Capital Market Integration in South Asia. Realizing the SAARC Opportunity [1st Edition] 9780081019160, 9780081019061

Table of contents :
Content:
Front-matter,Copyright,Dedication,Disclaimer,About the AuthorEntitled to full textChapter 1 - Introduction, Pages 1-4
Chapter 2 - Where SAARC Is Now: Products, Corporates, and Correlation, Pages 5-9
Chapter 3 - Where SAARC Can Reach: Showcasing its Main USP, Pages 11-17
Chapter 4 - General Precursors for Regional Financial Integration, Pages 19-20
Chapter 5 - Observations Specific to SAARC: Precursors to Consider, Pages 21-35
Chapter 6 - Potential Products and Activities, Pages 37-113
Chapter 7 - Recent Examples of Integration—ASEAN, MILA, Hong Kong–China, Singapore–China, and East Africa, Pages 115-119
Chapter 8 - Initial Role for Stakeholders: Regulations, Awareness, and Engineering, Pages 121-123
Chapter 9 - Conclusion, Pages 125-126
Appendix, Pages 127-129
Bibliography, Pages 131-135
Index, Pages 137-142

Citation preview

Capital Market Integration in

SOUTH ASIA

Elsevier Asian Studies Series Series Editor: Professor Chris Rowley, Cass Business School, City University, London, UK; Institute of Hallyu Convergence Research, Korea University, Korea Griffith Business School, Griffith University, Australia (email: [email protected]) Elsevier is pleased to publish this major Series of books entitled Asian Studies: Contemporary Issues and Trends. The Series Editor is Professor Chris Rowley of Cass Business School, City University, London, UK and Department of International Business and Asian Studies, Griffith University, Australia. Asia has clearly undergone some major transformations in recent years and books in the Series examine this transformation from a number of perspectives: economic, management, social, political and cultural. We seek authors from a broad range of areas and disciplinary interests covering, for example, business/management, political science, social science, history, sociology, gender studies, ethnography, economics and international relations, etc. Importantly, the Series examines both current developments and possible future trends. The Series is aimed at an international market of academics and professionals working in the area. The books have been specially commissioned from leading authors. The objective is to provide the reader with an authoritative view of current thinking. New authors: we would be delighted to hear from you if you have an idea for a book. We are interested in both shorter, practically orientated publications (45,000+ words) and longer, theoretical monographs (75,000 – 100,000 words). Our books can be single, joint or multi-author volumes. If you have an idea for a book, please contact the publishers or Professor Chris Rowley, the Series Editor. Dr Glyn Jones Professor Chris Rowley Email: [email protected] Email: [email protected]

Capital Market Integration in

SOUTH ASIA

Realizing the SAARC Opportunity SOURAJIT AIYER

Amsterdam • Boston • Heidelberg • London • New York • Oxford Paris • San Diego • San Francisco • Singapore • Sydney • Tokyo

Elsevier Radarweg 29, PO Box 211, 1000 AE Amsterdam, Netherlands The Boulevard, Langford Lane, Kidlington, Oxford OX5 1GB, United Kingdom 50 Hampshire Street, 5th Floor, Cambridge, MA 02139, United States Copyright © 2017 Elsevier Ltd. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage and retrieval system, without permission in writing from the publisher. Details on how to seek permission, further information about the Publisher’s permissions policies and our arrangements with organizations such as the Copyright Clearance Center and the Copyright Licensing Agency, can be found at our website: www.elsevier.com/permissions. This book and the individual contributions contained in it are protected under copyright by the Publisher (other than as may be noted herein). Notices Knowledge and best practice in this field are constantly changing. As new research and experience broaden our understanding, changes in research methods, professional practices, or medical treatment may become necessary. Practitioners and researchers must always rely on their own experience and knowledge in evaluating and using any information, methods, compounds, or experiments described herein. In using such information or methods they should be mindful of their own safety and the safety of others, including parties for whom they have a professional responsibility. To the fullest extent of the law, neither the Publisher nor the authors, contributors, or editors, assume any liability for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use or operation of any methods, products, instructions, or ideas contained in the material herein. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data A catalog record for this book is available from the Library of Congress ISBN: 978-0-08-101906-1 For Information on all Elsevier publications visit our website at https://www.elsevier.com

Publisher: Glyn Jones Acquisition Editor: Glyn Jones Editorial Project Manager: Tessa De Roo Production Project Manager: Omer Mukthar Designer: Maria Ines Cruz Typeset by MPS Limited, Chennai, India

This book is dedicated to the memory of my parents, Soma and Ranajit.

DISCLAIMER This content is written purely in personal capacity, and all views and opinion expressed by the author are entirely personal. It should not be taken to represent those of any other organization or individual whatsoever; including Motilal Oswal Financial Services Ltd, India (including any Group companies, Directors, or any employee associated thereof). This content is meant purely for information purposes solely and does not construe to be an investment advice or solicitation for any financial instrument whatsoever. Readers should rely on their own investigations. Any action taken by the readers on the basis of the information herein would be their responsibility alone, and not of the author, or any organization, or individual whatsoever. The circular hand image in the cover page is courtesy of Octopus Team, India. Conception and compiling of the entire cover page image is done by the author himself. This image is only for pictorial purposes and does not represent any formal integration project, per se. Any sentiments or feelings hurt as a result of this cover page image is deeply regretted; however, the author or any related organization is not liable in such situations. Currency symbols denoted in the cover page may not be official/ authorized symbols for some of the countries. These should not be construed to represent official symbols. These have been used only for pictorial reasons, to showcase local monies in an illustration. No other motive is intended, and readers should look at it as such. © Sourajit Aiyer Mumbai, July 2015

vii

ABOUT THE AUTHOR

Sourajit Aiyer has ~10 years work-experience. He currently works as AVP in investor relations and corporate planning with Motilal Oswal Financial Services, Mumbai, a leading Indian capital markets company. Prior to this, he worked in equity trading operations with UBS Investment Bank, London, UK; in financial analysis with Reliance Broadcast, Mumbai; and in financial research with Evalueserve, Gurgaon. He has completed internships with Tata Motor Finance, Delhi and Grameen Bank, Dhaka, Bangladesh. The Grameen Bank project involved field visits into rural districts of Bangladesh. He also met the bank’s Founder, Nobel Laureate Dr. Muhammad Yunus, for his inputs. He has written on over 65 unique topics in over 35 publications across 13 countries, including India, Switzerland, England, USA, UAE, Pakistan, Singapore, Malaysia, Qatar, Canada, Germany and Bangladesh. It includes Huffington Post, Al Jazeera, Yahoo, Straits Times, Foreign Policy News, Network18 Firstpost, Financial Express, Euromoney EM, EU Foreign Affairs Journal, Jang Media Group, All India Management Association, Eurasia Review, etc. Topics were on finance, economy, business, socio-economic & geo-politics in Developing Asia, focusing on impacts, challenges & solutions. Articles have been shared by OPIC (US Govt.’s development finance arm), Yahoo News, two universities of Pakistan, Bangladesh’s Defense College and Bangladesh’s TV industry; while others got good feedback from a senior IMF economist, the Indian P.M.’s Office and the Bhutan P.M.’s Office. He is the author of the E-Book, “Flying with the Winged Elephant: Niche opportunities for global businesses that may emerge in India”, published by Libertas European Institut, Germany and available on www. Amazon.com. Born and brought up in Delhi, he is currently based in Mumbai. He can be reached at [email protected].

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CHAPTER 1

Introduction Lee Kuan Yew, credited for converting Singapore into an economic success, once described ASEAN, the South-East Asian group, as “Unpromising Start, Promising Future.” This apt phrase can also describe SAARC, the South Asian group. SAARC has seen few successes, but geopolitical issues slowed progress. Global institutional investors are using acronyms for groups of developing countries which are homogeneous in stage of development and outlook—BRICS, MINT, Next-11, CIVETS, along with the existing regional groups—ASEAN, GCC, East Europe, CIS, Pacific Alliance, East Africa. But all is not rosy with these groups, which can impact their economic outlook. China’s slowdown is impacting commodity exporters like Brazil, social issues are creating rifts in South Africa, Russian geopolitics is impacting East Europe, Turkey’s proximity to Syria is a disruptor, Nigeria and Kenya are seeing terror threats, Chinese activity in South China Sea sandbars is raising hackles in Vietnam and Philippines, Thailand’s economy has slowed since the coup, GCC states have power-tussles with Egypt and Iran, while some of ASEAN’s fast growing economies comprise only a small proportion of its aggregate. At a time when the outlook of various regional groups seems uncertain, SAARC does not look so bad. SAARC is a unique combination of sizable Emerging (EM) and Frontier (FM) markets, which have low correlation to each other. Return on Equity and Margins of top companies in Pakistan and Bangladesh has improved relative to those of India, while Sri Lankan companies have seen buoyant topline growth. This should help counter volatility or cyclical growth of single-market exposure. Investors may argue why they should look at SAARC asset class, and it is better to look at India or FMs separately. India benefits from the returns and low correlation of SAARC’s FMs, while the FMs benefit from India’s size. Thus, a SAARC portfolio can increase the upside from multiple growth/return enablers, while minimizing the downside due to low-correlation constituents. SAARC’s economic growth from 2014 to 2020 will outpace all the regions mentioned earlier, as per IMF estimates. The incremental size it will add to its economy is next only to BRICS and Next-11. SAARC Capital Market Integration in South Asia. DOI: http://dx.doi.org/10.1016/B978-0-08-101906-1.00001-2 Copyright © 2017 Elsevier Ltd. All rights reserved.

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Capital Market Integration in South Asia

ranks high in savings growth, savings rate, and aggregate savings, as of 2020. Savings has a direct bearing on investment flows. Capital market penetration is quite low in SAARC, so depth can increase further. Income is more evenly distributed in SAARC except for East Europe, so investor breadth can widen. SAARC has young demographics with a near absence of social benefits, i.e., a longer earning life with the need for long-term, inflation-beating investments. Incremental capital formation is amongst the highest in SAARC, indicating creation of economic activity, jobs, income, and savings. Not only is SAARC a large consumer base, it is building production capabilities in both factory and knowledge sectors. Proximity of the SAARC countries to each other gives it a locational advantage for regional value-chain opportunities. Companies in SAARC countries excluding India may need this even more, since there are very few large-sized companies in those countries, which limit investable opportunities. If the corporate sectors in those countries expand, it will lead to further scope for market activity in those countries. Objective of this exercise: As this economic story unfolds, it should ideally translate into a financial story. This exercise discusses possible capital market Products/Activities regional stakeholders could explore to create closer interlinkage of SAARC’s capital markets, which could help realize the economic opportunity set to unfold in this region. Given the current state of maturity in the region’s markets, some ideas may be implementable now; while some may be implementable in the future as the markets mature further. However, the objective is to start deliberation on even the ideas of the future, since even that takes time. This exercise also looks at the economic projections of SAARC versus other regions (which is its main unique-selling point), their recent corporate performance, extrapolation of market indicators, and cases of integration in peer regions. Purpose of these ideas is to bring the region’s savings into local investments, instead of it moving overseas; evince retail and institutional interest through scope for diversification, yield, and risk mitigation; build product portfolios of the smaller markets; and reduce information opacity to ensure efficiencies in pricing. Ideas include Conventional and Unconventional thinking: Conventional ones are typically used in integration, like funds, futures, global depository receipts (GDRs), cross-listings, passporting, etc. Unconventional ones try to convert SAARC’s unique challenges and opportunities into ideas for capital markets, i.e., how SAARC’s current state of demographics, socioeconomics, healthcare, investor, and knowledge maturity can become opportunities. Specific rationale are written with each idea why

Introduction

3

it makes sense for institutions and investors—be it large savings pool for funds, access to a diverse bouquet of sectors, access to multiple products to generate volume/assets, local brokers’ expertise in local stock coverage (especially in high-potential midcaps), access to a broader set of investors helping in valuation, liquidity, and low latency for cross-listings. Products also have to be viable. Hence, a clear focus is on how to deepen awareness of new products and new markets with local investors and institutions for products based on regional securities. Only when this happens, the asset flows should increase—thus, aiding viability. Dual-currency conversion (to/from US$), double taxation of returns/ dividends, sharing of brokerage among local and foreign intermediaries, and collection of market data from all the markets need to be addressed. Compliance with international accounting standards and dual-regulatory approvals gives comfort to investors in cross-border products. Separating the product structure at the country level can reduce the risk perception. Any integrated product has to take into consideration the ground realities. Bringing an anchor partner can help counter implementation challenges in a geopolitically sensitive SAARC—from a country that has bilateral interests with SAARC members individually and is looking to earn returns from overseas investments. Such an anchor may also hold some sway with the SAARC members, which may enable disagreeable members to reach resolutions and agreement faster as they may not want to anger their larger bilateral partner. The anchor’s motivation would be the investment returns from SAARC’s opportunity and not really interfering in its internal affairs. That is easier said than done. But then, achieving consensus on SAARC projects from all its members has been the region’s challenge, and creating the economic motivation of investment returns to a strategic anchor may give them a reason to root for SAARC’s prosperity as a whole, without disrupting bilateral ties. An initial push from an anchor may help garner interest from institutions that look at EMs and FMs separately. Evincing interest from longterm pension funds, superannuation funds, and sovereign wealth funds is a necessity as SAARC is a long-term story, and their buy-and-hold strategy can better realize the value created in this region in the long term. A SAARC asset class may hasten further country-specific funds based on South Asian FMs, as overall FM funds have only a small allocation to these FMs. As institutional interest picks up, retail interest should follow. It is an opportune time for retail, as one can leverage on online/mobile trading with adoption of smartphones.

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Capital Market Integration in South Asia

For each product/activity, it discusses possible initial roles. Some work has been done to develop a harmonious framework. This would include financial disclosures and investor protection. One also needs to market the rationale of these initiatives to counter resistance, create awareness of the regional economies among the local investors, and engage with the industry to make them launch the products. Heterogeneous maturity of local markets restricts options, hence adoption of new products in the local markets is a precursor. The reverse may also occur, as integrated products may fuel the local demand. A role in financial engineering is also needed, since the structuring of integrated products by regional institutions is still in nascent stage. Financial engineering here refers to working on product structures, back-testing, and financial analysis. Hiring of specialized staff or consultants or identifying agencies to outsource these roles to is a precursor. In a region which is unexplored as an asset class, performance will be the kingmaker. Hence, the project of creating a SAARC asset class basket is based on selecting the best performers, irrespective of the country of origin. While this may not give equal representation to all countries, the basket selects the best companies to deliver on performance. This, in itself, can be a measurement yardstick for companies to up their performance. Smaller markets may fear losing business to liquid platforms overseas. But integration can broaden the access of local investors to a wider bouquet of products and new volumes that can offset the loss of migration of local business overseas. Integration can reduce the cost of capital for companies, leading to more capital-raising. The smaller players will never grow if they do not scale up, and integration can help in this. In conclusion, it is an opportune time to look at SAARC. Recent years have seen new governments in the member countries, and most have stressed their commitment to deepen SAARC economic relations. This commitment, along with the economic potential set to unfold in this region, makes it a hot iron to strike now.

CHAPTER 2

Where SAARC Is Now: Products, Corporates, and Correlation Heterogeneous maturity of local markets is an opportunity to deepen adoption of new products: The table given below lists the products in the SAARC markets currently. Common products are few, which restricts the opportunities for integration now. But it spells opportunities to deepen the local markets with new products in the long term. Low market cap/GDP ratio indicates the scope to list more stocks, since market capitalization is less relative to its economic size. Low trading velocity indicates the scope to deepen equity participation, since trading volume is less relative to its market size. Most markets rank low on these ratios, offering headroom for growth in the cash equities segment. Segments like futures and options (F&O), commodity, and currency are almost nonexistent outside India. Open-end mutual fund, a basic vehicle to mobilize retail savings into capital markets, is also quite rare. Closeend funds exist, but they cannot take subscriptions post the offer period, reducing the scope for mobilizing assets from future investors and for the asset management company (AMC) itself to reach a viable scale in its asset base. F&O comprise approximately 94% of India’s overall equities trading. While some F&O trading may be speculative, it also offers hedging and cash–future arbitrage opportunities, thus enabling risk management and price discovery. Performance of Top-200 companies in SAARC ex India countries improving relatively: This is a key reason to look at the SAARC asset class. Performance of Top-200 companies in each of NSE India, KSE Pakistan, DSE Bangladesh, and CSE Sri Lanka (as per June 2015 MCap) shows that the Return on Equity (ROE) and Margins of top companies in Pakistan and Bangladesh were relatively better than India in recent years, while YoY topline growth in Sri Lanka was among the highest in 2014. Moreover, this was at much lower leverage than Indian companies, indicating they still have further room to raise capital if needed for expansion projects.

Capital Market Integration in South Asia. DOI: http://dx.doi.org/10.1016/B978-0-08-101906-1.00002-4 Copyright © 2017 Elsevier Ltd. All rights reserved.

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Where SAARC Is Now: Products, Corporates, and Correlation

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Bloomberg data as of June 2015 shows NSE India is the largest, as compared to KSE Pakistan, DSE Bangladesh, or CSE Sri Lanka (NSE Nepal, MSE Maldives, and RSE Bhutan are excluded as Bloomberg does not have coverage on them). More importantly, India is significantly larger on “Per-Company” basis, that is, the market cap per company and revenue per company of the top-200 Indian companies are higher, indicating it has more large-sized companies.

Indian companies rank high in EBITDA margin, but lower in net profit margin. This indicates that while they are managing their operating costs, they have higher leverage which results in higher interest outgo. India’s average debt:equity ratio has been increasing, though its average leverage is still within acceptable limits. Conversely, Bangladesh is underlevered, resulting in low variation between its EBITDA and net profit margins. Pakistan has seen an improvement in net profit margin, although its EBITDA profit margin has not moved in-line. This may be explained by the reduction in its leverage. While low leverage is good, Bangladesh and Pakistan, which are way under-levered than normal limits, might explore taking on leverage to fuel capex and grow their corporate sectors. Only then will they see more large-sized companies and market cap moving north.

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Capital Market Integration in South Asia

ROE is currently highest in Pakistan and Bangladesh. Moreover, Pakistan maintained its ROE while it has declined in other countries. It is also critical to understand what is driving ROE—profit margins, asset turnover, or leverage. Profit margins and asset turnover are driving the ROE in Bangladesh, indicating efficient management of operations. Pakistan has also seen improved ROE owing to asset turnover and profit margins, indicating efficient management of resources. Taking on leverage can take this growth further into the future. Leverage seems to be driving ROE in India, though asset turnover has reduced. But leverage creates capacity to fuel future growth and grow the ROE in the long term. Moreover, the growth in top line in India has been muted since 2 years as the policy paralysis took hold, which impacted operating leverage and profitability. India ranks much lower than the other countries in terms of dividend payout, especially in the last 2 years. Dividends are a good way to reward shareholders, especially buy and hold long-term investors, who are not looking to immediately gain by selling. Since SAARC is a long-term story, dividends may be relevant.

Low correlation of SAARC markets to each other, and to global markets, can help reduce downside: Most SAARC markets have low correlation to each other, as measured by the quarterly returns of the indices from December 2009 to July 2015. This is owing to the low business and investment linkages between them currently. Their growth drivers are mostly domestic consumption or exports in specific sectors to the West. As the intra-SAARC linkages deepen, the correlation may gradually increase. But till that time, it will help reduce the downside risk as the volatility of one is countered by the others, while the portfolio gains from their growth. The Consistent Dividend Consistent Fundamental (CDCF) basket (which is the SAARC asset class as described in a later section) also has

Where SAARC Is Now: Products, Corporates, and Correlation

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low correlation with the Emerging Market (EM) and Frontier Market (FM) indices. Since these indices are overweight on China, Taiwan, Korea, Kuwait, Nigeria, and Brazil, it indicates the CDCF basket has low correlation with these markets. Conversely, the basket has high correlation with ASEAN index, which is overweight on Singapore and Malaysia, indicative of the deeper linkages between the two regions. Dow Jones SAFE 100 Index, the index representing the South Asian region, is reasonably correlated with the EM and FM indices, unlike the CDCF basket.

CHAPTER 3

Where SAARC Can Reach: Showcasing its Main USP Where this market can reach depends on the economic opportunity that unfolds in SAARC. The best way is to compare its projections relative to peers and showcase this as its main USP to investors for evincing interest in the region and the SAARC asset class. This section includes extrapolations of key Market Indicators, and a relative comparison of Economic projections of its GDP, Savings, Capital formation, and Income distribution. Market indicators: International Monetary Fund (IMF) and Bloomberg data show that while India comprises 79% of the SAARC region’s combined GDP in 2014 (i.e., the six larger member countries of SAARC), it comprises 91% of the region’s combined MCap. This is way low in Pakistan, Bangladesh, and Sri Lanka, indicating they need to enhance listings and capital raisings. MCap:GDP indicates the market depth relative to economic size. Share velocity ratio, which indicates volume participation relative to market size, is low in all markets, especially Pakistan and Sri Lanka. If we extrapolate the projected GDP of 2020 with these ratios, the combined market cap of these six member countries can be $3.0 trillion by 2020. But MCap:GDP should ideally increase with deeper market interest. If this were to increase by 30% from current levels, the estimated market cap as of 2020 can be $3.8 trillion. In the same manner, trading turnover can become $1.6 trillion or $2.7 trillion respectively by 2020, if not more.

Projected growth in GDP from 2014 to 2020 is highest for SAARC versus other regions: IMF’s country-wise projections show SAARC outpacing others in terms of Real GDP during 2014–20, i.e., in the production of goods and services. SAARC ex India ranks second, highlighting that the other economies are on a growth-performance trajectory. IMF does not Capital Market Integration in South Asia. DOI: http://dx.doi.org/10.1016/B978-0-08-101906-1.00003-6 Copyright © 2017 Elsevier Ltd. All rights reserved.

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Capital Market Integration in South Asia

cover forex prediction for Pakistan, hence its projections are based on 2014 exchange rate. Its numbers can be better if its exchange rate turns favorable during 2014–20 with efficient management of the economy and improvement in outlook, which can lead to higher foreign investment inflows and increased supply of US$.

SAARC’s growth ranks highest even in terms of Nominal GDP, not only in real GDP. Nominal GDP has its relevance in this context, as we are showcasing the equity/debt investment opportunity in these countries. Equity/ debt performance is a result of the company’s profits/EBITDA, which is derived from the revenues. Revenues can be impacted by both price and quantity, wherein price is an indicator of inflation in that country and quantity is an indicator of the increase in real production. Difference between nominal and real GDP is this price factor (inflation), which is relevant when showcasing an equity/debt investment opportunity of local companies.

Not only is the growth higher, SAARC’s projected GDP Compounded Annual Growth Rate (CAGR) in the next 6 years will

Where SAARC Can Reach: Showcasing its Main USP

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exceed the historical GDP CAGR of the previous 6 years, both in terms of real GDP and nominal GDP. This differential is even wider in case of SAARC ex India. No regional group but for BRICS, Next-11, and East Africa is set to see a significant positive differential, not even ASEAN, the Asian regional peer. Nevertheless, BRICS would be impacted by slowing growth in China, Brazil, and South Africa. ASEAN would see high growth in Myanmar, Vietnam, and Philippines, but these comprise a small proportion within ASEAN. East Europe ex Russia would see a pickup due to revival in the former-Yugoslav republics. Exchange rate projection for Pakistan, SAARC’s second largest economy, is not available with IMF. Hence, its estimations are based on 2014 rates. If its exchange rate moves favorably with efficient management of the economy, then its GDP projection in US$ terms may be better.

Growth is not sufficient; what also matters is the Size created: Size creates the rationale to invest big time in that market, as it offers economies of scale and operational efficiencies. The incremental GDP that would be created in the next 6 years is the largest in SAARC, after only BRICS. BRICS ranks highest owing to China’s size. BRICS ex China, on the other hand, is far lower due to pressures in Russia. No other group, not even ASEAN or Next-11, would create the sheer economic size as SAARC. Second, SAARC has a locational advantage in terms of exploiting value-chain opportunities to enhance its economic prospects even further. Next-11 comprises countries which hardly have any proximity or synergy with

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Capital Market Integration in South Asia

each other’s economies. The argument against SAARC is that it does not have deep economic ties among its members, and hence the scope for joint projects is limited. But neither does Next-11. But at least this can become possible in SAARC.

GDP is not sufficient; what also matters is the Savings pool: Ultimately, it is the savings that would flow into investments. Using IMF data for proportion of projected gross savings to GDP, we estimate the savings pool in these regions as of 2020. The size of the bubble in the graph below denotes the size of the savings pool in $ billion as of 2020. Apart from savings size and growth, we also look at the savings to GDP ratio which is the savings rate. Savings rate is crucial since it has a double benefit; not only is GDP increasing leading to savings growth, but the proportion saved is also increasing. Quadrant 1 in the graph denotes regions which would see high CAGR in savings, but the savings rate is a bit lower. Quadrant 2 shows regions with both high savings growth and savings rate. Quadrant 4 has low relevance in terms of savings (and hence, investment flows).

Where SAARC Can Reach: Showcasing its Main USP

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Growth in savings is among the highest in both SAARC and SAARC ex India. But SAARC is in Quadrant 2 due to India’s higher savings rate. While SAARC ex India will also see high growth in savings, it is in Quadrant 2 because some of those countries, especially Pakistan, have a comparatively lower savings rate than India. In fact, the current savings rate of Pakistan is a glaringly low 13%. This needs to increase, as it indicates that much of the economic value created finds its way elsewhere and is not channelized into domestic savings. This has to be reversed, given Pakistan’s weight within the SAARC economy. If the propensity to save increases with penetration of further savings products, SAARC ex India can also move closer to Quadrant 1. The outcome is largely similar even if one looks at the Savings from the perspective of nominal GDP. The savings pool as of 2020 in this case would obviously be higher in all regions owing to the impact of inflation. Growth in savings remains among the highest in both SAARC and SAARC ex India, just like in real GDP’s case. Since the same savings rate percent was applied to calculate the savings pool as in real GDP’s case, the country-wise savings to GDP will remain the same. But the savings rate for the entire category may be marginally lower here owing to varying inflation rates in the member countries. That is why SAARC has moved slightly into Quadrant 1 in the case of nominal GDP, as compared to that in real GDP. Inflation in almost all SAARC members would range between 5% and 6%, as of 2020. Nevertheless, the opportunity pool is immense.

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Capital Market Integration in South Asia

GDP and Savings are not sufficient; what also matters is the Distribution of Income: Countries where the income is more equally distributed signify that the purchasing power is spread over more hands, hence indicate higher volumes—be it for consumption or savings/investments businesses. United Nations Development Programme (UNDP) data shows that SAARC nations have a lower average Gini’s Coefficient (which measures relative equality in income distribution) as compared to other regions. The regional average is based on a simple average of the country-wise coefficients, not a weighted average; hence may not be a complete representation. But, it gives an indication, nonetheless.

