ANDRE CAPPON, CBM GROUP FOUNDER:"Stock exchanges in Central and Eastern Europe need to create their own class of assets"

English Section / 3 iunie 2021

"Stock exchanges in Central and Eastern Europe need to create their own class of assets"

Central and Eastern European stock markets need to create their own asset class to become more attractive to international investors and passive equity funds, said Andre Cappon, founder of the CBM advisory group in New York, USA.

He said the challenges of the region's markets are scale-related: they are generally small, less liquid markets with limited attractiveness for global investors. Cappon came up with a set of proposals for the exchanges interested in finding out what they can do to compete globally.

Cappon said: "Eastern European markets are less liquid markets, which again limits their attractiveness to global investors, even local investors. They are relatively unknown markets and they are small, which means they cannot afford massive investments in technology that would cost tens of millions of euros, investments which are needed to allow them to compete. Possible solutions: scalability can be achieved through consolidation and mergers - we have seen this happen in several regions.

The next thing that can be done is scalability through coalitions or by way of creating a federation. These are some of the ingredients: a family of indices, ETF products, a site with the stock prices, analytics, broker analyses. The BSE has already launched a brokers' hub that will include very interesting analyses for local companies. Another thing that can be done is to create a common category of blue-chip companies, you can have a shared network for the transmission of orders, but it is not something promising and a common technology can be used. These are some of the ingredients that could be considered for Eastern Europe".

The capital markets consultant also came up with a proposal for the markets in Central and South-Eastern Europe, stating that they should explore very strongly and very clearly "realistic opportunities for cooperation needed to achieve scale advantages".

"I would suggest setting up a stakeholder working group, (which should include) probably all of the people that attended here today. We (CBM Group) could support that by analyzing the investment patterns. It's very interesting to look at where global investors put their money and are investing and what criteria they rely on. Who the regional investors are and what the local investors are doing. Every one of those has different philosophies based on the references they follow and based on the degree of familiarity with these markets. We should do some very serious research on this topic before we start this working group. Then have a discussion about identifying opportunities for cooperation between exchanges, while respecting national specificity. You can all decide to conduct one big merger, but a big merger will be painful, it will be difficult. I think that mergers will come naturally once you have explored other possibilities for cooperation and at the end I would recommend some practical solutions that would work. Dan Paul announced in the beginning that he was willing to convene a meeting of exchanges, it could be in Bucharest or elsewhere, where we could prepare these things very carefully and present some discussions that could lead to a series of practical conclusions", said Cappon.

Andre Cappon presented several attempts at regional cooperation in the past, for instance the initiatives of the ASEAN exchanges and of those in the MILA initiative (Mercado Integrado Latino-Americano) - Chile, Columbia, Peru and Mexico in competition with the Brazil Exchange.

"I know that there are already several index families covering Eastern Europe. The whole idea is to create an image of Eastern Europe as an interesting asset class. And one of the speakers mentioned earlier that the post-communist transition in Eastern Europe is largely over. 30 years have passed, there is a new generation. They are countries with a well-educated workforce, and the cost of labor is much lower, for the moment. They are countries that have lower debt and less social issues than we are seeing in France, Italy or Spain... So we could create a perception of Eastern Europe (...), the whole region has a series of «tigers» (economically speaking - ed. note) and we could try to meet and realize how to «market» this region to the global investor. Then we could think of how to practically create an ETF for the region. Not long ago, Adrian Tănase from the BSE and I talked to someone in the Budapest Stock Exchange about creating an ETF and we did not make much progress, even though we should. I think it makes a lot of sense to create an ETF for the region. There are many ETF providers who would like to have something like this, we need to think about what the right structure would be and where to list it. It should have multiple listings, which does not make things easier, but in that way it would become a vehicle for regional investment. For example, if I am a pension fund in Romania or Poland and I want to create exposure to Eastern Europe it would be very simple through that ETF. Basically, this would be one of the immediate issues we could work on and we should have a pretty good chance to achieve something,", Andre Cappon explained.

