Ethiopian Capital Market – The ecosystem approach is an imperative

I have been following the formation of the Ethiopian capital market for the last 2 years from afar. No doubt, it would bring a significant change on how the financial market, and in particular how finance is accessed in Ethiopia. As a finance professional who has spent the better part of the last two decades working in the world of finance, I thought it would be prudent to consider ‘the ecosystem approach’ to ensure the capital market has all the elements to thrive from the outset. This is a pre-emptive opinion of the writer not written with apprehension but with dispositional optimism.

The role of capital markets is to serve as a bridge between investors and businesses by allowing them to raise the necessary funds. Capital markets complement traditional bank financing by providing an alternative source of funding; they reduce reliance on banks and enhance financial stability. A well-regulated financial market provides essential finance for governments, financial institutions, and small businesses. This is critical to fund infrastructure development, access to technology, housing, agribusiness, and promote entrepreneurship in support of small and medium enterprises that will promote job creation and meaningful economic participation in the years ahead.

They also provide investment opportunities for individuals and institutional investors. These opportunities include the buying and selling of shares, bonds, and other financial instruments.
Capital markets are essential for effective working, and this requires a robust legal and regulatory framework. Such a framework ensures investor protection, transparency, and fair market practices. Strong corporate governance practices are particularly crucial as they enhance investor trust and ensure that companies adhere to transparency, accountability, and ethical standards. Additionally, efficient trading platforms, stock exchanges, and clearing and settlement systems play a critical role in facilitating smooth transactions and enhancing market liquidity.

Capital markets involve various participants, including issuers (companies raising capital), investors (individuals and institutions), brokers, and market intermediaries. While there are encouraging signs of various banks and Ethio telecom selling shares and buying stakes in the Ethiopian Stock Exchange, there needs to be a concerted effort to encourage participation from diverse stakeholders, particularly retail investors who have reasonable cost and access to the market. It is important to have a variety of financial instruments available, including equities, bonds, and derivatives. Developing local debt markets is particularly important in Ethiopia, given the dire need for finance and chronic shortage of Forex, as well as the tainted image in attracting FDI due to recent security issues (Sovereign risk) for long-term financing.

Educating investors about capital markets, risk management, and investment opportunities fosters confidence and participation. Financial literacy programs can play a significant role in this regard.

The ecosystem approach in efficient capital markets refers to a holistic strategy that considers various interconnected elements and stakeholders to create a thriving and sustainable financial environment.

With the formation of the Ethiopian Capital Market Authority and the Ethiopian Stock Exchange (ESX), there is a need for a robust enabling environment with strong policy setting and a whole-of-government approach. One critical element for broad participation is investor education and capacity development. Investor education, building financial literacy, and resilience across the country breed investor confidence and the desire to participate in the market and invest. Strengthening investor protections and promoting transparency are essential for this to happen. In terms of capacity building, developing human capital is vital. Training programs, workshops, and educational initiatives help market participants understand capital market dynamics and best practices. The ecosystem approach emphasizes collaboration among different stakeholders, including governments, regulators, financial institutions, investors, and businesses. By working together, they can address challenges and create synergies. It is always the case that there remains tension between accountability and efficiency in an ecosystem where businesses focus on value creation through competition and regulators err on the side of caution to ensure the capital market is robust and remains viable.

A well-functioning ecosystem requires robust market infrastructure, including stock exchanges, trading platforms, and settlement systems. Efficient infrastructure facilitates smooth transactions and enhances liquidity. In addition, the capital market ecosystem ought to encourage financial innovation without stifling regulatory burden, particularly at this nascent stage. Encouraging innovation in financial products and services contributes to a dynamic ecosystem. New instruments, such as green bonds or social impact bonds, can attract diverse investors.

The ecosystem approach recognizes that efficient capital markets involve more than just financial transactions. They thrive when all elements work harmoniously, fostering economic growth and stability.

A word of caution – the capital market, with all its potentials and aspects to drive economic growth, has its own pitfalls. Without dimming the optimism, I will return to highlight some of them and how they could be minimized and the risk mitigated, at least at a macro level.

Mengistu Weldemariam is a senior consultant in business and finance. Previously a lecturer in corporate finance and accounting and currently works in consumer and investor protection. You can contact him via weldemariammengistu@gmail.com

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