GDP, Savings, and Income are not sufficient; what also matters is Investment (capital formation): Investments are the foundation of economic activity and hold the future for creating further jobs, income, and savings. An economy may see high growth today, but if it is not investing into creating future capacity, the expected growth will remain stunted. Moreover, one should note that millions of graduates are emerging across developing countries each year, with the increasing thrust on higher education. All of them have aspirations and ambitions, and the lack of adequate job opportunities enabling them to realize those aspirations and ambitions can eventually lead to social discontent and unrest. Many developing countries world over are already seeing a glimpse of this. Thus, investments for future growth is not an option, it is a necessity.

Where SAARC Can Reach: Showcasing its Main USP

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Using IMF data for proportion of projected investment to GDP and real GDP, we estimate the capital formation between 2014 and 2020. The incremental investment in SAARC is one of the highest, reflective of the growth in Real GDP and its incremental size, as seen in the earlier graphs. Next-11 is only marginally ahead. BRICS is ahead, but BRICS ex China ranks way lower. Even ASEAN would see lower investments than SAARC. SAARC ex India may be smaller in size, but those countries will see an even higher rate of capital formation than India. Same results are visible if one analyzes the same using nominal GDP. Next-11 is set to outpace SAARC in terms of capital formation as per nominal GDP, while it was not much higher as per real GDP. This is indicative of the higher inflation levels in Next-11 countries like Nigeria, Egypt, Turkey, etc. Moderate inflation is good as it provides the incentive to produce more; however, a very high inflation can be counter-productive to businesses dependent on disposable incomes and savings, which capital market and financial services business are.

Purpose of this section was to showcase that SAARC’s economic projections relative to other regions is the main USP to look at SAARC as an investible opportunity. The first task for any stakeholder is to pitch this economic opportunity. This relative economic performance is the best USP to use to catch the attention of local/global investors, especially when hardly anyone is looking at SAARC as an asset class as of now. Just pitching the possible products is not sufficient; pitching the economic reason to look at SAARC itself is also needed.

CHAPTER 4

General Precursors for Regional Financial Integration The fact that higher trade volumes between members have some correlation with the flow of financial capital between them has been long accepted. Trade interlinkages create “awareness” of the other market, which is a necessary imperative for monies to flow to facilitate payments and also to get investors interested in investing in that market. The “economic motivation” created by trade flows, where both the countries want each other to prosper for their own mutual benefit, leads to an inclination to take the relationship to the next level by way of investment flows, provided the investor profiles, market maturity, and savings quantum provide a rationale. A number of examples exist where deepening of trade interlinkages pushed financial interlinkages, like in the European Union, ASEAN, etc. Inter-SAARC trade flow is a very small portion of the total trade of the member countries. That may mean low awareness of each other’s markets/economies; and low motivation in hoping for the other’s prosperity till inter-SARC trade flows gets a boost. Increased linkages give a motivation to maintain peace, if only to protect your investment. Without economic motivation, the members will always be susceptible to bickering. A fair mix of economies at various stages of economic development creates opportunities for interlinkages, since one member demands something which another member can supply. On the other hand, if the members are at pole-ends of development, then it can be counter-productive since the smaller economy feels dominated by the bigger one, leading to altercation and failure of integration. If all members are at similar level of development, then interlinkage opportunities may be fewer assuming both countries are in same boat in terms of demand and supply. This is where SAARC is similar to ASEAN, with a fair mix of countries in various stages of economic development and financial market evolution. It is good that SAARC, just like ASEAN, has members falling somewhere in-between, since one country needs something that other might have to reach the next level of economic development. Each member country has Capital Market Integration in South Asia. DOI: http://dx.doi.org/10.1016/B978-0-08-101906-1.00004-8 Copyright © 2017 Elsevier Ltd. All rights reserved.

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achieved something in respective sectors which can be useful learning for the other members. Cultural links like diaspora settled in another country and involved in the local business community there also results in increased investment links. For example, Chinese-origin people settled in South East Asia and involved in the local business communities is a reason why such a strong awareness of each other’s markets exists, possibly resulting in higher China– ASEAN trade flows as well as China–Singapore financial linkage projects today. Similarly, Indian-origin people settled in the United Kingdom and involved in the local business community resulted in strong awareness of the market, and possibly for the United Kingdom becoming one of the highest recipients of India-outbound foreign direct investments. Currently, the diaspora from SAARC countries settled in other member countries is minimal. There are some Indians working in Bangladesh, etc., but most are temporary workers rather than people settled and involved in local businesses. SAARC needs to encourage more people-to-people connect, especially for business purpose and knowledge-sharing, so that local business sectors help create awareness of each other’s markets.

CHAPTER 5

Observations Specific to SAARC: Precursors to Consider Some observations come out while looking at the current state of SAARC economies and its capital markets. These have to be kept in mind while working on projects, so that the final outcome is realistic based on the region’s specific opportunities and challenges. Also, some of these are necessary precursors if any product idea based on integrated SAARC capital markets is to be realized, otherwise they can become challenges for implementation.

5.1  COUNTRY-DRIVERS LIKE DEMOGRAPHICS, CONSUMPTION, PRODUCTION, ETC. Young demographics with a relative absence of long-term social security benefits—thus, a longer earning life with a search for long-term, inflation-beating investment products: Most SAARC members have this common trait—a natural opportunity. The average age in the countries is only in its 20s–30s. This means the population can work for more years and has more years to save from incomes. Moreover, this is a region where long-term pension benefits are minimal while healthcare costs are increasing due to early diagnosis and lifestyle illnesses. Given the high inflation and near absence of long-term security benefits, people in SAARC have to actively think about saving in long-term, inflation-beating investment products to increase their own purchasing power and secure their own healthcare costs (and mental peace). The challenge in creating long-term investment avenues in the SAARC member countries is that most of the smaller markets are still restricted in the number of investment options they can offer to their citizens. The investment avenues have to be broadened to include regional economies since they may also offer additional investment options. Capital market integration projects is a definite way to bridge the gap between investor’s access to multiple investment products and mobilizing more local savings into long-term investments, and this message has to be pitched to the members. In this context of demographics, the integration of SAARC capital markets can open up a new universe of products for savings and investments. Capital Market Integration in South Asia. DOI: http://dx.doi.org/10.1016/B978-0-08-101906-1.00005-X Copyright © 2017 Elsevier Ltd. All rights reserved.

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Striking a fair balance between being a Consumer base versus Production base: Today, the world is looking at South Asia because it is one of the largest consumer bases. It has large population countries, each with a sizable middle class whose incomes and aspirations are growing. However, inflation is also high. Capital markets have to deliver inflation-adjusted returns, so that the households’ disposable income grows. For purchasing power to increase, it is better to save and then spend; rather than spend without saving. The savings habit of the region has to be deepened, as only then will it create demand for investment products. At the same time, it is equally important to leverage capital markets for access to capital, so that local businesses can produce more. South Asian capital markets need to channelize the monies available locally into capital raising through cross-border fund raising. Increase in capital investments will increase the production power to supply more goods and services and cater to the consumption demand. This would have a multiplier effect: As local production gets a boost, it fuels job creation, income generation, and purchasing power, thus incentivizing further investments into capital markets for increasing production. Both production and consumption are needed to turn the economic engine of the region. Increased capital access and consumption may help take the regional economies to the next level, and this can create opportunities for investors and companies in our countries which capital market projects need to tap. An opportune time, given the focus of SAARC governments on economic development: Most members have seen new governments in recent years, who have all spoken a common agenda of economic development. It is an opportune time to translate this into opportunities for deepening the regional capital markets. An objective of financial integration is to ease the flow of capital from one who has it to the one who needs it. Companies listing to raise capital would prefer markets where subscription can be higher. Integration can give a boost to local business expansion, thus aiding economic development. Moreover, this does not entail the constant need to become indebted to external assistances from multilateral or bilateral loans. Incomes from investment returns can also assist economic development by increasing the purchasing power of the people, apart from mobilizing local money into opportunities within the region without it getting parked overseas.

5.2  GETTING AROUND THE GEOPOLITICAL MISTRUST Bringing in an anchor partner to convert this challenge into an opportunity: SAARC’s main challenge has been geopolitical mistrust and the resultant

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lack of will between certain members. These are realities that new products have to keep in mind, since otherwise any discussion would be unrealistic utopia. The best way to smoothen geopolitical hostilities is to bring in economic benefits. Globally, economic benefits have been the best motivation in creating bridges of progress between politically and ideological opposites. It might be worthwhile to involve a partner which holds sway with the SAARC countries individually. The rationale is that some SAARC members may be disagreeable on the proposed projects because they see better rationale in partnering with an outside country rather than with fellow members. No country has an economic motivation to root for the progress of SAARC as a whole, though they may have linkages with individual members. But there are countries that are now looking to earn from overseas investments. Why not involve such an outside partner in the project in a way that it gets an economic motivation to see SAARC prosper as a whole? Given its bilateral economic linkages with the SAARC members individually, it may hold some sway over the individual members. Disagreeable members may then work on the areas of differences with dedicated timelines to achieve resolution, as they now see their important bilateral partner rooting for SAARC’s performance as a whole; and they may not want to upset it in case it spoils their bilateral ties. Such an influential partner may hasten the process of all members mutually agreeing on the projects, which benefits SAARC in any case. The partner earns investment returns from SAARC’s future economic potential, which is its main motivation. Who will such an anchor partner be: Such a country has to be one with (1) strong economic partnerships with SAARC members individually, (2) has government/institutional-backed entities involved in investments businesses, and (3) is eyeing earning investment returns from making overseas investments from its forex reserves. Given these criteria, Asian countries like China, Japan, or South Korea come to mind, apart from Western countries like the United States, the United Kingdom, or Germany. All of them have economic interests in varying degree with most of the SAARC members individually and may hold sway over them to an extent. If any of them do participate, they can gain by investing in the capital markets of a resurging SAARC economy. That does not harm its bilateral economic projects with the individual members, hence should not be perceived to pose any threat to its bilateral projects. If at all, it is gaining a new avenue of investment returns from SAARC asset class.

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Will SAARC members be agreeable to rope in an anchor partner: SAARC members may resist inclusion of an influential nonmember like China, Japan, or the United States, due to fears that it will influence regional decision making. However, one can draw the lines on the roles and responsibilities in the Memorandum of Understanding (MoU) at the initial level itself, making it clear that the role of such an anchor partner is only as a pure-play investor in the SAARC asset class. It invests money and earns returns. While this is easier said than done; however, any integration project in SAARC will always face headwinds given that economic interlinkages between the members are still low as compared with their interlinkages with others which house outside of this region. Hence, the economic motivation of many members to agree on SAARC projects is minimal, which does not benefit SAARC either. However, by getting an anchor partner, those members who are more receptive to China, Japan, the United States, the United Kingdom, or Korea, may become more agreeable on SAARC’s projects since now their larger bilateral partners have an economic stake in the region as a whole, and they may not want to upset their bilateral ties. This suggestion may be one way to get around the geopolitical bickering and seeing the project to completion, although this is still not a fool-proof solution. In the worst case scenario if no agreement is at all possible, SAARC may also explore projects on a bilateral/multilateral projects basis, so that other members do not suffer from frozen projects just because of few bickering members. China, Japan, or the United States may need this proposal as much as SAARC: It is important to remember that all these nations are also seeking external investment opportunities today, to offset to their domestic slowdown to some extent. Hence, they may have an interest in a SAARC project if it can yield attractive investment returns eventually. Let us take China’s case, since China is a disproportionately large bilateral partner of certain SAARC members. China is seeing some slowdown as increase in wage rates led to some global manufacturers shifting production to Myanmar, Vietnam, or Bangladesh, where labor is cheaper. China’s still remains a costeffective production hub since many manufacturing sectors involve clusters which house ancillary products related to its supply chain. So while some production may migrate, the clusters cannot migrate easily and may remain in China due to proximity to its holistic supply chain. Nevertheless, it is true that the Chinese economic engine is slowing marginally, and it is turning to invest part of its $3 billion plus forex reserves in overseas projects and realize investment gains. Moreover, it has internal challenges as some high-yield financial products of the provinces are in danger of default.

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China has already shown its intent toward overseas investments, with investments in the One Belt One Road Silk Road fund, BRICS’ New Development Bank, and the Asian Infrastructure Investment Bank, apart from large bilateral investments in several Asian and African nations. While some of these are of strategic importance for it, an investment in a region like SAARC may add value to its investment portfolio. SAARC is one of the fastest growing economic regions, and investors can gain from its economic growth. In any case, most countries, including India, are courting China today to get a slice of its monies as inward foreign investment into their countries. This proposal is simply an extension of that push itself. The SAARC asset class product may be worthwhile option for Chinese fund managers through their QDII quotas, if their regulations permit that.

5.3  BUILDING AWARENESS AND GETTING ACCEPTANCE FOR A SAARC ASSET CLASS Build awareness of each other’s economies among the region’s local investors: Level of awareness of SAARC economies among local investors in the fellow member countries is still low, in terms of sectors of opportunity, drivers of growth, and areas of competitive advantages. Most local investors are coming to terms with their own markets and opportunities, apart from becoming aware of those countries from where most of their foreign investment and trade inflows primarily come from. Capital market integration projects have to first build awareness of the economies among the region’s investors through knowledge-sharing initiatives, thematic publications on emerging opportunities, and roadshows of the regional companies in other countries. Liquidity is the main concern for smaller exchanges, but will they lose business due to integration: The impact on liquidity caused by the lack of investor depth is a primary concern in many smaller exchanges. Lower liquidity results in higher market impact costs and volatility. Integration of the regional markets can open up the local securities to a broader array of investors, thus generating more liquidity and investor depth in the highquality stocks. This is a key reason to build acceptance of integration, in the smaller exchanges. However, cross-listing of stocks in other markets may mean that some volumes move to the more liquid exchanges. Thus, opening up of markets may face resistance from the smaller markets. However, integration would also broaden the access of local investors and intermediaries of the smaller

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exchanges to regional products, and this can offset the loss mentioned earlier. Moreover, access to more products can help deepen the local markets further. In any case, those profiting from the current fragmented markets will oppose any integration, since they would lose their advantage in a market skewed toward their vested interests. However, this argument is entirely based on the level of competitiveness. If the local market is uncompetitive, they will always fear losing business. Markets with weak institutions and policies may see outflow to those with sound policies and institutions. Closing itself to foreign competition may keep the local market protected, but it also ensures their investors are buying at higher prices or taking more risk. To address their concern, the potential activities mentioned also include consulting services to bring the smaller markets at par in terms of products and infrastructure. Second, the integration can be on a common platform where all the regional exchanges have stakes. Becoming competitive does not necessarily mean business flows out; however, remaining continually protected will ensure the local market never really expands beyond a point. Single-stock/country exposure versus a diversified SAARC exposure to reduce initial risk perception: Investor communities of most member countries are yet to become fully aware about each other’s economies, sectors of opportunity, drivers of growth, and areas of competitive advantages. Given the information opacity, a diversified exposure may be better to explore initially. A single-stock/country exposure can be perceived as riskier. Deeper awareness is a precursor to accept products based on a single security/ country. Even institutional investors follow this—as entire emerging market (EM) or frontier market (FM) funds get launched before countryspecific funds. Hence, it may be more practical to go top–down and create acceptance for diversified regional products, as they can reduce the risks of single-stock exposure. As awareness builds and identifying individual stocks becomes easier, investors may become more open to single-stock/ country exposure. Separating out the product structure at the country level: An integrated product may be delayed if a single entity has to operate with retail investors of multiple countries. Guidelines governing money transfer, maximum dollar investment permissible overseas per country, etc. vary significantly among SAARC members. Separating the structure at the country level may make this process easier to manage and make it easily accountable at the level of each country. Cross-border integration would still require a common entity pooling monies, but institutionalizing separate country-wise

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structures might make implementation easier. Also, this might make the project implementable among a few members even if the remaining members are unwilling. Such a multilateral approach will be opposite of SAARC’s unified approach. However, keeping the structure flexible ensures the entire project does not get frozen even if some members remain disagreeable. Once the remaining members see the initial success, they may drop their resistance and be motivated to join. An alternative is to establish the common entity in a jurisdiction outside SAARC. Singapore houses many South Asia-focused funds and has a mature regulatory framework. That may make the process of harmonization easier since the regulations for integration can become slightly separated from each country’s regulations. It may reduce resistance if members feel the one housing the common entity is benefiting disproportionately. Apart from the investor community, connect between companies of SAARC is also minimal: There is no point of talking about trade and investments, when connect between the region’s companies is still low. A number of initiatives have been taken to connect businesses by the governments and industry associations in the member countries; however, it has yet to translate into business volumes on-ground. Regional value-chain opportunities can be a useful approach to connect businesses due to mutual gains, in case pure trade continues to see resistance due to the fear of local businesses losing to imports. Even tourism flows to neighboring countries are low, barring India–Sri Lanka or India–Nepal tourism volumes. It is still cheaper to fly to South-East Asia or Middle East, rather than to some SAARC neighbors. Lack of people-to-people connect has impacted the awareness that the people have about each other’s markets, and hence acceptance of products based on those markets. Reversing this mind-set is a necessary precursor to build acceptance. Can it get the attention of retail or institutional investors, or is an anchor investor needed initially: Initial retail and institutional interest can be low, since the acceptance of a SAARC asset class is low among institutional and retail investors. Retail investors are looking at their local markets now, with the exception of few US/Europe focused funds in India. Institutional investors may have better resources to build awareness of regional opportunities, but acceptability of the SAARC asset class may be a challenge with them too initially, as they are comfortable looking at EMs and FMs separately. Moreover, foreign funds are averse to additional registration processes as it increases the need for compliance, etc. In case the SAARC project requires them to register afresh, it may see resistance for additional

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registration. In such cases, any SAARC product may garner only minimal assets initially, as investors may prefer to wait-and-watch while building acceptance. If interest is low initially, getting an anchor investor on board might be worth thinking. Moreover, since SAARC is a cross between EM and FM, marketing the SAARC asset class may require an anchor from a country which has bilateral economic interest with the SAARC members, hence has a motivation to root for SAARC’s growth, as a whole. The ideal anchor investor might be a Sovereign Wealth fund (SWF) or Pension fund from China, Japan, the United States, the United Kingdom, or Korea, as they all have either SWFs or pension funds. Moreover, pension funds and SWFs have a long-term philosophy, which may be needed in SAARC asset class, as a buy-and-hold value philosophy would better placed to capture the economic value of this region, which may be realized only in the long term. An anchor partner with strong bilateral ties may make SAARC members more agreeable, while it gets an opportunity to earn investment returns, without losing its bilateral income from the members. In this manner, as the anchor investor gives the first-push, it would give comfort to institutional investors to accept the SAARC asset class subsequently. That, in turn, would also help generate retail interest. Trade and foreign direct investment (FDI) flows within SAARC need to pick up, as a precursor for products based on SAARC financial integration: This is very critical to realize on-ground. Despite a lot of discussion and advocacy, intraregional trade and FDI volumes are still extremely low as compared with the overall trade and FDI flows of SAARC countries. Regional financial integration occurs best when there are trade and FDI flows, since the economic interdependency fuels financial flows. There may be cases for integrated products at a bilateral level, where acceptance is high. But while a bilateral project might be faster implementable, it would not be a SAARC product. Hence, boosting trade and FDI linkages will be critical for achieving integrated SAARC capital markets. ASEAN’s interregional trade and FDI flows are way higher. This was boosted by the integration of the regional production network and supply chains. Along with FDI flows, cross-border banking and mergers and acquisitions also picked up. The matured ASEAN economies moved up the value chain, from production to knowledge-intensive activities, thus spelling a transition from emerging to developed economy. India’s own trade links with East Asia deepened as a result of specialization in areas of comparative advantage, and there is no reason why the same strategy cannot be achieved for deepening SAARC

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trade and FDI flows, as long as the political will is there. SAARC has a lot of catching up to do, and that spells a significant opportunity. South Asia is set to become a high-growth economy, and this message has to be conveyed: We have already discussed this rationale in a separate section earlier. Many will question the logic for a SAARC asset class, as most foreign institutions look at EM and FM separately in their asset  allocation. The best way to counter these is by showcasing the growth potential. SAARC is set to become one of the high-growth economic and savings regions, while having low correlation between the members. Moreover, the young demographics in this region means the economic growth momentum would sustain longer. In comparison, the rest of the developing world is aging. While there may be countries in other regions who may see high economic growth, these outliers may not boost the growth of the entire region as a whole, as compared to SAARC where most of the members are set on a high-growth trajectory.

5.4  GROWING INTEREST INTO EQUITIES, FROM BOTH INSTITUTIONS AND RETAIL Cross-border private investment flows are at highs globally, but not within SAARC: Recent years have seen an increase in cross-border private investment flows globally, as global investors have been seeking better yields. Post-2008 easy monetary policy by Western economies reduced yields in those countries while increasing the flow of liquidity, most of which found came to EMs in the search for higher yields. There was also a demand by global institutions for portfolio diversification in the wake of the risks highlighted by the 2008 crisis, and an exposure to EM and FM in the portfolios helped this. These factors were aided by the improving economic performance and growth potential of these economies. Resultantly, asset flows into EM and FM funds increased. In India itself, several global funds from across geographies have bought Indian equities on the local stock markets by registering with the Indian regulator. This influx of foreign capital into the Indian markets has been intrinsic to the growth of India’s equity volumes. Today, almost 20–25% of the $800–900 billion total volumes traded in Indian cash equities segment is by foreign institutional investors. About 20% of the $12–13 trillion total volumes traded on the Indian futures and options segment is by foreign institutions. By these, one can gauge the exposure that global funds have in the Indian markets. Estimates suggest that more than 20% of the shareholding of the

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companies listed on the NSE is now held by foreign institutions, and they comprise the second largest group after the promoters. However, cross-border flows are not visible between the SAARC markets themselves. A key precursor is to establish guidelines on payments and capital movement between the countries. This requires involvement of the central banks and the local banks. SAARC has been working toward this through the SAARC Finance group of regional central banks. However, private investment flows within the regional markets are yet to pick up. Given that the South Asian economies are expected to offer pools of opportunities for investors, it may be an ideal time to deepen intraregional capital flows by easing partial capital account liberalization, etc. Low correlation between regional countries may help portfolio diversification and volatility: Investors value diversification as much as returns, even more when the financial world gets hit by crises. Diversification is a useful way to reduce risk if the holdings have low correlation to each other. The downside of one is offset by the upside in the other; as compared to portfolios which has holdings with high correlation to each other. Most South Asian economies are driven by domestic consumption and exports from certain sectors of competitive advantage to Western markets. Domestic consumption is driven by increasing purchasing power, aspirations and demands, and propensity to consume. This consumption is decoupled from global events and would have low correlation unless the products are imported and the local currencies are weakening, or the creation of jobs to support the income growth is largely dependent on foreign investments. Exports are based on competitive advantage, hence unless competing countries develop their competitiveness in those sectors or the demand from export markets tanks, it will also have low correlation with the world. As long as the nation can maintain its competitiveness, it will win export orders ahead of competing peers. South Asian economies may have low correlation with each other, and this is a key aspect that capital market projects must pitch. However, as regional economies become integrated, the correlation might increase. Dividend and interest income earned from the country’s equity or debt investments in regional economies would be impacted by their performance, and lower income earned might impact demand for products here, and so forth. Nevertheless, increasing the access to regional capital pools may make the SAARC economies less susceptible to the possible flight of Western capital in the event of sustained rate hikes in the United States and Europe.

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SAARC asset class may boost introduction of further country-specific South Asian frontier funds: Foreign institutions have separate asset  allocations for EM and FM. Currently, assets into FM funds are way low as compared to EM fund assets. Moreover, in-line with the experience of EM funds where entire EM funds (like EM funds, Asian EM funds, Asia ex Japan funds, etc.) preceded country-specific funds (like India funds, Thailand funds, etc.), the country-specific funds for individual FMs are also yet to increase substantially. Most frontier funds are entire FM funds, and country-specific funds form only a fraction of this. Since SAARC has more FMs, a SAARC asset class might generate further investor interest in the South Asian FMs and help hasten the process for further country funds for Bangladesh, Pakistan, and Sri Lanka. This is a reason why SAARC ex India markets should look favorably toward adopting a SAARC asset class. Not only would they receive higher inflows as the region as a whole gets more acceptance, as compared to what they would have received had they been marketing themselves only as a frontier asset class; but the journey toward launching of further country-dedicated funds for these South Asian FMs might also become quicker. Acceptance of equities as an asset class for investment is slowly increasing in this region: This is contrast with the traditional preference for physical savings and bank deposits, and partly owing to the search for inflationbeating returns and increasing awareness about equities. Since most SAARC capital markets are largely restricted to vanilla cash equities, much of the discussion on integration will be on equities only. Stock markets have emerged as a major channel for mobilizing capital due to public offers by the local companies, creating market depth. Several Indian blue-chip companies have gone global and listed on the exchanges in the United States, the United Kingdom, etc. to leverage on the investor demand in those evolved markets for high-potential local equities. Leverage on online/mobile platforms across the customer value chain: Online and mobile platforms are being promoted in most of the markets of the region, be it for stock trading, mutual fund investing, or trading in F&O. It is a cost-effective method to service clients across the length and breadth of the country without the need to invest into full-scale branches everywhere. To the client, it gives the convenience of location and time. The regional capital market sector needs to build further online capabilities across the customer value chain, including in lead generation, customer need fulfilment, delivery of trading services, product promotion and comparison, educational materials and guides, portfolio reporting, and client

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queries. The sector also needs to understand from technology companies the emerging trends of digitalization in the capital markets space. Any capital market integration will have to take into account that the delivery of the product/services can be translated into the online platform, and how such platforms can help them gain scale. Allow more Mergers & Acquisition (M&A) among regional companies for value chain creation: M&A typically involves companies which can add synergies and thus, create more value than the sum of its parts. Since the transaction size often involves large stakes in the company as compared to pure minority investments, M&A is a practical way to encourage sizable FDI flows. The search for value creation through forward, backward, or lateral linkages leads to better performing companies and is a major driver for M&A activity. Backward linkages mean aligning with supplier firms, forward linkages mean aligning with client firms, and lateral linkage means creating a wider array of product offerings. Given that SAARC countries like Pakistan, Bangladesh, and Sri Lanka do not have enough large-sized companies in their own markets, M&A can be useful way to create larger enterprises. More number of large companies in the local markets will automatically have a bearing on the level of market activity by investors, for whom the universe is currently quite restricted. It is also useful when the current promoters of the company have exhausted their strategic inputs in taking the company forward in a dynamic market, and the infusion of fresh ownership may bring fresh strategic ideas. That would bode well for the business and its stakeholders, and better than becoming a company bleeding to near-bankruptcy. The country of the company being acquired may fear flight of profits since the ownership now rests with a foreign entity. However, the country may keep foreign ownership within prescribed limits. It can also set an approval process for foreign buyers to check that the profile of the acquiring company is not against its strategic interests. Currently, M&A within regional companies is almost negligible. While joint ventures do exist, increasing M&As may reap significant dividends for SAARC companies in the years to come.

