“The capital market must be expanded to take the economy forward“
Ch. Otgochuluu, Advisor to the President, shares with S. Bold-Erdene
his impressions of a recent visit to Germany to study the operation of
stock exchanges and of the legal environment regulating the capital
market. He also details the steps Mongolia must take to become a major
financial center in the region.
Where did you go and what are the first things you learned?
We visited Frankfurt, the banking and financial center of Germany.
The capital market plays a pivotal role in the economy everywhere. As we
saw in Mongolia, the country went into a recession when the banks
stopped issuing loans, as that was the only source of capital for most
major companies. The capital market has to be expanded to eliminate this
total dependence on the banking sector. The capital market works
through the stock exchange and the one cannot develop without the other.
Will the present plan to privatize the Mongolian Stock Exchange make it an integral part of the capital market?
Talk of privatizing the stock exchange has been around for many
years, but it became urgent following the announcement that 2010 would
be the year of business reforms. The connection is obvious. It seems,
however, that privatization will not be immediate. It is likely that a
foreign team will be asked to restructure the exchange and run it for
some time to put it on course and only then will it be privatized. There
could be other options as well. The inadequacies in the work of the
stock exchange now are not the fault or incompetence of its
administration or participants. It has to do with the uncertain
environment in which the stock exchange works, the severely restricted
capital market, the lack of experience and exposure among the staff and
the absence of proper state support and guidance.
What was the main objective of the visit of the mission to Germany?
The primary goal was to introduce Mongolian policy makers and
executors to the ways of the capital market in Germany, which has a
similar legal background as here, and offer them an insight into what
needs to be done here. The visit was sponsored by the GTZ and our team
included MPs, advisors to the President and the Parliament Speaker,
officials from the Ministry of Finance, the Government Secretariat, the
State Property Committee, the Financial Regulatory Agency, Mongol Bank,
the Stock Exchange and the National Development and Innovation
Committee. The second objective was to establish a working
relationship with the state organizations regulating the stock exchange.
Both objectives were well achieved.
What institutions did you visit?
The first place we went to was the Securities Institute, a private
organization that collects the views of business entities and offers
these to legislators. It also offers various advisory services to actors
in the capital market. For example, a lawyer working in the financial
regulatory agency may not know much about high finance and can seek the
help of the institute. Similarly it provides information to politicians
and the public and also do advocacy work on public issues. Then we
went to the stock exchange where shares and bonds of companies – large,
medium and small – are traded, on the floor in real time. We saw how
trading is conducted with countries in other time zones, like America
and Japan. We also studied its systems of internal monitoring and
network security.
How is the state involved in the operations of the stock exchange?
The Central Bank, the Ministry of Finance and affiliated
organizations regulate its operations to ensure that it does not deviate
from the fiscal and monetary policy, and also helps raise capital. We
watched a presentation from the Central Bank which showed how the bank
had once worked to develop the bond and dept market but gradually
realized that it could not do this alone. It started collaborating with
the private sector to better meet its needs. The stock exchange now
trades in bonds and has the full trust of the customers. Another
important organization we visited is similar to our Financial Regulatory
Agency. It controls and regulates activities of the stock exchange to
ensure that the rights and interests of shareholders and investors are
safeguarded.
Is the Frankfurt stock exchange private or public?
It has a special status of a state organization working for the
interests of the people, operating under license from the Ministry of
Finance of Hessen state in the federal republic. The license is in the
name of Deutsche Boerse LC or the German Stock Exchange. Hessen wants to
have Frankfurt as a major financial center, and Deutsche Boerse LC runs
the Frankfurt Stock Exchange according to stipulated requirements, and
is responsible for providing the technical capacity, human resources and
finances. The state has the authority to revoke the permit if it feels
its goal is not being met. Thus, it is neither public nor private but is
a combination of both. The State grants the stock exchange a license to
work, while the private sector, made up of profit-oriented business
entities, operates under that license. In Germany the state is not an
arbitrary controller. It has the final authority to see the system works
well, but business entities are deeply involved in framing policy. A
firm and clear regulatory system is in place, and this has helped German
stock exchanges overcome the recent crisis more easily than British and
American ones, which suffered huge losses. Actually, they are now
studying European standards and it is quite likely that the more
stringent German control system will be accepted as the model in the
world.
How does having an effective stock exchange benefit the state?
In many ways: It improves the financial capacity of the economy. More
capital flows into the market. Local and foreign investments increase.
