The Regulation Of Financial Markets In The Southern African Region – Current Status And Developments

The success of the financial sector is a key component for economic development

The financial markets sector is one important area of public concern in Africa. The need for adequate regulation and supervision of Financial Markets as an important mechanism for the promotion of economic development in African countries cannot be overemphasized. Financial markets regulation remains a very sensitive and complex activity when it comes to governmental policy development, with relation to defining strategic options pertaining to financial regulation. This article reviews the current status of financial farkets, the legal and regulatory frameworks in the Southern African region, with a special focus on selected countries.

The topic under investigation relates to the regulation of financial markets by governments within the Southern African countries both at national and international levels. It attempts to grasp its rationale, objectives, approaches and the practical ways of defining a regulatory framework for a modern African financial market and system. At a time many experts are calling for liberalization of financial services in Africa, it is important to analyze what are the rationale, advantages and implications of financial markets regulation for Southern African countries under the light of new international instruments and standards, such as the Basle II Framework and the WTO Agreement on Financial Services of 1994, whose operational modalities are is still under negotiations on various key aspects.

This paper attempts to examine the institutional and regulatory framework for the financial markets operations in order to understand the underlying principles of financial markets regulation development; to develop a concise outline of financial markets regulation framework within the South African countries; and provide as much as possible a clear understanding of policy development, key issues and challenges relating to the regulation of financial markets in the Southern African region.
The terminology used in the financial markets jargon is considered to be highly technical and can some times be confusing. While we attempt to keep a non technical language through out this paper, it is quite impossible to avoid the specific concepts used in the financial profession. For some key concepts, a concise glossary of most of the technical words is provided at request by the author.

The Southern African region: geographic coverage and scope

The broad Southern African Region considered under the present study is defined with reference to the SADC membership, currently comprising 14 countries, i.e. Angola, Botswana, Congo (the Democratic Republic of), Lesotho, Malawi, Mauritius, Mozambique, Namibia, Seychelles, South Africa, Swaziland, Tanzania, Zambia and Zimbabwe. However, our scope is limited by the criteria of readily available data, and the level of financial markets development in the countries under investigation. Angola and the Democratic Republic of Congo are emerging from long wars and are still rebuilding their economies and financial systems. Both have no formal financial market. Accurate and reliable data is very limited on their systems. The study covers a period of 10 years (1994-2004).

Background overview on Financial Markets

The regulation of Financial Markets, taken as a broad concept, is the process that encompasses regulation, (i.e. the establishment of specific rules of behaviour), the monitoring (i.e. observing whether the rules are respected) , the supervision (a more general observation of the behaviour of financial institutions and operators), and the enforcement (ensuring that the rules are complied with) of the established laws.

The ultimate economic function of financial markets is to mobilize and allocate resources through financial intermediation in order to accelerate the process of economic growth. This function is performed through two distinct but interrelated components of the financial markets, i.e. the money market and the capital market. It provides channels for transferring the excess funds of surplus units to deficits ones. They constitute the mechanism that link surplus and deficit units, attracting funds from savers in the surplus sector and channeling these to borrowers for the purposes of profitable investment.

For the purpose of providing a clear understanding of this topic, it is profitable to present a wide overview of a typical financial system and the place of the financial markets holds within this framework. As a practical illustration, we provide in a table of Annex I, the Conceptual Framework of a typical financial market system (the Case of South Africa).

Financial Systems and Financial Markets development

The financial system in the Southern African region consists of providers and users of financial services. The typical financial system consists of a variety of institutions, instruments and markets that facilitate the flow of financial resources between borrowers and lenders. The financial institutions include moneylenders, banks, insurance companies, leasing companies, venture capital funds, mutual funds and pension funds, brokerage houses, investment trusts and stock exchanges.

Financial instruments involved range from currency notes and coins, cheques, mortgages, corporate bills, bonds and stocks to futures, swaps and other complex derivatives. The markets for these instruments may be organized or may be informal. The users of the markets may be households, businesses and the government. Compared to those of developed countries (Europe, Asia and America), the typical financial markets in the Southern African region are characterized by the absence or a limited number and quality of the financial services providers, the absence of many of the instruments and the lack of depth in the markets.

