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The role of cross-listings in establishing a Southern African Development Community regional stock exchange

Master's Thesis 2013 121 Pages

Economics - Case Scenarios

Excerpt

Table of Contents

Title Page

Acknowledgements

Keywords

Acronyms

Chapter One Introduction
1.1 Background
1.1.1. Aims of the Research
1.2. Research Statement
1.3. Research Questions
1.4. Significance of the Research
1.5. Research Methodology
1.6. Limitation of Study
1.7. Literature Review
1.8. Sequence of Chapters

Chapter Two Understanding the Concept of Cross-listings
2.1. Introduction
2.2. Defining the Concept of Cross-listings
2.3. Reasons for Domestic markets and Firms to participate in cross-listings
2.3.1. Expand Investor Base
2.3.2. Liquidity
2.3.3. Increase Visibility
2.3.4. Financial Gains
2.3.5. Marketing Motivations
2.3.6. Bonding
2.3.7. Increased Analyst Coverage
2.4. How Cross listings can contribute to a Regional Exchange
2.5. Conclusion

Chapter Three Lessons from West Africa and EAC
3.1. Introduction
3.2.1. The Requirements for a proper Legal and Regulatory Framework
3.2.2. Investment Code
3.2.3. Supervisory Authority
3.2.4. Harmonisation
3.3. Regional Market Integration
3.3.1. Benefits of Regional Capital Markets Integration
3.3.2. Challenges of Regional Capital Markets Integration
3.3.3. Lack of Commitment
3.3.4. Overlapping Memberships
3.3.5. High Transaction Costs
3.3.6. Governments, National Markets and Companies
3.3.7. Lack of Information
3.3.8. Income Disparity between South Africa and Other SADC Countries
3.3.9. Lack of Public Confidence
3.3.10. Disruption Spill Over From One Market to Another
3.4. Lessons from Other Regions
3.4.1. West Africa
3.4.2. East African Community
3.5. Conclusion

Chapter Four The Euronext as a Working Example of a Regional Stock Exchange and Comparative Discussion with Africa
4.1. Introduction
4.2. History and Background of Euronext
4.3. Regulatory Authorities
4.4. Harmonisation of Listing Requirements
4.4.1. Rulebook I
4.5. Harmonisation of Legislation
4.6. Comparative Discussion with Africa
4.7. Conclusion

Chapter 5 Conclusions and Recommendations
5.1. Conclusion
5.2. Recommendations
5.2.1. Proposed recommendations
5.2.2. Harmonisation
5.2.3. Legal and Regulatory Framework
5.2.4. Institutional Framework
5.2.5. Commission of Securities Regulators
5.2.6. Promotion campaigns
5.2.7. Capacity building
5.2.8. Final remarks

Bibliography

CHAPTER ONE INTRODUCTION

1.1 BACKGROUND

It has been established that African stock markets are confronted with a multitude of problems which include, inadequate liquidity, low capitalisation, few market participants, a small number of listed companies and low trading volumes.[1] As a result, their broader economic impact has so far been limited.[2] The Southern Africa Development Community (SADC) stock markets with the exception of South Africa are small, both in terms of the number of listed companies and market capitalisation, and they display considerable illiquidity.[3] In general, the SADC region has shallow and underdeveloped financial markets. Their development has been hampered by a number of factors which include; political and economic uncertainty, fiscal dominance, weak judicial institutions, limited investment opportunities in the private sector, technological constraints, and the shortage of skilled personnel with expertise in banking and finance.[4]

It is contended that all these problems could be eased through regional financial integration. The integration of African stock markets and the introduction of regional stock exchanges will promote cross-border listings and thus stimulate increased liquidity across markets.[5] Thus, it is suggested that the integration of SADC’s stock markets and the creation of a regional stock exchange is one of the panaceas to overcome Africa’s stock market problems.[6] A regional stock exchange has the potential for tremendous benefits for both local and foreign investors, as well as for business enterprises in the region.[7] The term “regional stock exchange” refers to a stock exchange which would stimulate not only cross-border trading in securities of companies within the region, but would also attract securities investment from abroad.[8] Also, a regional stock exchange would belong to a region and such an exchange would be located in one of the countries in the region.[9]

It is in light of this that in 1997 a Committee of SADC Stock Exchanges[10] (CoSSE) was set up and is a collective body of the stock exchanges in SADC.[11] The main goal of CoSSE is fostering cooperation and collaboration between member stock exchanges.[12] Although it is essentially a private-sector association, CoSSE works under the ambit of the draft SADC Finance and Investment Protocol[13] (FIP) which seeks to contribute to the establishment of a regional stock market by facilitating regional integration between member states in the finance and investment field.[14] In 1999 CoSSE members agreed to harmonise their listings based on the Johannesburg Stock Exchange (JSE) rules as the basic framework, structure and format.[15] However, SADC’s vision to establish an integrated, regional stock exchange by 2006 was not realised.[16] Therefore, currently there is no regional stock exchange within SADC, but discussions are underway as to how the SADC stock exchanges can be integrated.

