Initial Public Offering (IPO)
Frontier markets would seem to offer active fund managers potentially a source of good returns, as well as opportunities for portfolio diversification. However, these potential benefits do not come without risks and challenges. These risks should be considered when determining which particular markets to pursue, and be recognized in investment processes in risk-and-return targets. Let us look at a number of these.
1. Regulatory, and Trading Execution Risk: Although increased interest in frontier markets has been enabled by market liberalisation and increased openness to non-local investors, market barriers should not be underestimated. Foreign ownership restrictions, currency limits, local custody rules, local funding and registration requirements are widespread and sometimes difficult to navigate. Some markets even require foreign market participants to execute trades via local brokers.
2. Transaction Costs: In many markets, high local transaction fees and commissions inflate trading costs.
3. Currency Risk: Investors, who seek to build a frontier market portfolio, need to be aware that they face a higher risk of investment exposure to potentially volatile currencies.
4. Governance Risk: Standards of corporate governance and financial reporting among listed companies in some frontier markets can be, at the very least, uneven.
5. Sector and Sovereign Risk: Part of the attraction of frontier markets is their low correlation with developed and emerging markets. However, investors should be aware that frontier markets are dominated by a few sectors, and hence a sizeable allocation can result in concentrated exposures to certain sectors. Frontier market equities are highly exposed to sovereign risk.
6. Liquidity Risk: Illiquidity is a feature of many frontier markets. Investors may be unable to execute trades when they want, or at the size they want. Bid-offer spreads can also be relatively wide.
7. Operational Risk: In some frontier equity markets, investing entails increased operational risk. Failed trades may occur more frequently than in developed markets, as settlement processes may be less standardised, less automated, and more prone to errors.
8. Political risk: As the recent political unrest in the Middle East illustrates, many frontier markets have fragile systems of government, which can be prone to instability. Turmoil can in turn lead to rapid declines in the market value of securities traded in impacted countries.
Now, whether an asset manager is considering launching a passive product, seeking alpha generation, or running a thematic growth strategy, it is obvious that risk must be managed carefully.
A single country, or regional, approach to frontier markets investment can create very significant sovereign, and sector/ stock concentration, risks. These limit the investment scope in such a way that it results in few potential securities, which meet minimum, objective capitalization standards or other criteria. The strategy can also limit the amount of capital that a fund can put to work. This is because of the risk that an investment in a given security will be too large to trade effectively.
Certainly, one attraction of frontier-market returns is their lack of correlation to each other, and to developed and other emerging markets. This means that adding frontier-market investments to a broader investment strategy can, in fact, reduce overall risk, and very probably improve risk adjusted returns.
Unquestionably, issues related to illiquidity, trade execution and settlement should be factored into the decision making process, and whether a manager can create an investment product with an attractive risk-reward profile. A local presence can have significant potential benefits in this regard. Being on the ground can also help an organisation monitor and mitigate other key risks, such as a lack of disclosure in financial reporting, or the potential for political uncertainty to destabilize markets, etc.
Frontier markets undoubtedly offer what are very likely compelling investment opportunities, which satisfy investor demand. Frontier markets are growing rapidly, but are still new enough to offer significant return potential, and attractive correlation characteristics, as globalisation continues to unfold.
Nonetheless, asset managers must work diligently to assess whether a frontier product is a good fit for their portfolios. Performance potential and asset gathering are only part of the equation. To be successful in developing an effective frontier investment capability, managers must ensure that their approach to risk management takes into account the particular blend of risks, which these markets entail.
Funds which invest in so-called frontier markets are often an appealing way to increase assets under management, particularly when given strong investor demand. Nonetheless, these markets present various risk management challenges.
Sometimes called “emerging markets,” “next-generation markets,” “N-11 (next 11) markets” as well as “frontier” markets, these lie beneath the top two tiers of markets, which normally attract asset managers. Investors paid US$2.6 billion into dedicated frontier funds in 2010. Relatively robust economic growth, impressive stock-market performance and increasing investor appetite for exposure to emerging markets such as Vietnam, Bangladesh and Pakistan are among the main reasons, why managers are launching stand-alone frontier funds, or allocating more assets to frontier markets.
Frontier countries are usually defined as those with economies whose size and growth are below Brazil, Russia, India and China (the BRIC group) and the next tier down, Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa (CIVETS), although as a matter of practice, some market participants deem CIVETS such as Vietnam to be “frontier.”
In the second quarter of 2010, China supplanted Japan as the world’s second-largest economy. Many analysts forecast that the size of China’s economy will surpass the US within two decades. Be that so or not, the global economy is reconfiguring, and frontier markets comprise part of this reconfiguration. Sustained demand from China, India and other rapidly growing economies for commodities and other products have bolstered the prospects of frontier markets.
Economic growth in the frontier market is being driven by various factors. In Vietnam, Bangladesh and Pakistan, rapidly growing, younger populations are fuelling increasingly competitive labor forces. They are benefitting from the so-called demographic dividend, as the rising proportion of working-age people in the population helps to sustain economic growth. Quite differently, Kenya, Nigeria and Ghana have younger populations alongside plentiful agricultural and natural resources. For some other frontier countries, notably Qatar, Bahrain and Kuwait, natural resources are the main economic driver.
