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Financial markets help corporation and governmental units to raise capital through the mobilization of public and private saving, in channeling those savings into productive and technological investments, and in showing the potential earning capacity of corporations.
Chapter 1 Introduction 1.1. Background Financial markets help corporation and governmental units to raise capital through the mobilization of public and private saving, in channeling those savings into productive and technological investments, and in showing the potential earning capacity of corporations. Financial markets are categorized in different ways, one of them is based on the maturity of financial claim traded. Under this way, financial markets encompass two components: capital market and money market. These markets cater to the financial requirements of the real sectors of the economy. The money market trades short-term debt instruments with maturity of one year or less. The capital markets, are those for longer-term debt instruments and stocks. A capital market can further be classified into non-securities and securities markets. The non-securities market provides non-negotiable medium and long-term debt through the involvement of development financial institutions (DFIs), banks, and contractual savings institutions that mobilize savings, later lending them directly to the users of these funds. The securities market provides medium and long-term equity and debt in negotiable from that are issued by government, companies, and corporations. The non-securities market in most developing countries, generally, is developed and well-organized. However, the securities market has lagged behind and developed rather late, even though in some developing countries, like Vietnam, it has not existed yet. Thus, this research study, therefore, emphasize on external and internal factors that influence establishing capital market, especially securities market in Vietnam. 1.2. Rationale Vietnam, now, needs huge capital from different resources for its industrialization and modernization stage. Besides, business environment in Vietnam has, recently, been changing fast. Along with opening the economy to the world, international relationship has improved. Government’s policies and regulations related to business operations also are being improved to facilitate doing business of enterprises and attract foreign investment. As result, many private companies and foreign companies in form of Joint-venture or full foreign owned enterprises have been set up in Vietnam. But now, Vietnam has encountered difficulties that how to raise capital for its industrializing and modernizing in generally, for expanding business operation of investment of domestic and foreign investors, especially. Due to the lack of development of a capital market is probably the most serious obstacle to a continued marketlization of Vietnamese economy. Vietnam’s present financial system is poorly equipped to meet these challenges. It is almost entirely credit-based, with the state banks playing the major role. The post-1989 Vietnamese market economy has shown, like others, that resources are created by the process of expansion of markets and rise in business confidence. Also, the drastic increase in mobilization issues may partly reflect the erosion of social safety nets that has taken place in recent years. Therefore, with a view to attract foreign investors and 36 mobilize saving efficiently, the government of Vietnam has taken few bold steps in making law relating to establishment of capital market in coming years. 1.3. Objectives Securities market is quite a new issue in Vietnamese business environment. For Vietnamese businessmen, they still have not an insight into the market mechanism. In order to provide them an overview of this market, the main objectives of the study is to explore legal issues, legislative framework and analyze advantages and disadvantages in carrying out securities market. Several specific objectives are as follows: • Assess the fundamental concepts, terminology about stock markets and investment as they relate to Vietnam; • To determine the well known of the market and the constraints to development; • To determine the impact of the banks’ role in the embryonic stage of sock market; • To determine from potential investors and listed companies what they expect; • To determine the organizational structure of this market; • To look into the future prospects of the markets and give recommendations. 1.4. Scope of the study This study is focused on analysis of obstacles that result from capital market which has not been established yet. It also analyzes opportunities and advantages in establishing and operating of this market. The study will concentrate on following areas: • Investment entities and participants in the market; • The regulatory and institutional framework; • The role of the stock market and the condition necessary for business operations in Vietnam; • The role of banks in embryonic stage; • Introduce the fundamental structure and the stages of the securities market development. 1.5. Research methodology 1.5.1. Information requirement In order to conduct the research, the following information are needed: • Socio-economic conditions analysis of investments, savings, and income. • Infrastructure in terms of banking system and information system. • Laws and regulations to guide participants in the market. • Changing financial system. • Policies that encourage foreign investors in the market. • Major players identification. • Investors’ attitude toward the market. 37 • The instruments which will be traded in the initial period. • Organizations which can help to establish stock market in term of equipment, training, an insight market mechanism. • The companies which have privatized and issued shares within corporation. • The organizational structure of the market. 