This week: The development of a capital market

Sunday Stabroek Perspective
Stabroek News
April 25, 1999


Continued...

The Securities Exchange

The term 'Stock Exchange' was first used in England in 1773. Since then Stock Exchanges have become an established feature of the developed economies of the world and a number have now been formed in many of the developing countries as a result of the introduction of financial sector reform programmes by their respective governments. It is fair to say, however, that the evolution of these 'emerging markets' as they are known in developing countries has not been without incident and it is vital, therefore, to understand and also not to underestimate the importance of the forces likely to impact the development of the financial market in Guyana as a result of the international trade and foreign exchange market liberalisation that is currently occurring.

In this context, the unfortunate experience of Mexico not so long ago and the more recent turmoil in the Far Eastern, Brazilian and Russian financial markets should provide Guyana with the opportunity to analyse how such a predicament developed so that safeguards can be incorporated to prevent a similar problem arising in this country.

The organisational structure of a Stock Exchange, or to use the broader terminology, a "Securities Exchange", can take various forms. A recent trend has been for it to be structured as a self-regulatory organisation established in accordance with the provisions of a Securities Industry Act. The Act would provide that no entity would be able to carry on business as a Securities Exchange unless registered as a self-regulatory organisation under the Act. A Securities Exchange would be defined as an entity that maintains or provides physical facilities where persons may meet to execute trades in securities or a mechanical, electronic or other system that facilitates execution of trades in securities by matching offers of purchase and sale.

The business of the Securities Exchange would be governed by a Securities Council which would possess the power to make and amend its rules in accordance with the provisions of the Act. Other sections of the Act would address, inter alia, areas such as Registration of Market Participants, Registration of Issuers and Securities, Distributions, Market Conduct and Regulations, Dealings by Persons Connected with Issuers, Civil Liability and Enforcement.

It will be recalled that a Call Exchange, the first step in the establishment of a Securities Exchange, had been formed in Guyana with trading commencing during December 1993. There were twelve businesses registered as members of the Call Exchange. They were Bank of Baroda, Bank of Nova Scotia, Beharry Stockbrokers, Caribbean Stockbrokers, Globe Trust and Investment Co., Guyana Bank for Trade and Industry, Guyana National Co-operative Bank, GNCB Trust Corporation, International Investments, Laparkan Financial Services, National Bank of Industry and Commerce, and Trust Company (Guyana). However, the level of business was always extremely thin and it eventually ceased to function as a market. The initiative to establish the Call Exchange was premature as it did not have the raising of new money as an objective and neither was it backed by securities legislation. This latter shortcoming has now been addressed with the passage, in December 1998, of the Securities Industry Act.

The Securities Industry Act 1998 provides for the establishment of a Securities Council and for the registration of various categories of market participants with that body. Such cateration of various categories of market participants with that body. Such categories include the activities of a broker, dealer, trader, underwriter, investment advisor, securities intermediary and securities company. Thus, the legislation has now been established to facilitate the formation of a Securities Exchange. A Securities Council will need to be constituted and the rules and regulations of the market developed.

There is a need for viable institutions to facilitate the development of the capital market and Securities Exchange in Guyana. We have already identified that the establishment of an effective capital market and Securities Exchange is a vital ingredient in the quest for sustainable economic growth in a market economy where the private sector is charged with being the engine of growth.

There will be a requirement for the establishment of stockbroking firms that will be members of the Securities Exchange. In order to qualify for membership, a company will need to comply with the rules and regulations relating to registration and licensing. These are likely to include, inter alia, the need to maintain a certain minimum paid up capital.

Transactions on the Securities Exchange would be conducted through a broker who would be a licensed individual acting as an agent for clients, purchasing and selling stock in the market for a commission. Sometimes a broker may act as a principal buying and selling for his own account.