Financial Markets typology and structure

The financial markets play a very important part in the economy of a country and the well-being of every person. They interact with other markets and have an influence on issues such as wealth, inflation and economic stability in a country. The financial markets have their own characteristics and to be able to regulate them or operate in them, it is important to comprehend these characteristics.

Classification of Financial Markets

Financial Markets can be classified into different categories depending on the characteristic of the market or instrument used to create categories. There exist two ultimate distinctions of financial markets. The primary market, i.e. for the sale of new markets, and the secondary market for already existing securities. The capital market, which is the market for the issue and trade of long-term securities, on one hand and the money market, i.e. the one of short-term securities, on the other hand,
In general terms, the money market is the market where liquid and short-term borrowing and lending take place. The lending of funds in this market constitutes short-term investments. In a certain sense all bank notes, current accounts, cheque accounts, etc. belong to the money market.
In financial market terms, the money market exists for the purpose of issuing and trading of short-term instruments, that is, instruments where the term remaining from the date when trading takes place to the date of redemption of the loan represented by die instrument (commonly referred to as the “term to maturity”), is of a short-term nature. In theory, this term for classification as a money market instrument is given as one year. In practice, however (especially in South Africa), instruments with a term to maturity of three years or less are normally classified as money market instruments although this is not a hard and fast rule.
For the purpose of regulation, the classical typology of Financial Markets recognizes the following major distinctions :

the inter-bank and credit markets
the Money Market ;
the Equity Market ;
the Foreign Exchange Market ;
the Bond Market (for Government bonds, Corporate bonds, Eurobond market, structured bonds, etc.) ;
the Derivatives Market: ( for Futures, Swaps and Options)
Apart from the above mentioned categories, an other important distinction is established between the domestic financial markets and the international financial markets.

The institutional framework for the regulation of Financial Markets.

A financial system cannot be effective without an adequate regulatory framework. For a financial system to be effective and promote healthy economic development, it is important to put in place a sound legal and institutional framework. Various strategies and approaches are generally considered by experts for the development of financial systems. Two major strategies commonly considered are the “evolutionary” and the “proactive” approaches. Other experts have made a distinction between the “go slow” versus the “big bang” approach.
The pro-active strategy provides legal, regulatory and prudential framework which accelerates financial market development through mechanisms, institutions and financial instruments set up for this purpose. This strategy is considered as the appropriate approach for African and other developing countries for three main reasons:

Inadequate neutral incentive environment and market forces that are insufficiently strong for financial markets to develop by themselves.
Lack of institution-building capacity to determine the pace and strength of financial markets development.
Need for flexibility to allow for the use of the most efficient institutional set-up, required training infrastructure and choice of technology that is most suited to the local conditions and level of development.
The Rationale, Principles and Objectives of Financial Markets Regulation
1. The necessity for a Financial Market Regulation

Why regulate Financial markets? This question is central to the subject under investigation in this paper and before we attempt to grasp the rationale and objectives of financial markets regulation, it is important to understand why such regulation should exist in the first place. The necessity for a financial market regulation finds its basis in the same principles applied to the financial sector in general. Borrowing and lending of money create certain risks, namely :
That the borrower will not be able to repay the money ;
That the lender is receiving a fixed rate on his investment while market rates fluctuate in such a way that the yield on his initial investment is now below current market related rates ;
That the value of the capital invested could decrease due to movements in the market. In order to clearly define the rights and obligations of investors, borrowers, operators and intermediaries involved in a financial system and who operate under contractual relationship, it is of the highest importance to develop a cohesive and comprehensive legal and regulatory framework.
The stakes involved in the running of a country’s financial markets are very high and it would be deeply irresponsible to apply the rule of “laisser-faire” in this very sensitive sector. In case some thing would go wrong or the financial system could undergo a serious crisis, it would result into a total collapse of the entire economy.

Such a framework should encourage discipline and timely enforcement of contracts, fostering responsibilities and prudent behaviour on both sides of the financial transaction. For a country’s market to develop and operate efficiently, the legislative and regulatory framework should incorporate rules on trading, intermediation, information disclosure as well as strict sanctions against defaulters and cheaters.

