Securities Markets

The sectoral development assessment is to some extent subsumed in International Organization of Securities Commissions’s (IOSCO’s) Objectives and Principles of Securities Regulation (see box 4.5). Investor protection, fairness, efficiency, and trans­parency are among the most important prerequisites for the development of organized securities markets. These important elements of effective securities regulation are also covered in the IOSCO objectives and principles. When investors have confidence, the market tends to grow.

In addition, the assessor needs to verify, by looking at the quantitative measures, that the market is, in fact, deep and liquid; that transactions and issuing costs are reasonable; and that an adequate range of both debt – and equity-type instruments are available. The range of instruments would include some derivatives if this inclusion can be supported by the scale of activity and by the technical needs and sophistication of the market partici­pants. The assessor also needs to look at the degree to which the market can provide new funding through public offerings. Benchmarking of the securities markets needs to pay attention to some hidden factors. For instance, in addition to market micro-structure and market size, the liquidity of the securities markets also depends on the degree to which securities are not held in blocks by insiders and, as such, are not normally available for


Box 4.5 Standards Assessments and Financial Sector Development


Standards assessments can inform development assess­ments. Sectoral reviews, plus an understanding of the state of development and the soundness of sectors, are needed to inform standards and stability assess­ment. The standards, codes, and core principles that are important for the sound and efficient functioning of the financial system cover both financial supervi­sion and financial infrastructure, and they are listed in box A.2.

International standards and codes for financial systems supervision have been designed to promote effective supervision and regulation of individual financial institutions and markets. Those standards (for banking, insurance, and securities market super­vision) promulgate a set of objectives, core principles, and good practices that cover regulatory governance, regulatory practices, prudential framework for the operations of financial firms, and financial integrity and safety net arrangements. All supervisory stan­dards recognize that a set of preconditions (outside the scope of those standards) must be met to allow effective implementation of the standards. The pre­conditions include sound and sustainable macroeco­nomic policies; a well-developed public infrastructure (accounting and auditing, corporate governance, legal framework, and so forth); procedures for resolv­ing problem institutions; and an appropriate level of systemic protection and safety nets.

A review of preconditions for effective supervi­sion—some of which are covered by their own stan­dards—can clearly help identify gaps in infrastructure and can provide inputs into development assessment. Similarly, assessments of the financial infrastructure as part of development assessment can give informa­tion on the adequacy of preconditions for effective supervision. A significant part of financial sector development policies relate to strengthening the public infrastructure. This strengthening not only promotes more efficient financial services with greater depth and access, but also creates conditions for effec­tive supervision.

Standards assessments themselves provide key information needed for development assessment and


for a range of policies to implement standards to help improve efficiency of financial firms and to assist with their institutional development.

• All supervisory standards include a set of princi­ples relating to the prudent operations of finan­cial intermediaries covering risk management, risk concentration, capital adequacy, corporate governance and internal controls, customer protection, and prevention of financial abuse. Policies that promote such prudent operations can help strengthen the efficiency of the institu­tions, strengthen their governance, and enable more effective and appropriately priced delivery of financial services. Information on those mat­ters from standards assessments provides valu­able input into development-oriented policy formulation.

• Some development concerns are addressed in IAIS Insurance Core Principle (ICP) 1. ICP 1 sets out preconditions for effective insurance supervision, which represent a subset of the pre­conditions for a well-developed insurance sec­tor. Prudential insurance assessments can also help in the fact-finding efforts for the develop­ment assessment, for example, in relation to investment requirements (ICP 21). Several other useful sets of standards and guidelines have been developed for other elements of this broad subsector (for a compendium, see OECD 2002).

• IOSCO Objectives and Principles of Security Regulations promote robust and efficient finan­cial markets. Thus, IOSCO principles 14-16 aim to ensure that issuers are transparent and fair, principles 17-20 to ensure that collective investment schemes are equally trustworthy, and principle 28 to ensure that secondary mar­ket manipulation is inhibited. IOSCO principle 23 deals with standards for the internal organi­zation and operational conduct of market inter­mediaries to ensure adequate client protection and risk management.


trading. Estimates of this free-float can greatly reduce the apparent size of the market and can put its true scale into perspective.

The domestic bond market is often more weakly developed than equities, and causes of this weakness should be reviewed. The reasons typically lie in tax rules; in the systemic dominance of banks, for whom a developed bond market would represent competition; or



in crowding out by heavy domestic government borrowing. More generally, government debt management can have a decisive influence on the functioning of the bond market.18 Effective public debt management can help provide the benchmarks needed to price more risky securities, and the physical and institutional infrastructures for government debt markets could reinforce and complement the needed infrastructure for bond markets gen­erally. The transactions technology infrastructure—in this case, also potentially includ­ing such features as privileged market makers—may also be inadequate. These and other prerequisites for bond market development are clearly described in World Bank (2001c), which also notes how sensitive bond market development is to monetary policy manage­ment and generally macroeconomic stability—prerequisites that lie beyond the scope of development assessment.

image009Liquid securities markets require a minimum scale to be cost-effective. Certainly, the cost built into the design of the trading platform and the regulatory burden can become decisive. Overheads of the market itself and of the regulator can also be too heavy to be borne by fees on the existing level of transactions. Where possible, the assessor should attempt to calculate those costs and the degree to which they are being subsidized. This calculation is especially important where consideration is being given to further com­puterization, a step that often may not be cost-effective or necessary in small exchanges. With many small securities markets, the inherent viability of the brokerage industry needs to be checked, which has been a problem in several countries. In some cases, most brokers are subsidiaries or divisions of banks, an arrangement that may help reduce overheads but may limit the energy with which the brokers develop their services. Of course, the impor­tant goal is not survival of the stockbrokers per se, but achievement of an optimal way of giving local firms and investors access to liquid securities markets.

Many securities markets have been subsidized through tax concessions to listing com­panies, but with limited success. Several countries have forgone substantial revenue in this way with the objective of encouraging the development of the stock exchange but without generating any sizable activity in the market.

The degree to which larger firms are going outside the country to issue shares or depository receipts in advanced stock exchanges should be examined. While such behav­ior can reduce local market liquidity, it also has the potential to result in the importation of improved transparency and other practices by a demonstration effect. It also results in lower funding costs for the companies that do have such access.

More generally, the question for small countries of whether outsourcing and closer integration with regional or global markets would be more effective than promotion of an onshore securities market must be seriously considered (compare to Bossone, Honohan, and Long 2002).

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