1.1.1 Aims of the Research

This study aims to evaluate the importance of cross-listings in establishing a SADC regional stock exchange and in solving the problems of SADC’s stock markets. Furthermore, the study seeks to identify important lessons from the East African Community (EAC), Francophone West Africa and the European Union that are crucial for pursuance of regional cross-listings integration within SADC.

1.2 RESEARCH STATEMENT

In 2008, CoSSE developed a framework for dual and cross-listings on regional stock exchanges. Thus, the issue under examination is how might cross-listings assist in establishing a SADC regional stock exchange?

1.3 RESEARCH QUESTIONS

The research seeks to provide the answers to the following questions:

(i) What are cross-listings?
(ii) Can cross-listings improve liquidity and facilitate stock market deepening?
(iii) How should the regional cross-listing integration scheme be regulated, structured and implemented?
(iv) What are the legal implications for the establishment of a SADC regional stock exchange by cross-listings?
(v) What are the constraints/benefits/lessons from other regions?

1.4 SIGNIFICANCE OF THE RESEARCH

The importance of this study is that it comes at a time when many African countries are reviewing policy options including the benefits of wider market participation through increased regional financial integration. In the SADC region, CoSSE is supporting increased financial market integration and leading the SADC countries towards a fully integrated stock market through cross-listings.

Furthermore, the research will provide information to CoSSE by giving enhanced insight and knowledge that will help to shed light on the role of cross-listings in establishing a SADC regional stock exchange.

The study will also be useful to the exchanges in Ghana, Nigeria and Cote d’Ivoire who are also seeking to integrate by 2014,[17] and to the JSE which is engaged in serious discussions with Ghana, Namibia, Zambia and Zimbabwe stock exchanges with the main aim of establishing a Pan-African stock exchange.[18] The study will be of value to the EAC which is also planning to set up a regional stock exchange.

Moreover, this study will be useful to companies seeking to exploit profit and growth opportunities on the abovementioned regional stock exchanges by means of cross-listings investment ventures.

Therefore, the study makes a significant contribution to the existing literature by filling the gap on how cross-listings assist in setting up a SADC regional stock exchange.

1.5 RESEARCH METHODOLOGY

The method employed for this study will be based on a desktop and library study. The primary sources of information will be treaties, protocols, memorandum of understanding agreements, and articles written by experts and organisations in the field. The secondary sources will include textbooks and information available from electronic resources and databases. A comparative study will be used to indicate the experiences of other regions in the pursuance of regional cross-listings. The comparison will be limited to the following regions: EAC and Francophone West Africa and Euronext. EAC and West Africa have a clear and effective, sound legal and regulatory framework regulating regional cross-listings. Euronext is a working example of a regional stock exchange.

1.6 LIMITATION OF STUDY

It is admitted that regional integration covers a wide range of integration forms which encompasses trade integration, monetary and, even, political integration. However, this study focuses only on how cross-listings enhance regional market integration. Moreover, the study is limited to the comparative analysis of the experiences of regional cross-listings in the Francophone West Africa stock exchange, the East African Community (EAC), and the EU, particularly Euronext.

1.7 LITERATURE REVIEW

Overall, there is a large body of literature that documents whether cross-listings enhance African securities exchanges in a way that overcomes the impediments to their development. Drawing heavily on the case of the Lusaka Stock Exchange, Mwenda argues that, although emerging stock markets are relatively illiquid, there is a need for capital markets in Africa to integrate by moving towards the establishment of a regional stock exchange.[19] He advocates the establishment of a regional stock exchange under the Common Market for Eastern and Southern Africa (COMESA), and SADC, as an incentive to improve the efficiency and competitiveness of the sub-region’s national securities markets.[20] Moreover, Mwenda argues, in favour of establishing a regional stock exchange that would coexist with the sub- region’s national stock exchanges, while simultaneously promoting multiple cross-border listings and cross-border investments, to ease liquidity problems on the national exchanges.[21] This is the plan CoSSE envisages, that all of the national exchanges would remain in place and would be cross-linked to a single desktop work station.[22]

The preamble of the SADC Finance and Investment Protocol states that, CoSSE is to pave the way towards cross-border listings and, trading and investments among the different member stock exchanges of SADC in order to facilitate the process of financial integration within the region.[23]

Sabri contends that cross-listing enhances the integration of emerging stock markets to global stock markets.[24] The idea of cross-listing is to list a domestic firm in international secondary stock exchanges, in order to obtain benefits and increased investment opportunities, as well as the advantages of liquidity.[25] Adelegan also notes that cross-listing can bring significant benefits which include the financing and corporate needs of stock markets, the provision of wealth diversification, greater efficiency, the lowering of the cost of capital, and increased market access for small stock markets.[26] However, the necessary conditions to harness the benefits of regional cross-listings include sound legal and regulatory frameworks, macroeconomic and political stability, harmonisation of listing rules, accounting law and disclosure requirements across the region, strong money markets, and incentives for listed firms and other market participants to take advantage of regional cross-listings.[27]

