Emerging Market Exchanges Need to Enhance Liquidity

Shanny Basar

The market capitalization of emerging market exchanges has more than doubled over the past 15 years but the growth in liquidity has not kept pace according to the World Federation of Exchanges.

Between 2004 and 2015 the market capitalization of emerging market exchanges increased from $3 trillion to $7.5 trillion and the annual value traded rose by two-thirds from $1.8 trillion to $3 trillion according a report from the WEF and management consulting firm Oliver Wyman. The study, Enhancing Liquidity in Emerging Market Exchanges, said growth has been uneven and has not been associated with a commensurate growth in liquidity.

“Over the same period, turnover velocity has fluctuated, reaching nearly 60% at some points but ending 2015 at just over 40%,” added the report. “Developed markets, meanwhile, were at 54% liquidity as of the end of 2015.”

Low liquidity constrains market development and the broader economy so improving the efficiency of trading, and offering better services to issuers and investors, could lead to significant indirect benefits.

The report identified three key areas that exchanges and regulators can focus on to grow liquidity – promoting the development of a diverse investor base; increasing the pool of securities and associated financial products and creating an enabling market environment. Each area has a number of corresponding liquidity levers such an encouraging international investors, launching exchange-traded funds and exchange-traded derivatives, and improving electronic trading technology.

Daniela Peterhoff, partner, global head of market infrastructure at Oliver Wyman, said in a statement: “Promoting a diverse investor base, increasing the pool of securities and investing in an enabling market environment are the three key actions points we identified to grow liquidity.”

The Philippine Stock Exchange is a case study in the report as turnover velocity increased from 12% to 16% between 2004 and 2015 and the total value of shares traded rose from $3.2bn to $40bn due to a number of initiatives. For example, secondary share trading on the exchange, as well as securities lending and borrowing, have been exempted from stamp duty; international corporate governance standards have been adopted and ETFs and a new real-time trading platform have been introduced.

Improvements in technology attracts investors and greater trading volume due to reduced execution costs and improved transaction speed and market transparency. Technology implementation varies between very early-stage emerging markets,  focussed on electronification and the dematerialization of the associated processes, and the most mature who have introduced co-location services and support for algorithmic trading firms.

For example, in Brazil, trading on BM&F Bovespa has been electronic since 2005 when floor trading was eliminated. In 2013 BM&F Bovespa introduced a new high-speed trading platform for cash equities with a trading roundtrip time of less than one millisecond, compared to 450 milliseconds in 2007. “As a result, the market has seen an exponential increase in the number of trades and lower volatility in asset prices,” said the report.

Emerging markets can also facilitate international participation through forging links with other venues, such as the Shanghai-Hong Kong Stock Connect program which launched in 2014.

The program allows investors outside mainland China to trade selected equities on the Shanghai Stock Exchange through Hong Kong brokers and for investors in mainland China to trade selected equities on the Hong Kong Stock Exchange, through members of the SSE.

“Despite predictions that the offering would result in a flood of cross-border trading activity, investment flows in both directions were still below the quota limits nearly two years after the links were established,” said the report.

The Shenzhen Stock Exchange is also being added to the Stock Connect program. Yesterday the Shenzhen Stock Exchange and Hong Kong Exchanges and Clearing Limited began their global roadshows for Shenzhen-Hong Kong Stock Connect in Hong Kong.

Wu Lijun, chairman of the Shenzhen exchange, said in a statement that Stock Connect offers unique investment opportunities for overseas investors and an international capital platform for innovative enterprises.

Charles Li, chief executive of HKEX, said in a statement: “The joint roadshows we kicked off are a major effort to promote the competitiveness of both the Hong Kong and Shenzhen markets.  Shenzhen Connect will further improve the mutual market access between the Hong Kong and Mainland markets and reinforce Hong Kong’s position as the leading offshore Renminbi asset management centre.”

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