Cappon: "Exchanges have been an exception class of assets over the years"

Exchanges have been an exceptional asset class, Andre Cappon added. He went into details in the conference, including the three case studies on past regional cooperation processes between exchanges.

Cappon said: "I have been running a New York-based consultancy focusing on the capital markets for almost 20 years. We have been fortunate to have more than 25 exchanges, clearing houses, depositories, interdealer brokers, data companies and rating firms as customers, so we saw the infrastructure of capital markets from all sorts of perspectives and focused mainly on emerging market stock markets.

We've worked a lot in Latin America, a lot in Asia, so I think we can offer some interesting things about how we see Eastern Europe.

In many ways, Eastern Europe, because of the post-communist transition, is behind all these markets. I think that the topic of consolidating exchanges is very interesting for all the participants and I will mention three case studies that could be of interest.

First of all, the story of stock market consolidation is a story we have lived through because we have taken part in some of these mergers and acquisitions, privatizations and exchange developments. Basically, exchanges have been an exceptional asset class. (...) While the All World FTSE index generated a yield of 2.6x, the exchanges recorded a return of of 15x-16x. So it was an incredible rally, investors in the exchanges achieved very good returns. What drove this incredible performance was the realization that exchanges are very interesting asset classes, a set of very interesting institutions, they are hubs of capital markets in a time when capital markets are replacing the classic financing system by banks. And there was, of course, a process of consolidation".

According to him, exchanges have always wanted to grow and merge with a smaller exchange.

"Everyone wants to merge with someone smaller than them, cut costs, implement a common technology platform and through that cost cutting create more profit and more resources for the next acquisition. So that has been the story of the big exchanges for the last 25 years, and the story began in Europe and continued in America, Asia, Latin America, and we will probably see this process in Eastern Europe at some point. What is the final result here, what is the situation now? Well, we have a number of global exchanges, which have global products, a global presence and global interests. The biggest I can think of are Chicago Mercantile Exchange, which is the world's hub for derivative products - there are very few others, 2 or 3 which compete with them, we then have Nasdaq, Intercontinental Exchange, Hong Kong Exchanges, Deutsche Borse and the London Stock Exchange group. They all have global ambitions currently. And then I think there are a number of national giants who sometimes want to be regional hubs: one is Euronext. We have worked on the apparition of Euronext over 20 years ago.

Also in Europe we have the recent merger of Switzerland and Spain, we have markets like Japan and Brazil, huge markets ... TMX from Canada, ASX from Australia, Singapore Exchanges, JSE from South Africa ... All of these are exchanges that have a natural place in the local market, which would also like to operate regional consolidations.

Then we have what's left, the national exchanges. Of which many are in Eastern Europe. They are usually smaller markets, less liquid, and they get less attention - that is where the problem lies. They all want to keep their national identity and attractiveness. None of these exchanges want to just sell off and have it end there. They all want to maintain a local financial center. At the same time, they all need to grow.

What that means: creating a category of assets, for example, South America's stocks are a big asset class. Therefore there is a need for a class of assets in Eastern Europe, big enough to attract global investors. Because the world of investors is very uneven. There are a few giants: Fidelity, Vanguard and Blackrock that dominate the world, and they tend to have their headquarters in New York, London and Hong Kong, and so on, and all these funds although they are international do not pay much attention to Eastern Europe - which is very-very small. So what is the solution for stock exchanges in Eastern Europe: it can either be a regional consolidation or a regional coalition that involves regional cooperation", Cappon explained.

