By Justice Mundonde
CAPITAL markets are the linchpin upon which the socio-economic growth and development of countries anchors. Over the years, emerging and developing countries have implemented innovative strategies to maximise the economic functions that capital markets play. The stock exchange, a sub-set of the capital markets, is argued to be the most important. This is reflected in the fact that the stock market often has the highest capitalisation relative to other markets like the bond markets or the future market for instance.
The informational role that the stock market plays is central to the rational allocation of capital in the economy. Market assessment of a firm’s current performance and prospects is embodied in stock prices. If investors are optimistic about the growth potential of a company, the stock price will rise and the opposite holds.
A high stock price is a positive signal that attracts more capital to the firm should there be need to raise additional capital to finance future growth potential. Through market price movements, the stock market plays a critical role in allocating capital, directing capital to companies reflecting strong fundamentals and greatest perceived prospects.
Virtually all assets, financial or otherwise, have a level of risk inherent in them. When telecoms companies build soft and hard infrastructure, for example, they cannot forecast with certainty the cashflows that the assets will generate and moreso the structure the cashflows will carry.
The impact of disruptive technologies on company cashflows can never be anticipated with accuracy.
Capital markets through the diverse instruments traded on them allow investors to assume risk relative to their degree of tolerance. If a company opts to raise capital through issuing both stocks and bonds to finance plant construction, risk-averse investors may choose to purchase bonds since they promise coupon payments along with principal repayment.
The more risk-tolerant investor can prefer to hold a stake in the company in the form of stocks, assuming most of the business risk and potentially reaping the higher reward in the process.
This way, capital markets play a risk allocation role in the economy, allowing inherent risks in capital markets to be borne by investors most willing to bear the risk.
The risk allocation function is of great value to firms that need to raise capital.
When investors can select and acquire securities that exhibit preferred risk-return characteristics, it is then logical to posit that securities on exchanges can be sold for the best possible price. This then facilitates the process of building the economy’s stock of real assets.
To guarantee that stock markets effectively and efficiently execute the above-explained functions, exchanges operate under a set of guiding legal frameworks and principles. One such set of principles is referred to as the listing requirements.
Listing requirements speak to predetermined conditions that a company must satisfy before a formal authorisation is granted for it to sell securities on an organised exchange such as the Zimbabwe Stock Exchange (ZSE) or the recently established Victoria Falls Stock Exchange (VFEX).
The establishment of listing standards by securities exchanges is motivated in part by the need for stock markets to manage their corporate reputation and visibility as well as acting as a safeguard mechanism for participating investors.
However stringent listing requirements may be, trading companies always strive to meet the requirements out of the need to enjoy the high-security visibility and liquidity that comes with formal exchange listing.
Listing requirements vary with exchanges. However, it’s standard practice for exchanges to institute metrics that measure the size and market share of the security to be listed and the underlying financial viability of the issuing firm.
For instance, when asked to list on the VFEX, a company is mandatorily required to prove that it is duly incorporated or validly established, has a minimum subscribed capital of US$3 million, with a satisfactory profit history for the preceding five years, and at least 30% of the shares being held by the public among other sets of requirements.
Size and liquidity listing metrics require closer examination in the context of public-private partnerships in Zimbabwe. The adoption of public-private partnerships (PPP) for sustainable infrastructure development is taking centre stage in many African countries.
Zimbabwe is among the countries that have reported in the recent past PPP projects that have reached financial closure.
In a PPP arrangement, the private sector is represented by an entity termed special purpose vehicle. The special purpose vehicle (SPV) brings together several stakeholders that include designers, contractors and service providers under a single umbrella.
This integrated entity, created sorely for handling the affairs of a particular project raises finance through a combination of equity and debt mobilised through various instruments.
Capital markets are critical to the execution of the SPV financing role and unfortunately, the listing requirements on many exchanges are a deterrent to PPP project companies from accessing capital, that is the stock market.
The SPV not being an established corporate debtor with a particular capital market track record but rather a new project-related institution, faces difficulty accessing capital markets that require a five-year profitability record in the case of Zimbabwe.
