I recently attended a conference hosted by IPC called Emerging Markets: Opportunities and Obstacles. At the event, the TABB Group presented some of their latest research on trading in the emerging markets of Eastern Europe and Asia. Then a panel of speakers discussed a range of topics related trading, regulatory environments and market structure in these markets. The conference also introduced IPC’s new financial extranet, Connexus. Here are some of the insights I took away from the fascinating panel discussion.
Interest in direct investment in emerging market equities is increasing but has always been difficult due to regulations on foreign ownership and capital controls. The most relevant of these markets is the BRICs (Brazil, Russia, India, China, South Africa), a collection of the largest of the emerging markets. Compared to the other three, Brazil is the most relatively open to foreign investors, though last year saw several punitive taxes on foreign exchange transactions and other capital controls. China continues to be the hardest market to crack for the foreign investor with Russia and India close behind. The case in China and India is much more a regulatory hurdle, while Russia presents problems from an operational standpoint.
Recent talks of market integration and regulatory reform may help to open these markets to foreign investors. This could dramatically increase liquidity and lower transaction costs as well. The cross-trading of derivative products, being developed in some markets, would also help traders and investors better allocate their capital and hedge relevant risks.
Momentum in Market Integration and Mergers
Market integration in Latin America has picked up over the last year, while other markets have seen more progress in mergers that reduce redundancy in exchanges. The stock exchanges of Chile, Colombia, and Peru began their process of equity integration last year in an operation called MILA. Equity holdings are held in custodial accounts and in the host currency within each country. The operation is using the FIX messaging protocol to facilitate communication between participating brokers. Actual cross-trading on MILA has come in well below expectations, due largely to the global risk sell-off. Even so, Mexico has recently committed to joining the integration sometime this year.
In Russia, the MICEX and RTS are the two main exchanges with the former accounting for the larger share of equity transactions. The exchanges recently released plans for a merger which should also change the operational platform within the country. Currency issues have presented a challenge in the past but may be partly resolved through a central depository. Elsewhere in Eastern Europe, Turkey has also recently announced a merger between two exchanges, the TurkDEX and the Istanbul Stock Exchange (ISE).
Competition between the two main Indian exchanges, the BSE and the NSE, has driven much of the innovation but government regulation may preclude any partnership of the two. The NSE was created by the government to stimulate competition, and it has helped to do that; so there are fewer incentives for the two exchanges to merge than in other markets. There is some hope among foreign investors that two clearing houses may merge or create some form of inter-operability to lower margin costs and transaction redundancy, but this is little more than hope at the moment.
Exchange and regulatory reforms have also been gaining momentum across emerging markets, especially in the area of facilitation for high-frequency trading. Besides merging the exchanges, Turkey is also working to make access easier for traders and other market players.
Egypt’s interim government has been working on regulatory reforms to get its market back on track after the Arab Spring uprisings last year. The EFSA, Egypt’s financial market regulator, will soon be preparing regulations to facilitate the issuance of bonds structured according to Islamic financial rules and will incorporate rules to allow for shelf registration of new issues. The recent downgrade of the country’s credit rating has hindered the ability of companies to raise capital. It is hoped that progress on these issues and political uncertainties will help reinforce confidence in the markets. Here’s an article with more information.
India moved to liberalize share trading on January 1st now allowing foreign nationals to invest directly in the country’s stock markets. Despite some liberalization, Indian companies still have specific limits on foreign ownership and several large issues have already reached their limit. This limits the amount of additional access to the markets offered by the new policy.
Some exchanges, specifically the BRIC nations and South Africa, have begun to meet and work together on cross-trading of derivative products on each other’s benchmark indexes. This could present investors with the opportunity to trade futures and options across index products and would help liquidity within the markets.