Marion Williams: The development of the Caribbean capital market
Speech by Dr Marion Williams, Governor of the Central Bank of Barbados, at the Capital Markets
Seminar, Central Bank of Barbados, Bridgetown, 11 May 2004.
* * *
First of all, I take this opportunity to express my great appreciation to Geoffrey Bell & Co. in assisting
the Central Bank, in organising this seminar at relatively short notice. This is the fourth biennial capital
markets seminar sponsored by the Central Bank. Geoffrey has featured prominently in organizing all
of them. Thank you Geoffrey.
I would like to express thanks to Geoffrey also in his role as a presenter as well as to thank the other
presenters, Dr. Carl Ross, Ms. Marie Cavanaugh, and especially Mr. Wain Iton who kindly stepped in
as our regional voice when Steve Bideshi informed us that he was no longer able to attend. The
purpose of this seminar is to stimulate discussion and generate ideas with respect to the development
and direction of local and regional capital markets and to place it in the context of what is happening in
the international capital markets.
Our presenters will cover topics such as the global economy, a topic which is important if regional
investors are to fully understand how to position themselves in the international markets and how
international interest rates and exchange rates are likely to move. Dr Ross's presentation on how
Caribbean bonds stack up in the international capital market is also important as it will help us to
gauge our performance relative to others.
The role of rating agencies has become increasingly important and this will become even more so with
the introduction of the new Basle Accord, which places greater emphasis on credit ratings. We thank
Mrs. Marie Cavanugh for giving us an inside view of how this is done. Our fourth presenter will give us
a good perspective on how close we are to realising a Regional Stock exchange and our last item will
be in the form of a panel discussion. We will have two question and answer sessions, one before the
coffee break and one before we close.
I thought I would set the stage by speaking about the importance of capital markets in the Caribbean
and outlining some of the challenges which we face.
An efficient market provides competitive financing alternatives, which then generate spin-off benefits to
the real economy. In addition, money market 'price signals' gauge the costs of government capital,
and permit monetary authorities to control liquidity. In addition, market participants enhance the level
of professionalism, independence and corporate governance.
Both primary and secondary markets are important to the effective allocation of scarce capital. To the
extent that capital markets are poorly developed, or lack liquidity and transparency, domestic investors
will reduce investment in favour of consumption, and thereby lower savings. Furthermore, investors,
both regional and non-regional will seek to diversify portfolios, and will tend to invest in countries with
more developed liquid and transparent capital markets which offer a wider variety of instruments.
These factors and the ability to enter and exit at will are critical to a well functioning market and are still
challenges in most Caribbean markets.
There is substantial room for improving debt markets in the region - where the development of
secondary debt markets lag equity markets. Possibly only Jamaica and Trinidad can be considered to
be countries with a genuine secondary market. However, unless we are able to further develop our
secondary markets, the role of capital markets in providing the link between the funding needs of
borrowers and lenders, in realising efficient fund allocation and assisting in accelerating economic
development will not be fully realised.
The demands of institutional investors for long-term investment opportunities have risen, so that a
challenge for capital markets is to provide a sufficient volume of long-term financial products in
response to the heightened need to deploy funds. In Barbados and indeed in many capitals across the
Caribbean there is a heavy build-up in liquidity and this is evidence that there is a demand for
investment vehicles.
We have now acquired the savings in the banking system but appropriate investment vehicles
continue to be in short supply. It is important that such vehicles be developed soon or there is a risk of
funds leaving the region. Fortunately, international interest rates are low so this is not an immediate
risk but it looms on the horizon as a possibility if we are unable to deploy excess funds before
international interest rates rise.
Capital controls, though important for maintaining the adequacy of international reserves, affect the
flow of foreign funds and the development of domestic capital market. Controls are therefore being
carefully evaluated and scaled back in the context of macroeconomic objectives, so that their
downside impact on capital markets development is minimised. The liberalisation which we desire has
to be achieved without creating other macroeconomic difficulties.
We have positioned ourselves to be part of an integrated financial system and already our systems
allow for funds to flow across national boundaries in seamless bank transfers. In this context,
Barbados is possibly ahead of many other developing countries in the sophisticated nature of its
payments and settlement systems. We also continue to integrate ourselves more fully into the regional
capital market. This has been most evident by the number of mergers and acquisitions and
privatisation involving regional companies within the past two years. Meanwhile our integration into the
international capital markets system at the level of government issues is progressing steadily, but is
constrained by the small size of issues. Again, macroeconomic stability must take precedence over
market impact and our desire for integration into the global market.