2. The Rationale of Financial Markets Regulation

The rationale underlying the financial market regulation is the general philosophy and ideological background pertaining to a specific country’s economic orientation, and the type of economic system adopted by the country’s leadership. At present, most of the countries covered by the study are characterized by a “market oriented ” economy. However, some of these countries have been under a centrally planned economy until the 1990s when they dramatically changed their economic orientation. It is the case of Tanzania, Mozambique and Angola. The changes were particularly due to persistent deficits in public budget and their inability to support the considerable burden of state owned companies unable to achieve the target economic performance. This new orientation facilitated the development of more diversified and active financial systems, leading to the creation of Financial markets in Tanzania and Mozambique. Financial Markets have their own unique characteristics and financial operators differ from one country to an other. The financial market framework should facilitate rather than impede the efficient operation of the financial system.
The Principles of Regulation
In theory, there is a distinction between general and specific principles. The following general principles are widely recognized for the formulation of an effective regulatory process:

Every regulatory arrangement should be related explicitly to one or more objectives identified;
All regulatory arrangements should be justified with respect to their cost-efficiency;
The cost of regulatory arrangements should be distributed equitably ;
All regulatory arrangements should be sufficiently flexible, in the sense of being amenable to changes in markets, competition and the evolution of the financial system ;
Regulatory arrangements should be practitioners- based.
Specific principles are identified as follows:

a. Principles related to the regulatory structure:
What is the adequate structure for financial markets regulation. One major issue in Financial markets regulation relates to the number of regulatory and supervisory agencies involved. The issue of the choice between a single regulatory authority or multiple specialized agencies is generally resolved according to the following principles:
there is a need to adopt a “functional” as well as an “institutional” approach ;
the coordination of regulation by different authorities and agencies will help to achieve consistency ;
there should be a presumption in favour of a limited number of regulatory agencies /authorities.
In practice, the institutional and functional approaches need to be employed in parallel because regulatory authorities are concerned with the soundness of institutions, as well as the way in which services are provided.

b. Principles related to the market efficiency :

These are principles designed to contribute to the promotion of a high level of efficiency in the provision of financial services. They are :
(a) the promotion of a maximum level of competition among market participants in the financial system, and (b) the securing of competitive neutrality between actual or potential suppliers of financial services. Competitiveness is likely to enhance market efficiency, which in turn causes the removal of restrictive practices that could impair trading in financial assets and the rationalization of market activity.
c. Principles related to market stability :

These principles are expected to contribute to the promotion of a high measure of stability in the financial system and an appropriate degree of safety and soundness in the financial institutions. There should be incentives for proper assessment and management of risk. It is necessary to impose acceptable minimum prudential standards to be observed in respect of risk management by all financial market participants.
d. Principles related to conflict conciliation :

Conflict conciliatory principles are designed to resolve potential conflicts arising between regulatory principles themselves. They would involve an integrated approach, aiming at the simultaneous achievement of regulatory objectives, and a target-instrument procedure for the selection of key regulatory instruments in order to facilitate the implementation of an integrated approach.
The Objectives of Financial Markets Regulation
For a Financial Markets system to perform to its highest capacity and level, regulation need to be both effective (i.e. to achieve its objectives) and efficient (i.e. to be cost effective in the use of its resources).

The economic dimension of a financial markets system requires that regulation should not impose unwarranted costs on the economy and consumers, nor impair the efficiency of financial markets. It is therefore necessary to consider a cost-benefits analysis exercise to assess the regulatory requirements.

The more complex a financial market is and more business operators increase, the regulatory process becomes more demanding and requires more specific objectives. Efficient financial regulation requires a multi-dimensional approach and a more optimizing process.

1. The overall objective of financial markets regulation:

The ultimate objective of financial markets regulation is to achieve the highest degree of economic efficiency and the best consumer protection in the economy.
2. Specific objectives:

The following Specific objectives can also be highlighted:
to secure the stability of the financial system.
It is important for a country’s economy to run smoothly and the financial sector must be protected against internal or external shocks which might be caused for instance by ineffective or inefficient trading clearing and settlement systems or a major lack of market liquidity ;

to ensure institutional safety and soundness.
The regulatory framework should be extremely cautious and avoid to impose obstacles or barriers that would impair the safety and soundness of financial institutions, which need to be profitable and have sufficient capital to cover their risk exposure and face global competition ;

to promote consumers’ protection:
It is crucial for a financial market to impose integrity, transparency and disclosure practices in the supply of financial services.

