The World Federation of Exchanges (“WFE”), the global industry group for exchanges and CCPs, has published a report that seeks to identify factors that attract international portfolio investment into emerging market (EM) equities.
Emerging market exchanges and policy makers are concerned with how to enhance international participation in their markets, as international investors play an important role in the development of emerging economies’ public markets. International investors can provide additional capital; enhance liquidity; promote greater competitiveness and adherence to standards of corporate conduct; and help balance local retail and institutional participation. World Bank data estimates the level of net international portfolio equity inflows into emerging markets between 2000 and 2017 to be more than USD 955 billion.
Today’s report looks at both foreign investment inflows to emerging equity markets, as well as foreign trading activity, to identify factors that are related to increases in both of these areas.
Factors associated with increases in foreign investment inflows include:
Emerging market equity returns, with just a one-percentage point increase in domestic returns being associated with a USD 24.4 million increase in monthly inflows;
Markets with higher corporate governance standards, with additional foreign inflows as high as USD 756 million over the sample period; and
A country’s inclusion in the MSCI Index, the use of IFRS reporting, and requiring or encouraging English-language disclosure.
There are also positive factors linked to higher levels of foreign trading activity, such as:
Larger and more liquid markets, with a one-percentage point increase in turnover velocity associated with a 1.3% increase in the value of foreign trading, and a 0.84% increase in the number of foreign trades;
Reduced trading fees; and
The introduction of market structure enhancements, such as the ability to short-sell and engage in securities lending and borrowing.
Conversely, the report also outlines a range of factors associated with foreign investment outflows, such as:
Emerging market volatility, suggesting that foreign capital tends to withdraw from emerging markets during periods of higher domestic market turmoil, consistent with the idea of a ‘flight to safety’; and
Explicit barriers to investment, such as the presence of restrictions on capital inflows, with markets imposing these restrictions seeing a reduction in inflows equal to USD 302 million over the sample period.
The report concludes with a number of actions that exchanges and policy-makers can take to enhance the attractiveness of their jurisdiction to foreign investors and traders including: prioritising the adoption of high corporate governance standards; reducing or eliminating barriers to investment such as capital gains and dividends taxes; reducing or minimising costs of transacting in the market; and introducing market structure features, such as short-selling, and securities lending and borrowing.
Nandini Sukumar, CEO, WFE said: “Nearly 70% of WFE members are located in emerging or frontier markets, and supporting the growth and development of these markets is a core strategic pillar and mandate of the federation. Today’s report demonstrates how important and interlinked international investors are to emerging economies’ equity markets, and we would urge our emerging markets members to review these practical recommendations as part of their ongoing capacity building programmes. The WFE commits to continuing to work with members and industry stakeholders to help emerging public markets thrive in the long-term.”
Siobhan Cleary, Head of Research & Public Policy, WFE added: “We recognise that some factors linking foreign investment and trading in emerging markets are beyond the control of exchanges and market participants, and need to be addressed as part of a collective effort. We also believe it is important for exchanges and policy-makers to ensure the creation of an enabling investor environment across different investor groups.”
The WFE’s Emerging Market (EM) Working Group includes 28 members whose role it is to develop relevant learning and information-sharing sessions for EM exchanges, and to propose EM-relevant research topics. Today’s report was collated using monthly foreign buy and sell trade data (volume and value) from 20 EM exchanges for the period January 2006 to April 2018, and is supported by a number of case studies from WFE EM members, and relevant academic literature.
Other WFE EM research includes a report into enhancing retail investor participation in emerging markets and a joint paper with Oliver Wyman focused on enhancing liquidity in emerging markets.