What Entrepreneurs Needs to Know in Preparation for an IPO

The Dar es Salaam Stock Exchange (DSE) has not had the Initial Public Offering (IPO) for quite some time. The DSE continue to have only 28 listed companies, six of which being companies cross-listed from other stock exchange, they are not domestic and did not raise capital in the local market prior to their listings. These were listed by introduction. And so, the question is: why do we have so few companies that have done IPOs and listed in the stock exchange? Why is it that the stock market has such a small percentage of companies? i.e., despite the fact that the DSE established the Enterprise Growth Market – EGM about six years to enable start-ups and small and medium enterprises (SMEs) to access capital from public markets for their growth and expansion. The EGM segment so far has six (6) listed entities.

Some of the entrepreneurs and business managers that we sometimes engage with indicates that the process of completing an IPO and listing into the stock exchange is tough, too long, expensive and complex. Most of them tend to cement their arguments by indicating that the sheer fact that the process involves many disciplines of accounting and financial reporting standards, capital markets and securities law, tax laws, etc means a small enterprise will struggle. They say the average entrepreneurs usually does not have expertise in all these areas. My advice has been — but you do not need to have all these competences and experiences to prepare and take your company public. The capital market regulator and the stock exchange has trained and licensed various categories of advisers and members for the purpose. Then comes another question– who is going to pay for these services? My response is — the entity raising capital will pay, however, most of these costs are not paid up-front, they get paid from the IPO proceed on success basis.

Therefore, it boils down not to the technical expertise or costs related to raising capital through IPO – rather the fundamental issue is there is no strong motive for raising capital by way of IPO. I also understand issues around transparency, disclosure requirements, family-owned businesses (and the emotions attached into it), tax liabilities, etc are some of the issues that run on top of entrepreneur’s mind as they contemplate the issue of going public. It however should be known that there are several benefits of considering raising sustainable capital by way of IPO vs the negative side – some of these benefits are: access to fairly priced long term source of capital, the potential for future capital raising from a diverse and wider investor base, a flexible capital repayments, the glamour and prestige and profiling of the company and its products, the positive sentiment to the company by its stakeholders – customers, suppliers, bankers, the government, etc.

And so, there are many sound reasons for going public. For instance, equity capital obtained from IPO is considered a permanent form of capital since there is no interest paid on equity, and this form of capital is not repayable like it is the case for debt financing. Therefore, from an entrepreneur point of view – funds generated by a public offering are considered to be relatively ‘safe’ form of capital for a business. It removes the entrepreneur from the pressure of periodical cash commitments, etc. This means capital obtained by way of IPO allows a company the freedom and flexibility to deploy and spend capital as it needs to finance growth and expansion of the company, while sitting on strong financial/capital base.

There are several cases where enterprises growth and development seems to be hindered by lack of capital, in some cases banks requires businesses to inject more equity capital into the business before they can provide more debt/loans. So, in a case where the business needs such capital in order to expand – it becomes a chicken and egg equation. In such cases, listed companies have advantages over unlisted companies – why? First of all, the company can utilize its investor base to obtain new equity capital (via rights shares issuance); second, if a bank needs more equity capital injection by the business as a condition for the bank to provide lending facilities to the company – such equity capital can efficiently be obtained via issuance of new shares to existing shareholders (rights shares issuance) whose base is wide and broad. This way the company have access to the capability to exploit opportunities while they are present – before the competitors (who are unlisted) can seize them.

Then there are many fiscal incentives that are provided to listed companies and its investors. There are tax incentives on corporate tax, withholding tax on dividends, no capital gain on transactions related to free float shares, no stamp duties, etc.

Having said the above, it is also true that in deciding whether going public is the right strategy for financing the company (or not), there are several issues to consider – i.e., there may be many legal considerations, etc. One among them is the consideration to convert the company from a private company to a public company in order to allow free transferability of shares. But, apart from legal concerned, probably the most important consideration is that the company should have an appeal to potential investors – this means that products and services produced by the company must be in relatively significant demand by consumers, customers and users. This way your company’s shares will have high demand from investors as it will indicate that there are potentials from upside growth, which will translate into good returns for investors.  

The other important fact that cannot be easily ignored is that your company will have to undergo some fundamental changes is preparation for going public. Matters of good corporate governance, the psychological change that is needed by both owners and employees — knowing that company’s management and directors shall henceforth have to answer questions from a diverse base of investors, some of them are sophisticated and pro-active; knowing that the company will be put under a microscope by investors, customers, competitors, the media, etc. 

Financing of Infrastructure Projects with Domestic Capital Markets

Improving infrastructure is not only critical for economic growth but essential for ensuring the improved wellbeing of the people. Easing and enhancing efficiency in which movement of goods, services, people, etc are conducted has significant impact in unlocking economic potentials. Empirical research shows that there is a strong link between infrastructure development and economic growth.

According to the African Development Bank (AfDB), road access in Africa is less than 35 percent, that just about 5 percent of agriculture in the Africa is under irrigation, that Africa’s average national electrification rate is about 45 percent, that the total electricity generated by Africa’s 54 countries (for its more than 1.2 billion people) is equivalent to electricity being produced and consumed by a single nation in Europe, such as Italy or France or the UK – but with about 60, 65 and 68 million people, respectively. There are also cases where the total electricity generated in an African nation, with 60 million people, is not enough to power a single airport in a developed country.

Will a continual dependence on foreign nations and/or financial institutions fill this funding gap for the infrastructure development? I guess, the answer will be no. We have been through this kind cycle and experience again and again. What Africa needs is to look into and develop its capital markets to facilitate mobilization of finances for its infrastructure development.