5.5  LOCAL MARKETS’ MATURITY HOLD CHALLENGES, BUT OPPORTUNITIES TOO Creating additional sources of volumes through arbitrage trading: Traded volumes are generated by a number of methods, other than just vanilla buying and

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selling of stocks listed on the exchange. Arbitrage trading help generate additional volumes. If a stock is listed on the local and a foreign market or in the cash and futures markets, and both these counters are equally open for investors to participate in, then a price differential between the two can offer opportunities for an arbitrage trade. In this process, the investor can buy in one market and sell in the other, or vice versa, and pocket the difference as trading gains. Arbitrage helps effective price discovery in the stock through the mechanism of demand and supply. This demand and supply ideally makes the prices converge, thus ensuring the lack of liquidity does not keep the price unrealistic. Futures offer another advantage. Many institutional investors have limits on the maximum exposure they can have on a scrip or sector in their asset allocation framework. There might be situations when a specific stock offers a compelling rationale to increase exposure; however the fund has already reached the maximum limit in the cash market. At such times, if the stock also has a future listed, then the investors can take subsequent exposure through that future while remaining within the asset allocation limits in the cash segment. Capital access through integration reduces the cost of capital and extent of capital raised: Financial integration eases the flow of capital from where it is in surplus to where it is scarce. Otherwise the scarcity of capital can push up its costs, which is detrimental for businesses keen to raise capital, which in turn, restricts their ability to expand. Access to multiple sources can help reduce the overall cost of capital, giving more elbow-room to businesses to raise additional funds to meet their needs, leading to higher capital investments which are intrinsic for economic growth and job creation. Also, listing in small markets may limit the funds raised due to a smaller pool of investors. Listing companies may prefer to raise capital in markets where subscription levels can be higher, which is beneficial as more resources can be mobilized. Extent of heterogeneity among the local markets creates a natural challenge: The regional markets vary in terms of investor profiles, product/asset class penetration, regulatory evolution, and mutual awareness. Most member countries are yet to launch equity futures, equity options, currency derivatives, commodity derivatives, interest rate derivatives, open-end mutual funds, and exchange-traded funds. The two most common products are cash equities and government bonds.This restricts the opportunities for integration. Deepen local product portfolios and interest, if acceptance is to be built in integrated products: The capital market sector needs to introduce new products

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and asset classes in the smaller markets and create awareness of them, with the objective to first deepen the asset classes within each country individually. Local investors have to become comfortable with new products within their own market. Local investors will be open to integrated products only when they are first comfortable in investing in such new product/asset classes within their own country. For example, if Bangladeshi investors are yet to invest in equity futures of Bangladesh companies, their acceptability of a SAARC index future will be minimal due to low awareness of the futures product itself. Hence, a necessity will be regulations to introduce new products and create awareness of them among local investors. However, the opposite may also occur—that is, the push toward integration first may actually give the eventual push for the local adoption of new products. Measuring the effectiveness of integrating the regional markets: Monitoring the integration projects by measuring capital flows, asset mobilization, volumes, risk-adjusted returns, correlation to global markets will help gauge their success. In projects where some members are unwilling to join initially for their own reasons, monitoring mechanisms will help measure the value created by those who went ahead with integration projects, and thus showcase that success to motivate the members who had opted out, to join in eventually.

5.6  REGULATIONS, GOVERNANCE, DISCLOSURES, AND PROTECTION Investor protection, credit ratings, and guarantees: Investor protection mechanisms need to be in place to handle crisis, misrepresentation by intermediaries and institutions, accountability in case of frauds, insider trading, and cross-jurisdictional cooperation. This includes strict KYC (Know Your Customer) filings to ensure the money flowing into the products is clean and not of doubtful origin. All these would help sustain investor interest in the long term. Credit rating for the cross-border listings and regional corporate bond issuances will be essential to develop investor interest. That may help filter out the companies with questionable governance and doubtful disclosures. A credit guarantee system to protect those providing cross-border credits, just like India’s credit guarantee for banks, may boost regional lending by protecting lenders from possible defaults. Strengthening corporate governance, financial disclosure, and taxation norms: Corporate governance standards in many local companies are a cause

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for concern. Basic norms relating to Board composition (including Independent Directors), maintaining quorum attendance, conducting of regular Shareholder, Board and Committee meetings, periodic disclosure of financials, hiring of External Auditors, etc. are sometimes evaded through allowable loopholes. This reduces the confidence of investors, which is a loss for the company. Strengthening of corporate governance standards can facilitate an attractive investment climate. Financial disclosures also have to be covered by leading global databases like Bloomberg, FactSet, etc., since sophisticated investors follow these databases for uniformity in the financial data methodologies. As of now, Bloomberg covers the corporate financials of only India, Pakistan, Sri Lanka, and Bangladesh. Varying fiscal year ends in these countries makes comparing annual numbers tough, hence even quarterly earnings need to be filed in time to ensure trailing-twelve month comparison using quarterly data can be done. Cooperation also includes taxation guidelines on capital gains and dividends, so that there are no negative surprises in the form of double taxation or retrospective taxes. That can erode the rationale of investing in a SAARC asset class. Cooperation mechanisms among regulators to avoid “only-discussions” with no “conclusion”: SAARC is not just about conferences and presentations. It has to implement actual outcomes on-ground if it has to succeed. Just discussions with no conclusion will help nobody. Since a harmonious regulatory framework is one of the precursors for capital market integration, there is a need to involve the regional regulators into cooperation mechanisms to share information and close out gap areas. If this cooperation is missing, then the regulatory framework will never get achieved, and implementation will be delayed. This might be easier if MoUs are signed between regional regulators for facilitating exchange of information.

CHAPTER 6

Potential Products and Activities For each of the potential products/activities, separate sections have been included on: purpose of the section what the product is all about its advantages its challenges the initial role stakeholders can play ●

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●

●

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Incubation for Start-ups for SME platform

Trading Link between major SAARC Exchanges

SAARC Master ETF with Country-wise Dual Feeder/ Investment CDCF Basket Funds Idea for Structure SAARC Asset Class Index Thematic Publications, E-Books, White papers, Inv. Frameworks & Roadshows

Turnkey Consulting Training & Eduation for new products/markets

SAARC International Financial Centre SEZ -(Singapore/SAARC)

Cross-Country Index futuresSAARC/Bilateral Indices

SDR CrossBorder Listing (IDR Listing) Solar Energy Bonds

Mutual Fund Passporting Scheme

Medical Tourism Insurance Product

Capital Market Integration in South Asia. DOI: http://dx.doi.org/10.1016/B978-0-08-101906-1.00006-1 Copyright © 2017 Elsevier Ltd. All rights reserved.

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6.1  SAARC MASTER ETF WITH COUNTRY-WISE DUAL FEEDER/INVESTMENT FUNDS Purpose of this section is to discuss a master-feeder fund structure using ETF and open-end fund concepts, to channelize monies from multiple countries into equities of multiple countries. It is like any foreign-equity based fund which is sold to more than one country, with a few tweaks in view of SAARC’s unique challenges. A mutual fund mobilizes savings from investors and invests it in securities in the capital market, depending on its asset class and securities weightage. An open-end mutual fund is open for subscription throughout the year, aiding asset mobilization on a continuous basis which helps the asset management company gain the scale of assets for profitability in this annuity fee-based business; while a closed-end fund is open for subscription only for a fixed period, restricting subsequent asset mobilization and hence, a heavy dependence on the sales during the initial offer period sales to create a viable asset size. An exchange-traded fund (ETF) is just like any mutual fund, except that its units are traded on an exchange and addition of fresh units follows the “creation-unit” concept since an entire basket of the underlying stocks have to be bought for requisite units. Most ETFs in the market today track an index passively, making it a cheap product. But the creation-unit concept makes it an expensive proposition if one wants to buy a fresh unit from the asset manager directly. Hence, subsequent asset mobilization (and creation of fresh unit) is largely restricted to institutions, as it would be unaffordable to most retail investors. Funds based on foreign equities require local investors to have understanding of the foreign markets and its pools of opportunity, hence it involves marketing and educating. Size of the savings pool in the target country and the outlook in the origin country are the main draw for asset management companies to even think of making products based on securities of the origin country for investors in the target country. It means the regulations on taxation of returns repatriated from the foreign holdings are in place, avoiding double taxation as that would eat into returns; apart from registration/compliance formalities in all the jurisdictions it deals in. Returns would be dependent on the exchange rate movements, as in any cross-border investment. Nevertheless, it is a practical way to give access to new markets and securities, to a wider group of investors.

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6.1.1  What is This? Funds based on foreign securities can be structured as a single fund which directly raises monies from multiple countries (like UCITS funds) and then invests in multiple countries (like any EM or FM fund). But raising monies from multiple countries into a single account directly has regulatory complications. Hence, the master-feeder structure is often used where individual country funds raise monies and then pool it into a single account from where it is invested (like offshore–onshore feeders). This helps address this challenge to an extent. However, SAARC has another challenge—which is of investing into multiple countries from a single pooled account. Given our geopolitical relations, SAARC’s challenge is getting acceptability for a fund product that integrates monies of all members into a common entity and then invests from that single entity into multiple markets. Multi-country funds which pool monies from different geographies and invest in different geographies assume that such regulations are in place. More importantly, it assumes the countries are comfortable in allowing a single entity work across all countries. In a region where member countries have often found it tough to arrive at a consensus on any joint-project, including in the financial sector, a single entity operating across all the countries may find garnering acceptance from investors, institutions, and regulators extremely tough. Even if one member is unwilling to participate with the other members in fundraising or investment stages, then it puts a freeze on the plan as it is a single entity at some stage—either in raising monies or in investing monies. Hence, the single fund entity can be broken into a master and dual feeder/ investment structure, wherein country-wise feeder funds feed the monies into the single entity from the different countries, and the investment from the single entity into different countries is done from country-wise investment funds—hence the usage of the term “dual,” as a dual feeder-investment fund structure works with the master fund. Such a master and dual feeder/investment structure may be comparatively easier to implement, although it is not a fool-proof solution in view of the specific challenges in this region. What this means is that the product structure is separated out at the country-level both in fundraising and in investment stages, and hence, the product can be structured only on those markets which have the regulations and acceptability in

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place. If one member is unwilling to participate, then only the fund pertaining to that member remains frozen, while those of the other member countries can still move ahead with the master fund. If that member wants to participate eventually, all one has to do is to “plug” its feeder and investment funds into the structure, that is all. If investors of one member are unwilling to invest into one specific market, then the fund may separate the investment fund of that specific market. Of course, this assumes the viability of the project remains. Basically, the way it works is that there is a feeder fund in each country individually collects monies from that country. In turn, the monies raised are pooled into a master fund. Thereafter, separate investment funds invest from that master to each of the target countries as per the normal weightage of the underlying securities (and the respective countries of those securities). These feeder funds raising monies are better off being open-end mutual funds, not ETFs. ETFs are restricted to those who hold broking accounts, which are anyway low in South Asia. Moreover, subsequent asset mobilization from retail investors is low in ETFs since the unit creation concept makes it an expensive proposition for retail investors. On the other hand, open-end mutual funds can be subscribed by any investor, irrespective of broking account. There is no unit creation concept here, and amount invested is only subject to a minimum ticket size. Hence, it is easier to add asset subsequently from retail investors. This is a very critical aspect as many investors may initially prefer to wait-and-watch as the acceptance of a SAARC-based product is still minimal, and many investors may convert only later after seeing the initial success. The purpose of an integrated product is to evince participation from as many retail investors across SAARC countries as possible. Hence, the fund structure has to accommodate this. Moreover, asset management is a business of scale if profitability has to be achieved, hence the structure has to raise the adequate asset size to become viable. ETF can be used for the master fund itself. This is because the features of an ETF enhance transparency and trading, thus helping in visibility of the portfolio, continuous reporting of prices, ease in trading in the product, and become a “SAARC asset class product” which is easily accessible to global institutional investors. Institutional investors have to be registered as Foreign Portfolio Investors in the market where the master ETF fund is registered and may not need registrations with all the individual markets since this is really a fund investment, not direct investment into equities. The Master ETF entity may be better off being registered in a geography

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which has higher number of registered global institutions looking at this region’s markets, if the SARRC fund product is indeed aspiring to be accessible to global fund managers as well. Singapore may be a practical choice here, since several portfolio fund managers are based there who are looking at these markets. Once all the monies have been pooled from the individual feeder funds into the master ETF, this money is invested into the respective markets as per the fund’s investing mandate and weightage. Exposure to multiple countries assumes that the regulations governing capital movement, money transfer, foreign investment limit (per country and per investor) are facilitative. Work may be needed to harmonize the regulations to this effect. More importantly, if investing across multiple markets from a single entity is a challenge given the current state of awareness (and acceptability) among local investors of the regional economies and markets, then it may be worth exploring if the process can be broken up into separate country-wise investment funds. This means the master ETF acts as a fundof-fund (FOF), and this FOF invests in each of the country-specific funds as per the weightage in its mandate. Once the relevant amount flows into that country-specific fund, that fund in turn invests in the local stock exchange and takes exposure to individual stocks of that country. Investment Manager in each of the country funds can be separate, which allows for local asset managers with expertise in local stocks to participate in the project in providing the local equity advice and local management of the respective feeder and investment funds. This means stakeholders in all the members can participate.

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6.1.2  Typical Investing Process in Cross-Border ETFs Since the ETF is listed on an exchange, any investor can trade in the units on that exchange via its broker. In this case, while the country-wise feeder funds feed their assets into the ETF, the local investors and registered foreign investors can trade the ETF units in their secondary markets. Large clients can buy fresh units from the asset manager (AMC) directly using the creation unit concept. The Authorized Partner (AP) is a key player, as they often act as a bridge between the AMC and the client. The client can approach the AP and place an order. Clients may pay cash for the purchase, or may transfer the basket of underlying to the AMC’s depository, or do a mix of the two. The AMC acts on the order only when they get confirmation from their operations that the cash/stocks are reflected in the client’s bank/depository account. The order is then sent to the respective brokers, who then execute it as per their trading times. The respective APs can buy the basket directly and transfer it to the AMC’s depository. On determination of the final cost of creation unit (based on prevailing exchange rates) and confirmation of net payment, the AMC will credit the equivalent units to the respective AP’s depository account in exchange for the basket and on to the investor. Units can be redeemed with the AMC directly. The client transfers units (via the AP) to the AMC’s depository and can be paid redemption proceeds either in cash or by delivery of the underlying basket to their depository. Creation unit is a fixed number of units of the ETF, which is represented by a basket of the underlying shares of the index. The AMC releases the information periodically on the cash to purchase this one creation unit. This basket may change periodically as the weights change. The price paid to acquire a fresh creation unit will also include the incidental costs related to the trades. Market Makers also play a role with the APs, helping provide liquidity to minimize impact cost, especially as the unit creation process here means large-sized trades. All settlement of securities and payments is done by the Custodian. They are typically the large foreign banks. The AMC and the brokers upload their respective trade files to the Custodian’s system, who matches these. ETF’s Net Asset Value (NAV) reflects the value of the underlying and the trading price reflects market’s interest. Any divergence can lead to arbitrage opportunities, which means creation/redemption of units till NAV and Price converges.

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6.1.3  Benchmark Index to be Used; and the Need for Earning Alpha When the Master invests into individual securities, the asset  allocation weightage may base itself on some index as a reference, which is what funds do world over, be it single-market funds or multiple-country funds. The fund may follow the index passively or may actively select specific stocks or go overweight/underweight in specific markets based on the fund manager’s discretion. Since the Master in this section is really an ETF and most ETFs passively follow a reference index, this SAARC ETF may similarly passively follow a benchmark. Whether it passively follows an established index, or a newly developed index basket itself, is the question? Dow Jones SAFE 100 Index is an index of this region since 2009 and tracks the 50 largest stocks trading in India and 50 largest stocks trading in Pakistan, Bangladesh, Sri Lanka, and Mauritius. Any ETF based on the index can help monetize it. However, a composition based on equal representation and capitalization may be insufficient to capture the value created by the region, given that the rapidly changing dynamics of the regional economies in recent years, which makes a case of active-management for asset allocation weights. SAARC is a long-term economic story, and there may be multi-baggers in the individual countries ideal for buy-and-hold value-investing which can get ignored by this index’s methodology. Second, the index might capture laggard stocks just because they are the largest, but they may not necessarily be high performers in coming years. Such stocks may pull down the potential performance of the ETF. Third, governance and disclosures in companies in the developing world may be improving, but is yet to reach the best levels. Hence, any index may inadvertently capture some bad-eggs from governance perspective, while a more active stock screening process may make it easy to avoid cases, even if the index includes it by chance. However, in a region which has inadequate acceptance as an asset class and has low mutual awareness of regional markets, the performance of the product will be king. Without performance, it may fail to evince interest from investors. With performance, all acceptance and awareness gaps can be closed much easily. That may be a rationale to allocate in a manner which can capture the region’s economic value and potential high-performing stocks, in order to deliver on performance and thus, earn alpha. Alpha will evince further interest from investors, thus adding to asset mobilized and help it move toward profitability. If the fund chases only beta, i.e., market returns, then it may not evince that extent of interest from investors. Given that

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the SAARC fund may see low initial acceptance, alpha has to be the incentive for investors to look at a product like this. In this context, the next section on CDCF Portfolio Basket Idea for the SAARC asset class may be a useful read. This portfolio is designed to deliver outperformance at lower/comparable volatility to the benchmark indices, as the Comparison tables show in that section. It captures stocks based on the track record of its performance. Such a basket can be registered as an index and then licensed to act as a reference for an ETF based on that asset class. We will not discuss further on the CDCF Portfolio Basket idea itself at this juncture, since the next section is entirely dedicated to this idea and readers can refer that section for further information on it. At this juncture, it is important to convey that while most ETFs passively follow an index, the index itself may be a newly developed and actively managed index. The ETF still passively follows the index, however the index itself is designed with the aim to achieve alpha over the market returns. For example, MOSt Shares M-50 ETF of India’s Motilal Oswal Asset Management was initially based on an actively-managed version of the Nifty-50 Index with the aim to beat the Nifty returns. If the SAARC Master ETF passively follows the CDCF Portfolio Basket idea as a reference, then it is similar to the M-50 example. Following an actively managed new index may enable higher returns than the market, by selecting the high-performing stocks from the individual countries. Such a basket will reward only merit and not its country of origin. Companies have to clear the performance bar if they want to be included, as only performance will help grab investor interest.

6.1.4  Need for Anchor Investor Who Can Give the First Push Any regional fund faces the hurdle of being accepted. Retail investors will feel they are better off sticking to home countries which they view as less risky. Global institutional investors are more familiar with the broader EM and FM asset classes. Any SAARC project may also face “resistance” from local elements with vested interests, apart from geopolitical resistance itself. Given this situation, there may be a need to bring in an anchor investor, from a country with bilateral interests with the SAARC members individually and is looking to gain from overseas investments. The anchor gains by the returns it earns from investing in SAARC as a whole, while the SAARC members gain by faster resolution and acceptance as the anchor country

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may have some sway over disagreeable members, if only to protect its investments. Resisting countries see a trusted partner joining hands, and they may not want to upset that partner who now has an economic incentive in the project. Using an initial anchor may also give retail and institutional investors comfort to invest into the SAARC asset class product subsequently.

6.1.5 Advantages Dual feeder/investment fund structure separates the fund entirely into country-specific pieces. Hence, if any member is not keen to allow regulations of regional monies investing into its markets, or it is not comfortable with a single entity working across all borders, then this structure can exclude that country. This structure does not freeze the entire project. As the countries opting out see the success that the participating countries see, they may be motivated to effect the necessary regulatory changes subsequently. If any one member wants to participate eventually, all one has to do is to “plug” its feeder and investment funds with the master fund. While priority must be to smoothen out the concerns which that member country has; however, if differences are absolutely unworkable, this structure does not hold the entire project at ransom. Agreeable members can go ahead with their country dual feeder/investment funds. A phased approach may not be bad actually. In fact, it may help test the idea initially and smoothen the initial teething troubles of the product step-by-step. Such a structure puts the onus of pushing for harmonizing of the regulations directly on each country. This is important, since this a region where the political will to enact joint-projects itself has often been questioned. It can be a useful way to get access to the high-performing stocks across this region and gain from the long-term value that these stocks can generate from the region’s economic journey in coming years. The structure of country-specific feeder/investing funds separates the corpus as much as possible, resulting in easier fund accounting. Transparency in fund accounting is another key criterion that can give comfort to investors. It eases the exchange rate conversion, calculation of risk metrics, and country-wise performance. The feeder funds are their own legal entities in the respective jurisdiction of that country. Moreover, the investment manager of each country fund can be a local AMC, hence ensures every member participates.

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6.1.6 Challenges Any master-feeder structure still requires a harmonious regulatory framework to allow cross-country investing and money flows; since there is still capital flow across countries in either a single entity investing or investing as an FOF into multiple country-specific funds. Hence, the regulations have to be in place. Know-your-Customer (KYC) regulations have to be uniform across the countries since monies are being raised, and investor protection is of paramount concern. Inclusion of dirty money into the project would be counterproductive to create trust and comfort of investors, be it retail or institutional. The structure of dual feeder/investing funds for each country adds to the paperwork involved in registrations and compliance, and a legal team may be needed to ensure adherence with regulations of all the members. Creating awareness and acceptability to invest across the regional markets will be a major challenge, and this goes back to the core need to pitch the rationale of the economic opportunity in this region. That will involve a lot of marketing and awareness initiatives, both to investors and institutions, as well as regulators. Volumes of the underlying stocks matter, as low liquidity of the underlying will impact unit creation process.

6.1.7  Initial Role for Stakeholders Advocating the common regulatory framework required for such a fund product to the respective regulators of each country has to be the paramount “advocacy” role. Till the time a harmonious regulatory framework is not adopted, the project’s implementation will be in limbo, or at best, implementable only in few countries. Educating the rationale of a SAARC product to each countries’ retail investors has to be the “educating” role. The region’s challenge is the low level of penetration of equity investing among the retail investors. However, broadening of the investible opportunities to include larger/ newer markets may become the motivation of retail investors from some of the smaller member countries to get interested in the project. Pitching this rationale to global institutional investors, especially from strategic countries that have a stake in South Asia’s economic progress, is where one may need to play an “investor relations” role. This includes engaging with potential anchors to get them interested and involved in the project. Apart from regulatory advocacy and investor awareness, one may also work toward “identifying” relevant asset managers of each individual

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country who have expertise in cross-country asset management so that the rationale can be pitched to them. However, finalizing the actual asset manager may rest on the respective governments in this case. Similarly, it may also work toward pitching the rationale to related parties like large custodians and brokers to get them interested in the project.

6.2  SAARC ASSET CLASS—SAARC “CDCF” PORTFOLIO BASKET IDEA Purpose in this section is to identify a portfolio idea to represent the SAARC asset class, by picking the top performing stocks of the region based on an investment framework. This can be the basis of SAARC products for local investors. Its quantitative criteria can also be translated into an algorithmic strategy for institutions. SAARC is a combination of EM and FMs in one basket, which have low correlation to each other. This gives it a cushion even if either EM or FM see a downside risk. Since it is in the same basket, the portfolio cost will be lower than a fund which switches between EM or FM. But such a fund may be rare as EM and FM funds are separate asset classes, hence they may not be able to switch in case of a downside risk in either market. Can there be a SAARC asset class? If ASEAN can aspire to create the ASEAN All-Stars Index, then so can SAARC! SAARC asset class can take the form of an equity index. Many foreign institutional investors follow popular indices tracking the markets they invest in and base their security weightages and composition on that index. FTSE and MSCI indices are common examples. The institutional investor may directionally follow the index weights for their own portfolio, including post-rebalancing. It may go overweight or underweight if it sees a compelling rationale to do so—overweight means increasing its exposure to a geography, and vice versa. This idea is based on a paper published by this author in a Switzerlandbased financial magazine in 2013—An alpha approach at a passive cost in volatile times—Experiment in an emerging and a developed market. This looked at developing a concentrated portfolio idea on a “Consistent Dividend Consistent Fundamentals” (CDCF) theme which can perform better than benchmarks. This paper studied India and Canada markets to develop the portfolio idea for an emerging and a developed market each. This CDCF portfolio idea was based on the premise that investing in a concentrated portfolio of consistent dividend paying stocks which achieved consistency in their fundamental performance at low leverage is better. The assumptions made in the stockscreening seek to identify quality companies who took good management

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decisions which are reflective in their consistent financial performance. The methodology also gives the chance to invest in high-potential midcaps (apart from large caps). Midcaps are often under-researched, but some are high potential with good management teams, solid business franchise, competitive advantages, and high-quality profits. Such stocks make for ideal buy-and-hold investing and add long-term value to portfolio.