1.5.2. Collection of data * Secondary data General information were collected from published materials. These materials were obtained from various sources such as Statistical Bureau of Vietnam, State Bank of Vietnam and Ministry of Finance. Apart from the mentioned sources, secondary data were collected from published information in both Vietnamese and English which were taken from Libraries, State Departments and Research Institutions. * Primary data Along with the secondary data, primary resources are also required. To obtain the primary data, interviews, and surveys were conducted. Guidelines were designed for conducting interviews with managers and officials working in the State Bank of Vietnam, Ministry of Finance. Besides, four State-owned Commercial Banks, nine banks (including foreign banks and branches of foreign banks), ten Jointstock Banks, forty investors (in which twenty domestic investors and twenty foreign investors) were selected for purpose of the research. Interviews and discussions with the managers in selected interviewees were conducted to get their opinions on the securities market. 38 1.5.3. Framework of study 39 Research objectives Research objectives External factors influencing establishment of Securities Market External factors influencing establishment of Securities Market Internal factors in Securities Market Internal factors in Securities Market Data Collections Data Collections Concepts, Literature on Securities Market Concepts, Literature on Securities Market Conclusions and Recommendations Conclusions and Recommendations Figure 1.1: Research Framework Chapter 2 Literature Review 2.1. Definitions 2.1.1. Capital markets There are various definitions on capital markets. According to Kidwell [1984], financial markets can be classified on the basis of maturity of the financial claims that are traded. Therefore, in this context, money markets trade in short-term debt instruments having maturity of one year or less. Capital markets, on the other hand, describes the market that deals with any long-term debt instrument or equity obligations having maturity greater than one year. Kitchen [1986] has used the term “capital market” to include both securities market and the money market. According to him securities market is the market dealing with government bonds and debt and equity issued by corporations. Another researcher, Robbins, makes no distinction between the securities and non-securities market and from the understanding of his definition, capital market is the securities market. M.B.Abbasi [1994] define capital market is as a set of institutions, processes and individuals which facilitate the flow of society’s saving into productive investments. Wijewardene [1993] also divides financial markets into the money market and the capital market. The former deals with maturity of one year or less, while the later consists of transactions with maturity of more than one year. In the capital market, he detailedly divides into medium- and long-term, transactions with maturity between one and five years are medium term, while those with maturity of more than five years fall into long-term. The capital market can therefore be divided into submarkets: • Loan market or the no-securities market, where the money is made available to the users in the form of loan from financial intermediaries without creating a tradable security in the process. • Securities market, where money is acquired by the users by selling debt or equity instruments to savers which may be tradable or non-tradable in the market. According to view of Asian Development Bank (ADB), capital market as typically defined include the portion of the financial system that provide medium- and long-term funds for creating fixed assets (such as plant and machinery) used in the production of other goods. In contrast, money markets provides short-term finance generally for working capital needs on a loan basis for period of less than one year. Thus, money markets provide shot-term funds for meeting fluctuating needs and must be paid relatively quick, and capital markets provide long-term funds which can be used to make “capital investments”. For the purpose of this research study, the definition given by the ADB will be used is clear and precise. 2.1.2. Efficient capital market 40 The purpose of capital market is to transfer funds between lenders (savers) and borrowers (producers) efficiently. In an efficient capital market, prices fully and instantaneously reflect all available relevant information. This means that when assets are traded, prices are accurate signals for capital allocation. Drake, P.S [1977] has done a great deal to operationalize the notion of capital market efficiency. He defines three types of efficiency, each of which is based on a different notion of exactly what type of information is understood to be relevant in the phrase “all prices fully reflect all relevant information”. 1. Weak-form efficiency: no investor can earn excess returns by developing trading rules based on historical price or return information. In other words, the information in past prices or returns is not useful or relevant in achieving excess returns. 2. Semistrong-form efficiency: no investor can earn returns form trading rules based on any publicly available information. 3. Strong-form efficiency: no investor can earn returns using any information whether publicly available or not. Allen, M [1991] has extended the definition of market efficiency. The market is said to be efficient with regard to an information event if the information causes no portfolio changes. The definition requires not only that there be no price change but also that there be no transactions. 