Issue 3, 2015. June-July



The Georgian stock market could be a powerful tool if used properly as the country seeks out ways to develop its capital markets. Finance writer Sally White sets the scene for a series of articles about the Georgian stock market and the role stock markets play in the region.

Sally White

Georgia is taking a radical look at its national money management. There is widening acceptance, following May's European Bank for Reconstruction & Development (EBRD) Tbilisi annual meeting, that Georgia needs deeper and more developed markets for capital. A new study, "the Georgian Capital Market - Diagnostic Study and Recommendations," written with the support of the Asian Development Bank (ADB) and USAID - has just been released by a working group comprised of the Ministry of the Economy, the Ministry of Finance, the National Bank, the Prime Minister's office and a former Chairman of the Securities Commission, who requested to remain anonymous.

A highly technical document, it nevertheless raises hopes that that local corporate access to risk capital and investors can be improved.

Challenges facing Georgia as the economy struggles include falling fund inflows:remittances from Georgians abroad in Russia and Ukraine are down, so is foreign investment, and export growth is threatened. Problems have also arisen as much capital provision from the Georgian banks has been in dollars - their strategy has been to fuel their cash requirements with dollars from international markets and to on-lend in dollars, too. With a weakening lari, this "dollarization" creates problems for their Georgian borrowers. Longer term solutions for capital provision in local currency are, say the EBRD, IMF et al., badly needed.

Proven international models are for longer-term local funding to be supplied via capital markets - through the sale of shares and short - and long-term bonds. On the supply side, these draw a wide range of investors internationally from institutions and individuals looking for gains and income. For the demand side, they provide a diversity of funds, including risk capital for companies of all sizes - not a popular business for banks.

The diagnostic document is bank-centric, reflecting the shape of Georgia's financial sector. However, it encompasses everything from the stock exchange itself to legislation, regulation, taxation, the banking sector, companies, funds, and government strategies and funding, with a glance at savings markets, pensions and insurance. This study will be discussed with all key stake-holders in a series of consultation over the summer.

The Background

"Georgia has become the regional champion in terms of reforms, economic development and progressing of democratic institutions" - the EBRD'S introduction for its Tbilisi-based annual conference in May voiced this familiar praise. Yet, in contrast to its robust banking sector, the stock exchange in Georgia, an engine for economic growth in other countries, has languished - neglected, with just a trickle of business and "on the brink of bankruptcy" (according to last year's Regulatory Impact Assessment from USAID). In neighboring Azerbaijan and Armenia, reported trading volumes and new issues far outpace those in Georgia, and the IFIs are boosting exchange business with public offerings.

For several years now, international financial institutions (IFIs) -including the World Bank (WB), IMF, ADBand the EBRD - have been commenting on Georgia's need to tackle its "undeveloped"capital markets. A capital market is a broad term that includes the stock market and other venues for trading shares, bonds and other financial products.

As the IMF commented last December in a Financial System Stability Assessment (FSSA) report on Georgia: "Capital markets are almost non-existent. ...[T]he government debt market is still relatively small. ...The development of the capital market has been dampened by the unwillingness of high-quality issuers to participate locally...Trade execution is carried out directly by the three share registries or via-off-exchange fixings, which undermines confidence..."

Georgia is like the European Union (EU) in having strong banks but weak capital markets. The EU is itself seeking to strengthen its capital market to "complement banks as a source of finance." With a priority of "jobs and growth" it is doing so, it says, to "overcome the obstacles which prevent businesses from reaching investors".

This is a view often stated in EBRD transition reports, but setting out its rationale the European Commission says in a Green Paper, Building a Capital Markets Union, published this February, that stronger capital markets would:

- unlock more investment for all companies, especially SMEs (micro-, small- and medium-sized enterprises), and for infrastructure projects;

- attract more investment to the EU from the rest of the world;

- make the financial system more stable by opening up a wider range of funding sources

- provide access to equity and impact on corporate governance

Change "EU" to "Georgia" and this text applies equally. For Georgia, the IMF says in its December SSFA, "SMEs development is an essential pillar of Georgia's development strategy," adding that "access to finance is among the main constraints to business growth."

The Georgian Stock Exchange, founded in 1999 with basic legislation, regulation and infrastructure already in place, held its own for a time. Yet recent years have been tough, indeed. This was not just because of the conflict with Russia and the local, then international, financial crises. Nor was it only because of the unwillingness of its tiny corporate sector of investors to use it. Of course, none of this helped.

Government strategies and actions and, as the IMF comments in that FSSA, the banking "authorities' skilful management," has enabled the banks (particularly two of them) to weather well the financial storms of recent years. But this has resulted in neglect of development of other capital markets and so now banks completely dominate the financial sector.