6.2.1  What is This? We conduct a similar CDCF basket experiment in SAARC, using Bloomberg data for 3151 companies, made up of 1711 stocks from NSE India, 542 stocks of KSE Pakistan, 343 of DSE Bangladesh, 288 of CSE Sri Lanka, and 267 of NSE Nepal. The final outcome from three rounds of backtesting done for CY2012, CY2013, and CY2014 throws interesting results of the basket’s NAV vis a vis the popular benchmarks. The idea is to develop a CDCF portfolio basket for the SAARC markets which can act as an index for products based on this geography, thus acting as a proxy for the SAARC asset class. So what are the aspects that can be “consistent” when it comes to stocks? Despite the recent economic headwinds, some management teams have delivered “consistent” growth and margins in their companies’ financial metrics. Second, volatile price trends may not always reward shareholders by appreciation as investors may not always liquidate at opportune times, missing opportunities to book gains. But some stocks “consistently” pay dividends. Lastly, stocks with low leverage have further headroom for expansion, to infuse capital and maintain its fundamental performance. These aspects are used to develop on the “consistent” theme of the screening for the CDCF idea. Three rounds of back-testing have been done on the stocks, with each using the last three rolling years of financial data. Thus, data from CY2014 to CY2009 has been used for the four markets—NSE India, KSE Pakistan, DSE Bangladesh, and CSE Sri Lanka. While NSE Nepal was also taken, Bloomberg has no data coverage on that market, and hence it was excluded due to data constraints. The financial data for the above mentioned calendar years includes Revenues, EBITDA, Net Profit, Margins, Net Worth, Return on Equity, Debt:Equity ratios, Dividend Yield, Dividend Payout, Closing prices, and Market Cap. The month of fiscal year-end differs among countries and companies, hence December (calendar year basis) has been taken for simplicity. Stock-screening methodology for each back-testing cycle (i.e., as of CY 2012, CY2013, and CY2014) assumes annual financial data in this experiment, which will remain as such for all quarters till the next year’s

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financials come. That is when underlying of the portfolio basket will change, and portfolio churn will happen. The NAV is estimated for each quarter-end using quarter-ending prices and free-float market capitalization. We assume annual rebalancing between each back-testing cycle to happen over the first-half of each year, given the time delays in companies declaring their results. Hence, rebalancing is effected from the June quarter of each year, for the results declared in December. One can also use quarterly financial data (trailing-12-month basis). However, only annual data is taken now to keep the working simple at this stage of the exercise. Stocks with a market cap of above $100 million as of the December of that back-testing cycle have been taken. While this may sound quite less, the screening is more based on the quality of companies rather than size. Although the size of the company does impact liquidity and impact cost, as of now, we assume that the intermediaries and institutions which may be involved would have the necessary wherewithal to invest in the midcap stocks of the individual markets. Even the SAARC ETF detailed in the previous section shows that retail investment would also occur through an institutional fund structure. We select stocks which showed revenue growth of over 5% on a rolling 1-Year, 2-Year, and 3-Year CAGR basis in each back-testing cycle. We assume 5% growth may reflect that the company’s “real” operations grew (or remained) in line with the average inflation level, which we assume to be within this range. We assume this may reflect the growth of its actual volumes within its revenues. Real volume growth is a truer indicator of fundamental growth of the company’s inherent business, rather than just the price effect. Hence, the screening methodology tracks those which achieved growth over and above the average inflation. We have taken the growth rates on CAGR basis as it reflects growth barring slight seasonal variances year-on-year. This methodology is repeated for net profits as well, since shareholders are rewarded only if the company’s profits grow. We have excluded EBITDA in this screening since Bloomberg data for EBITDA was not available for many stocks (ex-India), hence data constraints could have ended up throwing wrong results. The stress here is on maintaining profit margins, since profitability is a key performance metric of the management team to have run its business efficiently. The threshold level assumed for profitability is to select those stocks which achieved profit margins of at least 10% in each of the rolling 3 years in each back-testing cycle. Return on Equity (ROE) of at least 10% plus consistently is also a key metric used to judge the stocks on how efficiently they used their capital for shareholder’s returns. Also, companies with Debt:Equity ratio of

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less than 5× was selected, which allows them some headroom for future capitalization in case required for maintaining their growth track record. Next, the methodology targets those stocks which saw a Dividend Payout of over 20% and dividend yield of over 1%—consistently in each of the rolling 3 years in each back-testing cycle. A maximum weight of 10% per individual stock has been kept in the portfolio basket to avoid overexposure to any specific stock. No weight has been kept per individual market at this stage, given that a very low number of companies from Bangladesh, Sri Lanka, or even Pakistan which were making the screening criteria listed above. In such a situation, country-wise caps might reduce the scope for these markets. Based on the screening process, we arrived at these shortlisted stocks and estimated NAVs for each back-testing cycle:

Market cap (in $ Bn) of the stocks shortlisted in the three back-testing cycles with their CAGR from June 2015–December 2009:

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The experiment is based on the consistency of performance, rather than their size. Hence, $100 million is used as the base level of market cap for screening. However, most shortlisted stocks are way above this level. While these stocks pertain to different back-testing cycles (CY2014, CY2013, and CY2012 basis), and taking the sum total of the market cap of these stocks together will not be correct; nevertheless, comparing the CAGR of the sum total of the market cap of all these stocks with each one’s individual CAGR throws an interesting observation. Most of the stocks which have underperformed as compared to the sum total fall in the oil and gas sector, which has taken a severe hit globally since the last few months as oil prices have fallen to record lows. Historical Net Profit Margin, Return on Equity, and Debt:Equity Ratios of the shortlisted companies:

The table below shows that Corporate India comprises some of the largest companies in the SAARC region in terms of topline and bottom line, and many of the large Indian companies are among those which have delivered consistent fundamental performance, hence making into this list. However, the same is not true for Bangladesh or Sri Lanka, given that just a few companies from these two countries made the list. Pakistan also had few entrants in the earlier back-testing cycles, but saw additional names clear the bar in the CY2014 cycle. On the other hand, the dividend payout ratios are more evenly distributed, indicating that while India may have seen consistent growth in profits, it does not necessarily translate into higher dividend payouts.

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Historical Revenues and Profits of the shortlisted companies in $ Billion:

Historical Dividend Yield and Dividend Payout Ratio of the shortlisted companies:

Post stock-screening, weights are assigned as per free-float market cap, with a maximum cap of 10% per stock. These weights are calculated on a quarterly basis to do NAV back-testing at every quarter-end from December 2009. Scrip-units to be rebalanced as of each quarter-end are based on the free-float market cap weights as of that quarter-end, current prices of the

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underlying stocks, and the NAV calculated for that quarter-end. This NAV was based on scrip-units rebalanced as of the previous quarter-end. This means that the rebalanced scrip-units as of each quarter-end will be used with next quarter-end’s prices to calculate the next quarter-end’s NAV, since the assumption is that the scrips are held in that proportion through that quarter and NAV is calculated at the quarter-end, at which time the weights (and scrip-units) would change based on the new market cap. Estimated free-float market cap based weightages, with a maximum cap of 10% per stock:

Estimated scrip-units bought for each underlying scrip, as per 1 unit of the basket:

The NAVs calculated are both Price based and Gross based. “Price-based NAVs” factor in only the price appreciation of the underlying stocks. It excludes the impact of dividends. Adding dividends paid on the underlying

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stocks as per the scrip-units will give the Gross NAV. All dividends paid on the scrips are assumed to be done in final quarter only (i.e., December quarter) for simplicity's sake, hence the impact of dividends received will be seen in last quarter’s NAV only. The Price-based NAVs are used to compare to the benchmark indices, since most indices data is Price based and not Total Return based (which factor in the impact of dividends received on the underlying stocks). In cases of Total Return indices, the Gross NAV has been used for comparison. Also, the $ values of the benchmark returns has been used from Bloomberg to maintain consistency to the currency of the basket (which is also $), since otherwise it would not give an apple-to-apple comparison.

6.2.2  Comparison of CDCF Basket’s Performance with Benchmark Indices Country-weights in the NAV composition of the CDCF basket show the changes in corporate performance. While the NAV’s composition was overtly skewed toward India in the initial periods of the backtesting cycles, the last couple of quarters have seen Pakistan gain within the basket. Bangladesh is yet to achieve consistency in its 3-year track record, hence it yet does not have adequate representation in the basket. As its corporate performance continues, hopefully few more Bangladeshi companies should feature within the CDCF basket. For estimating the Sharpe Ratio and Alpha, the Risk-Free rate assumed is the 1-Year Government Bond Yield currently seen in the various countries. To estimate the yield for an index, we have calculated the weighted-average yield using the country-weights within that index with the yields of each respective country. The total proportion used in the weighted-average process is naturally not 100%, since the country-weights disclosed include an “Others” category as well. We have excluded the Others both in the numerator and the denominator; hence, the weightedaverage rate of the index is technically based on those countries whose weights are disclosed. The same process is done to estimate the Risk-Free rate for the CDCF Basket as well.

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The tables below show a comparison of the CDCF Basket’s returns and volatility per year with some of the relevant benchmark indices. The tables also show the correlation and alpha of the basket with each of these indices. Net NAV is used for the CDCF basket here since the indices are not Total Return, but Price Based:

CDCF Basket has delivered significant outperformance in annualized returns for the back-testing period (from December 2009 to June 2015) relative to all regional indices including the DJ SAFE Index, Indian, EM, and FM. The only market ahead in performance was Pakistan. CDCF Basket delivered this outperformance at levels of volatility much lower than that of SAARC markets (including that of India) and BRIC index; and at comparable levels of volatility to the broader regional indices like EM and FM. Resultantly, its Sharpe Ratio is way ahead of the entire pack, including ASEAN which although saw lower volatility but also saw lower returns. Only Pakistan’s Sharpe Ratio is ahead.

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On a YoY basis (CY15 YTD, CY14, CY13, CY12, CY11, and CY10), it delivered positive excess returns in each of the periods against the DJ SAFE index and the India (except in a couple of cases with the Indian midcap index). Its positive excess returns against the broader regional indices like EM, FM, and BRIC have been sizable too. However, the positive excess returns were slightly sporadic against the SAARC markets. Alpha generated by the CDCF basket has been in the range of 10–15% against this entire pack, with only ~5% alpha seen against the Pakistani indices. The alpha has been high even against the Indian indices. Also, the CDCF Basket has performed better than China, the market which has hogged limelight recently, both in terms of returns and volatility as well as in alpha. The tables below show a comparison of the CDCF Basket’s returns and volatility per year with some of the relevant benchmark indices on a quarterly basis. Again, the price-based NAV is used for comparison: ●

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CDCF Basket has delivered negative quarterly returns in only ~27% of the quarters under analysis, as compared to ~36–50% of the quarters in the case of the benchmark indices. It scores better than even the highgrowth SAARC markets in this context, including Pakistan, indicating its comparatively lower volatility. It has delivered positive excess returns against most of the indices at least ~60–80% of the times. While this was 80% plus against the DJ SAFE and ASEAN indices, it was closer to ~60% against the Indian indices. The only market where this score was lower (at ~40%) was against Pakistan where the markets had rallied during the 2012–13 quarters. Even against Bangladesh and Sri Lanka, this was ~70%, as well as against the broader regional indices like EM and FM. 2014 was a year where it saw positive excess returns than its regional peer, ASEAN, in all the quarters. Since the CDCF idea includes dividend as a key component, hence a comparison only on price-based NAV will be inadequate. The table below shows a comparison of the CDCF Basket’s Gross NAV returns with the DJ SAFE 100 Total Return Index. However, the Q-o-Q trend may not be comparable since all annual dividends in CDCF’s case are assumed to accrue in the December quarter only: ●

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Again, the CDCF Basket outperforms the DJ SAFE 100 TR Index at comparable levels of volatility. It delivers positive excess returns in each of the annual periods, and in 70% plus of the quarters. It delivers an alpha of ~10% against the benchmark index. Last eight successive quarters saw positive returns, despite reducing weightage on a rallying Indian market.

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6.2.3 Advantages For the SAARC asset class, one can look at the existing Dow Jones SAFE 100 Index since this was developed by an established index house and adequately represents all the member countries in its portfolio composition. Since most global fund houses follow established index providers like Dow Jones, MSCI, or FTSE, this may be a practical index to use for the SAARC asset class instead of the CDCF basket. However, the CDCF basket scores significantly in terms of performance versus the established benchmarks, and performance is the kingmaker. The portfolio basket can also be used to develop algorithms for use by institutional investors, based on their earnings and dividend criteria. Algos can automate the trading decisions based on the data seen in the systems on the universe of stocks. Since the CDCF screening criteria is really quantitative in nature, hence it can easily be interpreted into coding

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programming for an algorithmic trading strategy. This can be an ideal route to grab the attention of institutional investors in the SAARC asset class itself. This CDCF experiment was done for Canada and India markets in the original paper published in 2013 in the Swiss magazine, i.e., a developed and emerging market each. Now, it has been done even for FMs like Sri Lanka, Pakistan, and Bangladesh and thrown back similar results. Since the markets are quite different in terms of development and maturity, it validates that the strategy can be versatile across geographies. It gives a chance for high-potential midcaps from the regional markets to be included in an asset class index. Most indices focused on EM and FM regions concentrate on the large caps, hence most allocation of global investors also goes toward such stocks. But the potential of upside is more in midcaps as they have yet to go through their growth journey, and there are high-quality midcap companies led by able and ethical management which can take these companies ahead in long-term value creation. The CDCF basket gives a chance to look at those companies too (along with the large cap universe) to select the outperformers. It shows each country how its corporate sector is performing relative to the peers. In equities, performance is the ultimate bar to grab investor attention, especially when awareness and acceptability is quite low. Nothing else comes closer. Other methods like equal-weighted weights or equal representation from all member countries may not fully factor in the performance potential of that basket. For example, ASEAN Stars Index, which that region is developing most probably to showcase as the ASEAN asset class and pitch as the reference underlying for products based on that asset class, comprises of the 30 largest/liquid stocks from each of the participating exchanges. Hence, its performance may always be susceptible to downside risk, since the underlying stocks may not always be the best in terms of performance even though it is ensuring equal representation to all the countries. An approach based purely on consistent performance may not give equal representation to all countries, like Bangladesh seems to be inadequately represented since no company other than British American Tobacco Bangladesh made the cut in any of the back-testing cycles. While this low representation in the basket may not make Bangladesh too happy, it gives a clear indication that its corporate performance is way below par than the regional peers. In the same manner, Pakistan which was also inadequately represented in the earlier cycles added some names in the last

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cycle, indicating that Pakistani companies have seen a marked improvement in recent years which enabled them to make the cut. Another advantage is the gains it delivers to investors. The NAV of the basket, when compared to leading benchmarks, shows that it delivers superior outperformance at same levels of volatility. Every investment faces a challenge in delivering consistent outperformance, more so to beat inflation—investors’ biggest enemy. Even many low-risk asset classes often fail to beat inflation consistently, as historical trends show. The premise behind this concentrated portfolio basket based on the CDCF theme was to show that a methodology based on chasing consistency in fundamental performance can throw up opportunities for outperformance as compared to benchmarks, other asset classes, and inflation. Any fund product which tracks such a CDCF basket can also deliver similar outperformance to its own investors, adjusting for tracking error. It helps identify the quality companies, especially in markets about which information is still largely opaque to majority in the global investor community. FMs are just looking up, and the universe of funds tracking these markets is small as compared to those looking at EMs, which, in turn, is small as compared to those looking at developed markets. In such a situation where much is yet to be known about these individual markets, it makes the job more difficult for fund managers to understand and identify the quality companies. Size may not always be representative of quality. While there is no rocket-science about the screening methodology described for this CDCF basket, it may be a useful starting point to start identifying the high-quality companies in this region. Further drill-downs can always be done subsequently. The “consistency” theme is a key USP. These scrips have shown shareholder friendly results consistently. Apart from consistent growth in topline and profits and consistent ROEs and profit margins, it gives the opportunity to benefit from a consistent track record in dividends. The CDCF methodology attempts to deliver better returns than the benchmarks, hence an attempt to generate alpha as well as positive excess returns. However, despite the chase for alpha, the screening methodology does not really need high-level active management skills in the true sense. The methodology is set based on certain criteria and is easily replicable for each back-testing cycle for subsequent portfolio rebalancing. The idea

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might be described as a “passive-variant of active” or “modified-alpha.” Due to this, the skills required to maintain this basket’s strategy can entail a lower fee as comparable to other mutual funds, which bodes well for investor returns. The concentrated nature of the basket gives the opportunity to capture upside potential better as compared to a more diversified basket, since the risk of over-diversification can sometimes pull down aggregate returns. Leading experts often opine that the stock-specific story often comes into play in new/emerging markets, since the deal is to identify few good-quality and high-potential companies and gain from them. The concentrated portfolio approach along with its specific screening strategy attempts just that. A portfolio basket like this can be useful for a “Core-Satellite” allocation, whereby a more diversified Core is supplemented by “modifiedactive” strategies like this which gives opportunity to capture upside at low cost. Given that most foreign institutions follow such indices while looking at investing across countries, creating such an index to showcase the region as an asset class may be the best bet to bring the attention on SAARC. Such an index can be used as an underlying for fund products or even index futures.

6.2.4 Challenges Most foreign institutional investors follow asset-allocation for EM and FM separately, as separate asset classes entirely. This is because the countries comprising these two baskets vary significantly in terms of economic development, local market evolution, country risk, regulatory evolution, market volatility, liquidity, economic sector diversification, growth outlook, etc. Hence, the portfolios investing in these asset class baskets will also need to be managed as per its specific challenges. That is why institutions have traditionally preferred investing as per the separate EM and FM indices. Breaking this established mind-set is a challenge, despite the rationale of SAARC’s economic potential versus other regions. Deepening the awareness of the regional markets and companies with the investors in the regional countries is one of the critical success-drivers of this initiative. This coincides with cases of fund products based on regional securities as well as cross-border fund passporting or cross-listing of stocks or futures. If the local investors do not have a clear cut idea of

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the foreign market and its opportunities, their acceptability of any product based on the SAARC asset class will be low, be it the CDCF Basket or any other. If the CDCF Basket aims to elicit interest from global institutional investors, then it may have to rework the minimum market cap requirement and minimal liquidity criteria per stock. This is because global funds often have strict guidelines on the liquidity of the stocks they can invest in apart from need for lower latency, which is a reason small cap and smaller midcaps are often in the radar of retail investors, not institutional investors. Removing such high-potential midcaps from the CDCF Basket may then impact its NAV, and hence returns. The screening criterion does not have the flexibility to account for a temporary drop in performance in 1 year, despite performing well in all years before that. The minimum market cap assumed is on the lower side, the lack of liquidity in the shortlisted stocks might actually impact the smooth execution of the portfolio rebalancing, and hence, the expected performance. Sector exposure within the portfolio is often skewed toward few sectors instead of being significantly diversified. For example, the half a dozen oil and gas stocks which made the cut are now underperforming in line with global oil trends, thus pulling down returns. Similarly, country exposure does not have any limit. Hence, it may be overtly skewed toward few countries and less toward others, irrespective of the rationale that the shortlisted companies are based purely on their inherent performance. If some untoward incident happens in that country tomorrow, it may impact the overall portfolio. However, such a situation would similarly impact other funds too who are looking at that country. This is a pure stock-screening approach and does not take into account the macro-level factors impacting the economy, sectors, and companies. Moreover, it does not factor in valuation multiples of the underlying stocks. Portfolio churning is done only once a year given the usage of annual data, hence updating financials on an annual basis may ignore shifts in financial performance that may occur on a quarterly basis. In a region which is under-covered by regional and global investors, a highly concentrated portfolio may see slow acceptance initially. As mentioned in earlier sections, the role of an anchor investor can be very important, one who has a strategic interest in the SAARC region as a whole, who is chasing portfolio returns through overseas investments, and who has a long-term investing outlook.

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Sovereign wealth funds or pension funds from China, Japan, the United States, the United Kingdom, or Korea could become a new breed of foreign institutions to market the SAARC asset class basket to, and evincing interest from them would be a critical challenge. As and when such participation from such targeted funds increase, it should help gather subsequent interest from established long-only funds to look at EM and FM in a single basket.

6.2.5  Initial Role for Stakeholders The role starts with developing this CDCF basket in terms of equity analysis and back-testing. While a lot of effort on this has already been done for this chapter itself, subsequent work can be done on quarterly data which can give a more updated outcome as well as 10-year back-testing analysis which is typically used for testing most new product strategies. Conducting the entire back-testing and rebalancing for each cycle and quarter would help keep the list of shortlisted stocks updated and keep the SAARC asset class basket rolling. The next job is to register this portfolio basket as an index, so that it can become a formalized asset class for SAARC region. NSE India has an index development entity (India Index Services & Products Limited), which can be approached to register and develop such a basket as a formalized index. Once it becomes a registered index, it can be monetized by licensing it for index derivative products or can be used as a reference benchmark by funds tracking this region. More the number of funds referring this index, more its popularity. One may also have to take inputs from leading equity research houses on the shortlisted companies for qualitative screening. The screening method uses mainly quantitative screening criteria, and this may not be entirely sufficient. Some qualitative inputs on the shortlisted companies might also be required, and one can use those inputs to clean the basket of companies with questionable business practices, despite them delivering consistent fundamental performance. Another task is to market the rationale of this portfolio basket’s CDCF theme to the target audience, in order to garner support for the SAARC asset class. Simply having a product is not enough today; equally important is to market it well to the right people who will take it forward by monetizing it for licensed products (funds, futures, ETFs, etc.) based on the basket.

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6.3  THEMATIC PUBLICATIONS, E-BOOKS, INVESTMENT FRAMEWORKS, AND ROADSHOWS ON SAARC Purpose of this section is to discuss whether thematic publications, E-Books, investment frameworks, and roadshows can help disseminate information on the region’s emerging opportunities, rationale, and ideas. This can help address the lack of investor awareness of the regional markets and of SAARC’s opportunity. Collection and collation of market data of all the regional markets can be a useful first step to make a central repository of market data of this region. However, the role of data and information has to go beyond that. Deepening the awareness of the region’s local investors about each other’s economies is a critical imperative to deepen the interest in integrated capital market products. For any project involving regional investors to be successful, the awareness of each other’s economies has to be high; only then will the acceptability increase. Moreover, deepening the awareness of investors, both local/global, on the SAARC opportunity itself is also a necessity in view of the current knowledge state in the market. Last but not the least, evincing interest from the region’s institutions and companies is also needed for the SAARC market’s success. After all, they will create the product which will operate in integrated capital markets, and if they do not see the rationale, then no product will emerge. Dissemination of opportunities, rationale, and methods are all necessary precursors.

6.3.1  What is This? A research publication series on “top–down” thematic ideas conceived by systematic ideation and fact-finding, with the objective to promote awareness of the SAARC economies, in terms of their emerging opportunities, sectors of competitive advantage, and drivers of economic growth. This may be a much-needed imperative to reverse the current low level of awareness the local investor communities may have about each other’s economies, as well as present the SAARC region as a whole if foreign investors are to be made interested in the SAARC asset class. While such awareness may exist at the government-level or business-level of the member countries, this concern is really in context of the investors, be it retail, high net worth individual (HNI), or institutional investors. This is because for any integrated capital market product to become viable, it has to garner interest from the local investors of SAARC and the foreign investors looking at this geography, to reach a threshold of volumes/assets.

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The existing research reports brought out by the brokerage houses in these countries has two main limitations for the SAARC objective. Firstly, they focus essentially on the institutional and retail investors looking of that specific country only. They do not focus on the investors in regional SAARC economies. This is where such a thematic research publication series can add value. It can help bridge the information gap among the local investors of this region about each other. Second, these brokerage reports present the ideas pertaining only to that specific country, not of the SAARC asset class as a whole. Resultantly, foreign institutional investors are only too happy to bifurcate the regional countries into EM and FM buckets as per the methodology they follow globally for asset allocation in the developing markets. They do not have any compelling reason to look at the SAARC region as a whole, since nobody has presented it as an asset class. This is where the research publication can add value by presenting the SAARC asset class as a whole to the global investor community, just like the ASEAN asset class is trying. This can include separate series for B2B and B2C investor audience for the same report. B2B publications would be more detailed and extensive reports, aimed to evince the interest from the institutional investors and intermediaries. Detailed publications would provide the foundation for further discussions on the investment ideas and help in conversion eventually. B2C publications would be to-the-point synopsis reports aimed at the retail investors, who may not have the appetite to consume detailed and heavy research, but instead prefers a shorter version of the same report for their understanding and interest. Thematic ideas may also include an E-Book series published on SAARC’s emerging opportunities, regional value chain ideas for corporates, and trends. In fact, this document itself which is discussing possible product/activity ideas for SAARC capital markets can be an example of E-Book, which can be disseminated among the target audience to garner interest and awareness on SAARC’s potential and opportunities. If a key objective of SAARC right now is to deepen the acceptance and awareness of the SAARC opportunity, then content based on this opportunity has to be regularly beamed to prospective stakeholders. In the age of digitization technology and multi-device usage, E-Books have become a very convenient option for both the publishers, sellers, as well as the end-readers themselves. E-Book platforms like Amazon’s Kindle has come up, apart from other platforms targeting smartphones, tabs, etc., which make purchasing and reading easier.

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E-Book can also take the smaller format of an E-Booklet or a White-Paper series. These have lesser content, which is more manageable for a periodic series of publications. One advantage of an E-Book and E-Booklet series is that the ideation and dissemination of content can become a set-process executed by a single platform, instead of sporadic publications on SAARC topics as is available now. Making it into a setprocess can go a long way in regularly engaging with the business and investment community looking at regional opportunities. Investment frameworks mainly refer to structuring of investment screening ideas based on certain methodology, which can showcase quality investible stocks as per that framework. The idea is to identify and select investable companies based on the screening criteria and then repeat that process periodically to update the list of shortlisted stocks. The CDCF basket idea mentioned in a preceding section is an example of an investment framework, as it lays down a screening method based on criteria of fundamental and dividend performance of the underlying stocks from across this region’s markets. Ideation has to be a major activity in all of this, apart from the actual research process to produce the final thematic reports. Ideation has to identify emerging sectors of opportunity within each of the countries. More importantly, it has to identify potential regional value-chain opportunities within the economies of SAARC as well as global value-chain opportunities with countries outside this region. This can give a tremendous fill-up to the business links within the region and outside, by identifying potential business opportunities based on each country’s areas of competitive advantages, thus creating revenue maximization or cost reduction for the companies involved, which bodes better for profitability (and thus, investor interest in those markets). Regional value chains would also lead to economic dependency on each other, and this economic motivation may help overcome the region’s internal geopolitical challenges to some extent. The entire objective of ideation and production of these thematic publications is for the stakeholders to become the knowledge-driver for those looking at this region as a whole, and to become the go-to entity if global and regional investors are looking for opportunities on the SAARC region as a whole. Corporate-access roadshows in each other’s markets is a critical aspect of promoting the research findings among the target audience.

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It is basically extending the ideation into on-ground fact-finding and engagement with the target sector/companies or even any related government agencies. While research publications only help in the dissemination of the information, the corporate-access roadshows lead to actual interaction and engagement between the companies/industry and the investor community, thus creating connections and networking. Roadshows give investors the opportunity to meet the people from that company/sector face-to-face and ask more detailed questions as a follow-up to what they had earlier read in the research publications. Such roadshows are invaluable tools to build familiarity and awareness of the companies, and an essential step to create the comfort between the parties involved, and no investment activity can ever take place without the comfort, since money is involved. Hence, any research publication initiative focusing on themes about the regional economies has to be complemented with roadshow initiatives as well, to complete the journey from knowledge to action.

6.3.2  Let us Take an Example of Thematic Ideas Say, “E-Commerce” is an emerging theme in the regional economies, each of whom has a sizable consumer base with an aspiring middle-class segment. The thematic research can include what is the opportunity size of e-commerce in the regional markets, what are the players in this industry doing to increase market share of retail sales and addressing the industry challenges, what are the innovations emerging related to delivery models and supply-chain logistics that can give a long-term competitive advantage to this industry, how the regional countries can benefit from each other by connecting buyers and sellers from within the region to each other, so that the local sellers and makers also benefit from the e-commerce boom within the SAARC region, and not just the global sellers (non-SAARC) looking to sell to individual SAARC markets. Such thematic periodicals are a useful tool for knowledge-sharing both among the investors and also the economies themselves. They make the world aware of the emerging opportunities in the region, but also make the individual markets within the region invest further based on the market intelligence that comes out from the thematic research. That helps give a growth impetus to the industry itself, making it more sustainable. Thereafter, if the investor community wants to drill-down further on the thematic idea, the corporate-access roadshows help connect the

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companies operating in the industry with the investor audience, thus helping create a direct interaction to build deeper information and knowledge on the industry and companies, leading to more informed decision making by the investors.

6.3.3 Advantages Such thematic research will help develop awareness among the SAARC region’s investor and intermediary communities about each other’s economies and emerging opportunities, so that the local investors can identify the pools of opportunity to invest in each other’s markets. They can also help present SAARC asset class investible ideas as a whole to foreign investors, thus helping the broader investor interest in the region. They can also highlight sectors of competitive advantages in these countries, so that investors can develop the information of where future growth can potentially come for those markets. They can help identify potential regional value-chain opportunities within the regional economies based on each country’s areas of competitive advantages, thus giving a boost to the business links within the region. They can highlight the changes being effected in other regional markets and the gains seen by the markets that went ahead with changed regulations, since that may incentivize and give the push to the markets that are more resistant to change. They can also carry representations to the local regulators and selfregulating organizations on potential changes required to reach a harmonious framework. Apart from connecting the investor community with the businesses, roadshows can also act as useful B2B forums to connect the local business industries related to that thematic idea, with the purpose of exploring areas of mutual benefit related to supply chain, new end-markets, raw material souring, etc.