In these past few years, i.e., at least from 2015 today, our nation has been a good example (in my opinion) of how the capital markets could be used to mobilize domestic financial resources for strategic infrastructure projects – whether by issuance of Treasury bonds, or divesting part of the shareholding in a listed entity and placing the proceed on strategic investment projects or requiring payment of dividends to the Treasury to enable investment in such projects. On the Treasury bonds issuances and listing for example, the trend has been from TZS 595 billion in 2015 to TZS 1,225 billion in 2016, TZS 2,300 billion in 2017, TZS 1,895 billion in 2018 to TZS 2,395 billion in 2019 and TZS 3,500 billion in 2020, and a significant portion of these funds were directed to infrastructure project. Note that almost all of these funds a locally mobilized, as foreign investors are currently restricted to invest in such instruments (with the exception of East African). As a result, there has been also an increase of investor base (including retail investors) who invest to finance these projects, consequently a vibrant primary and secondary bonds markets, i.e., from turnover of TZS 305 billion in 2015 to more than TZS 2,100 billion in 2020.

What is the context? sourcing funds to finance a sizeable infrastructure project in Africa has always been fraught with difficulties. One major challenge is that the multilateral development finance institutions, which are dominated by the western developed countries, often impose stringent policy conditions to loans, and they are rightly so. But it also appears that the funding required to close the infrastructure gaps in a timely fashion is simply not easily in existence on these institutions’ balance sheets.

Another issue is that the major lenders, i.e., development banks, have historically been more active in financing social infrastructure such as health and education. Their approach to development in Africa has by and large been related to “poverty alleviation”. As it turns out, financing social infrastructure for poverty alleviation objectives isn’t the same as financing economic infrastructure which plays a critical role in spurring economic growth, which in this moment in time, has not been accorded serious attention in this region. While social infrastructure is important for economic development, however, economic infrastructure is even more urgent. Wealth creation and capital accumulation are facilitated more by investments in economic infrastructure.

The fact is the old approach of countries relying heavily on multilateral and development financial institutions to fund infrastructure has proved to be challenging. It is also incapable of closing the financing gap of such magnitude. In fact, neither the old nor the new institutions have the risk appetite for the kind of investments needed. If African countries continue to rely on these organizations and institutions, the pace for closing the infrastructure gap will be very slow.

The approach where geo-economic relationships are largely based on trade and investment as well as encouraging African countries towards looking inwardly for solutions related to financing our development, instead of the historical aid and assistance model, sounds like the better route to take. Furthermore, recent economic challenges in most nations have made traditional development finance institutions hesitate to provide resources for the significant but critical infrastructure investment required.

The truth is, our domestic markets are still relatively small, however needs to be developed slowly by introducing new infrastructure-based financial instruments by governments (i.e. infrastructure bonds, green bonds, retail-savings bonds, etc), municipals and local governments (municipal bonds), or even State-owned-entities and parastatals issuing bonds in local markets where both domestic and international players can access, then we can as well supplementing these efforts with pots to international markets issuances for Eurobonds or Diaspora bonds.

Traditionally, most African countries, have not consciously seen the capital markets as a critical source of finance for development. Yet raising debt financing in the capital market is one of the most potent sources of finance for rapid infrastructure development. This is because countries are able to raise funds for earmarked projects without policy conditionalities. And the cost of the funds, while relatively expensive compared with concessional loans from some International Institutions and multilateral sources, is often cheaper than loans from international banks.

It is on these bases, that countries have to be encouraged to pursue the development of domestic capital markets to raise funds for infrastructure projects. However, these funds should not be used to finance consumption or get misused and abused (like recent cases for some countries) but should be channeled directly into the financing of the much-needed economic infrastructure.

The railways, bridges, roads, canals etc in developed nations were largely financed with funds raised via issuance of bonds in the capital markets. This is because national budgets are often unable to support the required infrastructure expenditure. Country’s balance sheets in most cases lacks the fiscal space to accommodate the substantial financial outlays required for infrastructure development. That’s why nations should turn into tapping domestic market to raise finances for infrastructure development – that way also provide room for inclusive economic development, financial inclusion, etc.

Investing is shares — Understanding of sectors and companies

The need to carry research, analysis and/or investigation of the economy and sectors within the economy, when you are in the process of valuation of companies and shares one intends to invest into cannot be over emphasized. Such research and analysis, which then informs you whether you are about to pay the right price for a share you intend to buy, or not. In previous articles about similar topic, we indicated that one of the useful tools for analysing the outlook for an industry or sector is to use the Porter ‘five forces’ framework. We indicated that these forces identify the five underlying factors determining future profitability of the company you have invested into or are planning to invest into, these industry forces are:

  • Threat of new entrants
  • Threat of substitute products
  • Bargaining power of suppliers (buyers)
  • Rivalry among the existing competitors
  • Bargaining power of suppliers

Let’s look a little closer at the questions we need to ask when investigating an industry.

Suppose that you have to bet your entire nest egg on a football game. All you need to do is select a winning team. These are your choices: Young Africans, Simba, Azam, Biashara United, Tanzania Prison, KMC, Ruvu Shooting, or any of the 16 participating clubs in the Tanzania Premier League, probably the obvious choice for most of us would be either Yanga, or Simba, or Azam, given the odds.

Fortunately, this is where the comparison between football (or other) sports and investing in shares ends.

You don’t have to choose the absolute winner in investing in shares because there are lots of winning shares in second place, too. The basic point is that you can increase your odds of winning when you choose a winning industry or sector in the economy as part of your investment strategy. In the race to build wealth, all you need to do is to pick decent shares in a decent industry and do so on a long-term basis in a disciplined manner. Remember that investing in shares should be a long-term value investment as opposed to short-term speculative motives.

As mentioned above, a successful long-term investor (a value investor) looks at the sector just as carefully as he looks at the individual share of a listed company that s/he intends to invest in.