Onyuma et al observes that the regional cross-border listing trail was blazed by the JSE Securities Exchange of South Africa when it cross-listed on the Namibian Stock Exchange (NSX) in October 1992.[28] There has also been regional stock listing between stock markets in Botswana and South Africa since 1997, Malawi and South Africa in 1999, and Zambia and South Africa in 2003.[29] Onyuma et al states further that, cross-border listings have gained significance over the past few years since the signing of the EAC treaty in 1999.[30] Therefore, the development of cross-listings across national stock markets in Tanzania, Kenya, Rwanda and Uganda is a milestone in the EAC’s drive for regional market integration.[31]

However, while there are earlier works which have studied the impact of cross-listings in stock markets development, there remains a gap in the literature with respect to how cross-listings might assist in establishing a SADC regional stock exchange, which this research seeks to fill.

1.8 SEQUENCE OF CHAPTERS

The topic under examination will be discussed in five chapters.

1.9.1 Chapter One

This chapter introduces the research and discusses the problem of the study. It also sets out the context of the research in terms of identifying the problem and outlining the methodology. The chapter ends with a review of some of the literature that has been used in this thesis.

1.9.2Chapter Two

Chapter two gives insight into understanding the concept of cross-listings. This includes an in-depth discussion of the reasons driving domestic markets and firms to participate in cross-listings. The chapter also looks at the importance of cross-listings in fostering regional market integration in the SADC region.

1.9.3 Chapter Three

This chapter focuses on the lessons from other regions such as EAC and West Africa. The chapter also critically discusses the requirements for a proper legal and regulatory framework for regional integration of capital markets.

1.9.4 Chapter Four

Chapter four focuses on the Euronext as a working example of a regional stock exchange and comparative discussion with Africa.

1.9.5 Chapter Five

Finally, this chapter concludes the research and proposes recommendations on the establishment of a SADC regional stock exchange

CHAPTER TWO UNDERSTANDING THE CONCEPT OF CROSS-LISTINGS

2.1 INTRODUCTION

As previously noted in chapter one, the core aim of this research is to establish how cross-listings will assist in establishing a SADC regional stock exchange. Following the same route, this chapter attempts to provide an insight into understanding the concept of cross-listings.

After addressing the concept of cross-listings, this chapter examines the reasons driving domestic markets and firms to participate in cross-listings. Lastly, it addresses how cross-listings can contribute to a regional exchange in SADC as a lead-in to regional exchanges.

2.2 DEFINING THE CONCEPT OF CROSS-LISTINGS

The concept of “cross-listings” is a new and efficient instrument which enhances the integration of emerging stock markets with global stock markets.[32] Cross-listings refer either to the listing of ordinary shares of a firm on a different exchange other than its home stock exchange, or entail a single stock being listed on more than one exchange.[33] In addition, cross-listing is a strategic policy of firms to secondarily list their shares abroad.[34] Cross-listings can be achieved via direct listing, the Depository Receipts Programme, and Global Registered Firms.[35] Direct listing is where an increasing number of firms perceive the benefits of listing their securities abroad.[36] Generally such a firm’s primary listing is on a stock exchange in its country of incorporation, and its secondary listing is on an exchange in another country.[37] Cross-listing is especially common for companies that started out in a small market but grew into a large market. Furthermore, cross-listings is a mechanism through which domestic markets and firms can improve their access to the lower cost of external financing and consequently use the funds to invest in viable projects, and affirm a strong commitment to stringent rules backed by stringent enforcement.[38]

It is important to note that the concept of cross-listings expanded significantly in the nineties and it started in the United States of America (USA).[39] Burns and Bill regard cross-listings as a vehicle through which a firm’s management can bond themselves to a legal system with more protections against management self dealing or excessive consumption of private benefits of control.[40] Therefore, cross-listings can be characterised as a limited type of jurisdictional choice that involves opting into an alternative, perhaps stricter, regime from that in which the market is based, but not opting out of the default jurisdiction.[41]

Proponents of cross-listings assert that regional integration can bring greater efficiency, synergies and economies of scale; attract foreign flow of funds; foster risk sharing and portfolio diversification; act as an impetus to financial sector reforms, thereby broadening the competitiveness of regional financial systems and minimising the risks of financial instability; facilitate capital market development; and lead to economic growth.[42] Economic growth increases in integrated markets because of the better allocation of capital among investment opportunities.[43]