2.2. Structure capital market According to ADB, the capital market consists of two segments: the non-securities markets and the securities market. The non-securities markets provide non-negotiable medium- and long-term debt funds through financial institutions such as development finance institutions, commercial banks, and contractual savings institutions which mobilize savings and then lend these mobilized funds directly to business, industry, and users of funds. Securities markets provide medium- and long-term equity and debt funds in negotiable form which are issued by corporations and governments, or through financial institutions such as investment or merchant banks and venture capital firms, directly to individual and institutional investors are then traded among different holders. Thus , investors in the securities markets can sell their securities whenever they need funds, through equities they can participate in the financial risk of the enterprise. 41 Table 2.1: Organization of capital market [1] Non-securities markets Securities markets Instruments Loans Mortgages Leases Sales and lease-back Equity (shares and stocks) Equity equivalents (convertible bonds or debentures) Debt securities (bonds or debentures) Primary market Secondary market Institutions Development banks Specialized banks Commercial banks Saving banks Insurance companies Pension and employee Provident funds Leasing companies Corporate government issuers Investment, merchant banks Brokers, dealers Securities regulatory bodies Debenture trustees Venture capital firms Over the counter markets Stock exchanges Brokers, dealers Clearance and settlement agencies Transfer agents and mutual funds Generally, the institutions and individuals that constitute the capital market may be divided into two categories: 1. Participants: who are the ultimate savers and users of capital, as well as the financial institutions and intermediaries that channel capital from savers to users. 2. Supporting and supervisory entities: Which are typically government bodies that facilities and regulate the activities of the participants. The main features of capital market are three fold: • Collection and provision of capital for real investment, i.e. to fulfill the investment needs of the company. • Provide an opportunities to gain higher return through financial investment for investors, i.e. provide a medium of investment. • Provide higher liquidity, i.e. readily encashable and transactable investment instruments for investors in the market. 2.3. Significance of capital market 2.3.1. Economic development and capital market * Demand-following approach: The role of financial markets, largely comprising of the capital market, in economic development has been an area of increasing interest for development economics. This sector was initially through of as playing more or less a passive role in economic development - “where enterprise leads finance follows”. The view that growth in the financial sector is an outcome of the development in the real sector has been explained that this approach places emphasis the demand side for financial services; as the economy grows it generates additional and new demands for these services, which bring about a supply response in the growth of the financial system. In this view, the lack of financial 42 institutions in undeveloped countries is simply an indication of the lack of demand for their services. The more rapid the growth rate of real national income, the greater will be the demand by enterprises for external funds and therefore financial intermediation, since under most circumstances firms will be less able to finance expansion from internally generated depreciation allowances and retained profits. The financial system can thus support and sustain the leading sectors in the process of growth. The nature of the pace of growth of financial sector depends on factors such as growth rate real output and the commercialization and monetization of agriculture and other subsistence sectors. The demand-following-supply response of the growing financial system is presumed to come about more or less automatically i.e. the supply of entrepreneurs is highly elastic and no constraint on the provision of favorable legal, institutional and economic environment is envisaged. * Supply-leading approach: This approach suggests the creation of financial institutions and the supply of their assets, liabilities and other financial services in advance of the demand for them, especially the demand of entrepreneurs in the modern growth - inducing sectors. The supply-leading strategy has to simultaneously deal with the issue of transferring resources from traditional sectors to modern sectors, and to promote and stimulate an entrepreneurial response in these modern sectors. This strategy is considered to be most suited to the countries where entrepreneuship is a major constraint on development. In the process the top management of the financial institutions may ply the role of entrepreneurs in industrial enterprises. The supply-leading strategy is more effective during the initial phases of development and induces growth in the real sector by financial means. The more backward the economy relative to others, the greater the emphasis on the strategy of supply-leading finance. The use of this strategy, however, should ensure that the use of resources, especially entrepreneurial talents and managerial skills, and the costs of implicit or explicit subsidies should produce sufficient benefits in the form of stimulating real economic development for this approach to be justified. Irrespective of which of the two strategies is practiced, the thrust of recent times is focus on financial liberalization and encouragement of efficient markets through financial deepening and elimination of fragmentation of markets to improve the process of mobilization of financialial markets pdf' title='the basics of finance an introduction to financial markets pdf'>of efficient markets through financial deepening and elimination of fragmentation of markets to improve the process of mobilization of financial savings as well as the efficiency of investment. This would help eliminate the conditions of what M.B. Abbasi [1994] calls “financial repression” resulting from credit rationing, subsidized credit and other factors responsible for distortions in the financial markets. 