All applicants to become a broker (or any other market participant for that matter) will be required to satisfy certain "basic qualifications" as defined in the Act. In respect of an individual, this information may include, inter alia, details of professional or business qualifications and any substantial stockholding in any financial institution. In addition, applicants must be of good character and it is not unusual for there to be a stipulation that stockbroking be the applicant's prime occupation or business. Applicants may be required to pass a written examination and possess a recognised qualification in a related activity such as accountancy, economics, banking, business administration or law.

The actual medium used for trading varies from country to country and can range from various forms of electronic trading to a physical meeting of the brokers. A typical format for the latter provides for the brokers to come to the floor of the Securities Exchange where, through an auction system, efforts are made to match buyers and sellers.

It is not only stocks and shares that are traded on a Securities Exchange. The trading of bonds can also be carried out and an individual who is registered and licensed to carry out such an activity is known as an authorised Bond Dealer. Such a person, again, may trade as a principal, buying and selling for his own account or on an agency basis, trading on behalf of his clients for a commission.

The Financial Institutions

There will be a growing requirement for a variety of financial products and services to facilitate the development process. Viable financial institutions must be established to provide the wide range of financial products and services that both the private sector, as the engine of economic growth, and the public sector will be seeking.

Before focussing on the types of financial institutions that need to be established in Guyana, it is instructive, first, to review the composition and nature of the financial sector in this country at the moment. There are a number of financial institutions catering to the requirements of their customers but the range of products and services remains limited.

Currently, there are seven commercial banks operating in Guyana--namely, Guyana National Co-operative Bank, National Bank of Industry and Commerce, Guyana Bank for Trade and Industry, Demerara Bank, Citizens Bank Guyana, Bank of Baroda and Bank of Nova Scotia. The last two institutions are branch operations of overseas companies.

In the early 1990's, the lending practices of the banks, in general were most conservative and that situation prevailed primarily because of the attractiveness of treasury bills issued by the Government. The result was that during that period some two-thirds of the assets of the commercial banking sector comprised treasury bills and reserves at the Bank of Guyana. By comparison, private sector loans and advances accounted for under 20% of assets.

However, as a result of the decline in the attractiveness of treasury bills coupled with an increase in the competitiveness of the market resulting from the commencement of operations of Demerara Bank and Citizens Bank Guyana, the commercial banks adopted a more aggressive lending posture that resulted in the level of private sector loans and advances increasing to 50% by the end of June 1998. However, the terms are formally short-term and are frequently rolled over. The commercial banks do not offer long-term credit, although loans with a term of about three years are available to preferred bank customers. Although new financial products have been introduced, the range of products and services offered to the private sector still remains very limited.

There are three trust companies operating in Guyana--namely, Globe Trust and Investment Co., GNCB Trust Corporation and Trust Company (Guyana). The range of services provided by these institutions includes investment accounts, investment management, pension fund administration, property management, cambio, registrars, brokerage, underwriting and mortgage and bridge financing.

The New Building Society, which was established by the New Building Society Act, provides mortgage financing facilities.

There are a number of insurance companies including Clico Life & General Insurance Co., Demerara Mutual Life Group of Companies, Caribbean Home Insurance, Great Eagle Star Insurance Company (Guyana), GTM Fire & Life Group of Companies, Hand-In-Hand Mutual Fire & Life Group of Companies, GCIS, North American Fire & General Insurance Company, North American Life Insurance Co., Republic Insurance Company, John Fernandes Insurance Services and National Insurance Scheme. An analysis of the insurance companies' assets estimated at the end of June 1998 revealed that, in the main, these comprised foreign and local bank deposits and foreign loans and securities. Although exposure to domestic corporate securities has more than doubled over the past three years, these assets still comprise only 8.2% of total assets.

The estimated total assets of the pension schemes at the end of June 1998 amounted to G$7.4bn. Of this figure, G$5.9bn (79.5%) represented cash and deposits with the banking system, Government treasury bills and Government debentures. Only G$0.8bn (10.4%) of the total assets represented investments in shares and other securities of the private sector.