The important questions to ask yourself when you are choosing shares of a sector you intend to invest in, are:

  • Is the sector depicting the growing trend? – The saying “the trend is your friend” applies when choosing a sector in whose shares you intend to invest, as long as the trend is an upward one. If you look at three different shares that are equal in every significant way, but you find that share X is in a sector growing at 10 percent a year while the other two types of shares are in industries that have either little growth or are shrinking, which share would you choose? – Obviously the common wisdom, and other things being equal, will propel you to choose shares belonging to a growing sector.
  • Are the sector’s products or services in demand? – Look at the products and services that the sector provides. Do they look like items that the society will continue to want and demand for a foreseeable future? Are there any products and services that are on the horizon that could replace them? Does the sector face a danger of going out of fashion?
  • What does the sector’s growth rely on? – Does the sector rely on established historical trends, or on factors that are losing relevance?
  • Is this sector dependent on another sector? When one sector suffers, you may find it helpful to understand which sectors will subsequently suffer. The company or shares that you intend to invest into may be in the sectors that will be affected by side effects.
  • Who are the leading companies in the sector? – Once you have chosen the sector, you can choose from two basic companies, namely established leaders, which is a safe way to go or innovators, which have more potential.
  • Is the sector a target of government action? – Intervention by policy makers and politicians can have an impact on a sector’s economic situation.

Which category does the industry fall into? – Most sectors normally fall into two categories, namely cyclical category and defensive category. This translates into what the society wants and what it needs. Society buys what it needs in both good and bad times. It buys what it wants when times are good and holds off when times are bad.

Cyclical industries are those whose fortunes rise and fall with the economy’s rise and fall.

Defensive industries are those that produce goods and services that are needed no matter what’s happening in the economy i.e., food, housing, clothing, medical and health services, education, transportation, etc.

Once understood where the economy/market/sector is situated, based on the research and analysis — then comes the hard decision – which company’s shares should you buy from the stock exchange? Although every part of the investment decision-making process is important, this part is equally crucial and critical because it is your share-selection that will ultimately determine your investment performance relative to the rest of the market.

A very common question is, ‘how many different companies’ shares should I have in my portfolio?’ The answer is, ‘As many as you like’ – provided you have the capability to acquire them and are also capable of keeping track of all your shares by following on their corporate performance, corporate announcement i.e., dividend payments, appointment of people to fill in key positions in the company, rights issues, bonus issues, etc) market movement and other investors’ sentiment on the particular company.

Research indicates that if you own shares on only one or two listed companies, your portfolio is likely to experience a relatively high level of volatility (up and down share price movement) relative to the rest of the shares in the market. The volatility declines steadily, however, as the number of companies to which you hold shares increases. But be careful – if you spread your investments too widely, the performance of your portfolio will begin to simulate that of the market index, which you should be hoping to outperform.

Market Integrity and Good Governance: Trends and Changes within Exchanges

Market integrity is a cornerstone of fair and efficient markets, ensuring that participants enjoy equal access to markets, that price discovery and trading practices are fair, and that high standards of corporate governance are met. For this purpose, market integrity includes monitoring for market abuse and manipulative trading, fostering nondiscriminatory market access, price formation/transparency, strong disclosure standards, and investor protection. Stock exchanges play a pivotal role in supporting integrity: through overseeing listings, approving and supervising market participants, managing risk through settlement and custodian banks, reporting data, and enforcing rules as defined by regulators and by Stock exchanges themselves.

The 2007/8 global financial crisis prompted governments and regulators to develop and implement wide-ranging regulatory reforms. Throughout this period, Stock exchanges have demonstrated a high degree of resilience, reemphasizing their instrumental role in ensuring financial market effectiveness and systemic stability globally.

What has been the recent trend?

Regulators and Policymakers

In recent years, policymakers across the world have strengthened the regulatory framework with an emphasis on ensuring systemic stability and enhancing governance and good conduct in financial markets. Legislation has expanded the scope of instruments that must be transacted through stock exchanges, which are investing to meet this increased demand. The new regulatory demands span financial and non-financial risk management (including cyber risk): conduct of business, investor and data protection, prudential requirements, and fitness requirements for individual risk-takers and market participants.

The scope and complexity of these regulations has created an extraordinary challenge for stock exchanges, market participants, and regulators alike. Regulators broadly concur that ongoing dialogue between regulators, stock exchanges and market participants is desirable and that in some areas industry standards and codes of conduct may be preferable to a proliferation of legal rules.

Issuers

The appropriate supervision and oversight of the entities who use financial markets to raise capital and whose securities are publicly traded is a critical element of market integrity. For example, setting minimum listings standards and ensuring appropriate disclosure of information is integral to the protection of investors. However, the changing profile of issuers (including small- and medium-sized enterprises (SMEs) as well as state-owned enterprises) and how Stock exchanges are responding to ensure the continued preservation of market integrity is becoming vital.

(i) Small- and Medium-Sized Enterprises

Allowing companies to access external finance enables funding of new investments, innovation, economic growth and job creation. To accelerate economic and productivity growth, policymakers are looking to exchanges to address some of the funding gap for SMEs. This gap is partly the result of the regulatory constraints placed on bank-based intermediation imposed in the wake of the 2007/8 crisis. Many exchanges have responded by launching dedicated SME offerings aimed at reducing fixed regulatory costs associated with listing, while still ensuring appropriate levels of investor protection. At the end of 2020, among 70 WFE member exchanges, there were about 40 SME platforms, with over 7,000 listed companies and a combined market capitalization of US$1.5 trillion.

(ii) State-Owned Enterprises (SOEs)

The rapid growth of economies with state-directed developmental models has increased the relative influence of state actors in the global economy. State actors are consequently becoming more prominent participants in financial markets. While the listing of public equity in SOEs is not a new phenomenon, it has become more common. The Fortune Global 500 index of the largest listed companies by revenues included more than 100 state-owned enterprises in 2020, compared to about 30 in 2000. As SOEs raise capital or simply list on markets, exchanges and regulators seek to maintain rigorous standards of investor protection, while accounting for the idiosyncrasies of these institutions (such as golden-share voting rights for state owners, state-appointed directors, or politically determined objectives). About 45 percent of Exchanges indicate that they have tailored listing requirements for state-owned enterprises in their jurisdictions.

