CAPITAL MARKET DEVELOPMENT The way forward - Policies & Strategies

1. CAPITAL MARKET DEVELOPMENTThe way forward - Policies & Strategies AFRICA INVESTMENT CLIMATE CONFERENCE Johannesburg, 5 October 2006 Tom Lawless

2. CAPITAL MARKET DEVELOPMENTTopics for discussion • Over-arching thoughts • Macro foundation issues • Market structure & Regulatory environment • Policy constraints • Market infrastructure – trading, clearing, settlement & custody • Leadership • Key issues for growth of bond markets • Lessons and Observations

3. CAPITAL MARKET DEVELOPMENTOver arching thoughts • “One solution does not fit all” • You are different – craft your own policy & strategy solutions to your country’s circumstances • Do not be afraid to ask for help & be practical - you cannot live long enough to make the mistakes that others have made • Be cautious of adopting US style SEC regulations – they often are inappropriate & unsuited for our markets – Rule based

4. CAPITAL MARKET DEVELOPMENTMacro foundation issues • Have sound transparent economic, monetary & fiscal policies • Markets do not like surprises • Will & commitment of government to develop capital markets – need to take bold steps • Clarity of objectives - Do you need your own market? • Debate, discuss with participants & decide – leadership comes from both • What are your competitors doing or could they be your partners? • Good governance – “soft infrastructure” – “sine qua non” • Asian experience – deep respect for education, innovation, high savings rates • Urge you to introduce financial literacy programmes in schools • Credible market legislation & regulation • Improve the quality of banks & banking services • Develop, implement recognised accounting & auditing standards.

5. CAPITAL MARKET DEVELOPMENTMarket Structure & Regulatory environment • Healthy interaction between regulators & participants • Best market practice – IOSCO standards – be practical • Sound bankruptcy laws – “soft infrastructure” – so important • Money markets come first • Bond markets more difficult to develop than equity markets • Need for pricing benchmarks – government bonds, big corporates • Role of primary dealers & auction process • Market making can be done by Central Bank initially • PDs are not necessarily the magic wand for take-off • Roles of pension funds & asset managers • Prescribed assets – the good and bad aspects – think long term • Build a competitive portfolio management environment • Diverse range of issuers • Markets thrive on diversity • OTC or Exchange traded • Attitude of bond participants is the key • Not the equity brokers nor the regulator - Botswana CAPITAL MARKETS TAKE TIME TO DEVELOP

6. CAPITAL MARKET DEVELOPMENTMarket Structure & Regulatory environment Recognise the contradiction in that the objectives of the market regulators may not always be the same as those of the participants REGULATORS WANT More efficiency = tighter liquidity; means Narrower spreads = less profit PARTICIPANTS WANT Less efficiency = wider spreads; means More profit = OTC markets more attractive However more participants = more liquidity = more opportunity

7. CAPITAL MARKET DEVELOPMENTPolicy constraints • Taxation • Take a hard cold look at the impacts on market development • Non residents withholding tax on interest • Stamp duties • Trade off – revenue collection vs negative impact ? • Incentives ? • Regulations on Tap issues • How practical are they – each auction issue is a new bond - Kenya ? • Investors want large issues of fewer bonds – not many small ones • Impacts on investors – prudential guidelines • Access to markets • Markets need diversity of participants – local and foreign • Restrictions hinder development - ability to manage risk • Reluctance to open markets to competition – protectionism? • Foreigners prohibited access to money markets – Ghana • What happens to their bond activity at short end of bond curve?

8. CAPITAL MARKET DEVELOPMENTInfrastructure (Systems)- trading, clearing, settlement & custody • Trading • Do not create elaborate processes & systems – create the environment, let the market develop • Call auctions (2-3 per day) around a table ? – it is a start • Use OTC trading processes • Telephones, IDB & data vendor systems • Market wide ATS not wanted / needed – expensive, difficult to implement • Centralised reporting of trades for dissemination & surveillance • Clearing (Risk management) • Fraught with complications in bond & money markets • Equity markets have central counterparty systems – trade with impunity • Bond markets do not have that • OTC market risk processes work for bonds– bi-lateral counterparty limits • Regulatory frameworks should be aligned to recognise this

9. CAPITAL MARKET DEVELOPMENTInfrastructure (Systems)-Trading, clearing, settlement & custody • Settlement & Custody • Manual systems work although may not be ideal - Botswana • Do you need your own systems ? • Look around in region – can you use them? • This is a volume business – harness economies of scale • Can be the costly part of the trading cycle • Easier to adapt regional systems than developing, building / buying your own • Use equity systems if available – settlement processes similar Secure delivery vs payment – “Sine Qua Non”

10. CAPITAL MARKET DEVELOPMENTInfrastructure (Systems)-Trading, clearing, settlement & custody Systems – concluding comments • The easy part of market development • Do not let them become a constraint • Can become “the straw that breaks the camel’s back” • OTC market systems / processes work – use them Beware of free systems – there is no such thing as free !

11. CAPITAL MARKET DEVELOPMENTLeadership It starts at the top ! • Will and commitment of Central Government • Clarity of objectives – critical • Good market legislation and regulation • Who are your competitors and what are they doing? • Could they be your partners? Participants & authorities to have common objectives • Discuss and decide • Leadership comes from both • Establish a Structure that encourages innovation, risk taking so that participants can make a profit

12. CAPITAL MARKET DEVELOPMENTKey Issues for growth of bond markets • Sound economic, monetary and fiscal framework • Good legal system – bankruptcy laws – “soft infrastructure” • Effective, appropriate and harmonised financial market legislation and regulations • Money markets are the starting point – asset / liability matching / mismatches • Role of pension fund legislation is important • Privatise the pension funds • prescribed investments – promote but could also distort – be careful • Do not force a structure onto a market • Recipe for disaster ATTRACT PARTICIPANTS THAT CAN BE INNOVATIVE & PROFITABLE

13. CAPITAL MARKET DEVELOPMENTLessons & Observations – Be practical • Be practical – if you do not have all the right things in place • Do not re-invent the wheel ! • Size does matter – big balance sheets count !! • Intermediaries / speculators are important participants – do not squeeze them out • Get practical training / exposure from those who have done it before or do it now • Banks, traders, Exchanges, Regulators, settlement people • Importing big trading systems and market structures from Europe may be inappropriate for you “One solution does not fit all” – BE PRACTICAL

14. CAPITAL MARKET DEVELOPMENTLessons & Observations – Be practical From my experience • Exchanges are unusual places for listing & trading bonds • understand the different dynamics wherein banks are major bond participants vs brokers as major participants in equities • If an exchange is the chosen route – issuers and investors should not be members (users)– too many vested interests – they are clients! • Consider combining equities, bonds and derivatives into one overall Exchange structure – economies of scale / skills / scope – practical issues • But as separate markets – Different rules and Members (brokers in equities, banks in bonds and derivatives) • Recognise that trading and risk methodologies are not the same for each market Create structures that attract Widest range of participants = more liquidity = more opportunity!

15. THINKBIG HAVE A PLAN BUT START NOW WITH SMALL THINGS

16. Thank you for your attention TOM LAWLESS TEL: +27-11-888-3568 +27-82-901-7777 (mobile) FAX: +27-11-888-1411 tom@lawless.co.za Tom Lawless & Asscociates