According to the specialist, one of three consolidation processes is NASDAQ Nordic: "It is a traditional process. Nasdaq Nordic was initially the OMX exchange of Sweden. It started 20 years ago the consolidation in Scandinavia and the Baltic countries. It bought Copenhagen, Helsinki, Iceland, it began entering the Baltic countries and eventually it was bought by Nasdaq. Today it is the Nordic-Scandinavian extension of the Nasdaq. Everything was done through serial acquisitions, so you buy, you put in your own management, you implement a shared technology and so on. The shared base technology is very important, and OMX, the initial exchange in Sweden had a very significant advantage because it was one of the early leaders in terms of market technology and they provided trading, clearing and settlement services all over the world. Then, the NASDAQ approach is typically offering technology and trading and clearing platforms in exchange for money and a 10% stake. They have done that all over the world and they are ready to do it again. It is a traditional consolidation story where, as a smaller exchange, you truly lose your identity".

The next example given by Cappon is that of the exchanges of the ASEAN countries, which developed very quickly, but later lost its momentum.

"I've had the privilege of working on the birth of this project, working with the Philippines stock exchange at the time it was entering the the ASEAN exchanges phase.

It is described as a collaboration between several exchanges. They used the word «collaboration» very carefully. All of those countries had different languages, different regulators, different legal systems... Obviously, the official language is English, but the Philippines are very different from Malaysia, very different from Vietnam, Singapore... The region does have a shared characteristic though: it is a region of Asian tigers, countries that have developed very quickly. So they tried to capitalize on that and create a collaboration. What they have created: they have tried to create the ASEAN asset class, which together has a market capitalization of nearly 2 trillion dollars through 350 companies and several derivatives markets. It is a quite interesting concentration. Practically, there is a shared website with market data, analytics and analyses made by brokers, which is very interesting because if I am an investor in New York and I want to find out about something in the Philippines or Indonesia can access it in one place.

There are several regional and several ETFs, also very important because for an American investor or London, if all they want is exposure to ASEAN, all they have to do is buy an ETF - is a very simple solution. Next, trading: they have created a platform for transmitting orders that allows members of each Exchange to re-route orders to the other exchanges. It is worth mentioning, however, that this platform was not an extraordinary success: the volume is small and has always been small. Why: because clearing and settlement have always stayed in the parent countries. Which means, for example, that you were under the jurisdiction of the regulations in a particular country. After 10 years of ASEAN Link, what we have: we do not have a lot of volume on the common platform, which died almost naturally and what we have is the creation of an asset class", the expert said.

Moving on to the case of the MILA (Mercado Integrado Latino-Americano), Cappon said that it was a very promising effort, but which did not have an impressive level of success. According to Cappon, the MILA is still leading towards a merger between the main exchanges involved.

"The initial motivation for MILA was that in Latin America Brazil was becoming very big. Brazil represents about half of Latin America based on any ratio. And the Brazilian exchange is much more sophisticated, in many ways, than the American or British exchanges. So Brazil seemed like a threat, it essentially wanted to colonize of all Latin America. Chile, Columbia and Peru, then Mexico decided to create an alternative, MILA, which appeared in 2014-2015. They followed the steps of ASEAN Link. But they are smaller: the market capitalization is about 800 billion dollars, there are about 700 companies, they have also created a series of indices for the region and sectoral indices, a shared website with stock prices and analytics, the broker community was smaller - about 60 - and they were interconnected. There was a network for transmitting orders, but it was the exact same story as with the ASEAN, not much activity and the clearing and settlement would remain in the parent countries. Right before this conference, I called my friends from Chile, Columbia and Brazil to ask them what was happening with their project: well, Brazil is still very big, another 50%, Brazil has meanwhile begun buying holdings of 5-10% in each exchange in the region, so they have a board member on each board, so Brazil is still very much present. The network for transmitting orders does not have much volume and there is a rumor, in fact more than a rumor, that Chile, Peru and Columbia will merge. So there is a merger that is being worked on at this time, and the idea is to bring together clearing and settlement. But they will still have the problem stemming from the fact that they have different currencies and different regulators, but they are optimistic when it comes to the unification of the legal standards. They have the advantage of a common language - they all speak Spanish. This is the MILA experience", Cappon said.

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