The Institute of Private Enterprise Development, which is a National Development Institution, promotes the development and growth of medium, small and micro businesses.

It is clear from the foregoing analysis that although there is a well established financial sector in Guyana its practices have historically been very conservative and if it is to evolve in order to provide the types of financial products and services that both the public and private sectors are going to demand then there must be greater innovation and vigor on the part of the industry and, whenever necessary, the appropriate facilitation on the part of the Government.

New Financial Institutions

The types of financial products and services that are going to be required will include, inter alia, money market instruments, capital market instruments, securities issuance, securities underwriting, securities broking/dealing/trading activities, project financing, syndicated financing, mortgage financing, leasing, financial advisory services, mergers and acquisitions, investment research, asset management (cash and securities), currency risk management, venture capital and additional unit trusts/mutual funds.

In anticipation of the requirement for such an array of new financial products and services, it is critical that viable financial institutions are established so that the demand can be satisfied in a thoroughly professional and proficient manner. Existing financial institutions will need to be restructured in order to position themselves to cater effectively to the requirements of their customers.

New financial institutions will have to be established in Guyana to deliver the new products and services that the existing institutions either are not able to provide or for which they may be constrained from offering or not wish to develop the expertise to supply. Such new financial institutions could include, inter alia, merchant banks, financial advisory/consultancy businesses, unit trusts/mutual funds, home mortgage bank and venture capital companies.

The central bank recently approved GBTI's application to establish Guyana's first merchant bank

Merchant Banks

It would be useful to quantify what a merchant bank is and what its functions are. However, this is much easier said than done as the definition of a merchant bank is far from precise. The title is often misused as a general description of firms that operate in the financial sector. However, following the introduction of legislation this description could only be used in the U.K. by institutions which are recognised banks.

These financial institutions respond to client demands for a service which is confidential, objective, technically creative and predicated on the development of long-term relationships. They provide all manner of financial services and the range of these services reflects the growing complexity of international business.

Their activities were originally associated with foreign trade and international capital movement but the nature of their business has changed dramatically. Other services which are now offered include the taking of deposits and provision of loans, syndicated financing, company flotations, the raising of equity and loan capital through public issues and private placements, securities underwriting, securities broking/dealing/trading, project financing, leasing, foreign exchange, domestic and international private and public sector advisory services including mergers/acquisitions and disposals/privatisations, and dealing in a wide range of commodities.

Regarding the products and services that a merchant banking institution in Guyana may seek to provide, it is likely that the immediate focus will be on money and capital market instruments, company flotations, the raising of equity and loan capital through public issues and private placements, securities underwriting and broking/dealing/trading activities, project financing, financial advisory services, mergers and acquisitions, asset management and venture capital.

The Central Bank recently approved the application of the Guyana Bank for Trade and Industry ("GBTI") for the establishment of Guyana's first merchant banking operation. The merchant bank, to be called the Guyana Americas Merchant Bank, will be a joint-venture between GBTI, Secure International Finance Company and the International Finance Corporation ("IFC"), the private sector arm of the World Bank. The merchant bank will be located at GBTI's Regent Street branch office and is expected to commence operations shortly.

Financial Advisors/Consultants

Financial advisory/consultancy firms are not in the business of taking deposits and making loans and do not, therefore, fall into the category of a bank. Such businesses, which would have to be registered with the Securities Council under the provisions of the Securities Industry Act,te the development of a capital market and Securities Exchange is to provide encouragement and incentives for investors to invest. One of the ways of stimulating the demand for equities is to reduce the risk to investors through encouraging participation in unit trusts or mutual funds. This can be achieved by providing incentives to small investors in the form of tax breaks on their investments. There are unit trusts already in operation in Guyana and, given the experiences of Europe and North America, this is a medium for investment in securities that could develop rapidly given the right encouragement.

Home Mortgage Bank

It was identified in Trinidad and Tobago a number of years ago that one of the ways of remedying the inadequate level of funding available for mortgage lending was through the creation of an organised secondary market for mortgage loans.