However, cross-listings have implications not only for cross-listing markets, but also for countries in which these markets are based, as cross-listing markets might demand changes in home country law in order to better coordinate with the law of the cross-listed jurisdiction.[44] Thus, if cross-listing countries attempt to impose laws on cross-listing markets which conflict with the law of their home countries; this could reduce cross-listing and, therefore, the benefits which that foreign market brings to cross-listing jurisdictions.[45] It is contended that, even though cross-listings give wider opportunities to potential investors or companies to invest in multiple markets in order to exploit profit opportunities, they are susceptible to market conditions, and there is a potential loss of management control, associated costs, loss of privacy and an increase in reporting and disclosures.[46]

Regional cross-listings in Africa have either been policy driven or market driven.[47] Some of the government policy-induced regional cross-listings are the cross-listings between the Johannesburg Stock Exchange ( JSE) and the Namibian Stock Exchange (NSX) in October 1992.[48] In the SADC region there has been regional cross-listing between stock markets in Botswana and South Africa since 1997, Malawi and South Africa in 1999, and Zambia and South Africa in 2003[49]. For instance, Investec Limited of South Africa has primary listings on the JSE, and is also dually listed in Botswana since 1995.[50] Ashanti Goldfields is listed on the Zimbabwe Stock Exchange and is also cross-listed on the Ghana Stock Exchange (GSE), the London Stock Exchange (LSE), and the New York Stock Exchange (NYSE).[51] AngloGold Ashanti has its primary listing on the JSE and a secondary listing on the GSE.[52] Moreover, a number of companies are cross-listed on the Zimbabwe Stock Exchange and the JSE: Bicc Cafca Ltd, Falcon Investment Holdings, Old Mutual, Pretoria Portland, and Wankie Colliery.[53] Oando PLC, registered in Nigeria, cross listed on the JSE on 25 November 2006.[54]

The market driven cross-listings, on the other hand, include the West African triple cross- listing of Ecobank on the Bourse Régionalede Valeurs Mobilières (BRVM), the Nigerian Stock Exchange (NiSE), and GSE; and the cross-listing of Shoprite on the JSE and Lusaka Stock Exchange (LuSE) in Zambia.[55] Irrespective of the reason for the regional cross-listing, it is beneficial to both the host and home countries.

Decisions on regional cross-listings are taken by firms, while market regulators, policy makers and stock exchanges facilitate the regional approach to cross-listings by signing Memoranda of Understandings (MoUs) and putting in place the necessary conditions to harness the benefits of regional cross-listings and develop their capital markets.[56]

2.3. REASONS FOR DOMESTIC MARKETS AND FIRMS TO PARTICIPATE IN CROSS-LISTING

Academic literature has identified a number of different reasons which motivate local markets and firms to cross-list.[57] For example, firms and domestic markets cross-list in order to expand their investor base, increase stock liquidity, improve the terms on which they can raise capital, increase visibility of stock exchanges, and achieve non-financial benefits such as increasing their customer base through the broadening of product recognition among investors of the host country.[58] In addition, cross-listings enrich and strengthen each individual exchange by the addition of quality-level listed securities.[59]

2.3.1 Expand Investor Base

Cross-listings in a foreign market make the domestic market available to more investors and, consequently increase the shareholder base and risk sharing, which results in higher valuations.[60] Foerster and Karolyi provide empirical support to this perception, namely that cross-listing increases market value by expanding the shareholder base and improving liquidity.[61] In support of this notion, Canadian managers whose firms are cross listed in the U.S. place greater emphasis on the role of cross-listings in widening their shareholder base.[62] As cross listings increase the shareholder base, the market’s risk is shared among more shareholders and this increased diversification reduces the market’s cost of capital.[63] Baker reports that the major benefit of foreign listing is to broaden the shareholder base.[64] It is depicted that cross-listings increase the investor base of the stock market with beneficial effects on its cost of capital.[65] Cross-listings help to draw the interest of new investors and encourage them to start trading in both foreign and local markets.[66] The interest may come not only from the larger scope of corporate information available after listing overseas, but also from a signal of commitment to higher governance standards which a local market sends when deciding to enter foreign markets.[67] Furthermore, by cross-listing a domestic market could expand its potential investor base more easily than if it is traded on a single market, as cross-listings bring foreign securities closer to potential investors, and they increase investor awareness of the securities.[68] Therefore, firms and domestic markets participate in cross-listings because this provides an avenue for portfolio diversification for a wider investor base.

2.3.2 Liquidity

Significantly, cross-listing on deeper and more liquid equity markets leads to an increase in the liquidity of the stock and a decrease in the cost of capital. Liquidity is a crucial feature of stock market development since greater liquidity can translate into a lower cost of capital for the stock market concerned, insofar as it is valued by investors and factored into market prices.[69] According to a World Bank study, liquidity in stock markets increases long-term economic growth by easing firms’ access to funds for investment.[70] In addition, liquidity plays an important role in the ability of markets to attract trading volume.[71] Liquid markets also experience faster rates of capital accumulation and subsequently greater productivity.[72] Hence, it can be noted that stock market liquidity can positively influence economic growth, capital stock growth and productivity growth.[73] It is thus contended that cross-listings generate improved liquidity which lowers the cost of capital and increases share value.[74] Cross-listings lead to an increase in liquidity due to a pick-up in trading volumes in both the home and foreign stock market.[75] As a result of cross-listing, the home market and the host market will compete for order flows[76] for the cross-listed stocks and order flows will shift to the market with lower trading costs.[77] It is established that when local markets enter foreign markets, liquidity of the domestic markets improves significantly.[78] Therefore, secondary market liquidity increases following cross-listing in both the home and foreign market, accompanied by a reduction in trading costs and a narrowing of bid-ask spreads in the home market.[79]