Internationally, there has been a wide level of disintermediation and an increase in non-bank
competition in the financial markets worldwide.
Indeed, in many regional jurisdictions - less so in Barbados and more so in Trinidad and Jamaica -
firms can satisfy their needs by obtaining funding through the capital markets directly.
This should not be seen as a circumvention of the banking system. It is quite normal in the
development of financial systems. Markets evolve in different ways as economic and financial
environments lead participants to seek alternative credit intermediary channels. Capital markets are to
be seen as complementary to traditional financial intermediaries, and should therefore not be viewed
as a substitutes for a well-functioning banking system. While there is evidence of disintermediation in
some Caribbean counties, capital markets cannot substitute for banks as capital markets are
sometimes better positioned to provide longer term financing and sometimes higher risk financing than
banks.
Typically, firms in the region have been generally reluctant to expand their funding sources, seemingly
for fear of weakening of their relationship with banks. However, it is important for firms to feel free to
select what they judge as the most advantageous way to obtain funding in order to ensure a smooth
system of corporate financing.
As markets become deeper banks themselves will tend to seek to securitise existing loan assets and
to provide advisory and underwriting services for the issue of securities. This has been the trend
elsewhere, where bank securitisation has become quite normal.
Securitisation has its advantages as it allows comparatively riskier firms to access to capital markets,
and it lowers financing costs by segregating higher quality receivables or assets from the risky firms.
Properly used, in conjunction with derivatives, it can facilitate the transfer of risks of commodities,
foreign exchange and interest rates, to investors willing to accept these risks for a fee or profit.
Conditions necessary for the development of capital markets
Institutional infrastructure
One of the factors which is most important in the deepening of capital markets is the institutional
infrastructure - that is, the legal, taxation, and accounting systems. While, for the most part accounting
systems are reasonably up-to-date, many Caribbean territories have recognised that their legal and
tax systems require improvement if they are to be able to facilitate the rapid changes taking place in
commercial transactions.
If tax and accounting treatments are not clear, the evaluation of risks of individual products becomes
difficult and if such treatment is vague, one cannot as effectively and with certainty use technologies to
meet market demands. Institutional development must therefore be appropriate to objectives of having
a modern capital market system and must be clear in its framework.
Credit ratings are increasingly important. However, though they have the advantage of protecting the
investor, it is important that the investor who is willing to accept higher risks for higher returns, not be
discouraged by the system as this could have the result of suppressing the most important function of
capital markets, which is to attract investors with different risk appetites. Protection without
overprotection is what is desirable.
This caveat also applies to Securities Commissions. Investors look to Securities Commissions to
safeguard markets through establishing minimum standards of capitalisation, registration of securities
and market participants, timely and material disclosure, and effective enforcement. However,
commissions have to strike the middle ground of being strong managers without being overly intrusive.
In many emerging markets also the timely disclosure of material information is often inadequate.
Adequate financial disclosure is crucial for investors to make informed investment decisions - and
though we have had few issues of improprieties as has occurred in other developed country markets,
the Caribbean still needs to work on this aspect of its information sharing.
Utilization of evolving innovation in information technology
Another necessary condition for capital market development in the region is the aggressive
incorporation of innovative techniques offered by advances in information technology. Perhaps in no
other activity, with the possible exception of information technology itself, is the pace of innovation as
great, or the cost of failure to utilize the technology as high as in capital markets. One can miss major
opportunities if the technology is not able to identify them quickly.
Access to software to calculate default probabilities and various risks, which are critical when dealing
with financial products, can now be completed almost instantaneously with the appropriate technology.
In addition, due to the progress in telecommunications, including the Internet, massive data collection
has become far easier than in the past, so that investors - say in Hong Kong - can spot opportunities
as they arise, and can access information on the Barbados market and vice versa. We therefore have
to cease thinking of our markets as isolated. They are not. Investors are better positioned than ever
before to spot opportunities, and there are such opportunities in the Caribbean.
