investor base:A. Pension fundsColombia has a dual pension system in which public andprivate funds coexist. While the country’s private pensionsystem dominates the local market, pension funds usea buy-and-hold investment strategy, and thus cannot beexpected to provide significant market liquidity. However,scope still exists for policy-makers to consider reviewingregulations in the pension fund sector. For example,Colombia subjects pension funds to relative profitabilityrules, which require funds to achieve rates of return abovea prescribed minimum. These minimum return requirementslimit risk differentiation and have created herd-like be

Emerging Economies: Country Case Studies White Paper, a second report from our Accelerating Capital Markets Development in Emerging Economies initiative. Today, the consensus view remains that establishing capital markets is a long, drawn-out process because it requires step-by-step establishment of financial instruments, regulatory and legal