–The following is an extract from the Unlocking Investment and Finance in Emerging Markets and Developing Economies (EMDEs) World Bank program
–Building Robust Financial Markets and Institutions in EMDEs presented by Ana Fiorella Carvajal
The importance of capital markets development for the sustainable development goals or SDGS is clear there are huge financing gap in critical sectors that are needed to achieve the SDGS. For example more than two trillion in investment per year are needed just infrastructure over the next fifteen years. Similar massive investment gaps existing other sectors such as housing small and medium enterprises climate and corporate financing to speak of a few sectors that are directly connected with the SDGs.
Traditional funding sources such as government or banking finance will not be sufficient to fill this gap. In margin market many governments faith fiscal constraint banking regulations on the other hand may affect banks appetite to provide longer term financing but also the sheer size of the gaps makes it necessary to bring private sector funding to the table. And this is where capital markets got have a critical role by helping to mobilize institutional investors money to these a strategic sectors.
Just to give you an idea global pension funds today hold about $ trillion in assets under management global insurance companies about $ trillion and sovereign wealth fund for about another $ trillion. However when we look at capital markets in emerging markets we see that they are still playing a limited role in mobilizing finance. Even in the largest emerging markets capital markets are at best being used in government and corporate financing but it’s much harder to see them play an important role in our sectors such an infrastructure financing or financing for small and medium sized enterprises.
In addition emerging markets face a complete set of challenges when trying to develop their capital markets and these challenges affect the supply the demand side and also market infrastructure. And they comprise issues such as the limited supply of companies that are able to come to market a limited investor base market infrastructure that is deficient and also they are deficient regulator in supervisory environments.
The World Bank has been a fifteen emerging and developing economies in developing their capital markets for the last thirty years through a combination of advisers’ support and transactions. And there are five lessons that are coming out of this work. The first one is the need to ensure the pre-conditions are in place. There are series of conditions that our country must meet in order to develop its capital market.
These include for example the need for robust enabling environment a sound banking system microeconomic and political stability. And capital markets are also affected by the size of an economy. A country without a stable macroeconomic and political environment will not be able to attract long term investment. A country without a sound banking sector lakes a key pillar of capital markets development.
Since banks are the first provider of liquidity and credit and send signals to the market. Institutions such as the judiciary are needed to provide confidence to investors and so is the need for neutral tax regimes. And finally the size of the economy matters because capital markets require a critical mass of investors and issues to be deep and equipped. The second lesson for government is the need to develop a focus but well-sequence strategy.
The strategies should be anchor on sector specific assessment for an example an assessment of infrastructure or small and medium enterprises financing as key challenges and solutions are sector dependent. These strategies should also be comprehensive tackling supply demand side on market infrastructure issues. They should be tailor to the marketing structure with the instruments that are aligned with the level and sophistication of the market and responsive to market needs and finally they should be appropriately sequenced.
The third lesson is the need to incorporate non-traditional solutions innovation and to some extent banking regulation are triggering new mechanisms to channel investors mourning to strategic sectors beyond the traditional public markets. And one example that we see in now more often is lending an equity crowd funding platforms. The fourth lesson is the need to build sustained commitment developing capital markets is a long term endeavor that requires actions from both public and private actors across different political cycles. And keep in focus on one thing and commitment is a true challenge.
Mechanisms to ensure alignment on support include for example the constitution of communes with private and public sector representation where capital markets plans are disclose. And the last lesson is the need for robust regulation and supervision. It is critical first that regulations are aligned with international standards but at the same time they are proportionate so that they do not have stifled the market. Further more it is important that these regulations provide a space for innovation.
Once they are in place regulatory authorities need to make sure that there is a robust system of supervision and enforcement because regulations are as the strong as their supervision and enforcement are. And this is an area where we have found substantial weakness in emerging markets some of them to take the capacity issues but all those due to misperceptions. And the most important misperception is that we live that a strong enforcement can stifle innovation or choke the market? However the reality is that in the long run our regulated that is not really into enforce compliance with it’s rules looses credibility which in turn leads to investors losing confidence in the fairness of the market. From the World Bank perspective we actually have quoted key lesson from working in all these countries.
And is the need to provide a one stop shop to countries as they seek to address the challenges that prevent monetization of capital markets to this Strategic sectors. We use the case of Colombia supply six years ago the government of Colombia requested our support to mobilize institutional investors to infrastructure financing and in particular to the financing of highways. What we keep different this time was to put together a team that in fact acted as a one stop shop providing advisory in several different areas where challenges were found and using transactions to advance the objective of mobilize in pension funds money to infrastructure financing. In this particular case we provided support in many areas from advisory support in the framework for PPPs Public-Private Partnerships to the regulation of pension fund.
On under transaction side through the IFC which is our investment arm we did two investments one in financiers federal national and infrastructure development bank that will be key to the government Air Force to mobilize private sector funding to infrastructure financing. And the other in an infrastructure that fund that was created to mobilize pension funds. Through these advisory support and this investments the Colombian forties were able to finance the construction of eight thousand kilometers of road and the Colombian pension funds actually contributed to the financing via their investment in the infrastructure that fund which raised $ million.
Where in increasingly using this new approach which we call the Jcap for joint capital market initiative. This joint approach has been proven to maximize impact by leveraging capital markets for development. At this moment we have seven focus countries Bangladesh, Indonesia, Kenya, Morocco, Peru, Vietnam and the West African economic and monetary union. We could not do these programs without the support from our donors such as the Swedish and looks similar.
To conclude I would like to emphasize two points. The first one as I mentioned capital markets development is not a one year exercise is truly a long term and endeavor and governments need to be truly committed to it. And the second big message is precisely that what this commitment means is a commitment to work on ensuring that the pre-conditions are in place. And when I say pre-conditions what I mean is work on having a stable macroeconomic and political environment work and strengthening key institutions such as the judiciary having a neutral taxed regime having a strong supervisory authority and therefore if those conditions are there in the long run the investors with call