6.3.4 Challenges The only challenge in a knowledge-intensive work like research publications is of getting the right people who are capable of thinking the ideas and their possible solutions. Publications are not really governed by regulations, unless it is with the objective to earn money by advising on stock ideas, the reason why the research of brokerage houses is governed as per each country’s jurisdiction. However, here the purpose is purely

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knowledge sharing to increase the bar on mutual awareness of the regional economies, and the critical resource needed for this is the people who can deliver.

6.3.5  Initial Role for Stakeholders Becoming the knowledge provider on thematic investable ideas on the SAARC region as a whole means ideating, producing, and disseminating this knowledge by bringing out thematic research publications on opportunities in the regional economies, including areas of regional value chains. In effect, become the regional equity research house for presenting opportunities in the SAARC asset class. The deal is to become the go-to entity for investors who are looking for SAARC opportunities. It needs to identify a capable team whom it can hire for the ideation and production process for these thematic publications. Alternatively, if an in-house team is entirely not possible owing to time and budget constraints, then it may need to outsource the task to produce these thematic research series. It may need to produce the publications into B2C and B2B versions before dissemination, so that they can capture the attention of institutions/ intermediaries and retail audience with effective measure. Sending a synopsis version to an institutional investor may not evince interest from them, just like a detailed report may make a retail investor lost. Hence, appropriate versions of the same report need to be prepared before dissemination. It may introduce its E-Book series on SAARC-based opportunities and trends, which can be disseminated among the business and financial community to evince deeper interest on this region. E-commerce web sites make it easy to distribute E-Books to the public at minimal costs. It may need to organize regular roadshows of the regional companies in the other member countries in its role of corporate access. This would help showcase the high-quality companies of each country in other markets and give the investors, institutions, and intermediaries of that country a chance to interact with the company’s senior management firsthand and develop insights and perspectives. It can also work on financial engineering projects to develop investment frameworks on screening and identifying investible stocks, conducting the back-testing, and assessing the validity of the framework. These frameworks can then be presented to institutional investors as investable ideas for them to implement. That automatically creates a demand/market where otherwise there were none.

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6.4  SAARC INTERNATIONAL FINANCIAL CENTER SEZ (WITHIN SAARC OR SINGAPORE) Purpose in this section is to explore if creating an International Financial Center (IFC) as a Special Economic Zone (SEZ) for the SAARC region can make the process of creating a harmonious framework for integration projects easier, in light of the implementation challenges to rework the existing regulations in each member. Implementing a harmonious framework across each country’s regulations has its own challenges of countering bureaucracy, delays, and possible lack of will. However, making a separate IFC wherein it would house the requisite regulatory framework for integration projects might be an option, if it separates out the country’s existing set of regulations with the new regulations needed to participate in regional integration. This still means achieving a harmonious framework agreeable across all members, and it does add a new layer of regulatory processes since the IFC would then have its own set of guidelines separate from the country’s own set of guidelines, to register investors, intermediaries, funds, service providers, and products of the member countries. Apart from regulations, guidelines related to double taxation of income, dual exchange rate conversion costs, accounting standards, and foreign investment limits/quotas would also form part of this. However, this may make achieving regional capital market integration easier and conducive. An IFC may be based in any of the member countries which have the necessary infrastructure for a cluster of intermediary offices, fund offices, regulator office, technology provider offices, clearing and settlement process offices, other necessary ancillary services as well as investor protection and risk management offices. Alternatively, an IFC may be based in a neutral location like Singapore which has established connections with most of the local capital markets of the SAARC region, which has an evolved regulatory structure, and which hosts a large number of institutional investors looking at this geography. Many European or North American asset managers manage their South Asian portfolios from their Singapore offices. Hence, the sell-side analysts in the local brokerages also interact with the portfolio managers in Singapore. Thus, a location like Singapore could give the SAARC asset class products access to a broader set of global institutional investors. Moreover, its Singapore registration may suffice, and the region can directly start marketing the asset class to them, rather than first trying to convincing them for making registration procedures if the IFC is based in SAARC.

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6.4.1  What is This? An SEZ is not really a financial product idea, per se. Rather it is a financial infrastructure idea. Such an SEZ might be an ideal dress-rehearsal to test the effectiveness of capital market integration projects. Of course, even an SEZ like this would require each member country reworking its regulations to facilitate participation in the SEZ’s activities. However, the hope is that the extent of harmonious regulations required to set up such a financial SEZto-country structure may be relatively less difficult to handle as compared to getting each member to implement the frameworks required for country-tocountry interactions in integration projects. However, further work on examining necessary regulations is needed to arrive at a final conclusion on this! This financial center SEZ would need requisite regulations in place to facilitate launch of integrated products and make them accessible to intermediaries and investors across the region, as long as they are registered as per the SEZ’s KYC customer identification regulations. The KYC guidelines also need to ensure that the origin of the money flowing into the products is clean and avoid money laundering instances. It will also need regulations related to payment and capital transfer between the IFC and member countries, as well as the IFC and globally, so that investment between the various parties flows smoothly. This includes repatriation of profits and dividends as and when they accrue to the investors, wherever they may be based. This also includes regulations related taxation, like capital gains tax and dividend distribution tax, so that any taxation anomaly is not counter-productive toward achieving investor interest in integrated products. Apart from housing the trading infrastructure for the integrated products, and offices of the registered intermediaries (in case required), the SEZ could also act as a market place for the technology and periphery service providers to interact with the regional exchanges and investors from a single location. The SEZ can also house the required regulations to facilitate domiciling of mutual funds of a country that could be made available under a passporting scheme to raise monies from other members (just like Luxembourg has developed as the domicile center of the UCITS compliant mutual funds in European Union region).

6.4.2  Location of SAARC IFC SEZ Ideally, such an IFC SEZ should be in a country that has the requisite infrastructure in place to support the initiative in the first place. This

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includes the real estate infrastructure of that scale within a single cluster if possible, since the IFC will need to house the offices of regional brokers, offices of the exchanges and regulators so they can interact, as well as offices of services like clearing and settlement, technology, marketing and communication, thematic publications, and investor education. Sri Lanka or Bangladesh are the best suggestions, as they are neutral locations in context to India or Pakistan. Their capital markets are reasonably developed, although those in India and Pakistan are better developed. In case foreign institutional investors are to be invited in the SAARC products, then it may be better to house the IFC SEZ in a country where a fair number of asset management offices of foreign funds are already set up. Countries like India have been developing SEZs like the GIFT City in Gandhinagar. In fact, GIFT City is being developed as a center for the financial and technology sectors in India, so why not extend it for the SAARC IFC SEZ experiment? Real estate projects currently under construction can be utilized for the SAARC IFC SEZ. Alternatively, the IFC SEZ can be based entirely out of SAARC totally, like in Singapore. That might have more acceptance as an IFC location by all the individual SAARC members, apart from giving access to world class infrastructure and a large number of global institutional investors who are already based in Singapore. Foreign funds may be averse to multiple registration processes and that may become a deterrent to evince their interest in participating in a new IFC jurisdiction setup in SAARC. As they are already registered in Singapore, SAARC IFC based in Singapore may not require separate registration processes for foreign investors. Instead, they can directly start participating in the integrated SAARC asset class products. That may help gather interest much faster, as the region now can concentrate on marketing the SAARC products, rather than waste time in convincing them to register first.

6.4.3 Advantages It may be comparably easier to implemented newer regulatory framework for the SEZ than in the individual countries. However, the regulations of the individual members have to be changed to accommodate participation in such an SEZ. This center maintains the harmonious regulatory framework enabling all member countries’ intermediaries, stock exchanges, and investors to participate in integrated products and activities. In short, the

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launch might be quicker if an IFC route is used, rather than if one waits to align the regulations in each individual member country. Moreover, given the status of an SEZ, it may make the flow of capital and repatriation easier for that purpose specifically if the SEZ’s regulations facilitate it with the member countries, instead of having to match the foreign exchange regulations of each country to the other. It may also avoid the situation of smaller members feeling they are being dominated by the larger markets, which may sometimes happen given that the member countries vary significantly in their capital market development. Inside an SEZ, everyone is largely equal and it is the best that one can get to a level-playing field. Hence, no one member is really perceived as dominating, which in itself will be a harmonious environment. It can be an ideal dress-rehearsal to the broader objective of SAARC capital market integration and might be easier to implement among the countries instead of matching each country to each other.

6.4.4 Challenges An SEZ is still an integration project in itself, in terms of putting in place and implementing a regulatory framework, as well as getting the member countries to agree on a mutually agreeable location. It also involves real estate challenges since the rental expense of taking a location would be a significant cost which other integration products may not have. In this context, it may also be worthwhile to examine if the location for the SEZ can be procured either at subsidized rental rates or where the moratorium is delayed by 1–2 years post-implementation. Moratorium means the rents would start accruing after that time period instead from Day 1, thus giving the SEZ project initial time to focus on deepening the awareness/acceptability of integrated products among the investing public (since there would be a gestation period involved, given the current low level of economic interconnection in this region), rather than be worried about meeting rents. In case the IFC SEZ is being built into a greenfield property site, then it would also need disaster management mechanisms in case of any eventualities, just like any modern-day commercial property need to comply with. This includes alternative sites for the workforce to continue their work and back-up servers that store critical data and can be retrieved to continue normal work. Ensuring that the disaster management mechanisms are in place is something all participants in the IFC SEZ need to

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comply with. Alternatively, if the proposed IFC is in an established location like Singapore’s SGX, etc., then it would already have disaster mechanisms in place.

6.4.5  Initial Role for Stakeholders It can play a central role in coordinating with all the service providers across member countries to set up their project offices in the IFC, as the IFC would be the destination where the integration projects would be based. The IFC would not only include a central exchange platform, but also offices of all critical and peripheral services from the member countries so that they can interact and execute the transactions. One needs to analyze the cost–benefit comparison of setting up integration projects through an IFC SEZ rather than on a country-to-country basis, work out the detailed costing related to infrastructure requirements of housing the operations from a central IFC, and finding out the potential locations which fit the bill where the cost–benefit equation would be most favorable and rates can be negotiated to friendlier terms. It has to understand the specific regulatory framework this may require with each of the individual members so as to develop a prescribed framework, understand the money transfer, payment and foreign investment limits that would be applicable in such an IFC’s case, and try to address the geopolitical challenges that can arise between the members regarding the SEZ location by advocating the advantages. Essentially, it needs to assess if the final implementation can actually be relatively faster by using this route, as compared to trying to align the regulations in each individual member country with each other.

6.5  MEDICAL TOURISM INSURANCE PRODUCT Purpose of this unconventional proposal is to combine medical tourism and health insurance into a financial product. Demand for specialized healthcare is increasing, along with relative unaffordability by majority of the population and dispersed availability of facilities. A product like this can make healthcare accessible and affordable, while mobilizing local monies into an investment portfolio for investing in SAARC asset class. The rationale is to provide “Access” and “Affordability” for quality healthcare to every citizen across SAARC by creating a common insurance pool (leveraging the health insurance concept), thus making specialized healthcare accessible in facilities located across countries which

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may have otherwise been out of reach as local health insurance may not cover overseas treatment (leveraging on the medical tourism concept). Moreover, the young median age of this region means a longer working life to pay for premiums with lower propensity for chronic healthcare issues, which is ideal to build viability into a long-gestation business like insurance. Another major advantage of it is that the local monies mobilized through this scheme into an investment portfolio that can be used for investing in the SAARC asset class itself for investment returns. Thus, the need to raise an investment corpus to invest in the SAARC asset class can be partially met through local monies itself. Since SAARC asset class will be a new concept for most investors impacting initial acceptability, the corpus created here can help give an initial push toward asset mobilization into the SAARC asset class.

6.5.1  What is This? Medical Tourism Insurance Product is not really an investment product, but rather a type of insurance product. The basis is that the demand for specialized healthcare is growing, and many SAARC members still do not have all the specialized facilities. Even if they have facilities, the high cost of healthcare often makes it unaffordable for most citizens, forcing many to go without quality healthcare. There would not be a single member out of the eight members of SAARC whose citizens do not face this socioeconomic challenge to some extent. Similar to Health Insurance: The subscription price of a unit may be equivalent to what the premium of a typical health insurance scheme may cost; with multiple pricing (premium) options corresponding with multiple coverage plans—just like health insurance. The citizens in each member country buy the product in a quantum of units corresponding to the coverage amount they may want. For example, imagine the price of 1 unit is INR 5000 for an average aged youth to get a coverage of INR 200,000 for the year, subject to the typical terms and conditions of any health insurance scheme. If they want a coverage of INR 400,000, then they can buy 2 units for INR 10,000, and so on and so forth—quite similar to how health insurance works. The corpus collected from each SAARC member country can be collected into a common pool (at least of those countries whose foreign exchange regulations allow it). Pooling of the corpus would make it even larger than what the pool of an individual country might have been. Larger the pool of subscribers, broader is the opportunity.

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The product can be sold by designated brokers in each of the member countries, who may need to be registered insurance brokers in case the rules of the game declare this an insurance product. The exchanges may coordinate with this network of brokers (just like they now coordinate with network of brokers for facilitating the sale of mutual funds), thus becoming involved in the value chain of the service offering. Similar to Medical Tourism: Where it becomes similar to medical tourism is in providing the citizens from across SAARC access to an empaneled list of hospitals across the member countries, since typical health insurance plans available locally do not cover overseas treatments. The list of empaneled hospitals needs to cover as many countries as possible, at least for ailments for which the country has requisite facilities. This would ensure no country feels this scheme is benefiting the hospital sector of one country at the expense of others. To make the scheme viable, hospitals at various price ranges (from across countries) can be listed, with the aim that the patient will be referred to the relevant hospital based on the severity of the ailment. If the state of their condition does not require them to go to the most expensive option, then it is better for the scheme on the whole, as the claim will be lower. Since the magnitude of claims go a long way in ensuring the feasibility of any insurance scheme, claims can be kept in control by referring a case to the most affordable hospital based on the severity of the patient’s condition, instead of referring it unnecessarily to the most expensive option. Moreover, this would also distribute the referrals across hospitals across the region thus ensuring equity in the hospitals that benefit from this medical tourism, while giving the patient access to the quality healthcare they may not have been able to afford otherwise. Insurance Investment Portfolio: Insurance companies receive pools of monies in the form of premium received, and a portion of this money is invested into securities across asset classes to generate portfolio returns. The investments are made across debt instruments like government securities, corporate bonds, debentures, as well as into direct equities. This channelizing into direct equities makes insurance companies a formidable player in the domestic institutional investor community (along with domestic mutual funds). Since raising of investor monies into the SAARC asset class is a challenge given the low awareness of SAARC as an asset class, this is an ideal way of raising those monies. The monies received through premiums into

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the medical tourism insurance product can be used to invest in the local markets, thus providing the initial push of asset mobilization into the SAARC asset class products. That will help build initial size, plus show that the local institutions have conviction about the SAARC asset class, before selling it to global investors.

6.5.2 Advantages This can serve a national objective in all SAARC member countries—of making quality healthcare affordable to all citizens from across the region by creating a common health insurance pool; and providing access for specialized healthcare to all citizens in facilities which may have otherwise been out of reach for them by utilizing medical tourism. The availability of quality healthcare facilities is still dispersed; hence the product brings relevant facilities located across the region within the reach of the citizens, who hitherto could not. Moreover, most local health insurance plans do not cover overseas treatments, making medical tourism itself an expensive proposition. But this common insurance pool collected from across SAARC countries may be able to provide affordable treatment options in neighboring countries if they have the requisite facilities. If hospitals at various price ranges from multiple countries are listed, then it may ensure no member country feels any one country is benefiting disproportionately from the medical scheme. For example, imagine if three hospitals of three countries are listed for liver ailment, each providing certain facilities based on severity of the condition, then the patient will be referred to the hospital which is the cheapest as per the condition of the patient's ailment existing at that point of time, which is the best one can do. Also, empaneling multiple hospitals at various levels of pricing from across countries may keep claim amounts in check by ensuring the patient gets referred to the expensive option only if the severity of the ailment does not leave a cheaper option possible, thus ensuring the most expensive treatment is not given unless necessary. It can avoid the need for unnecessarily high claims that may otherwise arise just because the treatment was done in a more expensive facility than needed. This may help the entire viability of the project itself. The rationale is to expand the number of citizens able to afford specialized treatment which they could not afford. It is all the more critical since our region is one where very few people are covered by health insurance.

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Monies received into the medical tourism insurance product can be used to invest into the SAARC asset class products, thus providing the initial push of asset mobilization for SAARC products.

6.5.3 Challenges One challenge is to make hospitals see the rationale to participate; since they can fear that they would lose some business to other hospitals based on empanelment referral system mentioned above. However, one has to remember that the people who can currently afford medical tourism are a very small pool of affluent citizens since only they can afford. This proposal is actually broadening the total pool of patients significantly more than what conventional medical tourism might have been able to. Hence, in terms of absolute amount of patients, the number may actually increase significantly in case the product scheme does see a large number of subscribers, and the sheer size of incremental patients can make up for the business lost if some of the affluent patients are, in turn, referred to other hospitals instead. The pie can become larger, and a smaller piece of a larger pie can be much more than a large piece of a small pie. People who could otherwise afford it will now pay lesser to avail the same healthcare, i.e., only the premium amount. But the objective here is to bring more and more people within this pool, thus making healthcare affordable and accessible to more people than what it is able to do now. Thus, it becomes a business of scale. Many who could not otherwise afford overseas treatment for advanced medical situations will be able to do so now. The members may even look to exclude ultra-wealthy citizens from this product since they would be able to afford specialized healthcare by themselves, although this would sound a sensitive suggestion. Another challenge is the potential misuse by hospitals to bring patients for treatment when the severity of the illness does not justify that expense. This can be countered by instituting independent members (from across the countries) to form the Empanelment Referral Panel which would refer the cases to the relevant hospitals. Patient files are easily scanned and emailed these days, hence members can easily operate from across locations using telecon or video-conferencing. An independent body of members from across countries may create accountability since cross-questioning on the justification provided might reduce chances of biases while referring the case. Of course, this is easier said than done and can slow down the entire process of referring. However, if proper timelines can be set on the processes, at least it may ensure clean and accountable referrals, instead of misuse due to biased referrals.

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The empanelment process also means demarcating the empaneled list of hospitals based on the ailments it can handle, the facilities it can provide, and the price point of its treatment facilities. This demarcation would be another challenging task, but it is also critical for the long-term viability of the project as it can help avoid unnecessarily expensive treatments. Moreover, it ensures hospitals from across the countries. It creates an incentive to invest in setting up advanced facilities in countries which did not have it, so that those hospitals can get empaneled. In short, it reduces the relative monopoly that the very specialized hospitals in the region enjoy now for medical tourism. However, the answer to this is again in the numbers. Till now, the quantum of people who could afford expensive treatment was less. However, this product can make expensive treatment affordable to significantly more people thus increasing the pie manifold.

6.5.4  Initial Role for Stakeholders One can ask how a product like this is connected to the capital market, since it is more of insurance in nature. Sometimes, unconventional challenges specific to a region may require unconventional roles to address it. The role involves analysis of the market size given that it is a fresh idea. This involves estimating the medical tourism numbers and their ailments costs, in order to arrive at a market opportunity of the medical tourism market. Thereafter, this has to be coordinated with the potential size of the health insurance numbers across the member countries. This will also need analysis of the insurance regulations to arrive at a common framework of insurance across members so that such an integrated product can actually be implemented. One might play an advocacy role by advocating the benefit to the insurance providers and regulators of the various countries, in assessing how the exchanges can coordinate with a network of designated brokers to sell the product on their platform, using the case study of how exchanges today already coordinate with a network of brokers for facilitating the sale of mutual funds via their platform.

6.6  MUTUAL FUND PASSPORTING SCHEME Purpose in this section is to explore the possible sale of mutual funds of one member country to the other member countries, by working on uniformity of fund prospectus contents, guidelines for distributors, etc.

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Mutual funds are one of the best methods to take exposure in a new market/country/sector since it gives the comfort of diversification and avoids single-stock exposure, till such time that awareness and information about the other market builds. Hence, the job of identifying individual value-pick stocks becomes easier as the experienced fund manager is the one taking the investment decisions, as they know the local market best. The main draw attracting asset management companies toward Mutual Fund Passporting is really the savings pool in the target country—larger the savings, better the opportunity. The other main draw is whether the investors in the target country will seek funds based on new sectors/asset classes which the AMC can provide. Creating investor education on the new products and the markets (on which those products are based) is a key requirement of this scheme. Without the awareness of local investors about the companies/sectors of the foreign securities and of the products itself, the plan would fail. Taxation of the returns between the two jurisdictions is another aspect which the stakeholders need to keep in mind. Nevertheless, this is a practical route for investors in smaller markets, but with meaningful savings, to get access to a variety of fund products.

6.6.1  What is This? Mutual fund passport scheme is the ability to sell mutual funds of one country in another country. This means that a fund product regulated to be sold in one country is eligible to be offered for sale in another country as well, while complying with the second country’s regulations, covering both product and distributor aspects. This requires an integrated regulatory platform that allows a single fund structure to collect and invest across geographies. It was mainly with this objective that the Undertakings for Collective Investment in Transferable Securities (UCITS) came up in the European Union (EU) as a fund structure working across the EU markets. The UCITS’s objective was to allow open-end mutual funds (collective investment schemes) which are compliant to UCITS norms, to operate across the EU with a single authorization from one EU member state. This meant that a UCITS compliant mutual fund which had the authorization from one EU member state could also be sold to the investors in other EU member states without the need for further authorization. However, there have been challenges related to cross-border marketing of the funds, resulting in further deliberations till UCITS 3 and eventually, UCITS 5,

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were agreed upon. The subsequent versions of the UCITS structure include product component and service provider components, as well as the role of depositories, etc. A recent example of mutual fund passport in Asia is of the ASEAN Economic Community (AEC) mutual fund passport initiative in which Singapore, South Korea, Australia, and New Zealand have joined hands. While the initial study is currently going on between these countries, other ASEAN countries have also evinced interest. In SAARC’s case, the mutual funds covered under a passport scheme can be made available for purchase through the respective stock exchanges on a reciprocal basis. In this manner, the exchanges and its intermediaries can gain by the increased demand for mutual fund products across the region. India’s BSE Star platform for mutual funds is a useful example of buying mutual funds via the stock exchange platform, although this platform is only for Indian investors, intermediaries, and asset management companies. Nevertheless, this business model of BSE’s mutual fund platform shows that the exchange can coordinate with brokers for facilitating the sale of mutual funds, thus becoming involved in the value chain of the offering.

6.6.2 Advantages Allowing investors to diversify their portfolio investment exposures across countries is an objective of allowing mutual funds of one country to raise investment monies from another country. Through this mechanism, funds from various countries are made available to investors, thus allowing portfolio diversification. Another objective is of new asset mobilization and potential investment returns from regional markets. It creates investible avenues for both countries. If a fund of country A raises assets from investors in country B, then the investors in country B gain from the returns earned by that fund, while the asset management company in country A gains from the incremental assets raised from country B, which adds scale to its business enabling it to become profitable faster—since the mutual funds business is really a business of scale. This is useful in situations where country B offers limited investment opportunities, and hence the funds of country A open up more investible opportunities to the investors in country B. In situations where the inflow of assets into country B’s funds are low because investors in country A are

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not aware of country B’s economy, the market forces create an incentive for country B to market its economy in country A to build awareness and acceptability of its economy there, and thus generate more mobilization into its funds. A mutual fund passport can take off at a bilateral level, if it is not possible to launch across all countries at one-go. Thus, it can be set up in a phased manner depending on the strengthening of relations, information, and awareness between two/more markets in the region. For example, if India and Bangladesh are coming closer, then as long as the guidelines governing mutual fund prospectus/processes of these countries can be brought to a level field, the mutual funds of either country can be made available to the other. Moreover, when both are countries with a large retail savings base along with low penetration of mutual funds, there can be ample headroom for growth for mutual funds to mobilize further assets within these countries. Asia’s future is in the SAARC and ASEAN (AEC). Hence, a SAARC mutual fund passport platform can eventually be extended to include ASEAN funds too, on a reciprocal basis. In this manner, investors in this region can benefit from the economic growth of ASEAN, which is itself also working toward a mutual fund passport scheme. The infrastructure built today can create tremendous depth and breadth of products tomorrow.

6.6.3 Challenges The regulatory imperative is a harmonious framework governing mutual fund prospectus and processes, to achieve the same standards in the other country that are being adhered to in the original country. Of course, the flows can still be one-sided depending on which economy in the region has better prospects or has created more awareness of its prospects among the investors of the other countries in that region. As the performance of the other economies improves and awareness about their prospects and progress increases, they would also see an inflow of assets into its mutual funds. In this process, the depth and breadth of the mutual funds of both countries covered under the passport scheme can grow steadily. Nevertheless, this challenge of one-sided flows would exist in any region globally, not only in SAARC. At least the advantage is that assets are being mobilized into regulated financial products within the region instead of finding its way to foreign accounts where does not benefit the country anyway.

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6.6.4  Initial Role for Stakeholders One may have to analyze the guidelines governing mutual fund prospectus/processes of the fund regulators across the SAARC countries in order to arrive at a harmonized framework. This would set the regulatory base on which funds seeking to become compliant for the passporting scheme can base their structures. This is the first and most important step. Stakeholders may also need to market the passport scheme to the region’s asset management companies, distributors, and investors to make them realize the rationale and advantages. That can help build more participation and support toward the scheme. At the end of the day, the asset management companies have to develop such funds while the distributors have to sell the funds through various sales channels. Hence, if the AMCs or the distributors do not see the rationale of making or selling such a fund across member countries, the scheme itself will not develop.