In many frontier markets today, economic, fiscal and monetary policies are more supportive of sustainable growth than was typically the case a decade or two ago. Government debt markets are growing, and some frontier markets now support relatively well functioning stock markets with frequent IPO activity, although they remain small in terms of total capitalization.
Typical valuations of many frontier-market stocks in recent years have tended to be lower in terms of price-to-earnings than comparable stocks in developed markets, or indeed top-tier emerging markets. It should come as no surprise then that typical frontier market stocks are in the micro-/small-/mid-cap range. The financial and telecommunications sectors account for the largest frontier sector exposures within broad indexes, such as the S&P Extended Frontier 150.
Although a number of frontier economies are dominated by large energy companies, some of these companies are unlisted or remain government owned. And with many frontier-market currencies appreciating against the US dollar, investing in local currencies also demonstrates a potential for higher returns.
Having a unique geopolitical status with more or less direct access to Europe, Caucasus, Central Asia, the Middle East and North Africa, and a population of over 70 million, Turkey is building itself into the Tiger on the bridge between East and West. This is an expansion of a new market slanted towards the telecommunications, retail, banking and real estate, health, medicine, pharmaceutical and biochemistry sectors.
Due to the fact that 60 percent of Turkey’s population is under the age of 35, there is an excellent, long term work force available, which, however, can no longer be described as ‘low cost’, due to the very competitive labour rates currently applicable in China and India. Hence, there is a focus on improving the quality of available labour, to produce motivated and well qualified work force, in order to provide a value added aspect in the labour cost.
Another factor in Turkey’s favour is that substantial foreign investment reforms have been put in place, and, by the end of last year, over 23,000 international companies had invested in Turkey. A third factor in the list is Turkey’s successful performance during the recent global financial crisis. Given all these factors, it seems likely that the number of foreign investors will increase dramatically in the coming years.
Although quite possibly in the continued hope of EU entry, Turkey has followed the EU’s ‘Lisbon Strategy’ by directing its industrial development policy towards knowledge and innovation. It’s aim iss obviously to set itself up as the production base of Eurasia in medium and high-tech products.
Infrastructure reforms have also been a collateral enhancement. The old bureaucratic barriers were replaced by a comercial environment, which can be described as relatively welcoming and attractive. Laws have been amended or replaced, so that these now comply with the EU legal system – which however, one is obliged to remark, is itself beset by a frustrating bureaucracy.
New laws allow the formation of a company with 100 percent foreign investment and ownership. A company can now be formed with a single shareholder, and most required procedures relative to the company can be carried out online. Under these new regulation, foreign investment companies established in Turkey may acquire and hold real estate, subject to the permission of the local governorship; but such permission may be refused only in cases where the real estate is located in a military or special security zone, which zones are listed in the legislation.
The rapidly increasing business growth has a direct impact on the need of Turkish companies, or at least their interest in obtaining private equity capital.
In the face of the current, international financial troubles, thee are, once again, very promising signs with respect to the availability of financing for renewable energy projects. This has apparently been spurred on by the nuclear tragedy in Japan. It seem that there is now valid cause for optimism as far as financing availability, particularly for solar energy, is concerned.
Though credit is still very tight, a clearer, more definitive line is being drawn and market tiering is taking place based on more stringent evaluations of operational, financial and credit risk. Companies that have demonstrated some success in developing projects, and/or either putting proven technologies to good use, or commercializing new technologies, will be more secure in their ability to raise short- and long-term capital.
Power utilities are again becoming willing to sign long-term power purchase agreements with renewable energy developers. This can be a good basis on which to apply for finance. Power demand is not decreasing, and now, after Fukushima, when aging power plants are rapidly being retired, and clean energy is being pursued by governments everywhere, lenders and investors are again heavily motivated to get into that area.
In some countries, even local and state governments want to secure their own, future, local power needs; and, in some cases, these governments, or their public utilities, can be persuaded to enter into arrangements, which provide the basis of an application for finance by the clean power provider. When an energy provider knows how much power it can, and will, sell, and at what price; and when that becomes formalised in either a contract or other indisputable form, then, with that in hand, the provider will almost certainly be able to raise funds.
On the 17. March 2011, details of the proposed reform of New Zealand’s securities laws were made known. There are a wide range of proposals, of which probably the most important are:
- The definition of what is a security
- Exemptions from the securities law regime
- Disclosure requirements for security issuers
- Governance of collective investment schemes
- Liability regime for breaches of securities law
- Public enforcement of directors’ duties.
Definition of Security: A new definition of ‘security’ is proposed, with three distinct categories of financial products to be covered by the regime:
- equity securities
- debt securities
- collective investment schemes and derivatives.
The Financial Markets Authority (FMA) will be given the power to designate which products fall within those categories.
Exemptions: Five specific exemptions are proposed, as follows:
Sophisticated investors – a principle-based definition, providing certain protections, as, for example, in the case where a person invests over a set amount such as $500,000.