In some jurisdictions, securities exchange authorities have identified this constraint to PPP financing through the capital markets and have taken remedial measures. In 2016, consulting with the Asian Development Bank, the exchange commission in the Philippines instituted supplementary listing and disclosure requirements to accommodate SPVs spearheading the construction of sustainable infrastructure projects in partnership with the government of the Philippines to list on the local bourse.
SPV companies through the special window created for them are now exempt from the track record and operating requirements currently pegged at three years for all other companies in the Philippines.
Nonetheless, to manage the risk of SPV companies from raising capital from the exchanges and then misappropriate the funds for non-infrastructure development purposes, it is still required that before registering, the PPP company must provide evidence of having completed a certain construction phase.
Even projects that have reached the partial operational phase and require additional capital to come to full-service operation can be registered on the Philippines Stock Exchange.
The stock market reforms such as those undertaken in the Philippines are important for several reasons. Infrastructure development markets are characteristically oligopolistic. That market is often defined by few dominant players and the barriers to entry into the market are high and they take the form of capital constraints. Capital required to bring infrastructure into operational completion is high, typically US$100 million or more and this acts as an entrance deterrent for up-and-coming development infrastructure companies. In oligopolistic markets, dominant players can collude to maximise returns through manipulating cost structures and bidding processes. Authorities had to take punitive correctional measures against construction companies that were found guilty of collusion in construction works that preceded the hosting of the 2010 soccer World Cup in South Africa.
Reviewing listing requirements to accommodate SPVs is essential in shifting the project development market off oligopolistic and monopolistic structures towards increased participation by many players.
Companies that otherwise would not have been able to finance the high transaction costs associated with complex infrastructure projects, with access to a large pool of investors can afford to do so, thus widening the number of construction service providers in an economy. The long-term benefits of creating a competitive construction industry will be available for future generations to enjoy.
During the early 2000s, infrastructure began to emerge as a novel asset class independent of other classes of securities. Insurance companies, pension funds, sovereign wealth funds and other institutional investors are always on the hunt for long-term investible securities that offer longevity given that they manage funds over the long term. Infrastructure stocks provide that risk-return profile match that institutional investors have an appetite for. Furthermore, investment industry studies and those from academia provide empirical evidence of the attractive financial attributes that infrastructure securities offer to portfolio managers.
Over and above offering stable cashflows over the long-term, infrastructure assets are the go-to securities for portfolio managers seeking to manage risk through diversification. Even during episodes of global financial turmoil, researchers have provided evidence confirming that infrastructure securities have weak co-movement with other assets.
In which case they can be critical in managing portfolio volatility. In some studies, infrastructure is shown to have inflation-hedging properties.
It is not just the institutional investors that stand to benefit, individuals stand to benefit as well from the listing of PPP infrastructure assets. In any economy, some individuals are earning more than they currently wish to spend.
Infrastructure securities, because of their long horizon nature, provide a channel through which consumption can be shifted from high-earning periods to low-earning periods of life. Thus, PPP stocks allow individuals to separate decisions concerning current consumption from constraints that otherwise would be imposed by current earnings.
At the peak of economic turmoil in Zimbabwe, citizens whose savings were backed by real assets vanished overnight.
In putting together this opinion piece, it is not the intention of the writer to advocate for superimposition of the exchange reforms provided by the Philippines case but rather to initiate debate on how listing requirements can be reformed to accommodate project financing companies on the local exchanges.
Indeed, economic and political scenarios are different between Zimbabwe and the Philippines with each country having a unique landscape. However, what is common between the two countries is that investments need energy, water and sanitation, information technology, health services among others.
Unfortunately, the huge capital requirement is coming at a time when the central government and donor countries cannot single-handedly meet the financing needs.
This, therefore, justifies discussions on how capital market legislation can be modified to accommodate infrastructure financing to plug the gap in infrastructure that is undermining economic development in Zimbabwe. Capital markets development provides a source of funding for infrastructure.
- Justice Mundonde is a researcher and is currently pursuing a PhD in finance with Unisa. He can be contacted on firstname.lastname@example.org.