6.7  SOLAR ENERGY BONDS Purpose of this unconventional proposal is to explore if local needs like energy deficit can be used for financial products which channelize local monies to address that need. There is only that much debt one can raise from external assistance and sometimes local solutions for local needs can offer a partial fix. If infrastructure or power bonds can be workable solutions to raise funds for greenfield electricity generation and infrastructure projects, then why not solar energy bonds to raise funds for large-scale solar energy development parks? Most SAARC countries have been living perennially in energy deficit impacting the quality of life and business activities, and the high costs of importing coal, crude oil and gas for conventional energy power plants continue to bear down on the public finances of the member countries. China has been investing big time in solar energy parks in regions around the Gobi Desert area, where land and sunlight are available. Its solar investments may soon make it the biggest producer of renewable energy in the world after Germany. If this is not ample evidence of the global attention on solar generation, then what is? South Asian countries, unlike China, lack the financial resources to fund such energy projects. Hence, the proposal is to convert this into a financial product to help finance the projects, while addressing a very basic socioeconomic need of this region which impacts both people and businesses. Land tracts are available in areas with high sun radiation which

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are largely barren (like in Thar in India, Tharparkar in Pakistan, Eastern Bhutan, etc.), and these can be used productively for large-scale solar parks to produce power for local usage. The power can be on-grid via connection with national grids or can be off-grid in specific catchment areas. High-scale investments into socioeconomic infrastructure like energy in the border areas itself, may also reduce the chances of unnecessary border skirmishes, as nobody would want to ruin such critical assets in their own country and risk raising local ire. Moreover, given the SAARCConnect itself wherein the power produced may be sold across the borders too, that may help reduce chances of any neighbor ruining the assets in one’s country since it would impact the supply of critical energy to them, again raising the risk of local ire there. In a typical electricity generation or infrastructure project, the country’s nodal agency floats the tender. Power generation/infrastructure companies/developers can apply as per the tender to get selected and execute the project, for which it can raise the funds itself or as project finance from power funding/infrastructure funding companies. The developers can raise the funds in its own account or in a special-purpose vehicle (SPV) created for the project specifically. SPVs are often favored for executing large-scale power/infrastructure projects, as it helps in better management of resources for the project. SPV structure is also favored when the executing company forms a joint-venture with another entity, like in PPP (public–private partnerships) projects. The capital is mostly invested as debt, but can be partly in equity too depending on the nature of the project. As the project gets executed, the SPV/developer will repay the debt to the funding company from the cash-flows it earns from the sale of electricity generated or the collection of tolls (especially in BOT projects—build operate transfer). In EPC projects (engineering, procurement, contracting), the nodal agency/developer pays the amount to the EPC contractor, for which it raises funds from the government’s financial institutions or by its own from the public. The funding company who lent capital to the SPV/executing company/developer in the above example raises its own funds by issuing bonds to the public or through term-loans from banks. It earns the spread (difference) between the cost it pays on the bonds/loans and the money it earns from the project owner. In case the executing company raised the funds by issuing bonds, then it would earn the difference between the cost it pays to the bond-holders and the money it earns from executing the project.

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6.7.1  What is This? Solar Energy bonds would largely work the same way as infrastructure bonds in the above example. The relevant entity in the countries developing solar energy projects or the commissioning agencies for renewable energy projects can issue the solar bonds to the public. The bond would be based on that country’s prevailing reference interest rate and a mark-up premium over that interest rate which gives the bond-holder the appeal of higher yields. Issuance would be limited to one country, since the interest rates have to be accordingly. The corpus raised across the members can be invested in solar projects either across the SAARC region or only in that country from where those funds were raised. In case it is invested across the SAARC region, then it would help investments and generation of solar energy where the project offers the best rationale/feasibility. Thus, the efficient transfer of capital from where it is in surplus to where it is best needed. In case it is invested only in the country from where the funds were raised, it would be equivalent to each country raising capital for own projects. The power produced can be sold to that country’s utility/agency if the project is for on-grid connectivity, and it can even be sold to neighboring countries if the cross-border grid connectivity exists. However, the rate at which the solar power is sold has to be affordable for the local users in the countries buying the solar power (and naturally comparable to the existing rate of conventional power there). Alternatively, the project could also be off-grid for a catchment area wherein the solar power apparatus (PV panel, batteries, converter, and appliances) are set up in individual homes with/without wirings connecting the homes. However, this may be useful only in catchment areas where either supply of conventional is seriously absent or where a small-business cluster can be developed to provide a rationale for localized investments. Coming back to the product structure itself, a quantum of bonds depending on the corpus expected to be raised can be issued in the local capital market. The monies are raised from retail/HNI investors of the member country through the bond issue are pooled into a corpus. This corpus can be invested in solar projects across the region depending on the outcome from prefeasibility studies and detailed feasibility studies conducted on the prospective projects, and also as per the duration period of the bond itself to ensure asset-liability mismatch does not occur. The projects may have to go through an approval stage comprising of experienced

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personnel from member countries to justify the investment rationale and potential. This would be quite similar to how multilateral funding agencies like the Asian Development Bank and the World Bank function. The project that receives funding from this corpus can be by the SPV setup for the specific solar project, and the corpus lends a certain amount based on the project’s outlay. This would be quite similar to most infrastructure bonds or lending to infrastructure projects via the debt route. The corpus goes into the initial investment for the project that has been finalized after the prefeasibility studies and detailed feasibility studies. The power is used by the country where the project is located, as well as sold to the regional countries which have on-grid connectivity to the project country’s grid network. As grid connectivity in the SAARC region expands further, it can offer an increased scope for sharing renewable power further across borders through on-grid channels. The power is purchased by the recipient country at a certain cost per unit, and these receipts are the earning for the SPV/executing company. It, in turn, pays the funding agency (the issuer of the solar bond corpus, in this context) from these receipts, and the solar bond issuer, in turn, pays out to its bond-holders the periodic interest rate and capital return. Of course, this requires a parity between the per unit cost of power across the countries. Alternatively, the corpus could also invest directly into the solar energy contracting companies in the region who have built capabilities in executing solar power projects, so that it can provide the much-needed cash to bridge the gap that occurs between the procurement of material and the receipt of the payment from the client. That may have the advantage of investing into existent companies with running track-records of operations in solar energy projects. This route may also make the job of the issuer easier in terms of initial analysis and evaluation, as compared to direct investment into green-field project SPVs. A public issue of the solar energy bonds to local retail/HNI/institutional investors using the local capital market infrastructure can make it a transparent and accessible product across the region. Thereafter, if the bonds are tradable on the local exchange’s debt platform, then it can also add to trading volumes in the exchange, though bond trading interest is still relatively low in this region. Nevertheless, it can become a useful capital market product for the region mobilizing savings productively, just like infrastructure bonds.

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6.7.2 Advantages Size creates economies of scale, and the ability to demand better pricing from suppliers. Solar PV panels comprise 60–70% costs of installing a solar project, hence favorable terms on solar panels can make a big difference to the project feasibility. While individual solar projects may not have the scale to demand favorable pricing from the Chinese makers (who comprise the largest solar panel manufacturers today), a project which entails large-scale solar development parks may have the size where it can demand better pricing, since it is giving an adequate pipeline of panels to be imported. Thus, the scale created by such large-scale solar parks can bring in feasibility to the project, which individual projects often cannot. Quality of life of the citizens improves, especially in rural and semiurban areas which are a huge vote-bank. It also enables business activity, since otherwise businesses remain stuck due to want of power. All SAARC countries have energy deficit and spend a huge portion of their scarce resources to import costly fossil fuels. Most of the new generating facilities in the region are thermal-based, leading to a large import bill for coal since locally mined coal is often not of the quality grade for thermal power generation. While the current low price of oil may look attractive for oil-based power plants, oil prices also fluctuate severely. In such cases, solar energy can be a practical option to scale up. The SAARC region is largely tropical in its weather and receives a high degree of sun radiation which is an intrinsic need for solar power generation. Renewable energy production also ensures the country does not remain so susceptible to constant variances in fossil fuel prices and import costs. Sunlight is free, hence does not cause inflated import bills as fossil fuels. Moreover, the population density and agriculture tracts are located in certain areas. There are potential tracts of land which are not conducive for residential, agricultural, or commercial development but are yet located in proximity to the developed areas. This proximity is required because solar power can lose some of its intensity if the power has to travel a great distance from the source location to the storage location. While the payback period is a strain, the long-term operating costs are much lower than conventional power. Maintenance expenses are the only recurring expense in the long term, which would occur in any project anyway. It creates a fixed-income investment product for local retail/HNI/ institutional investors. Moreover, it mobilizes a portion through local capital instead of making nations’ indebted to foreign countries for every

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development need. There is capital available locally in all member countries which is otherwise finding its way to alternative investment avenues or perhaps, outside the country entirely. Routing this capital for a development project which offers competitive yields might be a win–win situation for both the investors and the country. If the bonds are tradable on the local capital market, it can also generate volumes for exchanges, apart from enabling transparency and liquidity in the bond products if the investors’ change hands over time.

6.7.3 Challenges The pricing of the interest rates of the bonds and of the final power produced will be key challenges, as it has to take into account the local prevailing rates and potential mark-up over and above that rate, as well as existing per-unit price of conventional power. In a situation where the project is based in a country where the perunit cost of conventional electricity is comparatively low (and hence the per-unit cost of solar power also needs to be low to provide the rationale for its ensuing demand), but the prevailing interest rates are on the higher side, the project has to be of a capacity enough to justify that the total proceeds from the project, despite lower per-unit cost, would be ample to pay the bond interest rate. Unless the project can do that, the bond would struggle to pay the higher interest rate in whichever that country is. Hence, the estimated corpus size for such a solar bond issuance needs to be worked out carefully. A certain corpus will be able to fund a certain capacity, and that capacity has to be enough to make the arithmetic workable. On-grid connectivity of the electricity grids between member countries would be another issue, if the pooled corpus is indeed invested in projects across the SAARC region, so that the produced solar power can also be consumed across the region. If the produced power has to travel across the member countries’ boundaries, then the grid system has to be in place to support it. As of now, on-grid connectivity is workable only between India, Bangladesh, Nepal, and Bhutan. In case the electricity is not available across boundaries, then only the country where it is produced and the countries which have on-grid connectivity to it will gain. One alternative to the on-grid challenge is to restrict the use of the produced power to the country where it is produced and the countries which have on-grid connectivity to it, though this means that only those

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countries would be interested in such a bond issue. Other countries would not really be interested since they do not really gain from the produced power. However, since creating on-grid connectivity is a focus area among SAARC members now for transfer of conventional power, this challenge might diminish in due course. Another challenge is of locating the production in a place that is in proximity to all the grids/countries the project aims to serve, because solar power can lose some intensity if the power has to travel a great distance from production to usage. Hence, while solar projects need to be located near the commercial or residential catchment areas as well as the on-grid networks of the countries it aims to serve, it also means working out the land acquisition norms in that country to facilitate such a production location. Land acquisition laws in most of the countries are archaic, and land compensation rates and title transfer have to become compatible first. However, this is a common challenge for any factory/infrastructure-based project which requires land tracts, and hence may get duly sorted if other infrastructure projects also have to pick up. For solar to be successfully adopted, the per-watt price of solar power at which it is made available to the end-users has to become comparable to conventional power; otherwise the demand potential will be restricted. While its eventual operating expense might be lower, the estimated cost of land acquisition and solar PV panel imports will determine the payback period and the extent of economies of scale that the project offers. While sun radiation may be free, the solar photo-voltaic panels are not; and solar PV panels make up almost 60–70% of the total cost of a solar project. China today produces half of the world’s solar PV panels, and suppliers of most Asian nations import from China. As long as fragmented groups of suppliers are importing solar PV panels, their bargaining power will be lower and they will continue to pay higher prices. On the other hand, few large-scale solar projects will mean importing significant volumes of solar PV panels for a single order. The sheer quantum of such orders would give more bargaining power to the executing company with the Chinese manufacturers for the solar PV panels. This would bring down the overall cost of production for the solar project, in turn enabling the production of solar power at a final per-watt rate comparable to conventional power. That would lead to a multiplier effect in its acceptability and demand from people.

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This can also be a win–win situation for the solar PV panel manufacturers in China too. Firstly, the sheer import quantum may increase due to large-scale solar parks in SAARC, and that may more than offset the loss they may face due to the buyers’ bargaining power and the need to sell the panels at a slightly lower cost. Second, certain Chinese solar PV panel manufacturers listed in Hong Kong and the United States recently saw significant share-price declines as the sector faced challenges, and an increased demand from the SAARC region might give it the much-needed uptick. Hence, while China’s solar PV panel manufacturing industry may lose in the short term due to the lower panel cost; however, it may win in the long term since the quantum of orders may increase for delivery, translating into increased production and job creation in China. Regional electricity utilities may resist rapid adoption of renewable power. This is because most electricity utilities have contract demands with users, i.e., a minimum range of usage that must be consumed since the utilities are working a lot to procure that power. This is because if the demand of conventional power suddenly reduces, it can lead to gaps between procurement and usage and hence, financial concerns. Hence, the renewable power production (and adoption) has to increase phase by phase so that the total demand stays within the range of the contract demand to the best extent, and hence reduces chances of resistance from electricity utility boards. The adoption has to be phased over a period of time, not at one-go.

6.7.4  Initial Role for Stakeholders A task is to identify potential tracts of lands across the member countries, where land acquisition rules are workable and which has proximity to critical energy deficit areas. It is important to base the projects near critical energy deficit areas to give the entire project a “social-investment” touch, as that can help garner support from the local governments for the land acquisition needs, which is itself a socioeconomic issue. In this case, once can offset the challenges of land acquisition by showcasing the project is bringing power to critically energy starved areas, which can improve the quality of life and enhance local business activities. One may also have to compare the electricity rates and consumption (and deficits) across the member countries with the reference rates that may be required in each country to determine which locations would be

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best suited to house potential projects, such that the entire arithmetic of the bond product is workable, and hence it makes investment sense. This may include working on the contract demand range of electricity utilities in these countries, to ensure the final demand of conventional power from the utilities in those locations remains within the contract demand range, otherwise one may see resistance from them. Investor education work also has to be an imperative so that demand for the solar bond product deepens, leading to a larger corpus during issue. A liaison role would be needed between the exchanges, capital market regulators, and the commissioning agencies to create awareness on the rationale for such a bond product and identify possible companies who can execute solar projects and issue solar energy bond products. It may also need to engage with domestic institutions/HNIs to gauge the interest level for such a product and make an estimate if the local investor base would be receptive to such a product like solar energy bonds. This includes coordinating with rating agencies since bond products also need to be rated first.

6.8  SDR CROSS-BORDER LISTING (OR IDR LISTING) Purpose of this section is to explore a listing structure for foreign equities in the local markets through the depository receipt route. Listing in another country’s exchange is a popular method of cross-border integration, facilitating capital-raising by those who need it from the country which has surplus capital. Cross-listing helps in those situations where the region may see less acceptability as a whole, but bilateral ideas are acceptable between two and more members. Companies can opt to list where it gets the best valuation, which is ideal for them. A more liquid and larger exchange means access to a broader set of matured investors. However, it requires extensive marketing of the company in the country of listing, in order to build awareness. Incompatibility in accounting standards between the geographies can be an impediment for investor comfort. This also means “single-stock” exposure, which may not be the best course at the initial stage in SAARC’s capital market integration given that the awareness of each other’s economies and companies is still low. Products that are diversified across companies and countries may find higher acceptance initially, as compared to products based on a single company/country which the investors in the listing country may not know much about. As awareness of each other’s economies and companies

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builds, then such products based on single-stock exposure (company listings or single-stock futures) may find more takers. However, there may still be the few cases at a country-to-country level where awareness levels are still quite high, and hence may prove ideal breeding grounds for listing of companies. This is a useful way for bilateral engagement among the region’s capital markets, between two members where the acceptability is still quite high. Given the region has its own list of implementation challenges for any integrated projects, such bilateral options may also be worth considering.

6.8.1  What is This? While direct listing of companies is one option, the easier structure is the GDR (or IDR in India’s case). IDR is like a GDR (Global Depository Receipt), except that it is listed in Indian exchanges and denominated in Indian Rupees, for companies who want to raise capital in India. It is the Indian alternative of the GDR. Each IDR of a foreign company listing in India would be equal to a certain number of equity shares in the company’s primary exchange of listing, and the holder of the IDR would be the owner of the commensurate number of equity shares that the IDR equals. When a company is listing IDR, it will list a quantity based on this share conversion ratio and the shares issued would be based on the valuation that the company commands. The IDR guidelines require the listing company to have prior listing in its home country/primary exchange for at least 3 years. The main reason behind this is to build comfort on the corporate governance and financial disclosure track record of the company, since prior listing would have required it adhere to such criteria. Standard Chartered Bank went for an IDR issue after the product was launched. Alternatively, if the IDR structure is not agreeable to member countries, then the region might explore the option of a SAARC Depository Receipt (SDR). The SDR would do largely what the IDR does, except that its name becomes more representative of the SAARC region as compared to IDR. But the SDR structure would still require listing in some exchange of one of the region’s member countries. The new structure for SDR can address a challenge the IDR faces— like requiring prior listing of the companies seeking to list IDRs. There may be many good-quality/high-growth companies in the region which do not have prior listing but are good investible companies and the capital raised can open further growth opportunities for business expansion.

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This will mean a new structure modeled along the business prospects and realities of SAARC-based companies. Apart from SDR or IDR, this structure can also be built by the other members who are comfortable with it, hence the field is open for PDRs, BDRs, SLDRs, as well.

6.8.2 Advantages IDR/SDR listings can open up the local securities to a broader array of investors, thus generating more liquidity in the high-quality stocks. The counters for this listing will be different from the counter in its country of origin (if it is traded there). The local investors of the country of origin might also trade in the SDR listed counter if they are allowed to do so, and if they perceive it to have lower market impact price due to higher liquidity as compared to their local markets. That will help generate a higher aggregate level of trading volumes in that scrip, than what was possible by only listing in the local markets. Most importantly, the IDR (or GDR) is essentially about raising new capital, from the markets which have surplus capital to those who need it for business expansion. Thus, the main boost is for the companies to raise capital and realize their growth ambitions, and becoming ideal long-term value investing stocks in their own right. It opens up the opportunity for capital raising and realizing growth. The GDR utilizes the liquidity available in the listing country, and it helps generate additional trading volume in the exchange where it lists. In IDR’s case, India has sizable retail, HNI, domestic institution, and proprietary volumes investing in cash equities (although equities still remain under-penetrated in India). Thus, the GDR would be a tradable equity product on the local stock exchange just like any other ordinary share, generating volumes in that exchange from the liquidity of its local investors. Even the SDR would offer the same advantage in the exchange/ country wherever the SDRs list. Whether it lists on any exchange of Bangladesh, Pakistan, or Sri Lanka, the SDR would help generate additional trading volume in that exchange. Moreover, in countries where investors are searching for long-term inflation beating investment products and the interest in capital markets is picking up, listing of good-quality/high-growth regional companies with competitive advantages could generate long-term investing interest. Thus, the investors gain from returns.

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Cross-listing of stocks can also open up the opportunities for playing arbitrage, i.e., sell in the local market and buy the SDR/IDR in the foreign market, or vice versa. This assumes both the markets are open to the investors. Arbitrage volumes comprise a significant proportion of traded volumes in the larger markets, and cross-listing of stocks is a useful method to generate investor interest in arbitrage volumes. Arbitrage also helps in price discovery, as the prices of the two counters should ideally converge due to the forces of demand and supply, ensuring neither price is at an unrealistic level. That may also be beneficial for the investors in the smaller markets, where the lack of liquidity might sometimes prop up the price at an unrealistic level.

6.8.3 Challenges Cross-listing of local scrips entails the risk that some of the local investor interest will flow to those markets which are more liquid than the local exchanges, thus resulting in loss of business. One way to address this is to ensure that local investors continue to invest only in the local market, and the foreign listed counter is open only to foreign investors of the region. Thus, the local business for the smaller market may largely remain intact. However, it still means that the local investors suffer from higher market impact cost due to the lack of liquidity in the local markets, which is an injustice, since the foreign investors see lower market impact cost. The IDR product specifically requires the company to already have been listed in its home country/primary exchange for at least 3 years, mainly to ensure adherence with corporate governance and financial disclosure norms. This narrows the universe of companies who can list IDRs, since it means that a company which is otherwise seeing high growth in revenues and profit margins and has built competitive advantages in its strategy to support its long-term growth, but did not list as the local capital markets as it did not have the volume depth to support several listed companies, now may not be able to list IDRs as it was not already listed in its home country/primary exchange. In this process, good-quality companies in the region, but who were unlisted, will remain out of the IDR universe. Either the IDR may have to relax this requirement for the regional companies looking to list IDRs; or else, if the SDR route is pursued, then the SDR guidelines will have to address this.

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If the SDR/IDR route is kept open for unlisted companies from countries which vary in corporate governance and financial disclosure standards, then it will require extensive work to achieve harmonization on those standards so that the investors’ comfort develops on the unlisted foreign companies looking to list SDR/IDRs.

6.8.4  Initial Role for Stakeholders Assistance would be required in marketing such companies and its sector in the listing country by coordinating roadshows, so that awareness and comfort build and thus, investor demand is created. This would be a corporate access role to bridge the gap between the companies and the investors. It may also have to work on gap analysis in corporate governance and financial disclosure standards across the member countries in order to arrive at a harmonized framework, especially in context of unlisted companies. This is an essential precursor to building a direct listing structure for companies from multiple countries. It will also need to identify and pitch to potential companies looking to raise capital, as to why they should consider listing on a SAARC exchange for their capital needs instead of an exchange outside SAARC. Thus, a marketing role is required to push the need.

6.9  CROSS-COUNTRY INDEX FUTURES (SAARC/BILATERAL INDICES) Purpose of this section is to look at cross-country index futures, either on bilateral basis or on SAARC asset class, as a product that can connect the local investors with products based on the regional markets. Bilateral means one country’s index is listed in another as a futures product, while SAARC means the SAARC asset class itself is listed on one/more regional exchanges as a futures product. In the earlier section, we mentioned the SAARC basket to showcase the SAARC asset class. A SAARC index future based on this underlying index would be a useful way to monetize the index and generate investor interest in SAARC as an asset class through increased volumes. The same could also be done on the existing Dow Jones SAFE 100 Index, as long as its performance provides a rationale. The SGX Nifty index future is an example involving India’s NSE Nifty index and Singapore’s SGX exchange. The fact that volumes on the SGX Nifty future in Singapore

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actually rival that of the NSE Nifty future in India shows how popular cross-country index futures can be. Of course, the success also depends on the inherent advantages the location provides to global institutional investors. Futures can also help generate volumes in that security outside of the cash equities segment, more so in cases where the investor wants to take additional exposure in that security but has reached the maximum permissible limit of single-stock exposure in the cash equities market. At this stage, index future may be better than a single-stock future. Single-stock future involves single-stock exposure and the associated risks; while index future is diversified across stocks (and maybe also countries). The demand to take single-stock exposure may be restricted till the time the awareness of each other’s markets and companies increases further. Till that time, a top–down approach using an index may work better.

6.9.1  What is This? An index future is essentially a contract to buy/sell a certain value of the underlying index (i.e., the stocks constituting that index) on a future date at the specified price. A single-stock future is the same thing, except that the underlying asset is that specific stock, not the index. The future product is tradable on the exchange’s derivatives section. The main purpose of futures is to hedge against potential risk due to the changes in the spot price of the index/stock by going long or short-selling, based on the estimation of the market direction. Mini-future contracts have also been introduced by the exchanges which have smaller lot sizes as compared to the original contracts, thus making it more affordable for retail investors to participate in future products (the lot size refers to a fixed quantum of the underlying security, and a future is traded as per its lot size). Derivative products like future involve daily mark-to-market (MTM) to reduce the chances of settlement risk. A daily MTM occurs in which the participants have to pay in cash any losses or collect any profits. The SAARC index future would be a future product based on the SAARC asset class index or on the DJ SAFE 100 Index, as the case may be. On the other hand, a bilateral index future could also operate among the countries that currently have introduced future products in their markets. For example, listing the NSE Nifty index future on the Karachi exchange, or listing the KSE 100 index future in the NSE in India, etc.

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6.9.2  Potential SAARC Asset Class Product for Global Institutional Investors in Reputed IFCs A SAARC asset class index future can also explore the option to list on exchanges in the IFCs, rather than in the regional exchanges. The exchanges in financial centers like Singapore, Hong Kong, Dubai, etc., have a sizable institutional investor presence looking at EM and FM asset class, and they would be more aware of the regional economies than local retail investors. In equity derivatives, it is worth remembering that only few global investment banks (Goldman Sachs, Morgan Stanley, etc.) dominate the institutional trading in equity derivatives in EMs like India, i.e., the trading is highly concentrated within a handful of global investment banks. If one wants to boost interest in equity derivatives, one may need to be accessible for clients like these global investment banks, wherever they might be! Many global investment banks engage in cash-future arbitrage, i.e., buy a basket of securities in the cash market as per its weights on the index and go short on the index futures so that they can gain from the difference. This actually boosts the cash equities volumes also, although it may be at a lower yield as compared to normal cash equities trades. Nevertheless, it is a useful way to generate volumes and market share on the cash market, by facilitating arbitrage transactions in cash-future by these global banks. This is all the more reason why an index future should realistically look at basing itself in an IFC where such institutional investors are based. Of course, this assumes the cross-border trading rules allow taking such positions on the local and foreign markets simultaneously. If that is allowed, then the investors also need to be registered with the local regulators so that they can take local positions. But, most global banks do have the registrations in place as foreign portfolio investors in most of the markets they invest in, including those of South Asia. Foreign institutions are more comfortable with IFCs due to established regulations and ease in capital movement, as compared to markets in developing countries. Hence, a SAARC index future can be pitched to such a center, just like India’s Nifty or Sensex indices have been launched as index futures in several IFCs across Asia, rather than launching them in a regional exchange where futures as a product is yet to take off, and may still take some time to gain acceptability. Of course, this involves the same challenge like in SAARC ETF’s case—most institutional investors have demarcated EMs and FMs as

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separate asset class baskets, while SAARC would cut across the two categories. Hence, it may be advisable to engage with financial centers whose countries may have an interest in the SAARC economies and may be more receptive to the SAARC asset class. This is somewhat similar to the suggestion of anchor investor in the SAARC ETF. Thus, it may be useful to look at financial centers like Tokyo, New York, London, or Shanghai, given the deep economic relations that China, Japan, the United States, or the United Kingdom have with most SAARC countries individually.

6.9.3 Advantages Compared to a fund, the future has a major operational advantage. The future’s settlement does not call for the delivery of the actual stocks associated with that underlying index, since futures use the concept of cash settlement. Thus, it does not involve the transfer of the underlying stocks, as in the case of a mutual fund. This makes a difference since share transfer can be complicated when multiple countries are involved. Another advantage of future is that it allows taking additional exposure to a specific stock when the investor’s exposure to that stock has already reached the upper limit in the cash equities market. The same advantage holds true for index future too, in case the investor holds the underlying stocks of that index in a basket in the cash equities segment. This situation can often occur with global institutional investors, who have limits on the exposure they can take to a single stock, market, or asset class. Hedging against changes in the spot price is the main advantage that future offers. This is useful in markets that are inherently volatile, where it can be tough to ascertain market direction. In any case, volatility levels in EM indices like India are higher than indices of developed markets like the United States. This is one of purposes that global investment banks use derivative products like futures so widely the world over, and they account for a lion’s share of this market. In fact, sometimes their cash equity positions are also. Given that ~INR 3.0–3.2 trillion per day is the average daily equity volumes in the Indian exchanges today, and futures comprise ~15–20% of these volumes, it gives a reasonable idea of the volumes made up by futures alone. Hence, futures products in the region can offer ample scope to gain traction in traded volumes, since delivery based cash-equities volume may not be enough to take volumes to the next level.

