Thursday, November 16, 2006

What is the future for Central Eastern European equity markets?

Today, in light of the discussion on the possible emergence of a new trading platform ('Banks plan to rival European exchanges' in FT 15/11/2006 ) which caused some stir-up in the major European exchanges, I would like to turn to smaller, regional equity markets, whose members will probably not be, at least primarily, of major interest for the founders of the above projects. To initiate a series of blog entries, I would just like to present some numbers on the CEEC stock markets and compare them to other European equity trading floors. In some time a note on the evolution of CEEC equity markets should follow, and something more formal on the degree of comovement.
Thus I would like to go back to reviving the idea of a unified trading platform which would incorporate existing equity markets of Central and Eastern Europe. As we have shown (by now illustratively, but some proper evidence will come) on this blog (here) there seems to be quite a high degree of comovement of stock market indices in the major CEECs.

Table 1. Main market size of equity markets in CEECs and selected EU comparisions.
Sources: Federation of European Securities Exchanges, OMX, Bucharest SE, Sofia SE.

Generally, as can be seen from Table 1 the CEEC equity markets are rather small. The largest, the Warsaw Stock Exchange is of roughly comparable size with the Wiener Boerse. Low trade volumes and thus a rather illiquid market make equity a rather rare source of financing, especially in the case of SMEs. Total market capitalization (including foreign companies, though admittedly it does not make much difference, as of end of October 2006) is rather small compared to GDP (2006) and ranges from under 10% in Slovakia an Bulgaria to over 30% in Poland and Slovenia, while trade volumes in the entire region are roughly 150% of those in the Wiener Boerse.
The Riga, Tallinn and Vilnius stock exchanges already form part of the OMX Nordic Exchange Group, which seems a wise decision, as the size of local markets generates a rather high information cost for investors. Over 80% of Baltic stock is traded over OMX, and the capitalization of domestic OMX traded firms relative to GDP ranges 10-30%.
However concerning the rest of the countries, a common platform of the Budapest, Prague and Warsaw exchanges, would quite probably boost the importance of the market, and potentially the inclusion other equity markets (like Bratislava, Ljubljana, Sofia or Bucharest) would strengthen the role of the new platform.
A common trading platform (something like the Euronext, or OMX) would allow better access to capital, and thus raise the importance of capital financing. Clear, uniform regulation, easy and transparent comparison of the developments would allow the reduction of costs both on the issuers and investors side, and thus boost efficiency. Of course a common equity market would increase the access to capital (by providing access to investors in all of the participating markets) but more importantly would improve the access of smaller investors to a more liquid, richer market, by reducing the cost of participation.
This of course is not easy – it would require strong determination especially in issues like supervision coordination (or a common supervisory authority), but as we see from the example of the Baltic States, a common platform is not nearly an impossible prospect.

The small, illiquid markets do not seem to have much future on their own – though of course it is not improbable that some of the existing markets will join formations like Euronext. Moreover the idea of a common platform for the region is obviously not a new one - initiatives from Wiener Boerse, Deutsche Boerse (e.g. NEWEX ) have however not been very successful (see see the work by Claessens for an overview). But as long as for medium firms listing in large Western equity markets is costly, and listing in the local exchange does not provide proper access to capital this niche could be exploited by a common platform. In reality, actual IPOs in the region are quite often highly oversubscribed, thus it would be the opening up of the access of investors to a wider range of investment possibilities, which could prove more important. Finally the increased size and liquidity of the market could attract firms that previously did not consider a public offering.
Generally, a common Central Eastern European equity market seems a rather appealing idea.


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