Summary
The purpose of this study is to investigate the reasons for passive turnover on the Lithuanian securities market and to offer recommendations that would enable the capital market to contribute to economic growth in the most effective manner.
Legal and institutional preconditions for the securities market in Lithuania are in place
In 1992 Lithuania began to lay the foundations for a securities market. The economic reform prompted a need to create a proper legal and institutional framework for the operation of a securities market. Both the idea to provide impetus for the rise of a new service on the market and specific actions to implement this idea were in private hands then. The authorities stepped in when the French Government, who was willing to provide technical assistance, agreed to do that only on the basis of an official bi-lateral agreement. On September 17, 1992 the governments of Lithuania and France signed an agreement aimed at creating foundations for an effective and competitive securities market.
In accordance with the agreement the Government of the Republic of Lithuania passed a Resolution on the Establishment of the Securities Commission and the Stock Exchange. The said resolution granted the Ministry of Finance, the Lithuanian Commodities Exchange and the Baltic Commodities Exchange to establish the National Stock Exchange, one of the key institutions necessary for the operation of the securities market. The National Stock Exchange (hereinafter referred to as the Stock Exchange) was founded during a statutory meeting of the shareholders on 20 April 1993. It was the first stock exchange to be founded in the Baltic States. The Ministry of Finance of the Republic of Lithuania became its main shareholder with 44.3% of authorised capital. At the time the state’s contribution to the establishment of a new market-oriented initiative seemed understandable and justified, the more so as the state intended to provide the premises for the stock exchange. Natural and legal persons acquired the remaining shares. In 1998, the non-profit Stock Exchange was reorganised into a joint stock company, but the ownership structure did not change. In addition to the Stock Exchange, all other institutions necessary for an effective operation of the securities market – the Securities Commission, the Central Securities Depository (for similar reasons also partially owned by the state) and financial intermediaries – are in place. Lithuania continued to lay legal and institutional foundations for an effective, safe and viable operation of the securities market.
The securities market remains stagnant
Despite the fact that the legal framework regulating the securities market and conditions for its development are in place, the market fails to play its role. The market fails to use its potential in such a way as to contribute to economic growth in the most effective manner and to offer the public a convenient instrument for capital trading.
In their programmes Lithuania’s governments traditionally pledge to promote the development of the securities market in all possible ways. In 2002 through 2002 alone quite a few measures were undertaken to boost the securities market Restrictions of the number of buyers and shares were eliminated. A capital gains tax was abolished. Procedures for pledging securities were simplified. Restrictions of the prices of securities acquired in direct transactions were revoked. The Board of the Stock Exchange was granted the right to exempt stock exchange participants from annual fees for direct transactions if a transaction was made or terminated by mistake. A new set of laws came into effect in 2001 through 2002, including the Civil Code, the Law on Joint Stock Companies, the Law on the Securities Market, the Law on Insurance of Investor Liabilities of Commercial Banks and Financial Intermediaries to Investors, etc. Unfortunately, the desired impetus to the securities market was not achieved.
The passiveness and stagnation of the securities market, even in the existence of favourable circumstances for its development, highlights the need to search for other measures that, together with legal and institutional factors, would facilitate a full utilisation of the potential of the securities market.
The reasons for the shallow market are multiple
The reasons why the securities market fails to perform its role are manifold. They may be divided into a few major groups: financial, administrative (procedural) and traditional (cultural). A brief overview follows.
The financial reasons for the shallow securities market are closely related to government borrowing policy. A relatively large volume of government borrowing, the reliability and profitability of government securities and regulations stimulating investment in government securities (insurance companies are allowed to invest without any restrictions only in Lithuanian government securities; banks’ investments in government securities are regarded as risk-free; interest is not taxed, etc.) result in a the bulk of resources of potential capital market participants being absorbed by government securities.
Administrative or procedural obstacles to the development of the securities market are related to the abundance and complexity of legal acts regulating the securities market. Rather than guaranteeing the security of the market, regulatory measures cause a negative side effect, stagnation of the market. Excessive regulations aimed at protecting small investors force companies and majority stakeholders to avoid running a business with a large number of owners. On the other hand, existing incentives to hide profits, to avoid paying dividends or to take them out indirectly leave small investors unprotected and disinterested in using the services of the securities market. The decision to privatise state-owned companies via direct transactions rather than on the Stock Exchange also indicate that state authorities are unwilling to make use of the existing market mechanism, thus aggravating the situation on the securities market.
The situation on the securities market depends on corporate governance traditions and evidences their weakness in Lithuania. In Lithuania, commercial banks are the centre of financial attraction. Potential buyers of securities (small and medium-scale investors) in most cases opt for bank deposits, just like potential capital buyers tend to look for financial resources in commercial banks rather than on the capital market. Commercial banks offer more common and familiar financial instruments which also help to avoid unacceptable bureaucracy.
