–ESX Project Leader Tilahun Kassahun explains
Following the establishment of the Ethiopian Capital Market Authority, the Ethiopian Security Exchange (ESX) has taken one of the first steps to be officially established during the week, on 3 October 2023.
EIH, along with its subsidiaries: Ethiopian Airlines, Ethiotelecom, Ethiopian Insurance Corporation, Ethiopian Shipping and Logistics Service Enterprise, as well as Berhanena Selam Printing Enterprise, have ventured the establishment of the ESX which is the first of its kind for the country.
The Ethiopian Herald has interviewed Tilahun Esmael Kassahun, Senior Project Manager, of the Project Office concerning the considerations that the new capital market platform has made to operate in the country, the potential benefits for the country and the overall prospect of it. Have a nice read!
The Ethiopian Securities Exchange (ESC) was established as a public Private Partnership. What does this mean, or what makes it different from other exchanges at home or abroad?
Most exchanges, in the rest of the world or Africa were set up as mutual entities by capital market service providers, i.e. these are brokers, and dealers, coming together, and setting up these associations. And that’s how actually, most exchanges were born. This is the case for the New York Stock Exchange, the London Stock Exchange or in Africa, Nairobi Stock Exchange.
But in Ethiopia, we don’t have those brokerage fraternities. At the same time the world has also changed on the how exchanges are owned and operated. Most exchanges have moved from mutual entities to a demutualized, i.e. for profit companies than associations of brokers. That is why to when the Capital Markets Proclamation was being drafted, the Government of Ethiopia had two options. One is to entirely set it up as a fully public entity, or also leave it entirely for the private sector. But then the dilemma would be you don’t want to be a fully public entity because this is a private enterprise. It’s a market infrastructure.
But it wasn’t clear that the private sector would have capacity or interest in investing in it. To alleviate this challenge, the government took responsibility and said, “Okay, I’ll help in the initial setup of the exchange. But at the same time, I’ll keep only a minority stake.” on the law itself, the government stake is expected not to exceed 25%, but depending on private sector interest. If there is no private sector interest, the government will take higher interest. But if there’s private sector interest the government’s stake could also be lower. But right now, I think we’re operating under the assumption that the private sector will take about 75% of the interest and the government will take around 25%.
Is Ethiopia ready to run a security exchange? What does it take to run a security exchange?
Regarding the question Is Ethiopia ready to have a secure exchange? I think a good way to answer this is to understand what an exchange is but also to understand what Ethiopia needs today. Just to give you a very rough figure, both the public and the private sector need around 20 trillion birrs in the next 10 years to fulfill several objectives. What does it mean by the public sector? it means for government expenditure to build roads, schools, or provide typical state services, social services, administrative services, police and military etc. We need 20 trillion in the next 10 years. It means almost 2 trillion per year. But then the government doesn’t collect $2 trillion every year from taxes. Then the government borrows from abroad or the government borrows domestically, and yet, that’s also not sufficient. And yet borrowing from abroad is also a challenging task. What capital markets do is facilitate avenues for government to borrow from domestic sources. We call them birr-denominated instruments, the government should collect or borrow money from domestic sources because usually, governments can pay their debt if it’s domestic, at a significantly less burden, and manner than borrowing from abroad. If you borrow from abroad, you have to pay in foreign exchanges. In domestic borrowing, the government can always pay back either by way of broadening or increasing its tax base. In essence, the same concept applies for the private sector. The private sector also needs the same amount of money. And all of us need this because we also want the private sector to set up factories, set up schools, set up hospitals, employ people and employ our unexploited natural resources. All of us need long-term capital, there are avenues to get long-term capital, but these are not sufficient. Then the question is now are we satisfied with what we have? If the answer is no, then what are the other avenues for expanding those pools of resources pool of funding pool of long-term partners? That’s exactly what the capital markets or the exchange do. But in saying that, we don’t promise panacea. The fact that the exchange is set up, doesn’t provide the solution the first year. The role of the exchange would be primarily to enhance liquidity promote investment, and promote saving to promote investor protection. And then the results with which you get to the objective and the process with which you get to achieve those results and impact could be longer complicated and technical, but you have to find a way to say my contribution, even if small is still a contribution that leads towards meeting those objectives. People often attach capital markets and stock exchanges to a high level of economic development. But, if you’re too developed or perhaps satisfied with what you have, capital markets may not be that critical.
You need it when you are in that trajectory where you say, I have my business plans or government has plans and then they need to raise capital.
A questing that comes after addressing the above is what is my macro-economic environment? Institutional, legislative, policy, human capacity environment already developed? The answer is no. You have to develop it and create that right macro environment as we go. We don’t start from a perfect world that is to say, okay, the foundations are there, we can build on what we already have.
Who are the potential actors expected to operate in or be involved in the securities exchange?
Generally to have a functioning, thriving capital markets ecosystem, you need one strong regulator. You need to enhance investor protection. Before investors invest, they need to be able to see information from investors. That’s why in December 2022, Government established the Ethiopian Capital Markets Authority. It has a board of directors, it has a director general, it has a team, and they are working on several directives. That has already been delivered. Other than that, you need the service provider. You need financial advisors, you need brokers and dealers, these are people who advise, and support issuers, but also support investors in the interpretation of the investment documents and instruments, they serve as interlocutors of the market system.
So, they are also the intermediary between the issuer and the investor.
Other than that, you need the investor. In Ethiopia, you need retail and the institutional investors to be ready to be able to participate. It means you and I have to save, we see an opportunity to invest in a thriving company, we need to be able to invest. We have to get into that knowledge and understanding of the environment.