The cross-listings of emerging stock markets to developed stock markets increases domestic prices by enhancing the ability of the domestic stocks to provide diversification and liquidity, and transfers a segmented local equity market to an integrated market with high liquidity and market capitalisation.[80] For example, Domowitz et al., based on a study of Mexican firms, submits that cross-listings increase liquidity as long as the advantage of being traded in a more liquid market outweighs the disadvantages of order flow migration.[81] Greater liquidity is associated with increased visibility, greater analyst coverage, improved earnings forecasts, and overall better investor recognition.[82] Cross-listings result in reduction of transaction costs for investors through gains in market liquidity.[83] In contrast, cross-listings may not always enhance liquidity, due to the potentially offsetting impact of market fragmentation.[84] It is argued that liquidity may suffer in both the domestic and the foreign market if inter-market information linkages are poor.[85] Order flow migration from the domestic to the foreign market after cross-listing, can, however, reduce the liquidity of the listed shares in the domestic market.[86] Cross-listing is a dynamic and destabilising force that can moved liquidity from local exchanges to international markets, thereby impelling a consolidation among market centres.[87] Nevertheless, cross-listings result in improved liquidity which is the major reason why domestic markets participate in cross-listings.[88]

2.3.3 Increase Visibility

The quest for increasing visibility of stock exchanges is the principal reason that drives domestic markets to participate in cross-listings. The putative benefits of increased visibility in the host country go well beyond the expected increase in shareholder base. Local capital markets are attracted to cross lists to larger markets, insofar as they provide access to a larger pool of potential investors.[89] Notably, being cross-listed on a larger stock market confers a reputation upon a domestic stock market. In addition, to greater demand for its stock, cross- listings provide a stock market with greater access to foreign money markets and makes it easier to sell debt there.[90] Increased visibility can also boost local stock market marketing efforts, by broadening product identification among investors and consumers in the host country.[91] Evidence shows that cross-listings enhance the visibility of a market and signal to customers and non-investor stakeholders that the market has become a global player.[92] For example, Daimler-Benz, a German firm cross-listed on the NYSE in 1993 and this cross- listing gave it direct access to the largest and most dynamic stock market in the world; as a result it became the first firm in the world to have a truly global share.[93] It is established that visibility of stock exchanges, as measured by analysts and media coverage, increases around the time of cross-listings.[94] Smith and Sofianos analysed the effect of the New York Stock Exchange (NYSE) listings on the liquidity of one hundred and twenty eight non-US stocks and found that, after the cross-listing, the average annual turnover ratio in the domestic market increases from 65% to 89%.[95] Bancel and Mittoo, in a survey of 305 European companies cross listed on foreign exchanges, report that the most perceived benefit of cross- listing is the increased visibility and prestige.[96] A cross-listed market becomes more credible by providing information to the local capital market and, in turn, this continuous flow of information allows the capital market to make faster and more accurate decisions.[97] Therefore, firms and domestic markets participate in cross-listings in the quest for increasing visibility of stock exchanges and firms.

2.3.4 Financial Gains

Firms and domestic markets participate in cross-listings for financial gain motives. Thus, cross-listing is regarded as a means for lowering a market’s cost of capital, that is, for enabling markets to get more money from investors when they offer their stock to the public.[98] It is noted that this effect stems from segmentation gains and diversification gains. Segmentation is whereby foreign listing allows the local stock markets to become part of the global portfolio.[99] Moreover, cross-listings bring foreign stocks closer to investors and offer several other straightforward advantages that stem from lower transaction costs.[100] Stulz submits that cross-listings provide financial gains by enabling markets to get more money from investors when they offer their stocks to the public.[101] It is evident that cross-listed domestic markets benefit from a lower cost capital and raise more external funds after they enter the foreign markets.[102] However, criticism levelled against market segmentation is that, it cannot explain the time-series pattern of listings.[103] For instance, with greater market integration over time, net benefits of a listing should diminish since the cost of capital for companies is increasingly determined globally.[104] Hence, it is argued that there should have been a reduction in cross-listings instead of an increase.[105]

2.3.5 Marketing Motivations

Another reason that pushes domestic markets and firms to participate in cross-listings is marketing motivations. It is claimed that cross-listings creates greater market demand for the market’s products as well as its securities.[106] Domestic markets do cross-list their capital markets as a tool to signal their transparency and private information; hence, they also try to deliver a positive signal of capital markets’ value to outside investors that they are high-value or high-growth capital markets.[107] Cross-listings attract positive publicity in the foreign market. However, a good marketing campaign may bring about the same outcome.[108] Therefore, it is evident that the drive for marketing motivations is one of the reasons domestic markets and firms participate in cross-listings.

