“Strengthening Financial Markets and Institutions in Africa” BY VICTOR OGIEMWONYI C.E.O/MD PA RT N E R S H I P I N V E S T M E N T C O M PA N Y P L C “Africa doesn't need strongmen, it needs strong institutions.” – Barack Obama “The above quote by US president, Barack Obama during his address to the Ghanaian Parliament in 2009 underscores the need for strong institutions to regulate every sphere of our lives in Africa.” To strengthen anything is to make it more stable, or sturdier than it presently is. It is the action taken to ensure that it will largely retain its form and integrity (i.e. its utility or fitness for purpose) in the face of testing or challenging forces of any kind. In the context of financial systems (the markets and the institutions together), strengthening will therefore imply a need to reduce financial fragility and minimise systemic risks through the development of optimally functioning systems and market discipline – majorly by promoting sound principles and best practices. At the multi-economy bloc level (like Africa), attaining stability will necessarily also have to include integration of the constituent economies’ financial systems. The ongoing trend in globalisation adds yet another layer of integration and, one must add, complexity, since Africa doesn’t trade in isolation from the rest of the world. The absence of stability in a financial system inevitably leads to financial crises which themselves are usually heralded by an asset price bubble. While stable financial systems do not banish bubbles per se, experiences from other nations and other economic blocs indicate that financial institutions could and should be doing more to recognise and deter bubbles. How we proceed in our task of strengthening Africa’s financial systems in the next few years has now become critically important if the economies of the African bloc, individually and collectively, are to be in a position to capture and enjoy the rosy range of GDP growth numbers being forecasted by the World Bank and other respected global economic institutions. At the domestic/national level, in proffering practical solutions we are minded to partition the challenge into four distinct focus areas, namely: Deepening our financial markets Broadening our range of financial instruments Improving our operational efficiencies and Strengthening our financial sector governance The collective level also compels us to focus on a fifth area: Deepening our financial integration. Deepening Our Financial Markets In its broadest sense, the depth of a financial market refers to the quantities of the securities available for trading in the market. In any market, it is important that demand-supply equilibrium is attained at reasonably optimal volume levels, lest scarcity-driven artificial upward price pressures begin to take hold. In the Nigerian context, whilst depth might not be an issue in the government bond markets, it is an entirely different story in the relatively larger but largely untradeable stock market. The growth that has taken place on the funding side, particularly with the consolidation and restructuring of the pension funds industry, has not been matched by a concomitant expansion of market liquidity. Indeed, with the possible exception of South Africa, market depth is a significant challenge in most African financial markets. Prescribing relatively high float rates - the proportion of a listed business’s issued financial instrument mandatorily made available for trading - will be a good way to begin the deepening process. The recent introduction, in Nigeria, of well-funded market makers willing and able to act as counterparties to trades is another step in the right direction. Increasing activity levels should be expected to translate into decreasing transaction costs which in turn will attract more activity in an expanding prosperity loop. Any growth on the funding side of the equation, whether as a result of increased internal allocations or because of external inflows, which is not matched by a comparable increment in absorption capacity on the asset side will, ultimately, result in price inflation, aka price bubble! A classic case of “too much money chasing too few goods”. The Nigerian stock market boom-bust experience over the period 2007 to 2010 is a ready attestation to this surprisingly common phenomenon. Broadening our range of financial instruments Simply put, financial markets exist to allocate and manage risks, and there’s no better weapon in the risk management arsenal than diversification. To broaden our markets is to expand the range of diversification opportunities available to investors; success at doing this will obviously manifest in an increased market size. We propose a two-phase approach to broadening the market and this must necessarily be hitched to the individual national economic growth engines. There’s no point trying to sprint before learning to walk; such an approach will avoid a onesize-fits-all solution. In the first phase we should focus on creating or expanding the number of tradable instruments available under the basic asset types – equities, bonds (sovereign and corporate) as well as commodities (minerals and agro-related). Thousand-stock markets should be our rallying cry! An immediate proactive approach to implementing this phase in tandem with the predicted GDP growth of the next few years should make it easier to attain in a shorter time frame than would otherwise be expected in a flat-lining or sluggish growth environment. Our SMEs are ready and waiting to be taken to the next level. With a broadened and already deepened market, it becomes easier to implement the second phase – creating a vibrant and economically useful