ACCESS TO FINANCE: The Rise of Capital Markets in Emerging and Frontier Economies

ACCA's new series of publications on capital markets, formally launched at the 2012 Council Meeting in Nairobi, Kenya, consists of two parts. The discussion paper, The rise of capital markets in emerging and frontier economies, provides a review of the academic literature on capital market development and proposes ways of enriching the global debate on the subject.
Making capital markets work in emerging and frontier economies, a compendium of case studies, provides firsthand accounts of critical episodes in the development of capital markets in Africa, Asia and the Caribbean from senior professionals in capital market authorities, exchange operators and accountancy practices. Together, the two papers provide an overview of the theory and practice of market development and an appreciation of the challenges for emerging economies and the stakes involved. Without some of these key insights presented in these, it is impossible to understand the many policy and market developments in emerging markets: Financial disclosure and assurance are critical to the health of capital markets and play a substantial part in determining whether their growth will benefit or hurt domestic economies.
Markets fail because of lack of liquidity - but they can also become unstable when liquidity outgrows their institutional frameworks. Capital markets are brands - reputations are hard won and easily squandered, but yield rewards. Capital market development is a regional agenda - no regulator, exchange operator or government operates in isolation. Dominant family firms and formerly state owned organisations are the norm, not the exception, in emerging capital markets. Governance arrangements need to reflect this and cannot simply be borrowed from practices in more established markets. Market development is a learning experience for everyone involved, be they regulators, market participants, or the general public. Some lessons take a long time to learn, or must be learned the hard way.
LESSONS FROM (AND FOR) EMERGING AND FRONTIER MARKETS
Bucking the trend
The leading emerging capital markets have resisted the loss of confidence in financial disclosures that afflicted most developed markets around the world. In the latter, confidence in disclosures dwindled well before the magnitude of the coming crisis was understood, making it a leading indicator of market dysfunction. Clearly, financial disclosures are valuable, though not all information creates value proportionate to the costs imposed on business. In emerging and frontier economies particularly, there is little room for relaxing disclosure and assurance requirements. Investors cannot be expected to assume the risk that comes with investing in what is often a novel and illiquid asset class without the best quality information possible, nor can they be expected to participate in markets where crucial information remains private.
Branding capital markets
There is such a thing as the 'brand' of a capital market: business, government and the accounting profession can work together to establish a reputation that attracts more participants and liquidity to their markets. Businesses in emerging economies actively seek out the kudos from listing in better-branded markets, and a reputation for strict and consistent enforcement of the rules is embedded into the regulatory capital of domestic capital markets. In fact there is a great deal of often overlooked infrastructure on which markets rely, both tangible and intangible. Payments, clearing, settlement and custody systems are crucial for ensuring the correct function of markets, and connecting these systems is a prerequisite for good market function and integration at the regional level. Frontier markets need to priorities these elements before moving on to more visible investments.
Exchange automation is another challenge for frontier markets, with countries often requiring careful planning, even external assistance, to help them cope with the substantial investment required.
Regional integration
Integration at the regional level is an important trend among emerging capital markets around the world, and one to which the naturally globalise accounting profession can contribute a great deal. Must of this agenda is about capacity building and best practice, with more established exchanges and regulators providing a valuable source of expertise and good practice for their peers. While this process works well on a regional basis, it depends on personal relationships between thought leaders and is therefore much less developed at the global level. This is regrettable. Clearly some of the challenges of regional integration are very similar across regions; for instance, it is common for grand designs of a centralised regional market structure to give way to multi-speed, peer-to-peer models of collaboration; this lesson keeps being re-learned around the world as different regions pursue their integration agendas in isolation.
Qualities of liquidity
Illiquid markets are failed markets; that said, more liquidity does not translate to greater success. When the rules are more accommodating towards liquidity providers than investors, the resulting volatility can threaten the stability of markets and drive away both businesses (issuers) and investors. Bringing in liquidity by introducing big players such as foreign investors or pension funds can be challenging as the quality of their participation may vary. As a rule, markets benefit little from 'dumb money' and not at all from 'too-smart' money exploiting inside information. The participation of the wider public is necessary for market liquidity; yet without an investment in public financial education, retail investors can be exposed to disproportionate risks. Policymakers have understood and correctly prioritised this, but public education requires patience and the intelligent use of appropriate channels to ensure maximum impact.
Governance and market conduct
The systems of control and governance as well as the competitive conditions common to many emerging markets give rise to some unique challenges. While widening the use of professional managers and the protection of minority shareholders are crucial steps towards developed market status, the principal - principal conflicts common to emerging markets are unlikely to be addressed fully by importing best practice from rich countries, where the focus is on principal-agent problems. In many cases the market has evolved parallel systems of controls or even informal markets for governance services, involving such agents as controlling block holders, auditors, and possibly other service providers.
Professional judgement and responsibility in an imperfect world
No market enjoys a perfect record of disclosure or assurance. In emerging and frontier economies it is particularly important for the accounting profession to distinguish between problems specific to individual listed firms, which must be challenged strongly by individual accountants and auditors, and systemic problems that must be dealt with at a higher level. Faced with persistent systemic weaknesses, accountants must be ready to exercise professional judgement and assume the responsibility that comes with it.
You can find the full capital markets discussion paper and ACCA's compendium of case studies on our Access to Finance microsite: www.accaglobal.com/en/research-insights/access-finance.html