The Regulation Of Financial Markets In The Southern African Region - Current Status And Developments
Financial markets regulation remains a very sensitive and
complex activity when it comes to governmental policy development, with
relation to defining strategic options pertaining to financial regulation. This
article reviews the current status of Financial Markets Legal and Regulatory
Frameworks in the Southern African Region, with a special focus on case studies
of selected countries.
The success of the financial sector is a key component for
economic development
The financial markets sector is one important area of public
concern in Africa. The need for adequate regulation and supervision of
Financial Markets as an important mechanism for the promotion of economic
development in African countries cannot be overemphasized. Financial markets
regulation remains a very sensitive and complex activity when it comes to
governmental policy development, with relation to defining strategic options
pertaining to financial regulation. This article reviews the current status of
financial farkets, the legal and regulatory frameworks in the Southern African
region, with a special focus on selected countries.
The topic under investigation relates to the regulation of
financial markets by governments within the Southern African countries both at
national and international levels. It attempts to grasp its rationale,
objectives, approaches and the practical ways of defining a regulatory
framework for a modern African financial market and system. At a time many
experts are calling for liberalization of financial services in Africa, it is
important to analyze what are the rationale, advantages and implications of financial
markets regulation for Southern African countries under the light of new
international instruments and standards, such as the Basle II Framework and the
WTO Agreement on Financial Services of 1994, whose operational modalities are
is still under negotiations on various key aspects.
This paper attempts to examine the institutional and
regulatory framework for the financial markets operations in order to
understand the underlying principles of financial markets regulation
development; to develop a concise outline of financial markets regulation
framework within the South African countries; and provide as much as possible a
clear understanding of policy development, key issues and challenges relating
to the regulation of financial markets in the Southern African region.
The terminology used in the financial markets jargon is considered to be highly technical and can some times be confusing. While we attempt to keep a non technical language through out this paper, it is quite impossible to avoid the specific concepts used in the financial profession. For some key concepts, a concise glossary of most of the technical words is provided at request by the author.
The terminology used in the financial markets jargon is considered to be highly technical and can some times be confusing. While we attempt to keep a non technical language through out this paper, it is quite impossible to avoid the specific concepts used in the financial profession. For some key concepts, a concise glossary of most of the technical words is provided at request by the author.
The Southern African region: geographic coverage and scope
The broad Southern African Region considered under the
present study is defined with reference to the SADC membership, currently
comprising 14 countries, i.e. Angola, Botswana, Congo (the Democratic Republic
of), Lesotho, Malawi, Mauritius, Mozambique, Namibia, Seychelles, South Africa,
Swaziland, Tanzania, Zambia and Zimbabwe. However, our scope is limited by the
criteria of readily available data, and the level of financial markets
development in the countries under investigation. Angola and the Democratic
Republic of Congo are emerging from long wars and are still rebuilding their
economies and financial systems. Both have no formal financial market. Accurate
and reliable data is very limited on their systems. The study covers a period
of 10 years (1994-2004).
Background overview on Financial Markets
The regulation of Financial Markets, taken as a broad
concept, is the process that encompasses regulation, (i.e. the establishment of
specific rules of behaviour), the monitoring (i.e. observing whether the rules
are respected) , the supervision (a more general observation of the behaviour
of financial institutions and operators), and the enforcement (ensuring that
the rules are complied with) of the established laws.
The ultimate economic function of financial markets is to
mobilize and allocate resources through financial intermediation in order to
accelerate the process of economic growth. This function is performed through
two distinct but interrelated components of the financial markets, i.e. the
money market and the capital market. It provides channels for transferring the
excess funds of surplus units to deficits ones. They constitute the mechanism
that link surplus and deficit units, attracting funds from savers in the
surplus sector and channeling these to borrowers for the purposes of profitable
investment.
For the purpose of providing a clear understanding of this
topic, it is profitable to present a wide overview of a typical financial
system and the place of the financial markets holds within this framework. As a
practical illustration, we provide in a table of Annex I, the Conceptual
Framework of a typical financial market system (the Case of South Africa).