2.3.6 Bonding

Cross-listing in a foreign market acts as a bonding mechanism used by firms that are incorporated in a jurisdiction with poor investor protection and enforcement systems to commit themselves voluntarily to higher standards of corporate governance.[109] In this way, firms attract investors who would otherwise be reluctant to invest. Bonding refers to the costs of liabilities that an agent or entrepreneur will incur to assure investors that it will perform as promised, thereby enabling it to market its securities at a higher price.[110] The bonding hypothesis suggests that cross-listings help capital markets to improve their corporate governance and protect minority shareholder interests by reducing the agency costs of controlling shareholders.[111] In addition, bonding mechanisms also include submitting to reputational intermediaries in the target jurisdiction, such as securities analysts, investment bankers, auditors and exchanges.[112] Cross-listings involve bonding, which causes markets to adhere to superior regulatory and governance standards.[113] Firms often cite the desire for improved corporate governance as one of the motivations for cross-listings on foreign exchanges.[114] Fernandes and Ferreira suggest that, an improvement in governance stimulates investors’ incentives to collect private information and thereby work to make stock prices more informative.[115] Conversely, an improvement in price information may be one channel through which a cross-listing attenuates agency problems between managers and shareholders.[116]

In doing so, markets provide a clear signal to shareholders that they intend to abide by higher standards than they would otherwise do in their home market.[117] Thus, it is evident that the increased disclosure and monitoring associated with the cross-listing acts as a bonding mechanism for controlling shareholders for less expropriation of market resources.[118] Doidge et al., show that cross-listed markets are valued more than non cross-listed markets because- the higher disclosure requirements, which usually occur in cross-listings programmes, reduce the opportunity to extract private benefits for controlling shareholders.[119] At the same time the bonding hypothesis will constrain insiders of the cross-listed markets from trading on private information, particularly if foreign legislation is tighter than the domestic insider trading rules.[120]

Cross-listings can be a tool for markets to signal to their investors that they are more willing to protect minority rights as corporate governance rules are stronger abroad.[121] Thus, it is argued that markets in weaker protection for minority shareholder countries are more likely to bond themselves by cross-listing in markets with stronger protection for minority shareholders, such as the NYSE.[122] Cross-listing in a country with better accounting standards allows the market to pre-commit to greater transparency and thereby reduce the monitoring costs of its shareholders and their required rate of return.[123] Litch contends that the bonding hypothesis is completely unfounded, and asserts that instead of bonding most issuers of foreign securities may actually be avoiding better governance.[124] Therefore, firms participate in cross-listings because of enhanced corporate governance and bonding associated with cross-listings.

2.3.7 Increased Analyst Coverage

It is important to note that an improved information environment associated with cross- listings is one of the reasons why domestic markets and firms are participating in cross- listings. Ammer et al. submits that information disclosure provides the primary influence on foreign cross-listing shareholding.[125] Thus, the better information environment is associated with the increased returns and the higher valuation of the cross-listed market.[126] One strand of literature suggests that more analyst coverage and more accurate earnings forecasts indicate an improved information environment.[127] Hence, it is observed that the analyst coverage hypothesis, which predicts that an increase in trading activity resulting from cross-listings induces entry of analysts.[128] Furthermore, cross-listings bring the cross-listed markets to the attention of more investors and lead to more analyst and media coverage.[129] Also, Ahearne et al. contend that cross-border listings mitigate the information barriers by stimulating local market media and analyst exposure in the foreign market.[130] Baker et al. points out that, cross-listings on the NYSE are associated with greater analyst coverage and heightened media attention.[131] Analysts can reasonably be viewed as financial watchdogs that should be at least as skilful as public regulators in uncovering financial chicanery, and hence a market that subjects itself to their scrutiny is arguably bonding its promise to make full and fair disclosure.[132] Similarly, a recent study finds that as foreign stocks cross-list in the United States, they obtain significantly increased coverage by securities analysts and, as an apparent result, forecasts of their future earnings become more accurate relative to forecasts of markets that do not cross-list.[133]

Furthermore, market value increases in direct response to increased analyst coverage. The improvements in a market’s information environment provides investors with more public information, allowing them to better evaluate the impact of firms’ investment decisions on future cash-flows.[134] Lang et al. show that the earnings forecasts of cross-listed capital markets are superior to those that do not cross-list.[135] This increase in information associated with cross-listings is helpful in making the capital market attractive to more potential buyers.[136] It is submitted that cross-listings is a vehicle to reduce information asymmetries between market insiders and outsiders through more disclosure.[137] Hence, it is clearly evident that countries participate in cross-listings because of the improved information environment associated with increased analyst and media coverage markets on capital market reactions to the cross-listing decisions.[138] This, in turn, may lead to lower cost of capital.