All this creates more jobs for the people and increases state revenue
from taxes. For example, when the German Government issues bonds, it
raises money that is spent on projects of national importance. There has
to be a proper local capital market where such bonds can be offered. We
visited the German financial agency which issues bonds. Interestingly,
it is under the Finance Ministry, but operates like a private company.
How is this managed?
There is fierce competition among the Government and private banks
and companies, all of which issue bonds, so the agency must have the
same flexibility as its competitors. Better human resources can be
attracted to work for it only if the agency offers terms comparable to
those in private entities. The agency has a government guarantee and is
also responsible for managing foreign loans of the state. It employs
highly qualified professional people, is not subject to political
interference and its sole commitment is to implement the “fund raising”
policy of the state.
How are the bond proceeds spent?
I was not interested in finding out about that. Certainly they are
used to finance mega projects, in infrastructure or elsewhere. We also
visited the German Development Bank. It is 100% state owned, and has
many products such as long-term loans for students and small and medium
enterprises, export and import advances, etc. It promotes international
investment and works like a private bank, raising capital through
issuing bonds, which carry a state guarantee and pay a little more
interest than others. The bank is credited with the revival of many
small and medium enterprises after World War II.
How has the German capital market grown so powerful in a matter of 60 years after that war?
Everybody knows that the German economy was in a state of complete
collapse after the war. America supported Germany both by monetary and
non-monetary means, but the capital and bond markets were rebuilt by the
Germans themselves. Initially the state strove to develop the bond
market by itself but did not have much success. At that time, it was
like what we have in Mongolia now, with the state distributing cash to
people. When this did not prove effective, a national economic council
was set up jointly with the private sector to institute monetary
reforms. The Ministry of Finance, the Central Bank, and major companies
were included in it. They agreed that the interests of state and
private businesses were interlinked. If a private company issued bonds
and went bankrupt, that destroyed popular trust in bonds, whether state
or private. They decided to begin with a new schedule. The start of a
year will have people with some money to spend. The Government would
first sell bonds for 50 marks or 100 marks, followed by private
companies, then it will be the turn of the state again. Thus it will
alternate. The interest offered was high and the term was short, so
people preferred the bonds to saving in banks. The bond market grew
swiftly and bond sales funded a number of social projects.
What about shares being the main tool of a stock exchange?
We learnt that a “securities culture” movement was initiated to help
develop the securities market, with the state promoting the sale of
shares to the public. Today, Mongolian companies get almost all their
finance from banks. It was the same in Germany then. Now bank financing
has become less and more and more money is raised in the capital market.
In England and in the USA, companies meet 30-40% of their capital needs
from banks and the rest by selling shares. In Germany, it is the
opposite, with banks still the major source, though less than earlier.
Does this mean that the German example will be the model for our capital market?
Yes, indeed, but we shall have to adapt it to our special
circumstances and not copy it in to. The Mongolian legal system is based
on the European one, our financing structures are similar, with the
banks dominating the monetary and financial markets in both countries.
But many think other systems, followed in stock exchanges in
many other places like Hong Kong, Singapore, South Korea, Shanghai,
Japan, the US and England will be better?
Of course, it is good to study the strengths of many models, but
there are certain things to consider. Our present budgetary law is based
on the New Zealand model. That country follows the Anglo-American law
system. That may not be suitable here. Following the German experience
in developing the capital market makes more sense as we have the same
legal system. We shall be embarking on something new and it will better
if, instead of embracing a system based on practices totally foreign to
us, we take as our model, regulations followed in institutions in
Central Europe, systems where are more familiar to us. Some countries
have already expressed interest to cooperate with Mongolia in developing
the capital market sector.
What is Germany’s position?
Yes, Germany is ready to offer support. Our two countries have a long
history of cooperation. During the hard days of transition, Germany
supported Mongolia in developing the market economy and continues to do
so. Capital market development is an essential part of this.
International time difference is an important factor in stock exchange
operations. This problem will not be so acute if we choose to cooperate
with the Hong Kong or other Asian exchanges. Yes, the time difference
can affect concurrent trading in different stock exchanges. But
cooperation with Frankfurt will not stop Mongolian companies to be
listed in any other country’s stock exchange. The briefer time
difference will facilitate constant information flow with Hong Kong.
However, our local stock exchange has to be developed also for the sake
of our small Mongolian companies that do not require international
listing. IPOs of major companies in foreign markets are not the only
consideration.
How can this be done?