Financial Systems and Financial Markets development
The financial system in the Southern African region consists
of providers and users of financial services. The typical financial system
consists of a variety of institutions, instruments and markets that facilitate
the flow of financial resources between borrowers and lenders. The financial
institutions include moneylenders, banks, insurance companies, leasing
companies, venture capital funds, mutual funds and pension funds, brokerage
houses, investment trusts and stock exchanges.
Financial instruments involved range from currency notes and
coins, cheques, mortgages, corporate bills, bonds and stocks to futures, swaps
and other complex derivatives. The markets for these instruments may be
organized or may be informal. The users of the markets may be households,
businesses and the government. Compared to those of developed countries (Europe,
Asia and America), the typical financial markets in the Southern African region
are characterized by the absence or a limited number and quality of the
financial services providers, the absence of many of the instruments and the
lack of depth in the markets.
Financial Markets typology and structure
The financial markets play a very important part in the
economy of a country and the well-being of every person. They interact with
other markets and have an influence on issues such as wealth, inflation and economic
stability in a country. The financial markets have their own characteristics
and to be able to regulate them or operate in them, it is important to
comprehend these characteristics.
Classification of Financial Markets
Financial Markets can be classified into different
categories depending on the characteristic of the market or instrument used to
create categories. There exist two ultimate distinctions of financial markets.
The primary market, i.e. for the sale of new markets, and the secondary market
for already existing securities. The capital market, which is the market for
the issue and trade of long-term securities, on one hand and the money market,
i.e. the one of short-term securities, on the other hand,
In general terms, the money market is the market where liquid and short-term borrowing and lending take place. The lending of funds in this market constitutes short-term investments. In a certain sense all bank notes, current accounts, cheque accounts, etc. belong to the money market.
In financial market terms, the money market exists for the purpose of issuing and trading of short-term instruments, that is, instruments where the term remaining from the date when trading takes place to the date of redemption of the loan represented by die instrument (commonly referred to as the "term to maturity"), is of a short-term nature. In theory, this term for classification as a money market instrument is given as one year. In practice, however (especially in South Africa), instruments with a term to maturity of three years or less are normally classified as money market instruments although this is not a hard and fast rule.
For the purpose of regulation, the classical typology of Financial Markets recognizes the following major distinctions :
In general terms, the money market is the market where liquid and short-term borrowing and lending take place. The lending of funds in this market constitutes short-term investments. In a certain sense all bank notes, current accounts, cheque accounts, etc. belong to the money market.
In financial market terms, the money market exists for the purpose of issuing and trading of short-term instruments, that is, instruments where the term remaining from the date when trading takes place to the date of redemption of the loan represented by die instrument (commonly referred to as the "term to maturity"), is of a short-term nature. In theory, this term for classification as a money market instrument is given as one year. In practice, however (especially in South Africa), instruments with a term to maturity of three years or less are normally classified as money market instruments although this is not a hard and fast rule.
For the purpose of regulation, the classical typology of Financial Markets recognizes the following major distinctions :
the inter-bank and credit markets
the Money Market ;
the Equity Market ;
the Foreign Exchange Market ;
the Bond Market (for Government bonds, Corporate bonds,
Eurobond market, structured bonds, etc.) ;
the Derivatives Market: ( for Futures, Swaps and Options)
Apart from the above mentioned categories, an other
important distinction is established between the domestic financial markets and
the international financial markets.
The institutional framework for the regulation of Financial
Markets.
A financial system cannot be effective without an adequate
regulatory framework. For a financial system to be effective and promote
healthy economic development, it is important to put in place a sound legal and
institutional framework. Various strategies and approaches are generally
considered by experts for the development of financial systems. Two major
strategies commonly considered are the "evolutionary" and the
"proactive" approaches. Other experts have made a distinction between
the "go slow" versus the "big bang" approach.