2.3.2. Mobilization of savings Mobilization of domestic savings - private and public is one of the three essential steps involved in the process of capital formation; the two other steps being the channeling of savings through a finance and credit mechanism and the act of investment itself. In Vietnam, the level of domestic savings is still low. Sustained high growth rates will be critically dependent on a significant increase in the level of domestic savings, both from the public and the private sector. The savings rate is projected to increase from 17.0 to over 20.0 percent of GDP during the projection period. 43 The government is expected to contribute significantly to this increase with its own savings; its efforts have already produced encouraging results in 1994. The scope for further increase in public savings through increase in revenues may be limited in the future since the share of revenue in GDP is already large. Further public savings will need to come from expenditure restraints which can only be implemented through careful setting of priorities in public spending. Progress in the mobilization of savings will however depend on the maintenance of a stable macroeconomic environment and the development of an appropriate incentive regime for investment - including the strengthening of the legal framework, the financial system, and the framework for the trade and investment. 2.3.3. Determinants of savings * Financial repression: One of the major impediments to saving in developing countries, according to M.B. Abbasi [1994], is the persistence of financial repression in these economies. The intensity of financial repression in an economy is measured by the existence of negative real rates of interest. The role of various factors leading to financial repression can be judged from their contribution to widening the gap between real and normal interest rates while interacting with ongoing inflation. The factors that contribute to financial repression include taxation, usual restrictions on interest rates, heavy reserve requirements on bank deposits, compulsory credit allocations etc. as they reduce the attractiveness of investment in financial assets and holding claims on the domestic banking system. * Income: Income, occupies the central place in determination of savings in the economy. The amount of savings is determined by the absolute level of income as well as the proportions of income saved out of each additional unit of income i.e., the marginal propensity to save (MPS). The MPS should, according to the theory, increase with the increase in income over time and across various income sections in the economy. * Interest rates: The rates of interest is a major determinant of the demand of money whereas the saving rate is only indirectly affected. A rise in the rate of interest reduces the level of investment which result in the fall of the level of income and hence savings in the economy. This indirect interaction implies a negative relationship between these two variables. * Taxation: Most studies of the effects of taxation on saving show that government savings increase with increased revenue taxation. However, several other studies [Please, S., 1970] indicate that the increase in government savings is more than offset by a decrease in the rate of private saving, while studies by Landan .L.[1980] found the reserve to be the case. * Foreign aid: Studies conducted on the impact of foreign aid on savings have found that foreign capital is a substitute for domestic savings. In other words, an increase in foreign aid usually result in a decline in domestic savings or more accurately a part of the capital inflow finances increased consumption. * Export: Several studies have shown a positive relationship between savings and exports. However, it is not clear whether this implies that the export sector has a higher propensity to save than other sectors, or if it is the growth engendered by exports which is responsible for the higher savings rates. 2.3.4. The role of financial intermediaries 44 Financial intermediaries are defined as the “economic units whose principal function is managing financial assets of other economic units - business concerns and individuals. Thus they bring savers and borrowers together by selling securities to savers from money and lending that money to borrowers” [Benton E. Gup, 1976]. UNIDO [21], has stressed the essential role that financial institutions have to play as intermediaries and promoters of industrialization process. The following statements support this claim. • Financial institutions in less developed countries have to play an important role in the process of economic development and they should be properly organized and oriented towards the specific objectives they are expected to fulfill [Zolates, Xenophan, 1963]. • In order to ensure efficient and rational mobilization of savings and channeling of these funds for the financing of the investment programs consistent with the development objectives, financial institutions play a very important role, because they act as intermediaries between surplus and deficit sectors in the country [Kivanc, Tarik, 1984]. • Economic development of any country depend on the contribution to growth of the financial sector [World Bank, 1985]. Edwards [1987], has listed characteristics of successful economies and all successful cases of economic resurgence which highlight the importance of finance and financial institutions in