Investors

Facilitating orderly investor participation in markets, while maintaining a level playing field, are key elements of ensuring market integrity. Stock exchanges serve a diverse set of investors with differing priorities and requirements for disclosure, market access, and investor protection. As investor expectations and composition change, stock exchanges have responded through, for example, investing in education of retail investors, adjusting disclosure requirements to take cognizance of evolving investor needs, ensuring the fair dissemination of regulated news, and the design of technology underlying matching engines and best execution solutions. Increasingly prominent institutional investors have their focus on market structure considerations, the trend towards greater demand for environmental, social and governance (ESG) disclosures, and the preservation of market integrity in the context of cross-border investment.

(i) Institutional Investors and Market Structure Issues

Over the past 50 years, at least in more developed markets, ownership of public equity has become increasingly concentrated in the hands of institutional investors. One study estimates that as at 2020, institutional investors owned around 75% of the outstanding shares of the top 1000 US companies by market capitalization, compared with 80% retail holding in the 1970s. In accordance with their increased prominence, these investors are becoming more vocal about a range of market structure related issues and demands of stock exchanges. Given their size and importance, Exchanges and regulators must consider their views while still accommodating sometimes competing demands from other investor groups and market intermediaries.

(ii) Foreign Investment and the Role of the Exchange

Cross-border investment is an engine of economic development and a substantial source of capital in frontier and emerging markets. Cross-border investment and market participation brings benefits to markets in terms of enhanced liquidity and the development of the local buy-side and investment community; however, it also poses new considerations for market integrity (such as cross-border supervision, currency convertibility in trade settlement, and equitable treatment of foreign investors). Many frontier and emerging market governments have adopted economic strategies to encourage such foreign investment and look to their local exchange as a key partner in such intermediation. Stock exchanges have, for their part, introduced mechanisms and adjustments to market structure to facilitate foreign investment and market participation.

Enhancements to Corporate Governance and Disclosure

Investors, such as sovereign wealth funds, public-sector pension funds, global asset managers, millennial retail investors, are pushing for enhanced disclosure of financially material ESG information. These include climate risks, compensation practices, diversity and inclusion, labor relations, responsible sourcing, and supply-chain management. Furthermore, investors are starting to demand that large corporates articulate their stances on the diverse challenges facing society. These investor demands are expanding the conception of integrity in public markets.

Because exchanges are often responsible for determining disclosure requirements and monitoring compliance, they tend to be at the forefront of building consensus and setting standards. Exchanges have taken the lead by requiring enhanced disclosure in their listings requirements or through issuing ESG-disclosure guidance for listed issuers. Between 2015 and 2020, over 30 exchanges published ESG disclosure guidance for their listed issuers. Exchanges also provide ESG-related training and information services for their listed issuers.

SMEs Experience of IPO and Listing

The 2017 World Federation of Exchanges (WFE) research which sought to understand companies’ experience of being listed and how this experience compared with expectations at time of listing – had asked companies whether, given their experience and what they now know about being listed, would list again, or not. Nearly three-quarters of all surveyed companies indicated that they would. This positive feedback among listed companies holds into our own jurisdiction where majority of companies also shares their generally positive experience following their listing.

In the said research, companies were also asked to indicate whether their experience of being listed was better than, worse than, or in line with their pre-listing expectations across a range of factors. While there are significant differences across indicators and geographies, companies across jurisdictions consistently reported a better-than-expected listing experience for certain indicators. The areas where companies consistently reported a better-than-expected experience were: (i) Impact on visibility and reputation; (ii) Effect on financial performance/profitability; (iii) ability to raise capital from a diverse investor base; (iv) Corporate social responsibility.

On the other hand, a reasonable proportion of companies reported a less-than-expected experience across the following factors: (i) Time and costs of aligning financial record keeping and reporting with listings requirements; (ii) Level of liquidity of the stock; (iii) Volatility of the stock price; (iv) Time and costs associated with meeting ongoing listings requirements.

What keeps SMEs Away from Listing? Our own experience

In examining the motivations and experiences of listed firms, the DSE’s 5-years participated in the Top 100 Mid-Sized Companies survey (as a co-sponsor) where questionnaires sought to understand what prevented unlisted firms from using public equity markets were shares and responded into, on it more than a half of the surveyed unlisted firms said they had need for capital financing and may consider listing but so far decided not to list. For these firms, the reasons for their decision not to list for now varied considerably across. Some SMEs decided that listing was too costly while others felt that meeting the listing requirements would involve changing too many internal business processes. Some SMEs were particularly concerned with transparency and also about costs of maintaininga listing, even though this was also given as a reason for not listing. Based on these responses one would conclude that, lack of information about listing contributed to the thinking and decision-making process for many SMEs.

Among the unlisted firms that said they had not considered listing, the reasons similarly varied across. Several companies mentioned concerns about the need to comply with various regulations, transparency and disclosure requirements, reporting standards, and associated costs being the major reasons, while a few companies mentioned unwillingness to lose control of the company. In line with the response that companies felt they didn’t know enough about listing, about half of firms said they had never considered listing.

Interestingly, very few companies that either considered listing and decided against it, or who had not considered listing, gave the availability of alternative sources of funding as a reason for not listing. This finding seems to reinforce the existence of a funding gap and the need to continue focusing on finding viable funding options for capital-constrained SMEs.

Firms were also asked about their associations with being a listed company. Unlisted SMEs had relatively unfavourable views of what it means to be a listed company. However, based on what surveyed firms said they associate with being a listed company, some of these views may be based on misperceptions about the experience of being listed on a main board rather than an SME board. The views of unlisted SMEs seemed to be shaped more by the experience of firms listed on the main segment than by those listed on the SME/EGM segment. For example, some unlisted firms strongly associated being listed with greater shareholder pressure and loss of company control. Likewise, strong associations of listing with shareholder pressure and illiquid trading more closely align with the reported experiences of smaller firms on DSE’s main investment market. In all these cases, there may be an opportunity for the stock exchange to emphasize the experience of firms on the EGM to counter these views among the pool of SMEs the DSE targets for future listings.