Even though, the evidence so far suggests a positive link between the information environment and cross-listing, the association is not clear-cut for various reasons. Sarkissian and Schill argue that overseas cross-listings reflect rather than reduce the information barriers that lead to investor home bias in international investment.[139] Rather, they observe that countries tend to cross-list in those foreign markets where the information barriers are already low; for instance countries that share large trade, cultural ties, and a similar industrial structure as their home market and are close geographically.[140] Again, it is contended that analyst activity is not a good proxy for private information trading because analysts are showcasing devices and do not possess significant private information.[141] Nevertheless, increased analyst coverage fosters the production of industry and market wide information and dampens market-specific return variation.[142]

2.4. HOW CROSS-LISTINGS CAN CONTRIBUTE TO A REGIONAL EXCHANGE IN SADC AS A LEAD-IN TO REGIONAL MARKET INTERGRATION

Capital market development literature proposes that cross-listing is important in fostering the regional markets integration of SADC’s national stock exchanges. Regional market integration refers to a market driven and institutionalised process that broadens and deepens financial links within a region.[143] Thus, cross-listing is a form of regional market integration scheme that is an important strategic and practical vehicle to help SADC’s national stock exchanges to integrate themselves into the world economy.[144] Mwenda highlights the importance of cross-listings by stating that SADC’s regional market integration could be achieved through cross-listings.[145] As a result, cross-listings will facilitate the development of more efficient and competitive capital markets in the SADC region. This will help to ease the liquidity problems of SADC’s national stock exchanges, especially the Lusaka, Swaziland and Mozambique stock exchanges.[146] Therefore, SADC’s regional market integration through regional cross-listings will facilitate cross-border equity investments by firms and operations between stock exchanges under existing market arrangements.[147]

It is important to note that regional integration of capital markets in the SADC region by cross-listings will allow savings to be pooled across the region; reduce costs and increase information sharing among members; diversification of risks; enhanced competition and innovation across financial institutions; wider choices of financial products provided to regional and foreign investors; and more integration into the global economy facilitated by increased attractiveness of markets.[148] Also, increased regional financial integration as a result of cross-listings enhances economic performance in the SADC region.[149] The regional financial integration of the national stock exchanges of southern Africa is vital because it bears strong implications for financial stability.[150] The establishment of regional market integration in the SADC region through cross-listing is significant, in that integrated markets would reduce costs, facilitate capacity building, and provide regional and international services and infrastructure.[151]

It is argued that cross-listed securities have always had a significant role in stock market development.[152] Hargis alludes to the role of cross-listing in development by stating that regional cross-listing has been shown to transform a segmented local equity market from equilibrium of low liquidity and market capitalisation to an integrated market with high liquidity and market capitalisation.[153] Many proponents of stock market development have argued that cross-listings can contribute positively to economic growth by increasing and improving the allocation of savings and investment.[154] Also, stock market development facilitates price discovery, price information content, and transmits signals to various stock holders in the market; which, in turn, facilitates decision making, thus allowing allocation of resources to their best use.[155] This is especially important in the SADC context whose economies before liberalisation were characterised by financial repression which inhibited price signals.[156]

The regional integration of stock exchanges in the SADC region through cross-listing is significant in that it is a means of overcoming the size and liquidity problems of existing exchanges, much more quickly than if these problems were to be overcome by the organic growth of national exchanges.[157] Thus, given the small, fragmented structure of SADC’s national financial markets, the most empiric importance of regional market integration in the SADC region is that it increases market size.[158] Moreover, it is a means of reducing the costs of investing in the SADC region for international investors.[159] Irving asserts that regional integration of the national stock exchanges in southern Africa through cross-listing offers a way of overcoming some of the impediments to development that most of them now face as relatively fledgling and illiquid exchanges.[160] For instance, with the exception of South Africa, the emerging stock markets in SADC are by far the smallest of any region in terms of the number of listed companies.[161] In 2012, 23 companies were trading in Botswana, 8 in Swaziland, 3 in Mozambique, and 13 in Malawi.[162] Hence, it is contended that only a SADC regional stock exchange can help to increase the assets and number of listed companies on a single SADC’s national stock exchange to a level compared to that of leading emerging markets in other parts of the world.[163] In addition, SADC’s regional financial integration will help small financial markets like Swaziland, Malawi, and Mozambique to take advantage of the systematic scale economies that accrue to larger systems.[164] SADC’s regional financial integration is important because it benefits countries by inducing foreign direct investment flows and enabling local financial institutions to grow into regional, continental, and, eventually, even globally players in financial markets.[165]