The reason for this is that the purchase and sale of mortgage loans through such a market provide liquidity to the financial institutions engaged in mortgage lending thus enabling more mortgage loans to be made. In order to create and activate an organised secondary market in Trinidad and Tobago, a privately managed mortgage bank was established.

The mortgage bank also contributed to the development and growth of the capital market through the introduction of medium- and long-term mortgage bonds which increased both the volume and term of domestic savings.

The Home Mortgage Bank ("Mortgage Bank") was established in Trinidad and Tobago by the Home Mortgage Bank Act 1985. Under the Act the Government of Trinidad and Tobago granted tax exemption on the interest income earned on bonds issued by the Mortgage Bank. The first bond issue of the Mortgage Bank in January 1987 was oversubscribed and this has been the case with numerous subsequent bond issues.

The shareholders of the Mortgage Bank include the Central Bank of Trinidad and Tobago, the National Insurance Board, commercial banks, insurance institutions and the IFC, which acquired a 10% interest. The shareholding structure fulfilled the IFC's stance that the Mortgage Bank should be privately controlled and managed. This investment by the IFC represented one of a number of such equity participations in housing finance institutions with which it is involved worldwide.

The purposes of the Mortgage Bank, as set out in the Act, are:

1. To develop and maintain a secondary mortgage market in Trinidad and Tobago;
2. To contribute to the mobilization of long-term savings for investment in housing;
3. To support the development of a system of housing finance and provide leadership in the housing and home finance industry; and
4. To promote the growth of the capital market.

The significance of this final purpose for long-term sustainable economic development within a mixed economy has been stressed most vigorously throughout this article.

As a result of the tremendous success of the Home Mortgage Bank of Trinidad and Tobago, a similar institution, the Eastern Caribbean Home Mortgage Bank, whose headquarters are in St. Kitts, was established under the Eastern Caribbean Home Mortgage Bank Agreement Act to serve the eight territories comprising the Organisation of Eastern Caribbean States ("OECS"), namely, Grenada, St. Vincent and the Grenadines, Dominica, Montserrat, St. Lucia, Antigua, Anguilla and St. Kitts/Nevis. The Home Mortgage Bank of Trinidad and Tobago took a 20% shareholding in the new institution and, together with the IFC plays a supporting role in the development of the new institution.

Venture Capital Companies

The Government has stated that the private sector is the engine of economic growth in Guyana. Often, it is a lack of equity capital that acts as a constraint to the development of new businesses. There is an immediate requirement for risk or venture capital to be made available in Guyana in order to facilitate the growth of the private sector.

This was recognised in Trinidad and Tobago and the Government passed the Venture Capital Act 1994 to encourage the development of a venture capital industry in that country. It may well be necessary for the Government to undertake such an initiative in Guyana so as to encourage financial institutions, through a venture capital arm, to participate in the risks associated with new business development.

Conclusion

Investment is the fuel for the engine of growth and investment is made possible through sawell be necessary for the Government to undertake such an initiative in Guyana so as to encourage financial institutions, through a venture capital arm, to participate in the risks associated with new business development.

Conclusion

Investment is the fuel for the engine of growth and investment is made possible through savings. Economic development is about accelerating the rate of capital formation. Capital investment needs to be financed using long-term funding. The capacity of the financial market in Guyana has to be expanded to facilitate the mobilisation of savings for investment purposes.

The establishment of an effective capital market and Securities Exchange is fundamental to the quest for sustainable economic growth in a market economy where the private sector is charged with being the engine of growth. Without these, it is fair to say that the private sector is unlikely to be able to perform its role and sustainable economic growth is unlikely to be achieved.

The establishment of Guyana's first merchant bank, Guyana Americas Merchant Bank, is an important step towards developing the institutional environment and support that is needed if we are ever to achieve sustainable economic growth and a resultant improvement in the living standards of all of us.