Last week, Financial Times Stock Exchange — FTSE Russell, a leading multi-asset global index, analytics and data provider published the results of its Annual Country Classification Review for countries monitored by its global equity and fixed income indexes. According to FTSE Russell’s Press Release dated 26th September 2019, Tanzania was upgraded from unclassified to Frontier Market status.
FTSE Russell went ahead to acknowledge Tanzania on meeting the requirements for attaining Frontier market status, congratulated us for market improvements implemented.
In this article, I would like to inform and help our stakeholders understand the impact of the reclassification (Upgrade) from “Unclassified” status to “Frontier Market” status of DSE/Tanzania Market.
To start with, this reclassification is a vote of confidence by FTSE that the capital markets of the Tanzania have made good progress.
But what does this all real mean?
Equity Markets Enhancement and International Standards
Earlier in January 2019 the Dar es Salaam Stock Exchange (DSE) achieved the Full Membership of the Word Federation of Exchanges (WFE) from being an Affiliate member for a two-year period. WFE being the global industry association for stock exchanges and clearing houses, headquartered in London. DSE’s graduation from an affiliate member to a full members was a measure of confidence by this global industry group which by itself was s follow up to efforts by the DSE to adhere into international set of standards and criteria, including: the recognized legal/regulatory framework; providing equal opportunity to market access by all types of investors; put in place efficiency mechanisms to admit and list securities and members in the Exchange; an adequate disclosures and market transparency tools; possessing an efficient securities trading, delivery and settlement infrastructures; good corporate governance framework and practices, independence of trading infrastructure and structures from that of settlements, these are among other factors.
And of course, there are other aspects of the market that are also scrutinized i.e. size of the market, rate of growth over time, types of listed instruments, market liquidity, size of investor base, number and quality of market participants – stockbrokers/dealers, custodian banks, settlement banks, etc.
Therefore, having achieved WFE membership, and other factors DSE was in a better position to achieve the Frontier Market status, admission and classifications criteria are relatively similar by both WFE and FTSE. FTSE Russell has 21 qualification criteria for its four-classifications ranging from: market and regulatory environment; to custody and settlement; into the dealing landscape; and lastly the state of derivatives markets. DSE met 11 out 21 criteria. In order to achieve a Developed Market status, one must meet all 21 criteria and for achieving Emerging Market status should pass at least 15 criteria.
Why Does Reclassification Matter?
The immediate expected benefit of reclassification will result from an anticipated increase in portfolio investment flows with the entry of foreign/global institutional investors and passive or index-tracking investors that will have to rebalance their portfolios to include Tanzania.
Typically, institutional investors are restricted to investing in developed, emerging and frontier markets, so the reclassification highlights the entry of a new class of investors into our domestic market, who previously were not there because DSE did not have visibility and profile to fit their investment criteria.
The increased exposure to international investment might also lead to an increase in initial public offerings (IPOs) – particularly if we all could see this as an opportunity, thus potentially leading to a much-needed deepening of the equity market in the country.
Improve Corporate Governance
The reclassification is likely to raise the bar in terms of corporate governance in the DSE. Foreign institutional investors will not be as complacent or inactive as domestic retail (and sometimes institution) investors.
Corporate governance rules need stronger enforcement and the timeliness and content of management and financial reporting needs a major overhaul to now include matters such as sustainability reporting and ESG (environmental, social and governance) reporting.
Reclassification is an opportunity for DSE listed companies to improve their corporate governance and investor relations in accordance with international standards, improve disclosure and transparency and comply with international reporting standards.
Build an Institutional Investor Base
Sound, well-functioning capital markets require a broad base of institutional investors to anchor markets. While this reclassification will attract foreign investors, they are not a substitute for domestic institutional investors such as pension funds and insurance companies, which typically operate as the backbone of a market. In recent days pension funds have remained dormant and passive in our domestic equity and debt market to the extent that only 4 per cent of their Assets Under Management is on listed shares, relative to their 20 percent benchmark.
As a country, we will need to consciously encourage and probably develop the regulatory framework that will facilitate building a domestic resilience on the backbone of our pension system and its assets as well as for the insurance sector. Why? Because, as it were – the role of both domestic institutional investors such as pension funds and that of Foreign Institutional Investors are simultaneously key to the success of the capital markets system. They both pump mobilized savings into the market, as they channel investments to the most rewarding sectors of the economy. But we need to understand that Foreign Institutional Investors trading behavior is so much influenced by the investment behavior of domestic institutional investors i.e. pension funds.
Currently, DSE’s market size, liquidity, price volatility and price discovery are heavily dependent on the flow of investment portfolio from foreign investors, meanwhile, the role of domestic pension funds in the market has been on a declining trend. So, much as this classification is envisaged to enhance the level of foreign investors participation in our market. However, in the medium to long run, as pension funds remain in other asset classes, foreign investors may also start staying away from the market, with significant impact in the market performance i.e. low demand for new issuances, and inactive local exchange.