On the positive side a large majority of surveyed unlisted SMEs have more favourable associations with being a publicly listed firm. More than half of surveyed SMEs thought listing would have a positive impact on their visibility and reputation. Related to this, three-quarters expected that listing would lead to greater public scrutiny. And over three-quarters of these firms expect that listing would enhance their financial access. This would suggest that the decision not to list is a function more of a lack of information than a negative perception about listing.

How could listing be made more accessible?

While acknowledging that one of the major factors for companies not to consider raising public capital and listing is the lack of information, that’s why the DSE is currently addressing this challenge by implementing the DSE Enterprise Acceleration Program (DEAP) , the program aiming at building institutional capacity for SMEs’ owners and managers so they can run their firms sustainably, cognizant to the fact that to be able to attract diverse forms of capital finance including bank finance, private capital and public capital finance requires 360-degree way of managing firms affairs.

The difficulty in simply extending the more traditional equity market solution to SMEs is that the nature of SMEs (given their smaller size and often fewer years in existence) means that the relative costs of listing and compliance (initial and ongoing) may be higher than they are for larger, more established companies. Their more limited institutional capacity also means the quality of their disclosure is likely to be lower than that of larger, more established firms. Finally, SMEs are also often intrinsically riskier than more established firms. Therefore, the challenge for the DSE is to find ways to reduce the cost burden without unduly compromising investor protection. The suggestion could be the need for addressing both direct and indirect costs of listing while also improving prospective firms’ understanding of what it means to be listed, including their ability to meet the listings requirements. But also raising awareness, building capacities and gaining experience of listing by DSE introducing the non-trading listing platform whose aim is enhancing SMEs visibility and profile while also enjoying the listing experience may be helpful.  

The case for SOEs in Africa’s capital markets development

Over the past thirty-or so-years, State-Owned-Entities (SOEs) have played a limited role in the development of many capital markets in the African economies. It is estimated that there are over 1,100 SOEs operating across the continent, but less than 50 of which are currently listed in the African exchanges. Hence, much as in most African countries, SOEs continue to play an important role in providing basic services such as electricity (generation, transmission, and distribution), water, telecommunications, banking, etc, but have thus far failed to promote development and vibrancy of capital markets.

Although many African countries implemented privatization programs during the late 1990s and early 2000s, over 90 percent of those divestments have been via trade sales to strategic and industrial investors. The lack of transparency in many of those divestments provided opportunity for corruption with many entry points, resulting in a series of corruption scandals, mismanaged of the key resources and creation of unnecessary unemployment. As it stands many people remain worried about the social impacts of SOE listings, as past listings have led to employment shedding without alternative opportunities being provided. Hence, not surprisingly, this has left large parts of the African political leaders, policy makers and the public at large with a rather skeptical view on potential divestments of SOEs.

One thing to note though is that, despite the discontent related with the way privatization were handled/mishandled, the fundamental reasons behind privatization and the accompanied efforts have not disappeared. Demand for infrastructure services is high and increased as population and peoples’ mobility increases — many of social and physical infrastructure to be provided by SOEs — remain high and continues to increase relentlessly; roads, railroads and telephone networks, water and energy plants as well as other infrastructure assets continue to decay as the performance of many SOEs remains weak while governments continue to exhaust state budgets in the capitalization and investments in SOEs. Across parts of Sub-Saharan Africa, SOEs account for a significant share of public sector balance sheets, with liabilities in some measures in some countries averaging 20 percent of GDP, and assets averaging 35 percent of GDP. Coupled with the usual inherent challenges, however in recent days, the challenges faced by these SOEs have been compounded by the COVID pandemic, which brought about a 5 percent downward revision in the 2020/21 growth outlook for Sub-Saharan Africa.

Thus, there remains few choices but to search for private investors participation in the financing of some SOEs, especially those with commercial objectives, via capital markets in a way making capital markets vibrant, achieving inclusive economic growth and economic empowerment should be encouraged. The important question that remains is how to best pursue those divestments, one of the highly recommended option is via IPOs and listings into Exchanges, but then it remains as to what role SOE listings can play as part of it.

Privatization/Corporatization of SOEs — Lessons from China

It could be by default or clever design. The strategy for capital market development (and its role in economic development) in China left strong evidence and an experience that could become as aspiration for many emerging, frontier and less developed markets.

It is about the calibration of capital markets so finely tuned and developed within the relatively short time. Stock market growth began picking up from the early 2000s when the world equity markets began to find feet from the recession, that was so severe, that analyst compared it to the 1970s. Buoyed by the domestic economic strength, growing investor base and rapid pace of portfolio funds flow in the economy, stock market in China showed sharp turnaround in valuations, strong surge till a brief pause towards 2008/09 and then resuming the pace in 2010 onwards until today.

China used the 2000s market surge to productively place a large number of Initial Public Offering (IPOs) through privatization/corporatization of the SOEs for the purpose of achieving more efficient, enhance governance, encourage growth of capital markets and democratization of finance and investments among its people. When the Chinese were doing this in early 2000, some of us took a similar path – privatization, only that it was different – the focus was less on the use IPOs, rather the Government agencies mandated to oversee privatization, focused more on private sales. As a result, only a handful of SOEs were conducted through IPOs, which was a missed the local economic empowerment opportunity and an opportunity to grow of local capital market.

The secondary market in China is borne out of strong primary market (the market for IPOs), unlike in our case where liquidity haven’t provided the thrust for further privatization IPOs and private sector capital raising.

Some of the cerebrated IPOs from China that amazed the global finance included: US$ 10 billion of China Construction Bank (2005), US$ 14 billion of Bank of China, (2006) US$ 22 billion of ICBC (2006), US$ 22 billion of Agricultural Bank of China (2010) and about US$ 25 billion of Alibaba (2014) to mention but a few. Some estimates put China at nearly 40 percent of total global new capital issuance in the past three decades.

Just like the recent development in African countries, i.e., stock exchanges established segments in their market to cater for start-ups and SMEs (for the DSE, it is the EGM), but more and different to the Chinese, i.e., the scope of diverse range of companies, two exchanges were instead established, the Shanghai Stock Exchange for the sizable and mature companies, and Shenzhen Stock Exchange was established to accommodate the listing of start-ups and SMEs. As opposed to the Chinese, for many African nations and for various reasons including the social-economic history and the pace of evolution — social set-ups, levels of enterprising spirit, the willingness to advance, the political posture and willingness, has left markets almost stagnant and SOEs struggling.