Concluding Remarks
In all Southern African countries, as it is in all countries of the world, the financial system is more regulated than any other industry. On the consumer protection grounds and others highlighted in this study, it is universally accepted that this should be so. Existing empirical evidence suggests that regulatory arrangements have a powerful impact on the size, structure and efficiency of financial systems, the business operations of financial institutions and markets, and on competitive conditions in the systems.

The success of a financial markets regulation depends basically on the capacity of the regulators to define the objectives of the regulation and also on the way the regulatory arrangements are related to their objectives.

Some of the countries in the Southern African Region which were able to promote a dynamic and effective regulatory framework, such as Botswana, Namibia, Mauritius, Zambia, Zimbabwe and in particular South Africa, are benefiting from the positive development of financial markets, with an unprecedented flow of capital from foreign investors.

However the financial systems in the region are still limited, in terms of the number of operators, quantity and quality of instruments and the depth of the systems. And there is still need to develop regulatory institutions, structures and mechanisms that can maximize the explicit objectives of regulation while minimizing the costs of services.

The author, is an International Consultant on Trade and Investment, Director of InterConsult Mozambique and is the Representative of Emerging Market Focus (Pty) in Mozambique. This insight paper is aimed at advising investors and business people involved in international trade by providing them with accurate legal data on the institutional and legal framework of Mozambique and the Southern African region.

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Financial Markets – An Overview

FINANCIAL MARKETS – AN OVERVIEW:

In common parlance, a market is a place where trading takes place. Whenever we think about markets, a picture that flashes across our minds is of a place which is very busy, with buyers and sellers, some sellers, shouting at the top of their voice, trying to convince customers to buy their wares. A place abuzz with vibrancy and energy.

In the early stages of civilization, people were self-sufficient. They grew every thing they needed. Food was the main commodity, which could be very easily grown at the backyard, and for the non-vegetarians, jungles were open with no restrictions on hunting. However, with the development of civilization, the needs of every being grew; they needed clothes, wares, instruments, weapons and many other things which could not be easily made or produced by one person or family. Hence, the need of a common place was felt, where people who had a commodity to offer and the people who needed that commodity, could gather satisfy their mutual needs.

With time, the manner in which the markets functioned changed and developed. Markets became more and more sophisticated and specialized in their transaction so as to save time and space. Different kinds of markets came into being which specialized in a particular kind of commodity or transaction. In today’s world, there are markets which cater to the needs of manufacturers, sellers, ultimate consumers, kids, women, men, students and what not. For the discussion of the topic at hand, the different kinds of markets that exist in the present day can be broadly classified as goods markets, service markets and financial markets. The present article seeks to give an overview of Financial Markets.

WHAT IS A FINANCIAL MARKET?

According to Encyclopedia II, ‘Financial Markets’ mean:

“1. Organizations that facilitate trade in financial products. i.e. Stock Exchanges facilitate the trade in stocks, bonds and warrants.
2. The coming together of buyers and sellers to trade financial product i.e. stocks and shares are traded between buyers and sellers in a number of ways including: the use of stock exchanges; directly between buyers and sellers etc.”

Financial Markets, as the name suggests, is a market where various financial instruments are traded. The instruments that are traded in these markets vary in nature. They are in fact tailor-made to suit the needs of various people. At a macro level, people with excess money offer their money to the people who need it for investment in various kinds of projects.

To make the discussion simpler, let’s take help of an example. Mr. X has Rupees 10 lacs as his savings which is lying idle with him. He wants to invest this money so that over a period of time he can multiply this amount. Mr. Y is the promoter of ABC Ltd. He has a business model, but he does not have enough financial means to start a company. So in this scenario, Mr. Y can utilize the money that is lying idle with people like Mr. X and start a company. However, Mr. X may be a person in Kolkata and Mr. Y may be in Mumbai. So the problem in the present scenario is that how does Mr. Y come to know that a certain Mr. X has money which he is willing to invest in a venture which is similar to one which Mr. Y wants to start?

The above problem can be solved by providing a common place, where people with surplus cash can mobilize their savings towards those who need to invest it. This is precisely the function of financial markets. They, through various instruments, solve just one problem, the problem of mobilizing savings from people who are willing to invest, to the people who can actually invest. Thus from the above discussion, we can co-relate how financial markets are no different in spirit from any other market.