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6.9.4 Challenges Most of the regional exchanges are yet to launch local futures products in their countries. Given the low level of penetration of futures as a product in the region, a SAARC futures product may be too ahead of its time. However, futures product based on the SAARC asset class may provide the needed impetus to launch futures in the smaller markets, where new products based on the broader SAARC asset class may find more takers than products based solely on local equities (which are limited in number in the smaller markets). Finalizing the modalities for bilateral listing of index futures is another challenge. Cross-country index products presuppose the investor community in the listing country is aware and acceptable of the index’s economy. Given that India and Pakistan are the main markets which currently have futures products on their exchanges and the extent of mutual awareness/ acceptability of each other’s economies may vary, this may just be a challenge. One reason for the success of the SGX Nifty futures was that Singapore’s global investor community was reasonably familiar with the Indian economy, and hence was receptive to the product. The extent of awareness/acceptability may impact the success of a bilateral index future or a SAARC index future, given that awareness of each other’s economies’ drivers of growth, performing companies, and sectors is still low, especially among the region’s retail investors. Investors in the SAARC economies may be more aware of the economies of their trading partners or the source countries of their foreign institutional investors. In such a situation, whether a bilateral index future is more advisable rather than a SAARC index future at the initial stage would depend on how many regional exchanges plan to launch futures in the immediate future. On the other hand, a bilateral approach would allow a phase-by-phase launch, without embroiling too many investors across multiple countries at one-go. That would also allow building the awareness of each other’s economies one by one. Given that futures itself is yet to be launched in some of the exchanges, investor education is critical to create the interest level in investors and avoiding situations of mistakes in investing. This also includes building the awareness of each other’s economies, which would pave the way for the SAARC index future eventually.

6.9.5  Initial Role for Stakeholders Identifying markets in SAARC where cross-country index futures may be implemented, by surveying the level of awareness the local investors in the

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listing country have of the economy of that index’s origin, as well as of the product itself. This is needed to build acceptability of a product based on those economies/asset classes. Ideally, the preference should be countries which are already trading in futures or plan to launch very soon. However, if such countries do not seem ideal partner economies due to geopolitical hostilities, then the role may also include engagement/ consultancy for setting up the futures products in the local markets in the first place. This means setting up a local futures product to build familiarity of the product, and then introducing a foreign equity future from a regional economy which has acceptance as a partner. Identifying suitable IFCs where a SAARC asset class futures product may find takers from the local institutional investors and engaging with such exchanges to explore opportunities and regulatory processes for setting up a SAARC index future/Bilateral index future in those markets. India’s NSE and BSE exchanges already have several such cross-border index futures products in global exchanges. Hence, potential issuers may engage with either BSE or NSE to develop the know-how of the index futures.

6.10  TURNKEY CONSULTING, TRAINING AND EDUCATION FOR NEW PRODUCTS/MARKETS Purpose of this section is to discuss if consultancy to introduce new products in the smaller markets is a precursor to launching integrated products in those markets. This also involves investor education for the local investor community. These can build acceptability once integrated products are eventually launched. The SAARC region’s exchanges vary significantly in terms of the products and asset classes offered. Within this region, India is the only country whose exchanges offer a range of products across almost all asset classes covered by the global stock exchanges today. Pakistan is another country whose exchanges offer products like futures and ETFs. Otherwise, trading in most other exchanges in this region is still restricted to cash equities and government bonds. Broadening the portfolio of products offered in the local capital markets is a critical precursor to launching of integrated products eventually. Adoption of new products across asset classes by the local capital markets will help deepen the awareness and interest of the local investors in the individual markets in those new products and would go a long way in widening the scope of products that can be used for capital market integration projects.

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6.10.1  What is This? There is significant opportunity for turnkey consulting services to help launch new products across asset classes, since many regional exchanges are yet to launch equity futures, equity options, currency derivatives, commodity derivatives, interest rate derivatives, open-end mutual funds, ETFs, corporate bonds, etc. Depending on the deficit areas in the smaller exchanges’ product portfolios, either the larger exchanges or specialized consulting providers (like in technology or training requirements) who possess the technical know-how and the requisite infrastructure to provide the consulting service to help the smaller exchanges launch new products. Such consulting services can ideally be on turnkey basis, so that the entire project is implemented from start-to-finish by the knowledge providers, and where the local operator can take over. Consulting can be bilateral (between the exchange which is interested to launch a new product and the entity which can provide the consultation) or multilateral (where two or more exchanges engage with the service provider for common purposes) in nature. An example of multilateral is if both exchanges in Bangladesh (Dhaka and Chittagong) take consultancy services from NSE’s Financial Institutions Group to help launch a new product on both exchanges simultaneously. A bilateral relationship would be one where only one exchange, be it Dhaka or Chittagong, is engaging with NSE. Training programs for Young Professionals engaged in the regional capital markets can be a cash-cow business. Many youths are interested for market-specific training, both in technical knowledge and its applied usage, as well as management skills in financial services. Local universities do not encompass these skills within their Finance programs, to the extent required in practical usage—hence the demand. If affordable training programs can be set, it can be a high-volume business. There are training programs being conducted currently, but the pricing of most is exorbitant. That creates a disinterest since only company sponsorships can be the practical route to pay the fees, and many financial institutions have cut-back on such freebies to their employees after the pressures of post2008 hit the financial sector. In such a situation where the demand is there and the high pricing is the constraint, the alternative to capitalize on this opportunity is by converting it into high volumes rather than high pricing, where the volumes make up for the lower pricing charged of financial institutions. Higher volume may not always mean a drastic reduction in the quality of those seeking training, as one can select enrollments to

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the programs based on professional background and experience. Some exchanges globally are doing these currently and are evincing healthy interest for both technical courses as well as managerial skill programs focused on capital markets. Apart from consulting and training, if the regional exchanges are to introduce new products and asset classes, then the investor education in those markets also has to develop so that the local acceptability and activity in those new products increases. Investor education includes basic knowledge, as well as implementation aspects like trading strategies and the Do-and-Don’t while investing in those new products. Otherwise, the new products will fail to generate investor interest in their respective markets, leading to low volumes and assets. Resultantly, if the new products launched in the local markets see low acceptance and awareness, then an integrated product based on the same product/asset class may also fail to arouse investor interest. Thus, developing investor education in the new products launched first in the local markets is a critical precursor toward realizing the success of capital market integrated products. This also includes gathering market intelligence within those local markets, as to which new products may succeed given their market size and investor preferences, since every product may not succeed everywhere.

6.10.2 Advantages Heterogeneity among local capital markets in terms of evolution and maturity can be detrimental to capital market integration. Smaller markets may feel insecure that they may lose out to the more evolved and liquid markets in the region. This is a concern in ASEAN’s capital market integration ambitions, where some of the smaller markets like Philippines, etc. are still evaluating the possible impact on their local markets due to integrating with larger markets like Singapore, Thailand, or Malaysia, since those three markets are more developed. In a situation of heterogeneity among local capital markets, proper consulting services and investor education programs may speed up the process of adoption of newer products by the smaller exchanges so that their journey of transition is made smoother, since otherwise without it, the adoption might be more expensive as compared to outcome yielded. In this way, smaller exchanges can retain their local business. Regional markets in SAARC are better attuned with the cultural aspects of this region, and cultural aspects often determine saving,

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investing, and spending decisions in many societies. Hence, service providers from within the region may be better equipped to address the cultural peculiarities of the South Asia region and mold the product advice with the region’s cultural traits.

6.10.3 Challenges Even after introducing new products and hence, offering the same range of products and asset classes as any other exchange in the region, the liquidity levels among these markets would still vary due to differences in the size of the local and global investor community among the individual markets. Resultantly, a portion of the trading activity, including from foreign investors, may shift to more liquid trading venues where price impact may be minimal, thus leading to loss of business for the smaller exchanges. In any case, the smaller exchanges were struggling with lower volumes since they were restricted in terms of products offered. Integrating local and regional securities may also mean that a portion of trading in local equities may shift to regional equities if those companies are better performers relatively. However, the loss in volumes in local equities may be offset by an increase in volumes of regional equities.

6.10.4  Initial Role for Stakeholders A liaison role to bring together capital market stakeholders of the region would be needed. This can be a formal liaison service of identifying gaps in the smaller exchanges’ product portfolios, understanding potential products that may work for them, and connecting them with the larger exchanges and technology companies that can provide consultation to help them set up those new products. This would require coordination with the smaller exchanges to pitch workable new products for them, as well as with the service providers who can serve the consultation service. This can be a useful way to build the smaller markets to par and which would help the cause of further capital market integration projects in the future. One can play a role by developing investor education programs in the regional markets to deepen investor awareness of the new products so that local acceptability in the new products increases. One can tie up with regional exchanges that possess the technical know-how, and thus use their infrastructure to deliver such programs, just like education programmes developed by the Indian exchanges.

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6.11  TRADING LINK BETWEEN SAARC EXCHANGES Purpose of this section to understand how Trading Link connects regional exchanges, to facilitate trading in all the listed securities by both regional investors and global institutional investors. For regions which are keen to attract institutional interest, this technology-based solution ensures minimal latency at lowest cost. This infrastructure is one of the best methods to showcase the entire region as a common asset class in front of global institutional investors and provide them access to the region. The direct connectivity infrastructure helps reduce latency and impact costs, which is one of the most critical metrics for global funds. The technology involved is also often usable for technology-based trading like algorithms, which are also being widely used by global funds. However, the setup costs are prohibitive for this product, and there is no turning back once investments are committed. Hence, there is a tendency for smaller markets to watch-and-wait. Trading Links currently exist in several regions, though mostly in the developed world. In the developing world, Pacific Alliance’s MILA (Latin America Integrated Market) is an integrated platform connected its regional exchanges while ASEAN is the most recent example closer to home. East Africa Community is also in talks currently to set up a platform, although its largest member, Kenya, has backed out owing to its concerns over the software. Nevertheless, ASEAN is a useful example to study in this section, given that it is SAARC’s closest economic rival in the Asia. ASEAN Trading Link is essentially a connectivity infrastructure, linking the exchanges of Malaysia, Singapore, and Thailand into a combined platform for regional and global investors. Basically it acts as a gateway to connect local brokers in each member country with each exchange, without the broker being registered in the foreign market/exchange. It has plans to include the remaining four exchanges of the region as well, and the Link would then provide common access to all the capital markets of the ASEAN region. Trading Link as a concept has a practical usage for global institutional investors. If any region wants to evince more interest from global investors, this is one sure way. Since direct connectivity links are set up between the exchanges and brokers, the reduction in latency due to execution speed (and hence, impact costs can be immense). This is one of the main metrics that global institutions look at to measure the success of trades. With EMs increasingly focusing on global institutional investors to bring in scale in their local volumes, and with global institutions also looking at EMs for trading opportunities, it is win–win opportunity.

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The technology helps reduce latency, while effecting that trade at significantly lower costs as compared to if its brokers had to directly engage with the foreign broker, which would have been costlier. It also helps present the region as an asset class and becomes a one-stop shop for global investors looking at that region not only for regional securities, but also products based on that asset class itself. For companies, the access to a broader set of investors can help reduce cost of capital, just like crosslistings do.

6.11.1  What is This? Structure of a typical Trading Link operates in a Hub-and-Gateway system. In the ASEAN Trading Link itself, an FIX network, Intra-ASEAN Network, is the common Hub connecting all the exchanges; ASEAN Link Gateways are the gateways connecting the India Angel Network (IAN) Hub to each of the individual exchanges; and Neutral Access Point is the direct Gateway connecting the IAN Hub with the global institutional investors who are located outside ASEAN. Brokers of each country are connected to their respective exchanges at the Gateway of their respective exchange. This Gateway connectivity for brokers is required so that local brokers can send/receive their trades to the partner brokers/exchanges via the Gateway/Hub. This connectivity is separate from the existing connectivity that broker would already have had with the local exchange for local trades. Each of these Gateways is located in a data center in proximity to that exchange or colocated in that exchange itself. Order routing involves local brokers to have a bilateral agreement with at least one broker in the other exchange and open a trading account with them, since they are not registered as members of that exchange where the trade gets executed. Such agreements ensure compliance and help in the settlement process. Once the local broker gets a trade enquiry from their local clients via call/online, the broker sends the order to their exchange via their local Gateway. The order is then routed via the IAN Hub to the foreign exchange’s Gateway and then to that exchange’s matching platform. At this time, it becomes an order of the foreign broker (which had the bilateral agreement with the local broker) as the local broker inputs the ID of their foreign broker partner while sending the trade. The foreign broker executes the trade on that exchange. The foreign broker can receive these orders real-time or at end-of-day. The local broker remains aware of the execution status, which flows opposite to the

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trade’s route. The gateways also act as the transfer point for the market data, which also flows opposite to the trade’s route. In the settlement process, the transfer of money and securities will be handled by the Custodian, just like it happens in any foreign trade, including currency conversion. Regarding risk, the foreign broker informs their risk criteria to the local broker. Based on this, the local broker will assign the same risk parameters to their clients. Naturally, every broker will have their own risk criteria as per their local compliance. In case the client is a global institutional investor based outside the region entirely, the same process will occur, except that the connectivity will be through the Neutral Access Point which is based in Singapore. Again, the firms will need a Custodian account or an executing broker in the respective markets they plan to trade in. The FIX network helps in vendor neutrality, as FIX is widely used by global institutional investors today. Hence, the Trading Link can accept orders based on FIX. For example, since most sell-side brokers in the Asian markets are basing their algorithms on FIX protocol, their trading algorithms can be easily offered to clients.

6.11.2 Advantages It gives access to a broader and diverse list of securities listed across the exchanges of the participating countries, thus helping in portfolio diversification, enhancing exposure to new sectors, and risk mitigation. In ASEAN case, it gives investors one-stop access to all the securities of one of the most dynamic economic regions in the world today. Moreover, all this comes at lower costs. Earlier, brokers had to set up point to point connections with brokers in the foreign markets. This means the cost of the entire network would have been on them, and they would have to manage the technology. The Trading Link offers substantial savings from these fixed costs and makes the business feasible for participating brokers. Lower latency is one of the biggest draws, as it involves direct connectivity infrastructure, as well as colocation data centers. Moreover, access to a broader pool of investors deepens the available liquidity in the securities, thus enabling execution of larger-sized trades. Thus, not only does liquidity impact latency and impact costs, it also helps create additional volumes which did not exist before due to execution concerns.

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Trading Link infrastructure is one of the best ways to get visibility from global institutions, and hence, visibility for the asset class based on that region from international investors. Thus, it has a multiplier effect of sorts. For example, ASEAN Stars Index is one of the indices created to act as the region’s asset class, by acting as an underlying for mutual funds, ETFs, futures, etc. The liquid and larger exchanges within the Trading Link benefit as they can become a center for the regional trading. In ASEAN’s example, Singapore stands to gain most as a regional center. It has invested in a new trade-matching platform, data center for colocation, and access points in prominent financial centers of Europe and the United States. These access points help investors of those countries connect to Singapore’s Exchange directly, and regional investors access global financial centers. However, this may raise fears of the smaller exchanges losing business to the larger exchanges, a possible reason why Philippines has delayed its joining the Trading Link. One has to showcase if the Trading Link can help increase overall volumes which can help make up the loss of local business. However, becoming a center for regional trading also involves huge technology costs. Technology needs are managed by the technology provider, like Sunguard in ASEAN’s case. Thus, brokers do not have to invest in technology and can instead invest in their core competencies. Needless to mention, it is huge business for the technology vendor. It provides several trader front-ends to each exchange, risk software to each exchange, post-trade software, as well as opportunities to market algorithmic trading products.

6.11.3 Challenges Regulatory standardization related to the legal aspects of the trade cycle, foreign ownership, settlement process, settlement days, taxation, money transfer, dividend tax, etc. is a critical prerequisite for any Trading Link project. Regulations across the member countries of SAARC are in varying maturity, and the set of rules often differ across the countries. Reaching a harmonious framework will be the main challenge. Viability can become a challenge if most of the regional exchanges are hesitant on joining. That can be either due to fears of losing business to smaller exchanges or due to the conviction of its own economic prowess. For example, Philippines has delayed its plans to join the ASEAN project

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due to possible resistance of its local brokers, while Indonesia has delayed as it possibly feels its economic performance will outpace the region, hence joining the Trading Link is not needed. Post-trade processes remain the other main challenge, continuing from the regulatory standardization point. Post-trade cycle involving multiple markets and multiple currencies with different settlement periods with low automation levels has its natural impediments. The capacity of the infrastructure has to handle the incremental volumes created, otherwise the entire project will fail. Brokerage sharing between local and foreign brokers is important, since it can impact commission earnings, and hence, the viability itself. In view of this, higher volumes would help compensate for reduction in net brokerage earned. Without potentially high volumes, the brokers may remain disinterested.

6.11.4  Initial Role for Stakeholders Regional exchanges may explore the feasibility of such a Trading Link project in SAARC by collecting primary feedback from regional players to understand possible resistance and acceptance. Given that this project entails significant technology investments and commitments, a primary feedback exercise will help ascertain if such a project is worth looking at or not at the current nascent stage of SAARC’s capital market integration, or whether it is worth looking at a later stage. If at all the feedback is positive, the role may include identifying potential exchanges that are agreeable to connect and pitching the idea to them. Only after that, will the role of the technology vendor arise.

6.12  INCUBATION FOR START-UPS IN SAARC FOR AN SME LISTING PLATFORM Purpose of this unconventional role is to discuss if a boost to SAARC-based startups through incubation services can help them scale up, and thus emerge list on a SAARC SME listing platform eventually. This will help increase the pipeline of quality-investible companies in the future, thus fueling market size in future. Start-ups do not come to mind traditionally when talking about stock exchanges, since exchanges deal with listed companies with a track record. However, leading stock markets have set up dedicated platforms for smalland-medium enterprises (SMEs), recognizing the need to prepare the next

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batch of potential large caps; after all, today’s small enterprise will grow and become big enterprises tomorrow. In India itself, both NSE and BSE have set up dedicated trading platforms for SMEs. However, this topic deals with start-ups, which are one stage younger than SMEs, since they are still in fledgling stage while SMEs have some track record.

6.12.1  But Why Choose Start-ups Ahead of SMEs as the Focus Area for SAARC’s Capital Markets Firstly, corporate governance and financial disclosure norms in most South Asian markets are still a concern, and many regional SMEs fare badly when it comes to adhering to corporate governance and disclosure norms. In such a scenario, start-ups can be made to comply with corporate governance norms right from the start itself as compared to SMEs who already carry a baggage of doubtful governance practices. If start-ups do have ambitions to list and raise funds from the capital market eventually, they can be useful targets for exchanges. Second, many start-ups are focusing on emerging business themes in their countries, and hence can become an ideal proxy of benefiting from the sectors of opportunity in each of those markets. After all, one of the purposes of raising investor awareness about each other’s economies is to identify emerging opportunities, and no business captures an emerging opportunity than a start-up focused on such new opportunities.

6.12.2  What is This? Incubation for start-ups is really an institutionalized support system providing value-addition services. It helps the start-up companies through sharing of best practices, mentoring and consultation with industry experts, benchmarking with global standards, sharing of past experiences of similar companies, investor networking, technology access, etc. Traditionally, incubation services for start-ups have been provided by the industry and academia. The US industry created support groups for startups like The Indus Entrepreneurs and Angel Networks. These groups comprise of experienced people who come with the domain expertise to understand the new ideas and typically have the wealth for providing the requisite angel funding. The IAN now has chapters in all the major Indian, mentoring the new entrepreneurs. Academic institutions also have worked toward business incubation, which is a key reason why the American venture capital sector (VC) is largely based in Boston and

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San Francisco—cities which coincidentally host top-notch research universities. Even India’s IIM-Ahmedabad provides an early stage business incubation cell called CIIE. London Stock Exchange’s Elite Program is an example of a consultative approach used by a stock exchange for mentoring new companies (though this really is focused on SMEs, not start-ups). Nevertheless, the Elite program’s consulting approach helps add critical value to the SMEs, and hence elicit more participation to the SME exchange platform. The Elite program offers consulting services across industrial, financial, and organizational skills to help SMEs. The “Get Ready” phase connects businesses with experts to stimulate ideas. The “Get Fit” phase puts into practice the ideas that the SMEs gained, through self-assessment tests, identifying areas for improvement and a quality certification which gives it access to select international investors. The “Get Value” phase offers support including marketing, branding, and communication. Thus, it helps enhance the SMEs’ relations within the global community of investors, bankers, and professional experts. The SAARC region could learn from LSE’s Elite Program and Indian Angel Network’s (IAN) mode of functioning, to develop a process of incubation support services for the regional start-ups, which are focused on tapping emerging business opportunities in the member countries. This support could include adherence to corporate governance and disclosure standards so that this set of companies elicits interest from investors for future fundraising; assisting by giving access to industry experts for sharing of best practices, advice, and learning; access to angel and VC funds looking at those sectors; connecting with technology providers; networking to connect them with companies for partnerships and investments; and assessing the market opportunity for the emerging ideas. The ultimate objective of the SAARC start-up incubation program would be to prepare a batch of new, young companies who are fit enough to list on the regional stock markets. The regional stock exchanges will need to develop a common SME platform where the listed companies can be traded by investors from across the region or develop an SME platform in each of the member exchanges where the companies of that country can trade locally. The first alternative would require harmonizing the regulations to facilitate crossborder investing in secondary markets in the region. To make this process easier, either this platform could be based in the SAARC International

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Finance Centre SEZ which was discussed in a previous section (if the IFC SEZ is doable) or it could be based in a neutral location like Singapore’s stock exchange. Basing in a neutral exchange might mean harmonizing the regulations of the local capital markets of SAARC can be worked around more easily, apart from giving these young companies access to a broader pool of global institutional investors who are more experienced in investing in young companies.

6.12.3 Advantages The SAARC start-up incubation program would help ensure the supply of good quality companies for listing in the future. It would help prepare a batch of new companies fit to list on the regional stock markets—new companies which have a good performance track record and are compliant with corporate governance norms who may generate positive interest from investors, and thus trading volumes. Every person with a brand-new business idea may not be a bornentrepreneur, and incubation support helps create the support infrastructure for new entrepreneurs to succeed in an entrepreneurship venture in terms of resource management, connecting with relevant people, and providing knowledge support. Incubation support also helps address the risk perception associated with choosing entrepreneurship as a career, especially in countries where the social acceptability of entrepreneurship is still low. It might help bring in more entrepreneurs, thus expand the pool of new business opportunities and job creation. How start-ups can influence the size of the country’s corporate sector in the years to come, and that it is not just a fad, can be gauged by looking at the traction in technology based start-ups in India. As per the NASSCOM Startup Report 2015, more than 800 tech startups are being set up every year. As of now, the total numbers of start-ups in this sector are over 3000. Many of these start-ups have seen ample investor interest from venture capital funds and angel funding networks, including personal investments from leading luminaries of Corporate India like Mr. Ratan Tata, among others. India is well poised to become the second largest center of technology sector start-ups in the world within a few years. While technology is the leading sector of Indian start-ups, there are other sectors as well. Nevertheless, this statistic gives an idea of the sheer

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number of companies that can eventually become big and start tapping the capital markets for their growth, even after accounting some of the start-ups may fold with consolidation.

6.12.4 Challenges Start-up incubation support may be far removed from the scope and focus of the regional capital markets, which are as of now working to generate interest in their listed scrips, let alone the next generation of scrips. Thus, it would require a shift in mind-set from looking solely at the current listed companies, to the universe of unlisted, emerging companies to prepare them for eventual listing. Regulations facilitating start-ups may also vary between the member countries, impacting the overall opportunity for start-ups in the region. Many regional economies are yet to see an uptick in venture capital (VC) and private equity (PE) activity, which would play a role in earlystage funding and thus, bridge the investing gap from birth to eventual listing. Apart from India, very few regional markets have a presence of the PE and VC industry. These have just started to pick up in neighboring markets like Bangladesh and Sri Lanka. Hence, the time for incubation support might be after the region has ample presence of PE and VC funds, since without them, start-ups anyway will struggle for funds.

6.12.5  Initial Role for Stakeholders This will also mean coordinating with regional angel funding networks (like IAN, etc.) or with management universities (like IIMs, IBAs, etc.) to develop an incubation support program that provides micro-consulting across sectors, access to industry experts for ideas and insights, connecting with the angel investor and VC fund community who can provide the early-stage funding, develop metrics and dashboards that can help the companies monitor the targets, performance, and variance during implementation, and access to marketing and branding advice. It can develop the framework of requirements the companies need to concentrate on such that they can list—which would really be a checklist for the start-up companies to be fit and eligible for listing eventually.

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It would also require coordination with the regional stock exchanges to develop either a common SME platform or an SME platform in each of the member exchanges, where the start-ups would list eventually. In case this SME platform is better based in a neutral location like Singapore, it would mean working out the regulations of the individual markets with that of Singapore to achieve a harmonious framework. That would also mean marketing support for those companies to the target investor audience during listing.

CHAPTER 7

Recent Examples of Integration— ASEAN, MILA, Hong Kong–China, Singapore–China, and East Africa This section is essentially making a validation of the ideas mentioned earlier—to see if some of those ideas are indeed being explored for capital market integration projects elsewhere in the developing world.

7.1  ASSOCIATION OF SOUTH EAST ASIAN NATIONS (ASEAN) ASEAN’s capital market integration initiatives have taken three formats—(i) mutual fund CIS distribution between Singapore, Malaysia, and Thailand; (ii) mutual fund passport scheme between Singapore, South Korea, Australia, and New Zealand; and (iii) stock exchange trading link between Singapore, Malaysia, and Thailand. Some of these initiatives have been implemented, while some are still under deliberation. The mutual fund CIS distribution scheme between Singapore, Malaysia, and Thailand was implemented last year after uniformity in prospectus was established. This would allow funds under this scheme to be distributed to retail investors in the other countries. This is a useful method to channelize the high savings of that region into investment fund products. Leading fund managers have already launched funds under this scheme, both in equity and fixed income asset classes. The mutual fund passport scheme between Australia, South Korea, New Zealand, and Singapore (along with Thailand and the Philippines) is currently under consultation and may go live next year. However, there are fears that participation may be lower than anticipated till the time cross-border taxation guidelines are finalized and if larger markets like China can enter the scheme too. Hence, there are viability concerns. ASEAN Trading Link, the exchange–broker connectivity infrastructure between Singapore, Malaysia, and Thailand has also been operational, though Indonesia and Philippines are yet to join. This is an efficient way Capital Market Integration in South Asia. DOI: http://dx.doi.org/10.1016/B978-0-08-101906-1.00007-3 Copyright © 2017 Elsevier Ltd. All rights reserved.

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to garner interest from global institutional investors who can use algorithms and get direct access to regional markets, as the connectivity reduces chances of impact costs and latency.

