Towards capital markets development: issues and challenges
The Daily Star
Being “the part of a financial system concerned with raising capital by dealing in shares, bonds, and other long-term investments”, capital markets constitute the main source of financing for companies in the developed world.
In Lebanon, financial intermediation through banks remains the main source of financing and things do not seem to be changing soon. Hence the questions: are developed capital markets important for the economy? If yes, what hindered its development throughout the past 20 years?
On the first question, most of the economic literature finds a positive relationship between capital markets development and economic growth. The reasons comprise an increased efficiency of sources of financing as alternatives to banking loans; an improvement in the transmission mechanism of monetary policy; an enhancement of the availability of long term financing; an improvement of financial stability as more instruments are available to manage risk; a more efficient capital allocation in the economy; and the attraction of foreign investment.
“In Lebanon, high growth rates are no longer a possibility through the banking system. As banking loans surpassed 100% of GDP, we have to start the shift towards a more balanced economy between the banking system and capital markets”, emphasized Firas Safieddine, vice chairman of theCapital Markets Authority (CMA).
As for barriers preventing the development of capital markets, the list can be stretched endlessly as there are issues related to transparency, governance, commercial law, tax policy, and to the market itself.
A conference organized by Euro money was held on May 31st, 2016 and tackled some of these issues.Our aimis to shed the light on the main obstacles that have to be addressed and on the need for a combined effort among Government, monetary authorities, regulators and companies.
The first set of policies should aim at ‘heating the swimming pool to push nonlisted private companies out of water’, meaning out of their comfort zone, and at making the advantages of getting listed outweigh those of staying private. The second is to have enticing attractions ‘outside the pool’ to lure companies to get out.
As put by Nicholas Chammas, president of Beirut Traders Association (BTA), “to this day, the stock exchange is not deep, liquid, and efficient enough so that companies are not really encouraged by what they see. We hope that the new Electronic Trading Platform will change not only the reality but also the perception of the market by the corporate world”.
Here the chicken and the egg causality dilemma resurfaces as to which issue should be tackled first: increasing the number of listed companies to enhance liquidity or deepening the market to incentivize companies to get listed. “Authorities could start by listing public entities such as Telecom companies, the airline companyMiddle East Airlines, and Casino Du Liban,” advocates Marwan Abou Khalil, head of Financial Markets at BLOM Bank.
Starting with legal issues, the Commercial code has to be revamped all together as it is in place since the mid of last century. There is no modern bankruptcy law similar to the chapter 11 in the United States, company charter cannot be overruled by a shareholders’ agreement, and dilution risk is increased as investors who hold their shares for more than two years will double their voting rights. This matter will not only discourage companies from getting listed but also discourage trading.
Moreover there is no law that protects minority shareholders in Lebanon.
Division of votes is not allowed by the current law and a shareholder can only give proxy to another shareholder. A fund that is acting as a proxy for many shareholders may not divide its voting rights in percentages among shareholders’ opinions, it has to adopt the majority viewpoint.
“There are many draft laws in the parliament or still at the government stage to remedy some of the law’s limitations, such as amending the private partnership corporation statutes to create a structure for private equity funds, allowing companies to issue preferred shares, and adjusting the legal framework for companies regarding the duties of board members…” commented Mohamad Alem, CEO at Alem and Associates.
Improving transparency and corporate governance requires from very large companies to publish their audited (from a list of certified auditors) annual financial statements along with the standardization of financial statements. This will help deterring companies from having double balance sheets and income statements, which increases the revenues for the Treasury and enhances transparency in the companies’ disclosure policies.
Najib Choucair, Head of Banking Department at the Central Bank andMr. Chammas share the same view on this issue, mentioning that “The culture of the family business which is deep seated in companies will take time to evolve as far as opening up capital to investors and companies’ books to market scrutiny.
”Mr. Choucair added: “history is not encouraging on the demand side too with investors reluctant to buy shares in companies without having a say in the board, as many have acquired share swithout being able to sell them and without being able to get a decent return on these shares or even getting basic information on the companies they invested in.”
Fiscal authorities can also provide some incentives to help, however they should be coordinated with the above mentioned measures to bear fruits. The government can reduce social security charges on companies and be stricter in implementing the law. Fiscal authorities are also trying “to eliminate biases in the tax system and to level the playing field regarding the tax treatment of personal and companies’ capital gains” as mentioned in an informal discussion with Alain Bifani, Director General at theMinistry of Finance. Currently legislation favors personal capital gains (exempted)over companies’ capital gains (subject to taxation through corporate taxes).
On the demand side, the major challenge would be to diversify the players to prevent having a one-sided market. Social Security Fund and other pension funds related to public or semi-public entities should be allowed or even required to have some of their liquidity invested in the equity or corporate bonds market. Incentives will have also to be given to the insurance companies to hold part of their portfolio in equities. For now, insurance companies are required to invest 50 percent of their collected premiums in Lebanon without any specification on the kind of assets they can hold. Requiring them to invest half of the 50 percent in equity funds could be approved by the CMA for insurance companies as a way of increasing and diversifying demand on the stock market.
Other measures to develop the market comprise: Putting a limit on the leverage ratio of companies will oblige them to increase their capital, and therefore they will either go to the market or move some of the owners’ personal assets into the company.
Leaning on banks to only accept the audited financial statements that are presented to the Treasury is also important.
Most of market players are praising the role played by the CMA in regulating capital markets, but what about developing capital markets? This issue needs a body that lays out a strategy comprising the changes needed in the laws, and any other needed measures, with lobbying at all levels to adopt the needed changes. Can the CMA be the champion of capital markets developments as it is the champion of regulations? Only time will tell.
This monthly editorial is brought to you by the Research Department of BLOMINVEST BANK.For inquiries, Contact: firstname.lastname@example.org
A version of this article appeared in the print edition of The Daily Star on June 08, 2016, on page 5.