derivatives market to further enrich and strengthen the risk management milieu. This is the point at which we will recommend the introduction of derivative products like futures (and CFDs), options, and swaps as well as securitisation products. Prudence dictates that a robust derivatives market cannot and should not be built on an anaemic underlying assets market. Firstly building a broad and deep market of valuable underlying securities and asset classes is an unavoidable prerequisite for establishing a successful derivatives market. Absent broadened and deepened financial markets, and the national and continental African growth stories may likely come to a premature termination, if not reversal. Improving our operational efficiencies Boosting efficiencies will need to be tackled from three perspectives or initiatives: Improvement in the quality and institutional competence levels of operating firms as well as a properly registered and continually trained and motivated professional cadre. Sensible acquisition and/or development of locally-sensitive cost-effective enabling technologies and platforms. Institution of transparent fit-for-purpose processes that make transaction execution frictionless and inexpensive. All three aspects must be deemed equally important if we are to develop the capacity and sophistication that will be needed to support the realisation of Africa’s immense potential in both the short and long runs. . Strengthening our financial sector governance Governance encapsulates “the range of institutions and practices by which authority is exercised” and in the present context refers to the mechanisms we already have in place as well as those that will be needed for tomorrow. There can be no strong financial system without strong enforcement. In Africa, more often than not, problems arise not because of the lack of rules, but as a result of poor, indifferent or selective enforcement. The failure of regulation (local and international) to predict the global financial crisis and the gross underestimation of its severity compel us to rethink our regulatory thrust: proactive regulation with the primary aim of preventing systemic crises. Such a refocused regulatory framework will need to be based on a set of simple goal-driven criteria that are enforced on a timely basis. At the same time, it will need to be dynamic in its ability to adapt to a fluid environment where change is the norm rather than the exception. Sincerity of purpose, transparency of action and consistency of application are the obvious prerequisites for this kind of regulation. It is also critical that the quality and quantity of available information be greatly improved. Ultimately, governance is much more than enacting rules, approving legislation, publishing standards and establishing new institutions. Meaningful and lasting financial reform can only come from behavioural change and this is only achievable by the introduction of incentives capable of inducing appropriate behaviour. This approach will necessitate creating a system of rewards and penalties that are perceived by market participants as being in their own best (self) interests. Deepening our financial integration and cooperation The recurrence of global financial crises with alarming regularity tells us that new and better coordinated frameworks are needed for the regulation of financial systems. It has now become obvious that while the benefits of globalisation are undeniably immense, they definitely do come with attachments that are also not ignorable. Countries that have climbed aboard the globalisation train (i.e. “liberalised their economies”) without first resolving economic infrastructural weaknesses on the home front were often visited by severe economic disruptions, widespread social upheavals and often times political leadership collapse. In addition to weak domestic financial systems, the non-availability of complete, adequate and timely information to assist investors undertake viable assessments of an economy’s capacity to absorb external shocks as well as its general financial soundness often leads to contagion – the negative perception/assessment based on a similarity index like geographical location (“neighbourhood effect”) or some other political economic indicator. In addition to weak domestic financial systems, the non-availability of complete, adequate and timely information to assist investors undertake viable assessments of an economy’s capacity to absorb external shocks as well as its general financial soundness often leads to contagion – the negative perception/assessment based on a similarity index like geographical location (“neighbourhood effect”) or some other political economic indicator. Summarily, and in conclusion, to promote financial stability within the African bloc, we must focus simultaneously on strengthening our individual domestic markets as well as improving our intra-African and extra-African frameworks. PROPOSITION Clear rules should be put in place and every one involved should be asked for an opinion and a consensus agreed and published as rules every. One will know how it will be operated if there were any crisis. This is important to slow down the pace of contagion when markets start to correct irrationally. The Central Banks (CBs) should ensure that all relevant financial institutions; not just commercial banks, should have access to liquidity against a broad range of eligible assets. Bagehot’s Rule: In times of crisis, Central Banks (CBs) should lend freely but against collateral & at a penalty rate, to avoid moral hazards. Financial Intermediaries should focus more on risk management; placing more emphasis on the liquidity risk. Thank you for your attention.