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The Need for Understanding the Securities Market

For most people living in environments where the level of financial literacy is low, securities market operations present an exoteric enigma. They hardly understand the kind of financial engineering that takes place in the securities market, not to mention the complex terminologies used by the participants in the market. It appears that if you are not a participant, hardly would you understand the lingo of the market. Yet, we expect these people to invest their earnings and life savings in a market they know very little about and do not fully understand.

Even in developed countries with high financial literacy rate, the workings of the securities market are not fully understood by all. Some analysts have argued that the recent global financial crisis could have avoided if questions had been raised about some of the financial engineering that led to the crisis. Indeed, in their ignorance, some regulations buried their heads and allowed tricks and techniques they did not understand to pass through the market without any thorough check.

Information empowers individuals, firms and even governments to make informed decisions. Current and potential players in securities markets frequently need to make decisions on the level and type of investment to make, and to know the risks and returns associated with such investment. These players need to have adequate knowledge of the investment climate that influences their investment decisions, and this depends on the availability of adequate and relevant information. For the securities markets to be promoted to become more efficient to enable it better contribute to economic growth, it depends on the availability and accessibility of adequate and quality information on its operations.

Information asymmetry contributes to the establishment of an equilibrium in which resources are inefficiency allocated. Imperfect information problems include weak information flows, agency problems that distort prices and retard competition and weak capacity for gathering and processing information. These problems and the market failure they bring about underscores to recognize adequate and relevant information as the key to promoting securities markets.

Securities markets perform a critical role in economic growth and financial stability. They serve as a mechanism for transforming savings into financing for the real sector, offering an alternative to bank financing. They are also a means for transferring risk and diversifying risk exposure, thus enabling firms to raise capital for new investments.

While the role of securities markets is more evident in developed economies, there is evidence of the growing importance of securities in many emerging markets and developing countries. In many emerging markets and developing countries, securities markets are becoming a major source of financing for the corporate sector.

In Africa, the financial landscape has changed with the growth of stock and bond markets as well as the private equity market. The number of stock markets in Africa has risen from 5 in 1990 to 18 currently, and assets and listings have grown considerably. Total market capitalization increased by 113% between 1995 and 2005.

Despite the rapid growth, African stock markets are still small compared to some stock markets in the Middle East countries and other emerging markets. The markets are dominated by a few large firms that represent a high proportion of total market capitalization.

They are also illiquid. Shares are barely traded and there are large gaps between buying and selling orders. Usually, trading occurs in only the few stocks that represent the majority of market capitalization. The markets also suffer from infrastructural bottlenecks. Trading, clearing, and settlement systems are so slow that it can take months to execute a single transaction, and most of the exchanges still operated manual systems.

Despite the problems of small size and low liquidity, studies have shown that returns on African markets have generally been high, in fact similar to those realized in Latin America, Asia and the Middle East, even when the results are converted into dollars. The annual return on the Ghana Stock Exchange, for example was 144% in US dollar terms in 2004 compared with a 30% return by MSCI Global Equity Index. The region’s markets have begun to help finance the growth of African companies but need to develop further to offer broader economic benefits.

A critical look at securities markets development in the Middle East region suggests common strengths, trends, and weaknesses, and point to future areas of reform. Within the Middle East region, progress on financial sector reforms has been uneven. Some countries such the Gulf Cooperation Council countries, Lebanon and Jordan have well-developed financial sectors, particularly banking sectors.

In most of the region, however, the securities market needs further development. Where such market exists, trading is usually quite limited. The development of these markets in some countries of the region is also complicated by legal limitations on ownership and the need for a clear and stable legislative framework.

The performance of the region’s capital markets in recent times has also been mixed. In the Gulf Cooperation Council countries, stock market corrections that started in early 2006 have continued, but outflows from these markets have benefited some other regional markets, especially those in the Maghreb countries. The Middle East countries, in general, perform reasonably well in regulation and supervision and in functional openness. But more needs to be done to strengthen the institutional environments and to promote securities market development.

To garner broader economic benefits from securities markets, the condition necessary for the markets to function efficiently must be in place. The key conditions include sound macro-economic environments and sufficiently high income levels; transparent and accountable institutions; adequate shareholder protection; and a well-developed banking system. Once in place, these conditions will encourage private capital flows, which are also very important for security markets development.




The systemic importance of securities regulations also requires adequate attention. Securities market regulation is required to address asymmetries of information between issues and investors, clients and financial intermediaries, and between counterparts to transactions. Securities regulation is also meant to ensure the smooth functioning of trading and clearing and settlement mechanisms to prevent regulation are thus threefold: to protect investors; ensure that markets are fair, efficient, and transparent and reduce systemic risk.

I would also like to suggest that your securities commissions should take action to improve information flows through public education and campaigns, investment in relevant information technologies and more generally to reduce agency problems and consequences of information asymmetry. Securities commissions should also facilitate the establishment of commodities exchanges in the hope of stabilizing commodity prices as well as creating alternative exchanges that can accommodate small, medium and micro enterprises.

Credit: This speech was delivered on behalf of the Finance Minister at the 24 AMERC meeting held in Accra last week.

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