Creating global securities exchange - issues and challenges

Abstract

The report looks at the performance of the stock indices of the emerging countries over the past decade. We then discuss each of the stock exchanges in these countries, their performance viz the no. of listed companies, market capitalization and of course the risk and returns of the major stock index. We also try to understand the unique characteristics of each of these markets by comparing and contrasting the performance of these markets in the past five years. We then explain the stock returns across these markets by macro-economic factors. Simple linear models help us in determining how the stock market has reacted to changes in macro-economic scenario of the country. We find the stock markets across different countries to have different sensitivity to these factors. There is much stronger correlation between the stock returns and the country’s macro-economic variables in the relatively mature markets. Also GDP growth, exchange rate and mid term government bond yields are found to be the most important variables in forecasting stock returns. Next, we try to devise an efficient stock portfolio which would give the investor maximum return for a constant risk or minimum risk for constant returns. We also see the benefits to an investor by short-selling in some of the emerging market indices. For a constant risk of 10-15% we recommend the investor to invest in Brazil and Thailand. If she has the option to short-sell in other emerging markets then we recommend her to short-sell in Indian and Hong Kong markets to almost double her returns. For a constant return of 10% we recommend investment in Thailand, India and Hong Kong markets and for a constant return of 15% the investor should look towards Brazil and Thailand markets. However, if we allow short-selling then the market portfolio changes dramatically. In such a case one should invest mainly in Thailand and Hong Kong markets for an expected return of 10%, and in Thailand, Hong Kong and Brazil markets for an expected return of 15%, while short-selling in India and Korea in both the cases to reduce his overall risk of the portfolio. However, by investing in such a market portfolio the investor becomes exposed to risks like currency risk, counterparty risk and regulatory risk. We therefore explore the possibility of a stock exchange which can safeguard the needs of such a global investor. We look at two basic forms of institutions that can serve this purpose. First is by linking the existing stock exchanges issuing common securities akin to ADR/GDR that can be traded across all stock exchanges. It would lead to reduced membership fee and 24-hour trading facility for the investors. However, one would need to solve the complexities associated with different legal and accounting practices in all the countries to really harness the benefits of such a system. Second is by establishing a new entity itself akin to WTO, UN etc which can allow the investors to trade hassle-free in securities of different stock exchanges. This would lead to benefits for investors through reduced cost, liquidity and better price discovery; benefits for issuers through reduced listing fee and standardized reporting requirements and benefits to brokers through lower charges and reduced counterparty risk. However, one needs to look at regulatory issues, technological issues, welfare issues and settlement system to make such an entity successful. With the threat of alternate trading systems, more and more stock exchanges are looking towards merger and alliances to provide better service to their investors and establish themselves in the global scene. The Frankfurt-LSE failed merger and NYSE’s, NASDAQ’s global plans are the major events in this direction. With the proposed NYSE-Euronext merger, the landscape of stock exchanges would change drastically. The time has come when the stock exchanges have to hasten to re-establish themselves as the dominant force in the world of financial markets by exceeding the expectations of the investor community.