Once the stock exchange is suitably organized, the next task will be
to promote investing in shares and bonds to the public. This can be done
in many ways. Privatization of the stock exchange and improvement of
the market environment should be done simultaneously. We shall need
foreign support but we have to be careful about this, as any stock
exchange offering support will also want its own interests served. It
would want to increase its financial turnover by exploiting the interest
in the natural resources in Mongolia because that is how stock
exchanges make money. It is quite like a landlord trying to have as many
talents as possible. Our banking sector is growing. From 1,200 loans
totaling MNT 60 billion in 2000, we now have 535,000 borrowers who have
taken MNT 3 trillion. The capital market will have to grow at a similar
rapid pace. Our abundant natural resources await international
investors, but as I said before, the stock exchange should also help
small and medium enterprises raise capital domestically. At every level,
the stock exchange must make sure its operations are transparent and
respect and protect the small investor’s rights.
Where do we begin?
All that you say will need a lot of money, and a lot of a time. We
are yet to begin the mandatory trading on the Mongolian stock exchange
of 10% of equity of all companies mining strategic deposits in the
country, simply because the stock exchange cannot handle the load now.
Also, the legal status of our stock exchange is not satisfactory and
there are numerous other problems. We do not have people with the
expertise and skills to overhaul stock exchange operations and put them
in a proper framework, and also to devise comprehensive monitoring and
overseeing regulations. There should be no delay in announcing a bid for
a management consultancy who will do all this, leading finally to
privatization of the Mongolian stock exchange. The choice of the
successful bidder will depend on his capacity to meet many criteria. It
will not be enough to have functioning stock exchange; we must also have
one that will help develop the total macro environment.
Why should another stock exchange be interested in doing this for Mongolia?
They will. The Frankfurt and the Hong Kong stock exchanges have
already shown interest, and I think once the bid is announced, stock
exchanges in the US, Korea and Japan will also participate in it.
How will this give Mongolian companies the chance to offer shares on foreign stock exchanges?
International corporations working in the Mongolian mining sector
have raised billions of dollars in Toronto, London and Hong Kong. They
know all the ropes. Mongolian owners of companies do not have the
required professional expertise in this complicated exercise. Appointing
foreign consultants is a very expensive proposition. Some stock
exchanges also stipulate that a company has to be listed on a domestic
stock exchange first, and the capital raised there has to be offered as
collateral if it has to be listed there. Few Mongolian companies trade
on the domestic stock market. Let us first strengthen our own domestic
market, by helping small and medium companies raise money in it.
Is it likely that foreign investors, big or small, will come to the Mongolian stock exchange to trade in shares? Why not?
It is true our market is too small, but as our stock exchange expands
its capacity and scope, gradually at least some of the billions of
dollars circulating on the foreign stock exchanges will flow to
Mongolia. Wages will rise here, and qualified Mongolians will not have
to migrate. There will be many other advantages. With proper management
skills and a stable and satisfactory legal environment, Mongolia can
well become a major financial center, at least regionally. When it is
seen how much money a financial professional earns, Mongolians will know
which profession to choose and how to prepare for it. We have the
talent capability to do well, all we need is the impetus and incentive.
Mongolia has a tradition of politicizing any promising sector
and thus making it unprofitable in no time. Is there any way to avoid
this in capital market development?
As many professionals as possible should work here. The national
interest should be regarded as the top priority, and the task of putting
our natural resources into financial circulation should be kept as
distant as possible from politics. International stock exchanges work on
the same principle. Monitoring must be professional and official
appointments must always be on professional grounds, not political.
How will the distribution of cash from mineral revenues affect the capital market?
The capital market is not related to the mining sector alone. A
developed stock exchange will help promote domestic producers and
investors in other areas, too. People benefiting from the mining sector
will have to take up other investment opportunities and thus create a
new market. There is no growth if you are static. Citizens with money
must spend it in the financial market.
How can we create this culture?
Take the example of Erdenet Mining Corporation. Its ownership is
closed, e.g. the shares are not traded. Say the equity capital amount is
MNT 20 billion. Another mining company with a similar equity can raise
at least USD 3-4 billion on the stock exchange. One of our renowned
analyst estimates that Erdenet shares could make USD3 billion if sold
internationally. That would give USD1,000 to every Mongolian. There are
many other strategic deposits. The state owns 34% of the Oyu Tolgoi
deposit. According to the law, the state can distribute 10% of its
equity among the people. That offers a huge opportunity to develop the
capital market.
Mongolian Mining Journal, May 2010, № 005.