As regional exchanges develop themselves, their structure will be vastly different from those of the
1980s. Markets which mature or develop at different times do so in different ways, since the
environment is different. Derivative transactions, which isolate risks intrinsic to underlying assets and
enable trading in these risks separately are now becoming the norm in other exchanges and will
become the norm in the region as well. These derivative transactions have enabled and facilitated the
unbundling and re-bundling of risks to generate combinations of risks and returns different from those
of underlying assets. This kind of modernisation is important, irrespective of size and scale and though
it is costly for small-scale operations it is essential in order to be competitive.
Importance for adequate levels of domestic savings
Although much attention is focused on international capital flows and foreign savings, which indeed
are important, domestic savings are a more stable and important source of investment funding for the
region. For capital market development, local currency debt and equity markets are paramount.
However, maturities need to be lengthened. The goal is therefore to promote the issuance and
transactions of longer-term securities with an overriding aim of extending the yield curve for public and
private debt.
There has been a challenge generally in the region in extending the yield curve. Bondholders are
exposed to inflationary situations in some economies, insufficient information in others, and legal
systems which for the most part do not fast track commercial judgments. There is much to be done.
These goals are best achieved in tandem with enhanced trading systems, clearance and settlement
mechanisms and efficient depository systems. However, the development of clearance settlement and
depository systems seem to be moving faster than other market developments.
As in many emerging markets, these hurdles can be structural barriers to foreign portfolio investment
in the region by private firms. Without resolute action to address this trend, small markets like those in
the Caribbean can be kept on the outer fringes of global finance. If we wish to feature prominently on
the world stage it is important that these niggling hurdles be crossed. It is also important that we face
the world as a single exchange with a little more depth than is possible with individual exchanges.
Acceptance of a 'credit culture'
Another condition for capital market development is the establishment of 'credit culture' in which
investors in general accurately evaluate risks and returns and follow investment and financing, based
on the results derived from such evaluation exercises.
It can be said that the development of capital markets has been retarded partly because of the lack of
an entrenched credit culture, and conversely, that a credit culture has not become entrenched
because capital markets are not sufficiently developed. However, there is evidence of the formation of
credit rating agencies in the region. These can be of assistance to investors who do not have the time
or the training to conduct their own credit analyses.
Efforts by the Central Bank of Barbados
Lastly, let me touch on the Central Bank of Barbados' efforts with respect to capital market
development.
The Bank has a close relationship with capital markets through its central banking operations.
Financial and capital markets serve as an important vehicle for transmitting monetary policy to
economic agents. If the financial and capital markets do not function sufficiently, policy effects can be
dampened. Interest rate changes, for example, represent just one example of the importance of an
efficient market in the effectiveness of policy as this change works itself through to lending costs and
hence to competitiveness and to profits and to asset prices. In terms of new instruments the Bank is at
the forefront in developing new secondary mortgage market products to potential investors in the belief
that capital markets require a wider range of products. It has also started a series of workshops with
the objective of assisting in the development of new financial instruments. Increasingly also, Credit
Unions need to be more integrally involved in the process of financial development.
At the regional level, governments need to include convergence of Caribbean economies as an
important goal in their national planning since greater convergence of Caribbean economies is
important for the development of a truly regional capital market. While there has been much progress
on the ground in terms of cross border ownership changes, there is still a wide disparity in interest
rates and inflation rates across the region. This is not a great deterrent for the growth of a regional
equities market and for the cross trading of equities but it is not the most propitious environment for
the development of a regional government securities market or for the cross-trading of government
securities of a higher interest rate regime in the jurisdiction of a low interest rate regime.
The opportunities for arbitrage are tremendous so it is desirable that there be greater convergence of
regional economies as soon as possible. The country most out of line both in terms of exchange rates
and interest rates is Jamaica, as the interest rate and exchange rate regimes of most other countries
in the region, perhaps with the additional exception of Guyana, are much closer to convergence.
Indeed, in early 2003 it looked as if interest rates and inflation in Jamaica were moving closer to
convergence with that of the rest of the Caribbean as well, but this changed sharply in early 2003 and
the convergence for which we hoped was abruptly dislodged.
We need to get back to that situation where economic convergence is a likelihood. Capital markets
need it.
Conclusion
Not only do authorities need to deliberately target economic convergence we also need to build
incentives into our operational frameworks and to reward desired outcomes. This calls for more
specific recommendations and for even closer interaction between market participants and the
authorities. It also underscores the need for cooperative mechanisms in building our markets.
Thank you ladies and gentlemen.