industrial investment. They are: 1) Political acceptance of the importance of industry in the national economy; 2) The political will to act to create favorable financial circumstances and appropriate institutions to help industry flourish; 3) An organization which acts as a financial ombudsman which, from a deep knowledge of the circumstances of a particular industrial situation, can approve a company’s investment plans (and frequently improving them in the process); 4) A financial system committed to the national success of its manufacturing industries; 5) Relatively cheap long-term loans for industry from the financial system; 6) The absence of any nonsensical theories about the ‘proper relation’ of debt to equity; and 7) A co-operative and practical approach by government, industry and banks to solve the national economic problem. It is widely recognized that during prosperous economic times there is always a rapid increase in overall indebtedness, and during economic recessions there is always a slowdown in the rate of growth of outstanding debt. The implication for financial intermediation is that the greater the amount of spending financed externally through debt on equity issues, the greater will be the role played by financial institutions. The term of financial institutions can be applied as the central bank (State bank of Vietnam), commercial banks, investment and development banks, finance companies, insurance corporation. 2.4. What is the securities market 2.4.1. Concept of securities market 45 [...]... markets can provide an opportunity for dishonest activity, such as conflict of interest, market rigging insider dealing, issuing false or misleading prospectus, pushing and selling overpriced or worthless stock ◊ Although stock markets may allocate funds to the activities which are expected to show the greatest financial profit, may not be the most profitable from a national point of view because markets. .. lowered * Bankers: The formal banking system now serves only a small proportion of the population and there is substantial reliance on informal markets A securities market would strengthen financial intermediation significantly by making available a variety of financial assets, such as bonds and shares, with attractive yields and opportunities for capital gain There are clearly certain immediate benefits... wishing to diversify internationally 2.4.4 Disadvantages of securities market The criticisms of stock markets are essentially the following: ◊ The encourage unequal distribution of wealth, by enabling those who are wealthy to invest with a view to increasing their wealth, without working for it ◊ Stock markets can encourage rash speculation both by individuals and institutions when followed by collapse... market can be referred to as all types of markets where existing securities are being traded between investors The features of this market are as follows: 1 To get holding securities cashed; 2 Fair price determination of securities, free auction (perfect competition) 3 The fair price in the secondary market affects the issuing price in the primary market, two markets are interdependent Securities Securities... performance of the economy (Market risk) Doubtful growth prospects and fears of inflation are bad for stock markets, which perform badly under either worry Investors need also to have confidence in the firm whose shares they buy (specific risk) They need confidence in the firm’s products and markets, its management and in its in integrity in disclosing information Finally they need to have confidence... [18] (1) Registered capital (2) Actual capital (2) divided by (1) 1991 1,232 260 19.6 1992 2,168 535 24.5 1993 3,169 1001 34.7 1994 4,041 1,500 37.1 1995 7,100 2,500 35.2 3.2 The financial environment ♦ Banking system: Vietnam’s financial sector reforms started in 1988 with the dismantling of the banking monopoly system At the same time, the State Bank of Vietnam (SBVN) performed both central and commercial... 15% 21% 20% 2% 91 Medium te rm loan 94 95 Long te rm loan Figure 3.2: The changes in loan proportion [27] However, at present operations of the banks and financial companies have many shortcomings This affects on establishment and development of financial market in general and securities market in particular Based on selected banks which were interviewed, some findings are below: First, the average... and so forth has not been clearly defined 56 Different requests are made of the taxation system by different groups of people responsible for taxation policy and financial policy-making, such as members of National Assembly, governmental financial specialists, and local administrators As yet there is no common criterion Secondly, the lack of a theoretical basis means that the current tax system does... including forty-eight banks, two financial Companies and five SOEs completed equitisation program total value of stock of these companies estimate VND 960 billion Besides, about VND 5,200 billion of government medium-term bonds and VND 150 billion of corporate long-term bonds Thus, total value of securities in the market is now about VND 6,400 billion (equivalent USD$ 600 million) [Financial Magazine, 1996]... Bills trading market came into being, the participants which are the CBs, the Joint-Stock Banks, the branches of foreign banks, as also the Financial Companies, the Insurance Companies the Fund for Insurance and the Investment Fund (collectively referred to as Financial intermediary organizations) The latter as the buyers, while the seller is the Ministry of Finance (Bank Treasury) and the regulatory . way, financial markets encompass two components: capital market and money market. These markets cater to the financial. Definitions 2.1.1. Capital markets There are various definitions on capital markets. According to Kidwell [1984], financial markets can be classified