Then the market infrastructures come. ESX will be now in the center of this environment where we say issuers can come to get listed and trade securities while investors come to the transaction through their brokers. They are intermediaries to invest in security. It’s a little bit complex system where you create security for investors, you need to educate investors, but then find a set of intermediary market infrastructure that connects investors to issuers.
Now that the security exchange is established by the specified stakeholders, how can other companies be involved?
There will be one security exchange in Ethiopia. EIH and subsidiaries are one participant that can contribute towards that 25%. The exchange will have about 900 million or about a billion birr capital or around $16.5 million. The government of Ethiopia through EIH and its subsidiaries collectively will contribute 25% to that. Say roughly $ 4.5 or 5 million will be from the government, then other investors including banks and, the private sector, will be contributing that remaining 11 million including foreign investors. Together it will be a share company owned by the government and other investors. That’s why we call it a PPP. Now these investors together own the exchange.
Other private sector entities like banks, need to come as service providers like investment banks, a broker, dealers, financial advisors, and custodians. They can be members and provide these kinds of services.
How do you see the potential of local companies applying to your listings?
This is the context in which we’re working. There are already a large number of public companies in Ethiopia and then there is already a large number of at least SOEs that are planned for listing. Our owner from the government, which is EIH also owns some of the largest SOEs. EIH commits to bringing at between five – ten of these companies in the first few years to the market.
There is no question of why or whether, but rather, it’s a question of when. Then we will be working with EIH and those SOEs are enterprises or companies to schedule their listing processes. As we speak, undergoing enlisting, readiness, assessment and exercise, they will be building capacity.
Other than that, the banks are already public entities. That means they’ve actively sold shares to individuals, and retail investors, like you and I. But then individual investors like you and I do not have the liquidity with which, we want to buy or sell a security, you have to go to WhatsApp find an unregulated broker, meet in a bank branch office or headquarters and try to buy or sell. This is a time taking and costly process. What the exchange will provide is efficiency in that process. Practically this means one investor can sell security to another investor very efficiently in a less costly manner. Right now, we have about 400,000 shareholders within the banking sector alone. And all 30 banks are public companies. There are more than half a billion securities in the market, have a billion shares. Every year between two to 3 billion Birr of securities are traded on average in the past five years, that’s the data that we have, which means now bringing that to 3 billion already into the market, but also creating efficiency. It means you should be able to buy or sell securities just with a simple phone call or text message to your broker or through a simple mobile application on your phone. Investors will get advice from your broker whether or not this is a worthwhile investment, then making that seamless and efficient means now you enhance liquidity. And once liquidity is enhanced, it means people are ready to invest.
What are the criteria or requirements for companies to be involved in the security exchange?
In terms of the requirements, we have written our rule book, I think we will announce it in the coming few months. But generally, what the rulebook says in terms of listing is the need to have a track record, capital, ability to meet certain corporate governance and financial reporting standards as well as ability to meet the ongoing obligations such as disclosing material information’s and changes happening in the company to investors to the extent it affects their investment decision etc.
We have also main market and growth markets. For instance, large companies can list in our main market while small and medium enterprises can list in our growth market. The requirements will be lower for a growth market, and an additional requirement will be capital. large companies can list on the main market, but the smaller companies can only list in the growth market.
What about the potential investor’s availability in the country?
We have something to start wit, like I said earlier, we have about 400,000 shareholders already. However the investor base is low and we need to develop it. In other countries, there is a mix of domestic retail investors, domestic industry investors and foreign investors. We need to grow our pension industry, insurance industry, asset management, and fund management industry.
Now the country needs a lot of finance to develop its infrastructure, services and economic sector. How does it support the government to raise finance for these purposes?
The government will be able to raise Local Finance, through issuing government bonds, and government treasury bills to the market and then individuals like us, banks, and pension funds, as I mentioned, as well as foreign investors can invest under securities. It enhances the capacity or provides an alternative source of finance for the government. If you’re an entrepreneur today or your company, your options to borrow money or to raise funding are very limited. One is you borrow from a bank, and then bank lending could be costly. But also it’s not accessible because you don’t have the collateral the banks require to lend it to you. Or you have to use your sources of financial family or out of pocket out of investment. And then we also attract FDI to fill in that gap. Nevertheless, all these are not sufficient. As I said, we have a growing number of labor force coming into the job market. We need to create jobs for them. Those jobs will be created by the public sector but also by the private sector. Both the public and private sectors have huge unmet demand for finance. But in particular, long-term finance, it’s different. It’s easier, for instance, for you to borrow from; one of the mobile financial applications, but it may not be easy if you want to borrow a three or five-year term loan. Then when you ask for 7 years, 10 years or 15, it will be very, very difficult. It could be costly, or unless you have collateral, no bank would be able to lend you for 10, 15 or 25 years. But that’s the difference with the equity market. When you are an investor and you’re investing in a company, you’re simply borrowing money or lending money to the company, with expectations that you see the company’s performance, you see the company’s management board, you see the company’s corporate governance, and you’ve trusted that company and say “Okay, here you go, take 100,000. But then you will give me dividends every year. That’s like long-term lending to a company. That’s what capital markets provide, it will provide an opportunity for companies to raise equity and debt finance, without having to attach a collateral.
It’s good to see capital markets and the role of the exchange as complementary to other modes and sources of finance; they don’t necessarily have to replace it. Of course, companies can raise equity but also bonds. Rather than borrowing from a bank, a company can go and say, Okay, I’ll issue a bond. And when you have a good credit record, investors can buy your bond or that means they can they can lend you a bond.
Thank you very much for your time
You’re most welcome!
BY ZEKARAIS WOLDEMARIAM
THE ETHIOPIAN HERALD SATURDAY 7 OCTOBER 2023
