CAPITAL MARKET DEVELOPMENT The way forward - Policies & Strategies AFRICA INVESTMENT CLIMATE CONFERENCE Johannesburg, 5 October 2006 Tom Lawless

CAPITAL MARKET DEVELOPMENT Topics for discussion Over-arching thoughts Macro foundation issues Market structure & Regulatory environment Policy constraints Market infrastructure – trading, clearing, settlement & custody Leadership Key issues for growth of bond markets Lessons and Observations

CAPITAL MARKET DEVELOPMENT Over arching thoughts One solution does not fit all You are different – craft your own policy & strategy solutions to your countrys circumstances Do not be afraid to ask for help & be practical - you cannot live long enough to make the mistakes that others have made Be cautious of adopting US style SEC regulations – they often are inappropriate & unsuited for our markets – Rule based

CAPITAL MARKET DEVELOPMENT Macro foundation issues Have sound transparent economic, monetary & fiscal policies Markets do not like surprises Will & commitment of government to develop capital markets – need to take bold steps Clarity of objectives - Do you need your own market? Debate, discuss with participants & decide – leadership comes from both What are your competitors doing or could they be your partners? Good governance – soft infrastructure – sine qua non Asian experience – deep respect for education, innovation, high savings rates Urge you to introduce financial literacy programmes in schools Credible market legislation & regulation Improve the quality of banks & banking services Develop, implement recognised accounting & auditing standards.

CAPITAL MARKET DEVELOPMENT Market Structure & Regulatory environment Healthy interaction between regulators & participants Best market practice – IOSCO standards – be practical Sound bankruptcy laws – soft infrastructure – so important Money markets come first Bond markets more difficult to develop than equity markets Need for pricing benchmarks – government bonds, big corporates Role of primary dealers & auction process Market making can be done by Central Bank initially PDs are not necessarily the magic wand for take-off Roles of pension funds & asset managers Prescribed assets – the good and bad aspects – think long term Build a competitive portfolio management environment Diverse range of issuers Markets thrive on diversity OTC or Exchange traded Attitude of bond participants is the key Not the equity brokers nor the regulator - Botswana CAPITAL MARKETS TAKE TIME TO DEVELOP

CAPITAL MARKET DEVELOPMENT Market Structure & Regulatory environment Recognise the contradiction in that the objectives of the market regulators may not always be the same as those of the participants REGULATORS WANT More efficiency = tighter liquidity; means Narrower spreads = less profit PARTICIPANTS WANT Less efficiency = wider spreads; means More profit = OTC markets more attractive However more participants = more liquidity = more opportunity

CAPITAL MARKET DEVELOPMENT Policy constraints Taxation Take a hard cold look at the impacts on market development Non residents withholding tax on interest Stamp duties Trade off – revenue collection vs negative impact ? Incentives ? Regulations on Tap issues How practical are they – each auction issue is a new bond - Kenya ? Investors want large issues of fewer bonds – not many small ones Impacts on investors – prudential guidelines Access to markets Markets need diversity of participants – local and foreign Restrictions hinder development - ability to manage risk Reluctance to open markets to competition – protectionism? Foreigners prohibited access to money markets – Ghana What happens to their bond activity at short end of bond curve?

CAPITAL MARKET DEVELOPMENT Infrastructure (Systems)- trading, clearing, settlement & custody Trading Do not create elaborate processes & systems – create the environment, let the market develop Call auctions (2-3 per day) around a table ? – it is a start Use OTC trading processes Telephones, IDB & data vendor systems Market wide ATS not wanted / needed – expensive, difficult to implement Centralised reporting of trades for dissemination & surveillance Clearing (Risk management) Fraught with complications in bond & money markets Equity markets have central counterparty systems – trade with impunity Bond markets do not have that OTC market risk processes work for bonds– bi-lateral counterparty limits Regulatory frameworks should be aligned to recognise this

CAPITAL MARKET DEVELOPMENT Infrastructure (Systems)-Trading, clearing, settlement & custody Settlement & Custody Manual systems work although may not be ideal - Botswana Do you need your own systems ? Look around in region – can you use them? This is a volume business – harness economies of scale Can be the costly part of the trading cycle Easier to adapt regional systems than developing, building / buying your own Use equity systems if available – settlement processes similar Secure delivery vs payment – Sine Qua Non

CAPITAL MARKET DEVELOPMENT Infrastructure (Systems)-Trading, clearing, settlement & custody Systems – concluding comments The easy part of market development Do not let them become a constraint Can become the straw that breaks the camels back OTC market systems / processes work – use them Beware of free systems – there is no such thing as free !

CAPITAL MARKET DEVELOPMENT Leadership It starts at the top ! Will and commitment of Central Government Clarity of objectives – critical Good market legislation and regulation Who are your competitors and what are they doing? Could they be your partners? Participants & authorities to have common objectives Discuss and decide Leadership comes from both Establish a Structure that encourages innovation, risk taking so that participants can make a profit

CAPITAL MARKET DEVELOPMENT Key Issues for growth of bond markets Sound economic, monetary and fiscal framework Good legal system – bankruptcy laws – soft infrastructure Effective, appropriate and harmonised financial market legislation and regulations Money markets are the starting point – asset / liability matching / mismatches Role of pension fund legislation is important Privatise the pension funds prescribed investments – promote but could also distort – be careful Do not force a structure onto a market Recipe for disaster ATTRACT PARTICIPANTS THAT CAN BE INNOVATIVE & PROFITABLE

CAPITAL MARKET DEVELOPMENT Lessons & Observations – Be practical Be practical – if you do not have all the right things in place Do not re-invent the wheel ! Size does matter – big balance sheets count !! Intermediaries / speculators are important participants – do not squeeze them out Get practical training / exposure from those who have done it before or do it now Banks, traders, Exchanges, Regulators, settlement people Importing big trading systems and market structures from Europe may be inappropriate for you One solution does not fit all – BE PRACTICAL

CAPITAL MARKET DEVELOPMENT Lessons & Observations – Be practical From my experience Exchanges are unusual places for listing & trading bonds understand the different dynamics wherein banks are major bond participants vs brokers as major participants in equities If an exchange is the chosen route – issuers and investors should not be members (users)– too many vested interests – they are clients! Consider combining equities, bonds and derivatives into one overall Exchange structure – economies of scale / skills / scope – practical issues But as separate markets – Different rules and Members (brokers in equities, banks in bonds and derivatives) Recognise that trading and risk methodologies are not the same for each market Create structures that attract Widest range of participants = more liquidity = more opportunity!

THINKBIG THINK BIG HAVE A PLAN BUT START NOW WITH SMALL THINGS

TOM LAWLESS TEL: (mobile) FAX: Tom Lawless & Asscociates Thank you for your attention