The FINANCIAL — Usually, the flagship of a country's financial markets is its stock exchange.
The FINANCIAL — Usually, the flagship of a country's financial markets is its stock exchange. Georgia has one too, and it is aptly named the “Georgian Stock Exchange” (GSE). Stock markets allow companies to raise relatively large amounts of money from the general public, while offering its current shareholders liquidity – the option to easily sell and buy shares if necessary.
A well-functioning stock market is of tremendous importance to any economy: companies can raise capital from a large number of investors, without being constrained by the limitations of bank financing. Because raising capital through the stock markets is an alternative mechanism to bank financing, it creates competition, and brings down interest rates. At the same time, raising equity will allow companies to access more debt financing from banks. It is also a form of democracy: stock markets allow ordinary investors to buy into big companies, and if they collectively own enough shares, to control those companies. If ordinary citizens are able to easily own stocks, they can profit if the country’s economy does well.
However, the Georgian stock exchange is on life support: while the market capitalization of the companies that are tradable on the exchange is $860 million dollars, the average daily turnover is only $330. This is down from 12.7 MM GEL in January of 2005, and indicates that there is practically no trading happening on the GSE. What happened?
In this article, I will go through a brief history of the Georgian efforts to establish a well-functioning stock exchange, and look at opportunities for future capital markets development.
The Georgian Stock Exchange was established in 1999, through a USAID-funded project and with the help of American experts. However, when the project was finished, “there was a supermarket,” as one person put it, “but the shelves were empty, and there were no buyers and sellers”: there was a lack of attractive instruments to trade. In other words, there were no good Georgian companies that were tradable on the exchange.
Things started to change when Bank of Georgia entered the picture. Long regarded as an uninteresting bank with almost no capitalization, things changed quickly when soon-to-be-prime minister Lado Gurgenidze took over the management of Bank of Georgia in 2004. The bank was turned around, aggressively pitched to investors, and the share price rose from little more than one Georgian Lari in 2003 to more than 65 Georgian Laris in the summer of 2007. On the back of Bank of Georgia’s success, volumes at the Georgian Stock Exchange rose, and a number of successful Initial Public Offerings (“IPOs”: when companies sell shares to the public for the first time) were pulled off.
In November 2006, Bank of Georgia conducted an IPO in London, which meant that the majority of the liquidity in Bank of Georgia stock moved from Tbilisi to London. However, the real death sentence for the Georgian securities market came in the spring of 2008, when an amendment to the Law on Securities Markets was passed that legalized OTC trading in publicly-listed securities. OTC trading, or over-the-counter trading, means that a stock that is normally traded on a stock exchange is now traded between two parties outside of the exchange. This means that transparency and competition decrease, and that stock trading becomes the domain of wealthy individuals making backroom deals, while the ordinary retail investor is left out in the cold without any possibility to sell or buy shares on the exchange, because there is nobody left to trade with. Any government interested in market transparency and investor protection should consider reversing this measure.
The full legalization of OTC trading, branded as “liberalization” and initiated by the well-known libertarian Kakha Bendukidze, resulted in approximately 95% of trading activity moving to the OTC market. Only a short while later, a possible deal with Nasdaq OMX, which by then had already bought the Armenian Stock Exchange, didn’t go through.This deal would have made the Georgian Stock Exchange part of a network of exchanges around the world.
There are other reasons why the Georgian Stock Exchange has been unsuccessful. Most Georgian companies are not interested in having members of the general public invest in their companies: they are used to working with a few large shareholders. Furthermore, there are few institutional investors present in Georgia. Hopefully pension reform in Georgia will change that, when bigger pools of money become available for investments in public securities. These types of reforms have worked successfully in countries like Poland.
Given the importance of functioning public capital markets in a country, the Georgian government should take some of the concrete steps outlined in this article. This will serve to create liquidity in the markets, and allow companies to easily raise capital. Most importantly, these well-functioning capital markets will allow normal Georgians to acquire a piece of the country’s growing economic pie.