So, what’s the lesson? Much as I clearly understand that the comparison shouldn’t be this simple, but China used the capital markets for privatization of most big-ticket SOEs, most African countries didn’t. China used the stock market to enhance their citizens’ economic empowerment and inclusivity in their economic growth, we didn’t. China used the stock market to finance economic growth in the relatively inclusive manner, we didn’t.

Financial Literacy and why it matters

This is a continuation of the last week’s article, but today’s article aims at explaining why financial literacy matters, that challenges of financial literacy are far, wide, and global – not only for us – even though ours may be larger and with urgency for actions.

As it were, financial literacy is a key pillar for any financial inclusion framework, and a critical success factor for financial mobilization and in extension achieving not only the efforts to finance the socio-economic development intent, but also helping humanity achieving at least nine of the 17 United Nations Sustainable Development Goals (SDGs). For instance, it is being said — eliminating poverty and achieving gender equality is simply not possible when two thirds of adults worldwide remain financially illiterate and women continue to trail men in financial decision making.

But, when people make reference to ‘financial literacy’ what do they real mean. Financial literacy may mean different things to different people. However, Investopedia defines it as an understanding of various financial areas including managing personal finances, money, and investing—which covers a range of applications that can vary from bringing marginalized communities into the mainstream in low-income countries to removing gender disparities in affluent countries, and everything in between.

In 2014, Standard & Poor’s in partnership with Gallup World Poll set out to get a handle on these issues. They surveyed 150,000 respondents across 140 countries regarding their understanding of basic concepts of risk diversification, inflation, numeracy, and compound interest. Those answering three of four questions correctly were deemed to be financially literate.

The survey revealed that although the problem of financial illiteracy is universal, women, low-income individuals, and the less-educated suffer from greater disparities in financial knowledge. Country-level financial literacy rates range from 71 percent (across Scandinavia) to 14 percent (Afghanistan, Albania) of the adult population. Worldwide, 35 percent of men are considered financially literate while 30 percent of women are considered financially literate.

Tackling Financial Illiteracy: The truth is, the problem of financial illiteracy is solvable, and when overcome, it can unlock solutions to an array of social challenges by making access to finance more widely available. Strategies to raise financial literacy rates are simple and require relatively low and non-recurring investments.

The stakeholder system for imparting financial literacy on a global scale is vast and disparate, but still there are adequate resources as explained here below:

Funding: Financing for the effort is coming from both public and private sources. One of the earliest champions of financial literacy, U.K.’s Department for International Development (DFID), created the Financial Education Fund to promote financial literacy in several African countries. The World Bank’s Universal Financial Access Program has recently led efforts to enable universal financial access for all. Other such as the Mastercard Foundation, Bill and Melinda Gates Foundation, etc have also actively invested in this cause. At some specific local levels, there are recognizable efforts by public and private sector actors towards this front.

Regulation: From the legal/regulatory perspective many central banks are currently working to strengthen financial literacy. In Tanzania for instance the Bank of Tanzania (BOT) through Financial Consumer Protection Regulations requires fair and equitable treatment of consumers who take out loans and other financial services and the BOT has directed banks to ensure consumer protection and education programs are implement across bank branches country wide. This is partly the recognition that a customer will typically never know enough and therefore informed consent and service provider liability should be introduced at the point of transaction.

Technology: on technology there are a number of start-ups, consulting firms, and quasi-governmental organizations that have developed low-cost assets or solutions for financial literacy. For instance, the Bill and Melinda Gates Foundation in partnership with other institutions have created mobile podcast videos focused on teaching financial literacy. Here at home, DSE runs an annual edutainment program (DSE Scholar Investment Program) to train and educate students on matters of savings and investment from the practical aspect.

Measuring Impact:  Impact assessments for financial literacy interventions are rare, however outcome indicators are well established. The simplest of these include the rate of literacy and gaps in literacy rates in terms of age, gender, nationality, or income group. One can rely on these and other indicators to demonstrate rising levels of financial literacy. For example, impact is measurable based on the level of activity in newly opened bank accounts or investment account in the stock exchange or the off-take of financial products, etc.

Nevertheless, as financial literacy improves, we would expect to see account balances continue to rise along with banking and investment activity. One measure of financial literacy is the increase in the average number of financial and investment products in a household. Therefore, impact assessments should determine, for example, whether there is an increased off-take in credit or life, accident, and health insurance policies, or if there is an increase in the number of digital financial transactions or there is an increase in investment activities at the local stock exchange, etc.

The need for collaborative efforts: If we are to achieve further economic growth, there is a recognition that financing such growth requires that sources are diverse, innovative and largely internally mobilized. This being the case, such approach and achievement will be made possible with the support of increased financial literacy and improved education. For wholesale improvements in education, the public, private, and social sectors must continue to seek opportunities to collaborate. Without partnerships and a systems approach, this herculean task cannot be completed. Efforts from organizations like the World Bank and OECD, laudable as they are, have only scratched the surface of the challenge. Such initiatives require the local support from a larger number of financial services players collaborating with key stakeholders to create an ecosystem of alliances that also include innovators, nonprofits, social enterprises, incubators, educators, and skills development agencies.

Forging true partnership toward this goal demands a different mindset, one that requires courage and compromise. Partners must accept that private players will drive business value through their involvement. It is logical that banks and financial institutions invest in inclusive finance and financial education as it will only contribute to enhancing the market pie for financial services. This is a win-win outcome, and a key to unlocking solutions to our “finance for growth”.