As the Georgian government's just-published document "Capital Market Diagnostic Study and Recommendations" points out, a "level playing field" has been lacking. Apart from the tax code, the legal and regulatory systems, lack of promotion, and lack of official support or links to international financial infrastructure (to name just a few) are all listed as needing to be addressed.

Plus, "several policy missteps (were) made in 2007." Then "a radical set of amendments were made" to the law which, although "couched in terms of liberalization," resulted in trade being allowed to move off the market. The current state of Georgia's stock market is largely "self-inflicted,"t he study says.

The USAID Regulatory Impact Report says the migration to OTC trading is contributing to structural deficiencies which "discourage potential Georgian or foreign investors ..."

In 2014, the Georgian stock market's trades totaled $28m. By the end of last year, only 1.82% of securities trading transactions were going through the stock market. Thus, a huge majority of trading was off-market, eroding protection for investors and diminishing the status and attraction of Georgia's stock market in the eyes of domestic and international investors.

As the USAID report of last September - Regulatory Impact Assessment: Georgian Law on Securities - comments, the state of the stock exchange "leaves the majority of local business with limited options for attracting additional capital."

It adds: "Commercial banks have almost fully assumed the role of capital providers for small and medium size business." Some of the largest companies who needed finance from capital markets have sought it through foreign stock exchanges.

Like all trading venues, stock markets need the support of high-spending customers if they are to stay in business. However, no one came to the rescue of the Georgian stock market. Not the Georgian corporates or the Georgian bankers (internationally banks prefer to be the provider-of-capital of choice). Not even the international organizations came to the rescue, even though they point to the Georgian stock market's lack of development. The IFIs have issued bonds totaling of GEL 205m in the last year or so, all avoiding the stock market.

However, there are many contrasts in the former Soviet space. Take Azerbaijan, described by the U.S. State Department in its Diplomacy in Action country briefing as also having an "undeveloped financial service sector — banking comprises more than 90% — which inhibits economic stability, growth and diversification." There the IFIs have been joined in government strategy to strengthen capital markets. As announced in the WB's Azerbaijan Partnership Program Snapshot of April 2015, it has a $13.6 million programme in progress to increase the use of equity and debt financing. Both the EBRD and the ADB have, according to Bloomberg, "actively" expressed interest in selling debt in manat.

A Trend News Agency report gave Baku's Stock Exchange trade last year as totalling $8.2bn, although that was down by 3.74% on 2013. Azerbaijani state securities' trade fell 41% to $4bn, but corporate securities' trade nearly tripled to $3.8bn. So, the Baku bond market has become extremely successful, even attracting oversubscriptions by investors when $4bn worth of applications were received for a new $1.25bn sovereign bond last year.

While the Baku Stock Exchange has seen 49 bond issues, it is just starting to develop shares trading. Once volume is sufficient, the exchange plans then to move on to developing equity derivatives. According to Pasha Bank in last September's issue of BNE Invest in Azerbaijan, "Azerbaijani companies are increasingly looking towardAzerbaijan's capital markets to raise funds on favourable terms."

In Romania, again working with government, the EBRD has taken a 4.9% stake in the Bucharest Stock Market (BVB) and EBRD's website states that, "As a shareholder, the Bank is working to establish the BVB as the preferred exchange for Romanian issuers and traders, as well as for investors with an appetite for Romanian stocks and other financial instruments." It has invested €75m in the $500m market-traded bond programme.

In Armenia, with another government seeking to develop its way out of having a bank-dominated financial sector, the Armenian Stock Exchange has become part of the major international NASDAQ OMX network of exchanges. In February last year, it listed the inaugural bond of the EBRD in Armenian dram. The EBRD bond follows the Armenian government's issue of its first Eurobond.In February this year, the exchange announced that it was launching an online trading platform for government bonds.

The Head of the Armenian Stock Exchange, Konstantin Saroyan, was quoted by the Armbanks financial-banking news portal as saying that the online platform would allow individuals, too, to participate in online trading. According to Saroyan,"it is very important for the exchanges that this plan succeeds."

He added: "It is no secret that many banks prefer off-exchange trade of government bonds, but NASDAQ OMX Armenia will try to prove that transactions with government bonds effected through the exchange are more profitable and more attractive." Last year, total Baku Stock Exchange total trade reached a record $5bn, according to Armenpress news agency.

Unaccustomed to being outperformed in this way by its neighbours, and short of funds to drive economic growth, Georgia is now making capital markets development a strategic priority.

Sally White has worked in capital markets for several decades, including for international banks, brokers, the media and as a consultant with the London Business School.