7.2  LATIN AMERICA INTEGRATED MARKET (MILA) Pacific Alliance came up as a trade bloc (Chile, Peru, Colombia, and Mexico) to counter Mercosur (Brazil, Paraguay, Argentina, Uruguay, and Venezuela) in Latin America. Initiatives like visa-free travel and integrated visa offices/trade offices in other countries have been taken, apart from intraregional trade. MILA was the integrated capital market initiative of Pacific Alliance launched in 2011. It combined the stock exchanges of Chile, Peru, and Colombia as a common trading platform. Last year, Mexico was also integrated. In terms of market capitalization, MILA now rivals Brazil’s Bovespa stock exchange. The initial efforts went toward building awareness of the platform and the regional markets/economies among each other’s investors. The idea was to make the investors familiar with the companies and sectors of opportunity in the other markets. A communications system between the brokers of these countries was put in place, to make it easier to coordinate for cross-border trades. However, the trading volumes have been slow to pick up. Even after Mexico’s inclusion, the uptick in turnover has been slow to pick up. One factor has been the investor confidence during times of elections, as that brings some element of uncertainty on the economic roadmap. Second, currency conversion is to/from US dollars with each of the local currencies, which can be a challenge for investors in terms of exchange rate loss and forex costs. Varying taxation policies in the participating countries has been another concern. A final challenge was that the local stock markets were skewed toward one/more sectors rather than being broadbased across all sectors, which restricted the variety of investable options available to prospective investors. Regulations related to brokerage-sharing among the regional brokers are also an area of concern, as it can impact the commission accruing to each broker from the trade. Nevertheless, the biggest beneficiary of MILA has been the smaller markets like Peru, as it gives them access to a wider array of investors and products, while ensuring liquidity and depth. It also brings the smaller markets in the focus of global institutional investors, as they may not have evinced that extent of interest just by themselves. Moreover, as a common

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platform, it can give access to a variety of sectors, which may not be likely if the exchanges market themselves separately, given the sectoral skewness in each market. Mutual funds which would invest in the platform have also come up, and these can become vehicles to mobilize retail monies into the markets. MILA is a good example of a slow-and-steady road toward integration, a definite plus.

7.3  MAINLAND CHINA–HONG KONG Hong Kong–Shanghai Stock Connect has been one of the recent, and possibly successful, capital market integration project in recent years. Started in 2014, it was aimed to boost volumes through mutual market access by acting as a cross-border investment channel between the Hong Kong and Shanghai exchanges. Investors in one market can trade in stocks of the other using their local brokers, and the orders will be routed to the foreign exchange by the subsidiary of its local exchange that has been established in that foreign market for this very purpose. The flows going through the Connect are subject to daily/aggregate quotas on both sides, allowing trading in only certain categories of Chinese shares, and requirement of a minimum account balance for Chinese investors. All settlement is done in Yuan on both sides, in-line with China’s attempts to internationalize its currency; hence it avoids the challenge of dual conversion (to/from US dollars). While it was slow to start, the Connect has picked up, both northwards and southwards. The southbound traffic increased as Mainland Chinese investors were keen to invest in the Hong Kong market, also aided by the fact many high-profile Mainland China companies have preferred to list in Hong Kong recently as it gives access to a wider community of investors. The northbound traffic increased as the Connect enabled access to a larger base of international investors to the growing Chinese market. Brokers on both sides stand to gain in their own ways—Hong Kong brokers would gain as large institutional investors typically prefer to stick with their global brokers while entering a new market and allocate only 5–10% commissions to local brokers. Chinese brokers may also gain due to their lower operating costs (hence, the ability to win volumes on pricing), and a wider research coverage of local stocks, especially mid-caps which are not extensively covered by foreign brokers. A similar Connect is under plans between Hong Kong and China’s Shenzhen markets. Mutual Recognition between Hong Kong and China is another initiative toward capital market integration. This is essentially a Mutual Fund

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Passporting Scheme and would allow Hong Kong domiciled mutual funds to be sold to retail investors in Mainland China, as well as Chinese funds to be sold to investors in Hong Kong. Almost a dozen Asset Management Firms from both sides each have evinced interest to take part in this scheme. Mainland China’s massive household savings pool is the main draw for foreign fund houses to look at the China market, especially as existing UCITS funds cannot be sold to Mainland China investors. The access to a wide variety of products from Hong Kong is the main draw to the Chinese investors, especially given the demand for high-yield funds by Mainland China investors after the local interest rates dropped in recent times. Many Hong Kong funds are trying to address this demand with suitable products. Again, the flows are subject to quota on both sides, and the funds have to comply with both the regulators. A critical challenge is to enable the local investors in Mainland China to understand the foreign products, hence investment into some amount of investor education is a necessity.

7.4 CHINA–SINGAPORE China and Singapore went the cross-listing way. In 2013, the Chinese regulator and Singapore’s exchange agreed to establish a framework for direct listing, wherein Mainland China stocks could cross-list in Singapore. The idea is to connect China’s high-growth companies with the matured regulatory platform of Singapore and the access to a wide group of global institutional investors it can provide. Better valuations in Singapore are another factor driving this, just like it has driven several Mainland Chinese companies to list in Hong Kong. The regulatory requirements and due diligence process will encompass both countries. Financial disclosures have to meet the standards of the country of listing (Singapore) or International Accounting Standards, thus giving better comfort on financial disclosures. Ideally, countries which have similar accounting standards are better suited for cross-listings. Both these criteria, on regulatory compliance in both countries and international accounting standards, are aimed to provide additional comfort to global investors, so that past experience is not repeated, when some S-Chip Chinese companies listed in Singapore saw accounting issues. Chinese companies keen on listing will also need to go for a preconsultation with Singapore’s exchange, prior to submitting their application with the Chinese regulator. This direct listing program would also require

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effort into marketing the procedures and requirements to Chinese companies keen on listing in Singapore, so that information opacity is not a deterrent. Some companies have also evinced interest to go for dual-listing in Taiwan, using TDR (Taiwanese Depository Receipt), after ease in its regulations.

7.5  EAST AFRICA East African Council members (Kenya, Tanzania, Uganda, Rwanda, and Burundi) are using the interconnected trading link for their capital market integration. The trading link would connect the local platforms in these markets to create a single platform operating real time. It would allow regional investors to trade in the regional shares without approaching foreign brokers. The trading link will also reduce trading and settlement time, as the settlement systems of the markets would be linked. However, the project received a jolt as Kenya, the region’s largest market by far, opted out of the program as it was allegedly dissatisfied by the tender process to select the software vendor, Infotech, and the compatibility of the vendor’s software with the local systems. Nevertheless, the remaining members are going ahead with the program, although viability may be impacted if the region’s largest market stays out.

CHAPTER 8

Initial Role for Stakeholders: Regulations, Awareness, and Engineering While each of the product sections lists the initial roles that stakeholders can play, this section presents a synopsis. Essentially, initial role for stakeholders can be classified into three main heads—i.e., Regulations, Awareness, and Engineering. Regulation - Build framework - Advocacy role - Create adoption - Product depth

Awareness

Engineering

- Economic growth - New opportunities - Knowledge-partner - Build acceptability

- Product structure - Feasibility analysis - Capacity building - Counter resistance

Regulation: This may be as simple as establishing a common framework for market data collection from varying data methodologies of the regional markets, to as tough as analyzing and advocating the common regulatory framework required for the various integrated products and platforms. This would also include gap analysis of this common framework with that existing in each of the individual members so that they can come at par with each other to develop the integrate platform, or with that needed in a single platform like an IFC. This also includes advocating for financial disclosure and governance, as well as accounting as per international standards, as only such compliant companies will evince comfort from investors. Assisting the smaller markets with regulations to develop their product portfolios, as well as ensuring registrations of the new products (like SAARC asset class basket) also need to be adhered to. Till the time a harmonious framework or adherences are achieved, implementation will only be partial. Maturing of the markets is a necessity for the success of integration, and one has to push toward regulatory maturity in member countries.

Capital Market Integration in South Asia. DOI: http://dx.doi.org/10.1016/B978-0-08-101906-1.00008-5 Copyright © 2017 Elsevier Ltd. All rights reserved.

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Awareness: This includes efforts in creating awareness on (i) the rationale of SAARC as a region, (ii) the rationale for the SAARC asset class, (iii) emerging opportunities in these markets, and (iv) new products and asset classes. This is a crucial role to ensure that the acceptability builds, given the low awareness of local investors of each other’s economies and on the SAARC opportunity as a whole. It has to engage with institutional investors, anchors, exchanges, corporates, regulators, brokerages, custodians, rating agencies, publishers, e-commerce sites, SME-owners, entrepreneurs, and private equity funds for creating the awareness and acceptance of these various initiatives, as well as identify and target prospective players who can be ideal for launching these product ideas. It had to specifically engage with institutions and companies that have a stake in South Asia’s economic future. In most cases, evincing this interest may be a precursor to eventually pushing stakeholders and investors toward creating products based on the SAARC asset class. An opportunity exists to become the knowledge partner in conceptualizing, producing, and disseminating thematics on the SAARC region, through Publications, E-Books, Investment Frameworks, and Roadshows to showcase high-potential opportunities. Engineering: An engineering role is needed in developing the initial structures of new products. This includes equity analysis, back-testing, and screening to identify investible ideas. Engineering also includes feasibility and cost–benefit analysis on the projects to estimate viability, market analysis of the industry, and opportunity pool, and working out the arithmetic behind the product’s numbers. It has to identify suitable industry participants across member countries who would work toward launching such new products, as well as the target markets where the projects could be best implemented initially with least challenges. Finding alternative routes by which new products can be launched faster, pitching solutions to counter the resistances from the member countries, and developing modules for consulting and training for capacity-building for the smaller markets may also form part of this. Most of these engineering projects will be long-duration projects and can be part of the long-term roadmap toward capital market integration. Hiring of specialized staff or consultants who can deliver on these project roles, or engagement with suitable external agencies to whom these tasks can be outsourced is another task. Without the manpower to support these initiatives, the success in knowledge-driven initiatives would be limited. The mantra should be to collaborate, rather than compete. This holds both amongst the regional economies, as well as with the economies outside the

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region. Since economic linkages between the member countries are still way below than what can be realized through deeper trade and investment flows, one can play a critical role in identifying, exploring, and marketing the opportunities for regional value chains. Or, it can at least liaison with SAARC-level agencies which do. This also includes value chain opportunities with the neighborhood around the SAARC region—be it Far East Asian countries, South East Asian countries, or the Middle East, especially in cases where the businesses are not dependent on concentrated clusters for supply chain linkages, and where the SAARC region can offer opportunities to reduce transfer or turnaround times. If value chains are based on the nations’ competitive advantages, it can build long-term value despite the short-term pain to local producers. Economic dependency gives the best motivation to work toward financial integration, and deepening of economic linkages is a necessary precursor for eventually achieving capital market linkages.

CHAPTER 9

Conclusion Nobody thinks a SAARC project would be easy, knowing fully well the geopolitical and market challenges that impede implementation. However, the economic potential of the SAARC region, its main USP, really stands out relative to its regional peers, including ASEAN. Given this economic ­potential and its implications for the financial markets, failure to leverage this through integration projects would be a tragedy. Regional peers have their own set of challenges, but each one is taking steps. Unless SAARC proactively works to convert this opportunity, it would fall behind. Apart from the expected growth in its economy and savings, it has a more equal distribution of income relative to peers. This widens the market for investment products. Deepening of regional value chains and trade and investment ties can help boost the growth prospects of the region further. Some product ideas may be relevant now given the state of maturity of the regional markets, while some may be relevant later. Investors can ask why they should take a SAARC exposure, instead of an India-only or FM exposure. Rationale have been enumerated in each of the sections. Another question is whether India needs SAARC or whether SAARC’s FMs need India? Actually, both need each other. India benefits from the growth and low correlation of SAARC’s FMs, while they benefit from India’s size. A SAARC portfolio creates upside from multiple growth enablers, while minimizing downside through low-correlation constituents. A SAARC product has to showcase itself on performance, so that a motivation is created since SAARC asset class is unexplored. Institutional interest has to come from funds with a long-term horizon, since SAARC is a long-term economic story. Also, local adoption would determine the success of the integration projects from local investors. Hence, a focus to deepen local product portfolios. That would help the products achieve scale and become viable. SAARC members intent on bickering on regional projects need to remember that a SAARC financial story can deepen the allocations from global institutional investors into the South Asian FMs, broaden the access to new products and asset classes which can help local players scale up, Capital Market Integration in South Asia. DOI: http://dx.doi.org/10.1016/B978-0-08-101906-1.00009-7 Copyright © 2017 Elsevier Ltd. All rights reserved.

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increase the scope for local companies to raise capital and expand, and channelize savings into local investment products rather than going into overseas accounts. Even if mutual agreement is impossible, one may explore projects on bilateral/multilateral basis, although it would not be a SAARC-wise project. But once the benefits through a bilateral/multilateral project are visible, it can eventually help evince interest from disagreeable members. However, one has to take into consideration the realities impacting the region. Workable solutions to counter mistrust have to be thought of. Some suggestions for this were mentioned in preceding sections. Options have to be kept dynamic and flexible. The members need to start with tasks that can realistically be agreed upon. Integration can broaden the depth of the smaller markets through access to new products and capital. In short, it is an opportune time to look at SAARC financial projects, given the economic potential set to unfold.

APPENDIX The regional groups showcased in the economic projections section comprise of the following countries:

Since some regions are overtly skewed toward one large economy within its composition, separate categories have been taken excluding such heavyweights, so that the relevance of the remaining members would be highlighted better. These include categories like BRICS ex China, SAARC ex India, and East Europe ex Russia. The following tables present a synopsis of the IMF projection data of the countries comprising these regional groups, both in terms of Real GDP and in terms of Nominal GDP—across GDP, Savings, and Capital Formation. These tables only present the 2014 and 2020 data columns due to space constraints, hence a year-on-year trend comparison will not be possible with only this data. Detailed tables can be procured from the author.

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Appendix

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INDEX Note: Page numbers followed by “f” refer to figures.

A Alpha modified-alpha, 60–61 need for earning, 43–44 passive-variant of active, 60–61 AMC, 5, 42, 45, 80, 83 Anchor investor, 28 need for, 44–45 Anchor partner, 22–24 Angel Networks, 109–110 Arbitrage trading, 32–33 ASEAN, 1, 8–9, 12–14, 19, 59, 82, 102, 125 capital market integration initiatives, 115–116 ASEAN Economic Community (AEC), 81 ASEAN Trading Link, 115–116 Asian Development Bank, 85–86 Asian Infrastructure Investment Bank, 24–25 Asset class, 1, 3–4, 11, 17, 25–29, 31, 43–44, 47–64 product, for global institutional investors, 97–98 Asset turnover, 8 Authorized Partner (AP), 42

B Bangladesh, 1 CDCF portfolio basket, 59 DSE Bangladesh, 5, 7, 48 EBITDA margin, 7 exchange-traded fund, 43 financial disclosure, strengthening, 35 geopolitics, 24–25 market indicators, 11 Mergers & Acquisition, 32 return on equity, 8 Bhutan RSE Bhutan, 7 Bloomberg, 35

Brazil, 1. See also BRICS CDCF basket, 8–9 GDP growth, 12–13 BRICS, 1–2, 12–13, 127 GDP growth, 12–14 investment, 17 New Development Bank, 24–25 Business communities cultural links, 20

C CAGR, 12–14 Canada CDCF portfolio basket, 59 Capital formation, 16–17, 16f, 17f Capital market, 1–3, 21–23, 25, 28–35, 38, 64, 70–71, 73, 79, 85–88, 91–92, 100, 102–103, 108–109 China, 1. See also BRICS anchor investor, 28 CDCF basket, 8–9 China–Singapore cross-listing, 118–119 GDP growth, 12–14 geopolitics, 23–25 One Belt One Road Silk Road fund, 24–25 CIS, 1 CIVETS, 1 Concentrated portfolio, 47–48, 60–62 Consistent Dividend Consistent Fundamental (CDCF) basket, 8–9, 44, 47–64, 50f, 51f, 52f, 53f advantages of, 58–61 challenges to, 61–63 compared with benchmark indices, 54–58, 54f, 55f, 56f, 57f, 58f defined, 48–54 stakeholders, initial role for, 63 Consumer base versus production base, 22 Corporate governance, 34–35 Corporate sector, 7

137

138

Index

Creation-unit concept, 38 Credit ratings, 34 Cross country index futures, 95–100 advantages of, 98 challenges to, 99 defined, 96 global institutional investors, asset class product for, 97–98 stakeholders, initial role for, 99–100 CSE Sri Lanka, 5, 7, 48

D Debt performance, 12 Demographics, 21 Diaspora, 20 Distribution of income, 16, 16f Diversification, portfolio, 30 Dividends, 8. See also Consistent Dividend Consistent Fundamental (CDCF) basket Dow Jones SAFE 100 Index, 8–9, 43, 55–58, 95–96 DSE Bangladesh, 5, 7, 48 Dual feeder-investment fund structure, 39–40, 45–46

E East Africa, 1 capital market integration initiatives, 119 GDP growth, 12–13 East Europe, 1–2 EBITDA margin, 7, 7f, 12, 48–49 E-Books, 65–66 Economic development, 19–20, 22 Economic motivation, 19 Economic projections, 11 Economy, 1–4 Egypt, 1 Emerging market (EM), 1, 3, 8–9, 26–31, 39, 44–45, 47, 55–57, 59–61, 63, 65, 97–98, 104 EPC (engineering, procurement, contracting) projects, 84 Equity, 12, 29–32 private, 112 return on, 5, 8 Europe GDP growth, 12–13

European Union, 19 Exchange-traded fund (ETF) advantages of, 45 alpha, need for earning, 43–44 anchor investor, need for, 44–45 benchmark index, use of, 43–44 challenges to, 46 investing process in, 42 master-feeder fund structure using, 38–47, 41f stakeholders, initial role for, 46–47

F FactSet, 35 F&O trading, 5 Feeder fund, 38–47, 41f Financial disclosure, 35 Financial product, 74, 83–84 Foreign direct investment (FDI), 28–29, 32 outbound, 20 Foreign fund, 42 Frontier market (FM), 1, 3, 8–9, 26–31, 39, 44–45, 47, 55–57, 59–61, 63, 65, 97–98, 125–126 FTSE, 58 Fund-of-fund (FOF), 41, 46

G GCC, 1 GDP growth, 11–14, 12f, 13f Geopolitical mistrust, 22–25 Germany geopolitics, 23 Gini’s Coefficient, 16 Global Depository Receipt (GDR), 92 Goldman Sachs, 97 Guarantees, 34

H Health insurance versus medical tourism insurance product, 75–76 Heterogeneity among local markets, 33 High-growth economy, 29 Hong Kong–Shanghai Stock Connect, 117–118

Index

139

I

K

IDR listing. See SAARC Depository Receipt (SDR) cross border listing IIM-Ahmedabad, 109–110 IMF, 11–14, 17, 127–128 Income distribution, 16, 16f India, 1, 5 dividends, 8 EBITDA margin, 7 financial disclosure, strengthening, 35 IIM-Ahmedabad, 109–110 NSE India, 5, 7–8, 44, 95–97 outbound foreign direct investments, 20 return on equity, 48 Indus Entrepreneurs, 109–110 Inflation, 22 Institutional investor, 27–28, 33 Insurance investment portfolio, 76–77 Integration cross-border, 26–27 capital access through, 33 market, 2–5, 70–71, 73–74, 91–92, 100, 102–103, 108 regional financial, general precursors for, 19 International Financial Center (IFC), 121 advantages of, 72–73 challenges to, 73–74 defined, 71 location of, 71–72 as Special Economic Zone (SEZ), 70–74 stakeholders, initial role for, 74 Investing process, in exchange-traded fund, 42 Investment, 16–17, 16f, 17f, 19–20 foreign direct, 20, 28–29, 32 frameworks, 66 investment insurance, 76 portfolio, 74–75 Investor, 11, 17 protection, 34 Iran, 1

Kenya, 1 Korea anchor investor, 28 CDCF basket, 8–9 geopolitics, 24 KSE Pakistan, 5, 7, 48, 96 Kuwait CDCF basket, 8–9 KYC (know-your-customer) regulations, 34, 46

J Japan anchor investor, 28 geopolitics, 23–25

L Latin America Integrated Market. See MILA (Latin America Integrated Market) Lee Kuan Yew, 1 Leverage, 8, 47–48 on online/mobile platforms across customer value chain, 31–32 Liquidity, 25–26 Local investors, 25 London Stock Exchange (LSE) Elite Program, 110

M Mainland China–Hong Kong Connect. See Hong Kong–Shanghai Stock Connect Malaysia CDCF basket, 8–9 Maldives MSE Maldives, 7 Margin, 5, 7 EBITDA, 7, 7f, 12, 49 profit, 7–8, 12 Market capital, 1–3, 21–23, 25, 28–35, 38, 64, 70–71, 73, 79, 85–88, 91–92, 100, 102–103, 108–109 emerging, 1, 3, 8–9, 26–31, 39, 44–45, 47, 55–57, 59–61, 63, 65, 97–98, 104 frontier, 1, 3, 8–9, 26–31, 39, 44–45, 47, 55–57, 59–61, 63, 65, 97–98, 125–126 indicators, 11, 11f integration, 2–5, 70–71, 73–74, 91–92, 100, 102–103, 108 stock, 5

140

Index

Master fund, 38–47, 41f Mauritius exchange-traded fund, 43 Medical tourism insurance product, 74–79 advantages of, 77–78 challenges to, 78–79 defined, 75–77 stakeholders, initial role for, 79 Mercosur (Brazil, Paraguay, Argentina, Uruguay, and Venezuela), 116 Mergers & Acquisition (M&A), 32 MILA (Latin America Integrated Market), 116–117 MINT, 1 Morgan Stanley, 97 MSCI, 58 MSE Maldives, 7 Multiplier effect, 22 Mutual fund closed-end, 38 open-end, 38 Mutual fund passporting scheme, 79–83 advantages of, 81–82 challenges to, 82 defined, 80–81 stakeholders, initial role for, 83 Myanmar GDP growth, 12–13 geopolitics, 24–25

N Nepal NSE Nepal, 7, 48 New Development Bank, 24–25 Next-11, 1–2, 12–14, 17 Nigeria, 1 CDCF basket, 8–9 NSE India, 5, 7, 48 NSE Nepal, 7, 48 NSE Nifty-50 Index, 44, 95–97

O One Belt One Road Silk Road fund, 24–25 Online/mobile platforms across customer value chain, leverage on, 31–32 Open-end mutual fund, 5

P Pacific Alliance, 1, 116 Pakistan, 1 CDCF portfolio basket, 59 EBITDA margin, 7 exchange-traded fund, 43 financial disclosure, strengthening, 35 GDP growth, 11–13 growth in savings, 15, 15f KSE Pakistan, 5, 7, 48, 96 market indicators, 11 Mergers & Acquisition, 32 return on equity, 8 Passive cost, 47–48 Philippines, 1 GDP growth, 12–13 Pooling, 74–75 Portfolio CDCF basket, 50f, 51f, 52f, 53f, 54f, 55f, 56f, 57f, 58f concentrated, 47–48, 60–62 diversification, 30 insurance investment, 76–77 Private equity, 112 Private investment flows cross-border, 29–30 Production base versus consumer base, 22 Product portfolios, 33–34 Product structure at country level, separating out, 26–27 Profit margin, 7–8, 12 Public–private partnerships (PPP), 84

R Regional financial integration, general precursors for, 19 Regional markets effectiveness of integrating, measurement of, 34 Regulators, cooperation mechanisms among, 35 Retail investor, 27–28 Return on equity (ROE), 5, 8 Revenues, 7, 12 Roadshows, 66 RSE Bhutan, 7 Russia, 1. See also BRICS GDP growth, 12–13

Index

S SAARC, 1–5, 11 asset class, 1, 3–4, 47–64 capital market, 1–3 CDCF portfolio basket, 50f, 51f, 52f, 53f, 54f, 55f, 56f, 57f, 58f connect between companies of, 27 correlation of markets, 1, 8–9 cross country index futures, 95–100 distribution of income, 16, 16f diversified exposure versus single-stock/ country exposure, 26 economic development, 22 economy, 1–4 exchanges, trading link between, 104–108 exchange-traded fund. See Exchange-traded fund (ETF) GDP growth, 11–13, 12f, 13f geopolitical mistrust, 22–25 growth in savings, 14–15, 14f, 15f integration, 2–4 International Financial Center, as Special Economic Zone, 70–74 investment, 16–17, 16f, 17f medical tourism insurance product, 74–79 mutual fund passporting scheme, 79–83 solar energy bonds, 83–91 thematic publications, 64–70 top-200 companies, performance of, 5, 7–8, 7f, 8f trade flow, 19 turnkey consulting services, 100–104 SAARC-based start-ups through incubation services, 108–113 advantages of, 111–112 challenges to, 112 defined, 109–111 reasons for choosing, 109 stakeholders, initial role for, 112–113 SAARC Depository Receipt (SDR) cross border listing, 91–95 advantages of, 93–94 challenges to, 94–95 defined, 92–93 stakeholders, initial role for, 95 Savings, 14–15, 14f, 15f

141

Shares M-50 ETF of India’s Motilal Oswal Asset Management, 44 Singapore, 1 CDCF basket, 8–9 China–Singapore cross-listing, 118–119 International Financial Center, as Special Economic Zone, 70–74 SGX exchange, 95–96, 99 Single-stock/country exposure versus diversified SAARC exposure, 26 Solar energy bonds, 83–91 advantages of, 87–88 challenges to, 88–90 defined, 85–86 stakeholders, initial role for, 90–91 South Africa, 1 GDP growth, 12–13 South Asia, 1, 8–9 consumer base versus production base, 22 cultural links, 20 South Korea geopolitics, 23 Sovereign Wealth fund (SWF), 28 Special-purpose vehicle (SPV), 84, 86 Sri Lanka, 1 CDCF portfolio basket, 59 CSE Sri Lanka, 5, 7, 48 exchange-traded fund, 43 financial disclosure, strengthening, 35 market indicators, 11 Mergers & Acquisition, 32 Stakeholders, initial role for, 46–47, 121, 121f awareness, 122 CDCF portfolio basket, 63 cross country index futures, 99–100 engineering, 122 International Financial Center, as Special Economic Zone, 74 medical tourism insurance product, 79 mutual fund passporting scheme, 83 regulation, 121 SAARC-based start-ups through incubation services, 112–113 SDR cross border listing, 95 solar energy bonds, 90–91 specialized staff or consultants, hiring of, 122

142

Index

Stakeholders, initial role for (Continued) thematic publications, 69 trading link between SAARC exchanges, 108 turnkey consulting services, 103 Stock market, 5 Syria, 1

Turkey, 1 Turnkey consulting services, 100–104 advantages of, 102–103 challenges to, 103 defined, 101–102 stakeholders, initial role for, 103

T

UCITS (undertakings for collective investment in transferable securities), 39, 80–81, 117–118 United Kingdom anchor investor, 28 geopolitics, 23–24 United States anchor investor, 28 geopolitics, 23–25 USP, 11, 17, 60, 125

Taiwan CDCF basket, 8–9 Taiwanese Depository Receipt (TDR), 118–119 Tata, Ratan, 111 Taxation norms, 35 Thailand, 1 Thematic publications, 64–70 advantages of, 68 challenges to, 68–69 defined, 64–67 example of, 67–68 stakeholders, initial role for, 69 Trading link between SAARC exchanges, 104–108 advantages of, 106–107 challenges to, 107–108 defined, 105–106 stakeholders, initial role for, 108

U

V Venture capital (VC), 109–110, 112 Vietnam, 1 GDP growth, 12–13 geopolitics, 24–25 Volatility, 30

W World Bank, 85–86