The pro-active strategy provides legal, regulatory and prudential framework which accelerates financial market development through mechanisms, institutions and financial instruments set up for this purpose. This strategy is considered as the appropriate approach for African and other developing countries for three main reasons:
The pro-active strategy provides legal, regulatory and prudential framework which accelerates financial market development through mechanisms, institutions and financial instruments set up for this purpose. This strategy is considered as the appropriate approach for African and other developing countries for three main reasons:
Inadequate neutral incentive environment and market forces
that are insufficiently strong for financial markets to develop by themselves.
Lack of institution-building capacity to determine the pace
and strength of financial markets development.
Need for flexibility to allow for the use of the most
efficient institutional set-up, required training infrastructure and choice of
technology that is most suited to the local conditions and level of
development.
The Rationale, Principles and Objectives of Financial
Markets Regulation
1. The necessity for a Financial Market Regulation
Why regulate Financial markets? This question is central to
the subject under investigation in this paper and before we attempt to grasp
the rationale and objectives of financial markets regulation, it is important
to understand why such regulation should exist in the first place. The
necessity for a financial market regulation finds its basis in the same principles
applied to the financial sector in general. Borrowing and lending of money
create certain risks, namely :
That the borrower will not be able to repay the money ;
That the lender is receiving a fixed rate on his investment
while market rates fluctuate in such a way that the yield on his initial
investment is now below current market related rates ;
That the value of the capital invested could decrease due to
movements in the market. In order to clearly define the rights and obligations
of investors, borrowers, operators and intermediaries involved in a financial
system and who operate under contractual relationship, it is of the highest
importance to develop a cohesive and comprehensive legal and regulatory
framework.
The stakes involved in the running of a country's financial
markets are very high and it would be deeply irresponsible to apply the rule of
"laisser-faire" in this very sensitive sector. In case some thing
would go wrong or the financial system could undergo a serious crisis, it would
result into a total collapse of the entire economy.
Such a framework should encourage discipline and timely
enforcement of contracts, fostering responsibilities and prudent behaviour on
both sides of the financial transaction. For a country's market to develop and
operate efficiently, the legislative and regulatory framework should
incorporate rules on trading, intermediation, information disclosure as well as
strict sanctions against defaulters and cheaters.
2. The Rationale of Financial Markets Regulation
The rationale underlying the financial market regulation is
the general philosophy and ideological background pertaining to a specific
country's economic orientation, and the type of economic system adopted by the
country's leadership. At present, most of the countries covered by the study
are characterized by a "market oriented " economy. However, some of
these countries have been under a centrally planned economy until the 1990s
when they dramatically changed their economic orientation. It is the case of
Tanzania, Mozambique and Angola. The changes were particularly due to
persistent deficits in public budget and their inability to support the
considerable burden of state owned companies unable to achieve the target
economic performance. This new orientation facilitated the development of more
diversified and active financial systems, leading to the creation of Financial
markets in Tanzania and Mozambique. Financial Markets have their own unique
characteristics and financial operators differ from one country to an other.
The financial market framework should facilitate rather than impede the
efficient operation of the financial system.
The Principles of Regulation
In theory, there is a distinction between general and
specific principles. The following general principles are widely recognized for
the formulation of an effective regulatory process:
Every regulatory arrangement should be related explicitly to
one or more objectives identified;
All regulatory arrangements should be justified with respect
to their cost-efficiency;
The cost of regulatory arrangements should be distributed
equitably ;
All regulatory arrangements should be sufficiently flexible,
in the sense of being amenable to changes in markets, competition and the
evolution of the financial system ;
Regulatory arrangements should be practitioners- based.
Specific principles are identified as follows:
a. Principles related to the regulatory structure:
What is the adequate structure for financial markets
regulation. One major issue in Financial markets regulation relates to the
number of regulatory and supervisory agencies involved. The issue of the choice
between a single regulatory authority or multiple specialized agencies is
generally resolved according to the following principles:
there is a need to adopt a "functional" as well as
an "institutional" approach ;
the coordination of regulation by different authorities and
agencies will help to achieve consistency ;
there should be a presumption in favour of a limited number
of regulatory agencies /authorities.