Another importance of cross-listing is that it helps to facilitate the integration of SADC’s national stock exchanges and the creation of a SADC regional stock exchange. It is argued that with a regional stock exchange, southern Africa will be able to participate in and to benefit from the growing international integration of stock markets.[166] Moreover, a regional stock exchange would be more conspicuous and would make it easier and faster for southern African funds to be floated on international markets.[167] Such a market, as opposed to several small individual national markets, would make the SADC‘s region stocks more accessible to foreign investors.[168] Cross-listings would help member exchanges of SADC to be competitive both in the region and on the international stage.[169] With heightened competition between national markets, these markets will be compelled to improve their operations. Therefore, cross-listing is an important step in creating a SADC regional stock exchange, given that regionalising the critical regulatory legal and accounting ancillary services may not necessarily be so easily achieved outside the framework of the more effective and deeper regional integration arrangements.[170]

2.5 CONCLUSION

From the foregoing discussion it is concluded that, the concept of cross-listings dates back to the nineties. It has been understood that it can bring greater efficiency, synergies, and economies of scale; attract foreign flow of funds; foster risk sharing and portfolio diversification; act as impetus to financial sector reforms, thereby broadening the competitiveness of international financial systems and minimising the risks of financial instability; facilitate capital market development; and lead to economic growth.

It is clear that domestic markets and firms participate in cross-listings due to the following reasons: to their expand investor base, to increase stock liquidity, to improve the terms on which they can raise capital, to increase the visibility of stock exchanges, and to achieve non-financial benefits such as increasing customer base by broadening product recognition amongst investors of the host country. The significance of cross-listing is that it is a form of regional market integration scheme that is an important strategic and practical vehicle to help SADC’s national stock exchanges to integrate themselves into the world economy.

CHAPTER THREE LESSONS FROM WEST AFRICA AND EAC

3.1 INTRODUCTION

Considering the various possible options of integrating stock markets, it will be interesting to look at the lessons that may be learnt from experiences in West Africa and EAC to advance the path towards a SADC regional stock exchange. Even if member countries of the SADC region chose a different itinerary, from that of these regions, it is a well-known fact that these stocks markets have a well-established practice in the field. Serious lessons can also be learnt on how to promote stock market integration in the SADC and to lay a solid foundation for the creation of the SADC regional stock exchange.

This chapter firstly outlines the requirements for a proper legal and regulatory framework for the regional integration of capital markets. Secondly, it elucidates the benefits and challenges of regional financial integration. The final part focuses on the lessons from other regions such as West Africa and the East African Community (EAC). Concluding remarks are given at the end to sum up important areas addressed by the whole chapter.

3.2.1 The Requirements for a Proper Legal and Regulatory Framework for the Regional Integration of Capital Markets

A sound legal and robust regulatory framework is critical for the competent functioning of a regional stock market. It acts as a bulwark against the backdrop of a financial or economic crisis, and provides clarity and confidence for market players and consumers alike.[171] The preconditions for a sound legal and robust regulatory framework for a regional stock market consists of: the harmonisation of legislation, such as bankruptcy, listing and accounting laws; the establishment of regional self-regulatory agencies and regulatory commissions; coordinated monetary arrangements; and harmonised reporting standards.[172] In particular, the tax treatment of investments must be harmonised, since tax policy is an important incentive or disincentive both for issuers and investors.[173] Moreover, effective regulation for cross- listings requires harmonising corporate governance standards, common standards for stock brokers, and national rules for capital gains, withholding taxes and transaction costs.[174] Therefore, the preconditions for the robust regulation of regional exchanges serve as the foundation for adequate access to sustained stock market development and stability.

3.2.2 Investment Code

A sound and robust regulatory framework for regional exchange requires the creation of a common investment code; such a code is fundamental to the efficient operation of securities trading and investment across borders within the SADC region.[175] This investment code, together with the municipal laws of SADC member states, can provide legal rules on securities regulation at the regional level.[176] In order to be effective, the common investment code would have to be adopted in member states’ national legislation, making it binding on all member states, and provisions of this code must take precedence over municipal laws of SADC member states.[177] Furthermore, an efficient legal and regulatory framework for regional exchanges requires the institution of a regional supervising authority, which might be either private or public, charged with responsibility for off-site analysis of adherence to prudential rules and regulations on a regional basis.[178] A regional supervising authority must be an independent, quasi-judicial regulatory agency with the responsibility for administering the SADC securities exchange laws.[179] The regional regulatory agency must be politically independent and not subject to political interference; such independence is vital for consumer and industry credibility.[180] Independence acts as an incentive to the regulator to adopt best practices of corporate governance and accountability.[181]

3.2.3 Supervisory Authority

The regional supervisory authority must be well-equipped with appropriate standards and regulations, as well as human capacity in order to establish its credibility.[182] Thus, the supervisory authority must be adequately resourced with skilled personnel in order to match the skills of those they are regulating.[183] Skilled personnel such as lawyers, accountants, financial analysts, and examiners, investigators, economists and other professionals must be employed by the supervisory authority.

[...]


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Title: The role of cross-listings in establishing a Southern African Development Community regional stock exchange