Enhancing Financial Literacy for Economic Benefits

Lack of understanding on how financial markets works is one of the significant deterrents to participation in the financial markets and in particular the stock market and share ownership. Research show that lack of literacy prevents households from participating in the stock market. Research further indicates the welfare loss from non-participation in the stock market can be sizable. Thus, the role of financial literacy should not be under-estimated. And as more people within societies live into a system where they have to decide how much to save for retirement and how to invest their retirement wealth, it is important to consider ways to enhance their level of financial knowledge or to guide them in their financial decisions.

As it were, individuals are increasingly put in charge of their financial security after retirement. Moreover, the supply of complex financial products has increased considerably over the years. However, we still have little or no information about whether individuals have the financial knowledge and skills to navigate this new financial environment. On the other hand individuals have become increasingly active in financial markets, and market participation has been accompanied or even promoted by the advent of new financial products and services. However, some of these products are complex and difficult to grasp, especially for financially unsophisticated investors. At the same time, in many economies market liberalization and structural reforms in social security and pensions have caused an ongoing shift in decision power away from the government and employers toward private individuals. Thus, individuals have to assume more responsibility for their own financial well-being. 

Are individuals well-equipped to make financial decisions? Do they possess adequate financial literacy and knowledge? Existing research on this topic indicate that financial illiteracy is widespread, and individuals lack knowledge of even the most basic economic principles.

Some of the aspects for consideration as our society evolves includes asking ourselves questions such as what is the importance of financial literacy and what is its relation to the stock market development? Are financially knowledgeable individuals more likely to hold stocks? Is there a causality relationship between financial knowledge and investing in the stock market? The truth is that the lower the understanding of basic economic concepts related to economic growth (GDP), inflation and interest rate compounding outperforms the limited is the knowledge of investing in stocks, units and bonds, and what about the concept of risk diversification, on the working of financial markets?

Given what we know with regard to the limited knowledge about economics and finance among us, then it somehow says that financial literacy should not be taken for granted is we pursue domestic financial mobilization in the financing of our development. The truth is that majority of households possesses very limited financial literacy. Furthermore, given that financial literacy differs substantially depending on education, age and gender — this suggests that financial education programs are likely to be more effective when targeted to specific groups of the population. As such, privatization programs or policies and legislature actions for listing of companies from specific strategic sectors should take into account that, when put in charge of investing for their retirement, financially unsophisticated individuals may not invest in the stock market, not because they lack funds for investing in targeted companies but largely due to lack of the specific financial knowledge. Thus, to work effectively, privatization and strategic sectors’ listing programs need to be accompanied by well-designed financial education programs.

It is noted that the challenge of limited financial literacy is not only for us, but most financial literacy surveys also conducted worldwide show that a majority of the population in most nations do not have sufficient knowledge to understand even the basic financial products and the risks associated with the products. Thus, the majority of individuals may not adequately plan for their future and are likely to make ineffective decisions in managing their finances. The same is true for us where a significant proportion of the population has a very limited understanding of financial products and services. This is particularly the case among the rural poor but also across the relatively more affluent peri-urban and urban mass market.

As a result, efforts on improving financial literacy and educating consumers around financial products and services has become an essential means toward greater economic, social and financial inclusion as well as an important complement to market conduct and prudential regulation. For capital markets in particular, investor education is important to promote greater retail participation in the market on a sound basis – in other words the best protection for investors is education.

Again, for us, financial literacy, consumer education and investor education is in its early stage and programs for educating the public are conducted on a sectoral basis across the financial services sector. In most cases, within each sub-sector, whether banking, pensions, insurance or capital markets, these are done separately by the regulator, self-regulatory agencies, industry associations, and among individual firms. There are also external based efforts, mostly by non-profit, donor-funded, organisations which also provide financial literacy and education targeted at lower income groups. However, such pursuance are largely in silos and not coordinated.

That is to say though each of these initiatives is useful in its own right, a holistic and coordinated approach to financial education is needed to ensure consistent messaging and to educate consumers as to the benefits and risks of the full range of financial products on offer in market, including banking, insurance, retirement, capital market products as well as informal financial products.

At the same time, however, it is important to recognise that different strategies need to be applied to different groups of the population, owing to the heterogeneity of demand for financial services across the country, both demographically and geographically. By way of example, the content of financial education targeting the Tanzanians in the rural areas should differ significantly from the financial education provided for the urban retail mass market.

On Harnessing the Power of a Savings Culture

Learning how to manage money is an important life skill and getting the right balance between spending, saving and investing is fundamental for a better life and wellbeing.

It was somehow clear during the partial lockdown, where it was observed that a significant portion of the population could not manage to sustain themselves without daily income, and only a few were able to sustain themselves without it. This brings to the fore the whole aspects of the necessity of financial literacy especially the harnessing of the culture of saving in a society.

By the way savings is said to be one of the wise practices. For instance, the bible teaches that saving money is a wise practice for many different reasons.  Proverbs 6:6-8  says: Go to the ant, you sluggard; consider her ways, and be wise, it has no commander, no overseer or ruler, yet it stores its provisions in summer and gathers its food at harvest; and Proverbs 13:22 says: A good man leaves an inheritance to his children’s children. Without the discipline of saving, you cannot be able to have food or cater for health challenges during difficulties, nor would you able to leave inheritance to your children, let alone your children’s children.

Now, given that most of the households in Tanzania depends on their daily wages, striking the balance between savings and spending remains quite a challenge. In most cases families are left with minimal or no savings. Yes, according to the recent world bank report, Tanzania like most African countries’ savings rate is still relatively low, at around 30 percent of the gross domestic product. One may argue that this rate is better than many other countries, however for that argument to hold one needs to also consider the low level of our per capita income, the quantum is still relatively lower.

One way to promote a savings culture is through financial literacy. Financial literacy enables us to possess the set of skills and knowledge that allows us to make informed and effective decisions related to the management of our financial resources. Understanding basic financial concepts allows us as the people to know how to navigate in the financial system and financial markets. It is obvious that people with appropriate financial literacy training make better financial decisions and manage money better than those without such knowledge.

