Emerging and Frontier Markets: Market reforms enabling frictionless investor access
Hai Jade Fuan Head, Product Commercialisation, Financing & Securities Services
30 Aug 2023
Are the on-going reforms sufficient to drive investment flows into emerging markets?
Amidst the difficult return environment, investors are scoping out Emerging Markets (EMs) for much-needed alpha. By adopting structural and regulatory reforms, a number of the EMs in our network are trying to make it easier for global investors to participate in their local markets.
Will these changes be enough to attract more liquidity into EMs?
Opening up to investors
If liquidity is to flourish, it needs to be frictionless for investors to access EMs. This is something which many EMs are looking to enable by introducing market reforms.
Let’s take China, for example, which is continuing on its path of market liberalisation.
Earlier this year, we saw the introduction of northbound Swap Connect, which lets offshore investors access the country’s USD5 trillion interest rate swap market.
Swap Connect offers investors greater trading opportunities and better risk management facilities for their cash bond portfolios. Analysts are also bullish the reforms will help offset some of the outflows to hit China’s debt market, especially once the interest rate environment becomes more favourable.1
The volume of onshore swap trading activity already looks promising. Data released by the China Foreign Exchange Trade System, the interbank trading and FX division of China’s Central Bank, showed that RMB 8.3 billion of swaps were traded on the very first day that Swap Connect went live.2
Other markets, including Tanzania and several markets in the Middle East, are also opening their economies by easing foreign ownership restrictions, streamlining regulatory processes and enhancing investor protections.
We are seeing positive results here too.
Saudi Arabia, for instance, was upgraded to EM status by index providers MSCI and FTSE after implementing extensive market reforms (e.g. rolling out an independent custody model, adopting T+2, etc.), leading to sizeable foreign investor inflows.
Data from the Tadawul, Saudi Arabia’s Stock Exchange, shows that there were 3,151 registered Qualified Foreign Investors (QFIs) in the country at the end of 2022, an exponential rise from 2017 when there were just 117.
Throwing new investment tools and products into the mix
A number of EMs are widening the scope of investment tools and products available to outside investors, in order to further stimulate liquidity.
Having made margin financing and securities borrowing available to Qualified Foreign Institutional Investors (QFIIs) in 2020, the Beijing Stock Exchange (BSE), a listing venue primarily for local SMEs, launched its own margin finance and securities borrowing facilities in February 2023.
By enriching available investment strategies that support investors’ demands and facilitating market price discover, , we believe these measures will in turn encourage more investments and liquidity into the domestic SME segment. In the case of the BSE, turnover volumes have steadily risen over the course of 2023.3
With the global appetite for Islamic financial products on the rise too, EMs in the Middle East and parts of Asia (i.e. Saudi Arabia, Indonesia, Malaysia, etc.) are attempting to turn themselves into Islamic finance hubs.
In addition to Islamic bonds (Sukuks) and Shariah compliant investment products, we have also seen an increase in the number of Islamic loans, syndications and funds being launched, many of which have a strong environmental, social, governance (ESG) tilt.
As more markets develop their own dedicated Islamic stock exchanges too, we anticipate Islamic financial products will see further cash infusions.
This is echoed by research from S&P Global Ratings, which highlighted that the volume of Shariah compliant assets jumped by 9.4 per cent in 2022 to surpass the USD3 trillion mark, before adding that similar growth is expected for 2023/4.4
Improving Market Governance and Transparency
A number of EMs are developing frameworks aimed at removing some of the administrative obstacles facing foreign investors and improving transparency in their local markets.
India is a prime example here, having implemented changes to make client onboardings and account openings more straightforward.
The Securities and Exchange Board of India (SEBI), the country’s regulator, has done this by allowing Foreign Portfolio Investor (FPIs) registrations to be approved based on scanned copies of application forms and supporting documents, together with digital signatures.
Elsewhere, Indonesia introduced Law No. 4/2023 on Development and Strengthening of the Financial Sector, a wide-ranging piece of legislation aimed at improving the country’s domestic capital markets. Among the key changes here are new rules on share ownership reporting and a tightening up of insider trading laws.5
We believe this shift away from manual-based processing – together with the adoption of regulations encouraging greater openness – will make it easier for investors to access EMs.
Getting over the finish line….
Although many EMs are implementing meaningful structural reforms, it is clear that more work still needs to be done in certain regions.
Despite the deluge of Initial Public Offerings (IPOs) in the Middle East, accessing the region can still be a difficult process for investors.
The absence of harmonisation around NIN (national investor number) generation across the multiple Gulf Co-operation Council (GCC) markets is a lingering problem for intermediaries, as it makes it harder for them to support clients who want to invest in the region on a cross-border basis.
Although there is a lot of promise in Africa, the region too faces some fundamental challenges.
While several of the leading African economies have made extensive post-trade enhancements (i.e. delivery versus payment for settlements, permitting Central Bank money to be used in settlements, adoption of Swift, etc.) and eased market access (i.e. through the launch of the Africa Exchanges Linkage Project), flows are ultimately hamstrung by the lack of liquidity and depth in the underlying markets themselves.
Enabling change through engagement
Our clients want us to be engaged with the local market, educating local infrastructures, associations and regulators on best practices, and carrying out advocacy initiatives.
We actively coordinate with regulators and industry associations on behalf of institutional investors on ways to improve market access.
We have tirelessly advocated for EMs to make it easier for investors to enter their markets. Recent examples here include our engagement with regulators in India on digitalising the FPI registration process, while we continue to push GCC markets on the issue of NIN standardisation.
By collaborating with local market participants, we can help provide them with the solutions and workarounds, making it easier for our clients to access these markets, and ultimately obtain decent returns.
The objective of attracting more liquidity to EMs is multi-determined – the ongoing reforms are a necessary but admittedly small part of the broad range of interventions that will deliver the result. It is important for investors and intermediaries to maintain an engaged posture. This will ensure that changes do not introduce new headaches that detract from the competitiveness of EMs.
1 Financial Times – May 23, 2023 – China widens foreign access to swaps after $130bn bond sell-off
2 Financial Times – May 23, 2023 – China widens foreign access to swaps after $130bn bond sell-off
3 CEIC Data
4 The National News – July 21, 2023 – Global Islamic finance industry to grow 10% in 2023-2024 despite economic slowdown
5 Baker McKenzie – March 1, 2023 – Indonesia: Amendment of the Capital Markets Law – New post IPO compliance requirements
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