The next issue that needs to be redressed is what is the distinction between various financial instruments that are floated in the market? The answer to this question lies in the nature or needs of the investors. Investors are of various kinds and hence have different needs. Various factors that motivate investors are ownership of controlling stake in a company, security, trading, saving, etc. Some investors may want to invest for a long time and earn an interest on their investment; others may just want a short term investment. There are investors who want a diverse kind of investment so that their overall investment is safe in case one of the investments fails. Hence, it is the needs of the investors that have brought about so many financial instruments in the market.

There is one more player in the financial market apart from buyers and sellers. As stated above, the one who wants to lend money and the one who wants to invest the money may be situated in different geographical locations, very far from each other. A common place for this transaction will require the meeting of these persons in person to close the transaction. This may again result in a lot of hardship. It may also be the case that the rate at which the lender wants to lend his money or the duration for which he wants his money to incur interest, may not be acceptable to the borrower of the money. This would result in a lot of glitches and latches for closing the transaction. To solve this problem, we have a body called the Intermediaries, which operate in the financial markets. Intermediaries are the ones from whom the borrowers borrow the harbored savings of the lenders. Their chief function is to act as link to mobilize the finances from the lender to the borrower.

Intermediaries may be of different kinds. The basic difference in these intermediaries is based upon the kind of services they provide. However, they are similar in the sense that none of the intermediaries are principal parties to a transaction. They merely act as facilitators. The kinds of intermediaries that operate in financial markets are:

• Deposit-taking intermediaries,
• Non-deposit taking intermediaries, and
• Supervisory and regulatory intermediaries.

Deposit-taking intermediaries are those that accept deposits from a principal. They accept deposits so that the deposits can be utilized for the purpose of advancing loans to the persons who are in need of it. Example – Reserve Bank of India, Private Banks, Agricultural Banks, Post Office, Trust Companies, Caisses Populaires (Credit Unions), Mortgage Loan Companies, etc.

Non-deposit taking intermediaries are those which only manage funds on behalf of the client. They act as agents to the principal. They merely bring together the borrower and the lender with similar needs. Unit Trusts, Insurers, Pension Funds and Finance Companies are an example of this kind of intermediaries.

Supervisory and Regulatory Intermediaries do not actively participate in the trading of securities in the financial markets as parties. They perform the function of overseeing that all the transactions that take place in the financial markets are in compliance with the statutory and regulatory framework. They step in only when any error or omission has been committed by either of the parties to the transaction, and take steps as is provided by the statutory and regulatory scheme. The Bombay Stock Exchange, National Stock Exchange, etc. are examples of this kind of intermediary.

PRIMARY MARKETS AND SECONDARY MARKETS:

In financial markets, the financial instruments (securities) may be traded first hand or second hand. For example, A wants to invest Rs. 1 million in XYZ Company, which is a newly incorporated company. One share of XYZ Co. costs Rs. 500. In this scenario, A will purchase 2000 shares of XYZ Co. XYZ Co. is issuing shares to A in return to his investment, first hand.

Suppose after purchasing the shares from XYZ Co., A holds the shares for a year and thereafter wants to sell the shares, he may sell the shares through a stock exchange. B wants to purchase 2000 shares of XYZ Co. B approaches the stock exchange and purchases the shares therefrom. In this case, B has not directly purchased shares from XYZ Co., however, he is as good a holder of shares as anyone who purchased the shares from XYZ Co. directly.

In the first example, A purchased the shares of XYZ Co. directly. Hence, he purchased his shares from the Primary market. In the second example, B did not purchase the shares from XYZ directly, however, his title over the shares is as good as A’s, even though he purchased the shares from Secondary market.

KINDS OF FINANCIAL MARKETS:

When securities are issued in financial markets, the borrower has to pay an interest on the amount borrowed. Securities may be classified based on the duration for which they are floated. The kinds financial markets that exist based on the duration for which the securities have been issued are:

• Capital Markets: This kind of financial market is one in which the securities are issued for a long-term period.
• Money Markets: In this kind of financial markets, securities are issued for a short-term period.