In general it should be noted that the future and viability of the securities market depends solely on globalisation processes, competition, and integration into the global capital movement. If financial and administrative constraints were removed, this inevitable integration process would make it possible to develop new traditions and to use on a wider scale globally popular services offered by the securities market.
The future of the securities market should be related to the privatisation of the Stock Exchange
The globalisation of the securities market is often understood in a narrow sense as the merging of trading systems of the stock exchanges of different countries, or, in other words, as the elimination of procedural constraints. This line of reasoning is quite solid: recent trends are towards mergers of European stock exchanges and the rise of a few strong securities trading hubs.
For instance, Euronext, composed of Amsterdam, Paris, Brussels, London, Portugal’s Lisbon and Oport stock exchanges, concluded an agreement with the Warsaw stock exchange regarding cross-country membership and trade. Members of these stock exchanges will enjoy access to the products of all of the mentioned stock exchanges. The Tallinn and Helsinki stock exchanges have merged their trading systems. Stockholm, German, Swiss Virt-x, which accounts for about 7-8% of Europe’s annual securities trade, have also expressed intentions to merge and cooperate with other stock exchanges.
There is no doubt that mergers with larger and stronger stock exchanges would significantly alter Lithuania’s stock market by making it more visible to foreign investors and creating conditions for increased liquidity of Lithuanian securities. Taking into account the global trends and activities of the neighbouring countries in this area, it is advisable not to postpone integration processes until unfavourable conditions set in. After the stock exchange systems of the neighbouring countries merge, Lithuanian issuers and investors are likely to use the services of new, more attractive trading hubs and to skip the deserted Lithuanian Stock Exchange.
The necessity to integrate the Stock Exchange is widely recognized. Possible merger options are being discussed. However, there are circumstances that may have a negative effect on decision-making. First of all, a decision on merging the trading systems per se is being postponed (for example, the stock exchanges of neighbouring Estonia and Latvia are much more ahead in solving these issues). Secondly, and most importantly, even if a decision were hastily made in the existing circumstances, most likely it would be based on political rather than economic arguments. The likelihood of a politicised decision is related to the fact that the National Stock Exchange is in essence run by the state. This will inevitably affect the choice of criteria for selecting trading systems.
Only a private owner of the Stock Exchange, who would be interested in its effective and profitable operation, could make a rational and economically sound decision concerning a further development of the Stock Exchange. This is necessary in order to avoid any future speculations as to whether the decision was rational and effective. Therefore issues related to the privatisation of the Stock Exchange and the integration of trading systems should be addressed in a coherent, systematic manner. It is advisable that the Stock Exchange be privatised first, while the choice of a trading system partner, if necessary, be left to the private owner.
Stock exchanges are as a rule private. Privatisation thereof is supported by international organisations. As regards the Baltic States, the Helsinki stock exchange group (HEX) became a strategic investor in the Tallinn stock exchange after it acquired 61.6% of the stock in 2001. HEX is also negotiating with the Riga stock exchange concerning acquisition of its stock. Meanwhile, the Lithuanian National Stock Exchange is not even included in the list of objects slated for privatisation. Under such circumstances there is no adequate interest on the part of investors in the privatisation of the Lithuanian Stock Exchange.
As mentioned above, the state’s ownership of the Stock Exchange was determined by the then economic and political circumstances. However, even at that time there was no doubt that a private stock exchange is the best solution. That is why the effective legislation permitted the establishment of competing private stock exchanges, but market conditions precluded the rise of such stock exchanges. It was not “strategic”, “priority-related” or other ideological motives that determined the state’s participation in the Stock Exchange. These would have doomed the Stock Exchange to remain forever in state ownership or to be bottom-listed among items for privatisation. Currently, with legal and institutional preconditions for an effective and viable operation of the securities market in place, the state’s participation in the capital of the Stock Exchange is not necessary and in some cases even detrimental to its development.
The above arguments demonstrate that privatisation of the Stock Exchange is crucial for the overall development of the capital market and should not be postponed. It was advisable to include the National Stock Exchange in the list of entities slated for privatisation and to transfer it to the State Property Fund in order to enable potential investors to file privatisation bids. It should be noted that the sale of the most important and largest entities is to be completed by the end of 2002, so the preparation of a privatisation program for the National Stock Exchange should be oriented accordingly.
Conclusions:
1) Although legal and institutional preconditions for the development of the securities market in Lithuania are in place, the market fails to utilise its full potential and to contribute to economic growth.
2) The future and viability of the securities market should be related solely with globalisation processes and integration into the global capital movement.
3) Only a private owner, who would be interested in an effective operation of the Stock Exchange, would make a rational and economically sound decision concerning a further development of the National Stock Exchange.
4) It is advisable to include the National Stock Exchange in the list of items for privatisation and to transfer it to the State Property Fund in order to enable potential investors to file privatisation bids.