In practice, the institutional and functional approaches
need to be employed in parallel because regulatory authorities are concerned
with the soundness of institutions, as well as the way in which services are
provided.
b. Principles related to the market efficiency :
These are principles designed to contribute to the promotion
of a high level of efficiency in the provision of financial services. They are
:
(a) the promotion of a maximum level of competition among
market participants in the financial system, and (b) the securing of
competitive neutrality between actual or potential suppliers of financial
services. Competitiveness is likely to enhance market efficiency, which in turn
causes the removal of restrictive practices that could impair trading in financial
assets and the rationalization of market activity.
c. Principles related to market stability :
These principles are expected to contribute to the promotion
of a high measure of stability in the financial system and an appropriate
degree of safety and soundness in the financial institutions. There should be
incentives for proper assessment and management of risk. It is necessary to
impose acceptable minimum prudential standards to be observed in respect of
risk management by all financial market participants.
d. Principles related to conflict conciliation :
Conflict conciliatory principles are designed to resolve
potential conflicts arising between regulatory principles themselves. They
would involve an integrated approach, aiming at the simultaneous achievement of
regulatory objectives, and a target-instrument procedure for the selection of
key regulatory instruments in order to facilitate the implementation of an
integrated approach.
The Objectives of Financial Markets Regulation
For a Financial Markets system to perform to its highest
capacity and level, regulation need to be both effective (i.e. to achieve its
objectives) and efficient (i.e. to be cost effective in the use of its
resources).
The economic dimension of a financial markets system requires
that regulation should not impose unwarranted costs on the economy and
consumers, nor impair the efficiency of financial markets. It is therefore
necessary to consider a cost-benefits analysis exercise to assess the
regulatory requirements.
The more complex a financial market is and more business
operators increase, the regulatory process becomes more demanding and requires
more specific objectives. Efficient financial regulation requires a
multi-dimensional approach and a more optimizing process.
1. The overall objective of financial markets regulation:
The ultimate objective of financial markets regulation is to
achieve the highest degree of economic efficiency and the best consumer
protection in the economy.
2. Specific objectives:
The following Specific objectives can also be highlighted:
to secure the stability of the financial system.
It is important for a country's economy to run smoothly and
the financial sector must be protected against internal or external shocks
which might be caused for instance by ineffective or inefficient trading
clearing and settlement systems or a major lack of market liquidity ;
to ensure institutional safety and soundness.
The regulatory framework should be extremely cautious and
avoid to impose obstacles or barriers that would impair the safety and
soundness of financial institutions, which need to be profitable and have
sufficient capital to cover their risk exposure and face global competition ;
to promote consumers' protection:
It is crucial for a financial market to impose integrity,
transparency and disclosure practices in the supply of financial services.
Concluding Remarks
In all Southern African countries, as it is in all countries
of the world, the financial system is more regulated than any other industry.
On the consumer protection grounds and others highlighted in this study, it is
universally accepted that this should be so. Existing empirical evidence
suggests that regulatory arrangements have a powerful impact on the size,
structure and efficiency of financial systems, the business operations of
financial institutions and markets, and on competitive conditions in the
systems.
The success of a financial markets regulation depends
basically on the capacity of the regulators to define the objectives of the
regulation and also on the way the regulatory arrangements are related to their
objectives.
Some of the countries in the Southern African Region which
were able to promote a dynamic and effective regulatory framework, such as
Botswana, Namibia, Mauritius, Zambia, Zimbabwe and in particular South Africa,
are benefiting from the positive development of financial markets, with an
unprecedented flow of capital from foreign investors.
However the financial systems in the region are still
limited, in terms of the number of operators, quantity and quality of
instruments and the depth of the systems. And there is still need to develop
regulatory institutions, structures and mechanisms that can maximize the
explicit objectives of regulation while minimizing the costs of services.
The author, is an International Consultant on Trade and
Investment, Director of InterConsult Mozambique and is the Representative of
Emerging Market Focus (Pty) in Mozambique. This insight paper is aimed at
advising investors and business people involved in international trade by
providing them with accurate legal data on the institutional and legal
framework of Mozambique and the Southern African region.
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