Persons with a close relationship to the issuer, such as relatives and close business associates.
Equity as part of employee share schemes, where, provided the employee share schemes meets certain criteria to be exempt from most disclosure and governance requirements, but still required to provide short-form disclosure.
Small offers of equity or debt, which is a newly introduced exemption under the new laws, using a similar definition to that in Australia. A basic disclosure document would still be required. Small offers would be limited to, within a 12 month period, $2 million raised and up to 20 investors, with a cap of $100,000 per investor (unless sophisticated).
There would also be narrow exemptions for specific entities / products.
However, on the flip side, an onerous product disclosure statement (PDS) will replace the current two tiered system, in order to promote comparability between financial products. What is required would depend on the type of product and type of offer, with content to be prescribed in regulations under the new Act. The PDS would have two parts – a two page key information summary, followed by the body of the PDS containing more detailed information on the product (being information that is crucial to an investor’s decision to invest). Other information, additional to the prescribed content, may be disclosed on the new Register of Securities (to be established by the Financial Markets (Regulators and KiwiSaver) Bill).
More regular ongoing disclosure will also be required. Stay tuned for discussion, after the final decisions are taken.
Through an extraordinarily innovative structure, we are pleased now to be able to offer equity funding, in larger amounts, for existing companies, wishing to access the capital markets for funding. I will set out, below, the essentials which are involved. The actual execution of the processes, just as in the case of any usual IPO and similar, require some experience and expertise in these matters.
Ba means of the issue of GDRs (Global Depository Receipts) issuers in a former Soviet bloc country have acquired the right to list on European trading platforms, including London Stock Exchange, Luxemburg Stock Exchange, Frankfurt Stock Exchange, Vienna Stock Exchange, Warsaw Stock Exchange and Berlin Stock Exchange. The first four of those have alternative markets (specially organized trading platforms admitting the issuers that do not qualify for listing on the respective stock exchanges).
In making an IPO by means of issues of GDRs, a foreign depositary bank, depositing its shares with a national custodian, acts as a shareholder of record. GDRs are issued on the basis of a Depository Agreement. The actual investors – GDR holders, being beneficial owners of shares in the national issuer corporation, with their interests represented by the depositary bank, do not become the shareholders of record of such shares from a legal standpoint, merely because the concept of beneficial ownership is not yet so widely developed in the national law. Thus, the shareholder of record of the shares is the depositary bank, acting on behalf of the GDR holders, they being beneficial shareholders. It is not a matter of great consequence, since the ultimate effect is the same.
Do not be seduced by offers of easy funding, which close in “7 days or less”. In the real world, that does not exist. But, if your clients are seeking, through an IPO, a simple and relatively inexpensive way of listing on a well recognised exchange, so as to be able to access the capital markets, and being able to repeat that step without restructuring in the future, this could be an extremely beneficial way forward. Of course, the initial listing will almost always permit the subsequent straightforward listing on the exchange of the home country.
I will be happy to accept contact from professionally qualified intermediaries, lawyers etc., or very serious and capable applicants.
The U.S. Dodd-Frank Act passed last year requires that an individual’s primary residence be excluded from the $1 million net worth test for accredited investor status. On January 25, 2011, the SEC issued proposed rules to implement the exclusion.
Unquestionably, this new test will reduce considerably the pool of prospective accredited investors. This, in turn, will have a substantially negative impact on prospects for companies to raise capital. Those companies, which had previously prepared documentation, will be required to review and, almost certainly, amend their offering documents.
Securities offered to accredited investors receive favored status under the Securities Act of 1933 – relating, for example, to registration and prospectus delivery requirements. Under ‘Regulation D’ Rules 505 and 506, securities may be sold to an unlimited number of accredited investors but not more than 35 non-accredited investors. Furthermore, the mandated specific disclosure requirements of Regulation D need not be satisfied if the securities are sold only to accredited investors. I have to say that this is why we had almost always pursued private placements under Regulation D.
Until last year, the equity in an individual’s primary residence was included in the calculation of net worth. However, that is now excluded. However, the new Act muddied the waters somewhat, in that it was not clear about the treatment of mortgage debt, particularly when that resulted in negative equity. Hence, it is now proposed that the value be the amount arrived at by subtracting from the property’s estimated fair market value the amount of debt secured by the property, up to the estimated fair market value. To what extent that will affect the situation must still be unclear; but affect it, it most certainly will.
This exclusion of a potential investor’s primary residence from the calculation of net worth must inevitably, and significantly, reduce the pool of eligible ‘accredited investors’. That can only have a negative impact on private equity markets in the United States.
The next problem is that the net worth test for individuals will likely become even more stringent in the future, making it much more difficult for companies to raise capital from private investors.
Because the primary residence exclusion came into effect on July 21, 2010, companies, and private funds raising capital, should review their offering documents, including investor suitability questionnaires, purchase agreements, and private placement memoranda, to ensure conformity with the new regulations.
For those companies who now feel the pinch because of the above, we believe we can offer a completely different and innovative alternative method to raise capital.