So, it calls for all stakeholders – from private and public sector – to continue to stress the importance of financial literacy and developing the savings culture among us. Specifically, for us who are in the financial markets, whether in the banking sub-sector or the capital markets, or pensions, or insurance to inculcate financial literacy among Tanzanians. This is not only important but also a matter of necessity because individuals and households lacking adequate access to affordable and convenient formal financial services may be severely constrained in participating fully in an inclusive economy, if they lack basic financial knowledge.

Furthermore, financial education can help individuals to understand the basic principles of money management, including how to plan and budget as well as how to manage their finances. They can learn how to build a personal saving plan, or create a personal portfolio investment plan – all to support short-, medium- and long-term savings and investment goals; whether for building a house, or funding children’s education, or to generate sustainable income during the period of retirement.

One may rightly ask: why is it crucial for people to save, while they have periodical sustainable sources of income, i.e. those employed and earns monthly salaries? The answer is simple, the matter of savings is never defined by whether you earn or the amount of you earn at this moment. It is actually a matter of principle, let go back to the wisdom from the spiritual and faith. The book of Proverbs 21:20 says – In the house of the wise are stores of choice of food and oil, but a foolish man devours all he has. Also Proverbs 13:11 tells us – Wealth [gotten] by vanity shall be diminished: but he who gathers money little by little makes it grow. So, educating oneself and pursuing the discipline of savings and investing for the future is where wisdom [towards financial freedom] begin.

But the matter of savings as it applies to individuals, it applies to nations as well. Any nation needs to create the saving culture and the saving-investment identity. This is necessary for the national income, because the amount saved in an economy will be the amount that can be directly invested or intermediated for investment in new physical machinery, new infrastructure, new inventories and the like; for, it is true than in an open economy private saving plus governmental saving plus foreign investment domestically equates into physical investment. In other words, the flow of investment must be financed by some combination of private domestic savings, government savings, and foreign savings – it is good to enhance domestic private and government savings.

Going back to personal finance – from overspending and financial setbacks to incurring massive debt and simply just not making enough money, it seems to me that there are always several huddles that one has to overcome. Therefore, cultivating the habit of savings is very important and can be helpful in many aspects of life. A good saver can set aside funds for business, a good saver is debt free and has already made a right as well as bold step towards financial freedom. A good saver can also reach certain goals that cannot be attained on the limited income that one gets.

Investors: On Business Ownership, Dividends and Capitalization of profits

Shareholders attitude towards management is largely determined by management’s demonstration of performance as far as company’s strategic, operational and financial performance is concern. Shareholders has the right to demand for clear and satisfying explanations when performance results appear less than what should be, and yes shareholders have the right to demand for improvement, or even consider the removal of underperforming management (via a Board of Directors) – if it comes to that. As it turns out, poor performance has an impact on the investors’ returns, share prices, valuations, wealth creation as well as sustainability of the company. However, as the process requires, with very few exceptions, that underperforming management are changed by action of shareholders during their Annual General Meeting (AGM). Good governance standards and practices requires that it is the responsibility of the Board of Director, who are also entrusted with such fiduciary duty, to place, replace or remove companies’ management, of course on behalf of shareholders.

Investors: dividends vs. capital build up

Dividend payments are dictated by the company dividend policy, normally a frequent subject of debate between the investing public, majority shareholders and company management. In general the investing public wants a more liberal dividend policy, while management (and sometimes strategic investors/majority shareholders) in most cases prefers conservative dividend policy which allows companies to keep the earnings in the business to strengthen the company by enabling availability of efficient financial resources for future growth and expansion. And so, in a way management asks shareholders to sacrifice their present interests, benefits and preferences for the good of the enterprise and for shareholders future long-term benefits. The basic argument being by paying smaller rather than liberal dividends the company can use the money for shareholders’ direct and immediate advantage by retaining the funds for profitable expansions and growth.

Nevertheless, on a sweeping through history and time, the attitude of investors towards dividends has been undergoing gradual but significant changes, for instance years ago it was typically a weak company that was forced to hold into its profits, instead of paying them in the form of dividends, and the effect was almost always adverse to the market price of those shares. But currently it is quite likely that strong and growing enterprises will be the one that deliberately keeps down its dividend payments.

There has been always a strong case for reinvesting profits in the business where such retentions could be counted on to produce increased earnings, relative to when investors will be paid dividends and investing by themselves in other companies or asset classes. But, even then there are strong counter-arguments, such as: profits belong to shareholders, and they are entitled to have them paid out within limits of prudent management; that many of the shareholders need their dividend income to live on, otherwise why invest?; that the earnings they receive as dividend are real money while those retained might not be materialized or show up later; etc – these arguments are in some cases very compelling that stock markets shows persistent bias in favor of liberal dividend policies (and payments) as against companies that paid either no dividends or relatively smaller ones.

In these past few decades, however, the profit reinvestment argument has been gaining ground, informed/intelligent investors have come to accept a low-dividend-pay-out policy, this is so much true that in many cases for profitable and growth companies low dividend payments or even absence of any dividend seems to have virtually no effect on market prices (but the key word is “profitable and growth companies”); i.e. the case will not be the same for loss making companies.

All being said, it is fair that shareholders should demand of their management’s either a normal payout of earnings – say two-third of the profits – or else demand a clear-cut demonstration that the reinvested profits would produce a satisfactory increase in their investment valuations, wealth enhancement or investment earnings are more than alternative investment options. In many cases a low payout is clearly the cause of an average market price that is below the company fair value, and here the shareholders have every right to inquire and probably complain.

Otherwise, it is also important to mention and for us to understand that sometimes a stingy dividend policy could be imposed on a company either because of its financial position particularly in cases where most of its earnings are used to pay debts (according to debt conventions) or bolster its working capital or in cases where the company is in the sector whose regulations requires that a certain level of earnings cannot be paid as dividends, i.e. in the case of banks where there are sometimes thresholds and need for regulator’s approval on dividend payments. When this is the case there is nothing much that shareholders can say about it – except perhaps to criticize the management for permitting the company to fall into such unsatisfactory financial position, or complain as to why regulators in some cases and in such sectors are less considerate, as far as investors interest are concern.