The trading of financial instruments and the closing of transaction need not necessarily take place at the same time. There may be a time gap between the taking place of a transaction and closing or effectuating the transaction. The kinds of financial markets that can be distinguished on this basis are:

• Spot Markets: The transaction is brought into effect at the time the trading takes place. By the very nature of the transaction, it can be understood that the risk associated with this kind of market is very minimal since the parties have no scope of going back on their promised actions.

• Forward Markets: In this kind of market, the transaction takes place on one date and is effected on some future date, which is mutually accepted between parties to the transaction. As the date on which the mutually accepted transaction is effected is different from the date on which the transaction is mutually accepted, there is a risk that one of the parties may not be in a position; on the date the transaction is to be effected, to honor the transaction. Hence the level of risk in this market is higher than that of spot markets.

• Future Markets: This kind of financial market closely resembles Forward Markets, with the difference that in this market, the quality and the quantity of the goods that are traded are specified on the date the transaction is entered into, though the transaction is to be effected on some future date. There is also an added advantage in this market in comparison to Forward Markets in the sense that there is a security of guarantee in case one of the parties fails to honor his part of the undertaking which he had promised while entering into the transaction. Hence, the level of risk associated with this market is comparatively lower than that of the Forward Markets.

RISKS IN FINANCIAL MARKETS AND HEDGING THEM:

“In this business if you’re good, you’re right six times out of ten. You’re never going to be right nine times out of ten.”

~Peter Lynch (Research Consultant, Fidelity Consultant)

When a transaction takes place in financial markets, there is always a risk factor associated with the transaction. The various risks that financial markets are usually associated with are:

• The lender may not repay the money to the borrower,
• There may be an abnormal upward or a downward movement in the price of securities, thereby hampering the interest of the buyer or seller of securities respectively,
• Negative sentiments or expectations may make some financial instruments unattractive or the whole financial market an unattractive place to the investors and force them to withdraw their investments, resulting in deep plunge of prices of the securities which once seemed very luring and attractive,
• Change in the fiscal policies of the government may make the financial markets unattractive for foreign or domestic investors,
• Change in political power in a country may result in a preferential treatment to one industry, and/ or step-motherly treatment to another, which was not foreseeable by the investors, thereby sharply decreasing the value of their securities.

From the above discussion, we can understand that investment in Financial Markets entails a lot of risks. There are other risks associated to investing in financial markets which may be a result of many composite factors which are closely or remotely related; like serious fluctuations in foreign markets or in Indian scenario, failure of monsoons. To tide over this problem, various hedging securities are traded in the financial markets. The holders of these kinds of instrument lower the risk that is associated with financial markets, by purchasing the risk that is associated with a kind of transaction. Therefore, the holders of hedging instruments are not a party to the original transaction. They are merely the ones who minimize the risk in a transaction by purchasing the risk associated with a transaction. Since these financial instruments are derived from another transaction, these instruments are also called ‘derivatives’. The ones who buy the risk are compensated in monetary terms. The higher the risk, higher will be the compensation and vice versa.

CONCLUSION:

“An investor without investment objectives is like a traveler without a destination.”

~Ralph Seger (Founder, Seger-Elvekrog Inc.)

Financial Markets are complex and unpredictable. The movements in financial markets of one country may be the effect of incidents occurring in some foreign land. It may be difficult to comprehend the financial markets at a given time and place. However, an intelligent player in financial markets always takes decisions by carefully studying the trends in the financial markets and closely following the cues in the domestic and international markets.

One also needs to be clear as to why one wants to enter the financial markets. If one wants to enter as an investor, one should invest in securities which have the potential of returning his investment with interest after the period of time for which one wants to invest. In this case one should generally purchase securities which are safe and have a reputation of giving good returns. On the other hand, if one wants to trade in securities, one should carefully study the trends prevailing in the day to day markets and make an intelligent decision by basing one’s judgment on that ground. To minimize risks, one should have a diverse portfolio, so that even if one or some of the investments suffer, the others make good one’s loss.

To conclude, the author would like to admit that financial markets are a very interesting playground, in which a player needs to be flexible and patient. There may be initial hiccups when one starts investing, however, with time, as one starts to understand the financial markets, things start falling in place; and a reminder, never under-estimate the result of a remotely connected incident in financial markets.

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