Saturday, November 9, 2024

Investor protections in the context of Capital Markets- Its benefits and whose role is it?

By Mengistu Weldemariam

This will conclude my series of articles that began outlining the critical pillars for the Ethiopian Capital market to thrive (the ecosystem approach), now this as a final piece I discuss the importance of investor protection and broader challenges in sub–Saharan Africa and how investor protection enhances economic growth and broader participation and financial inclusion.

Investor protection in the capital markets context refers to the measures and regulations designed to safeguard investors’ interests and ensure fair, transparent, and efficient markets. Investor protection measures vary at across countries.

Efforts to safeguard investments are evident across international, regional, and domestic levels, with several initiatives and treaties aimed at providing protections for foreign investors and their investments. For instance, Investor protection in Sub-Saharan Africa has been a focus of development and improvement in recent years. As of October 2022, there were 525 Bilateral Investment Treaties (BITs) with African countries, including almost 50 intra-African BITs, which set out a number of protections in favour of foreign investors and there are more than 30 multilateral treaties with investment protections, such as the COMESA Treaty, the OIC Investment Agreement, and the ECOWAS Supplementary Act for Common Investment Rules.

In addition, almost 50 African states have adopted Foreign Investment Laws (FILs) which provide substantive protections for foreign investors, like the guarantee of fair and equitable treatment, national treatment, and protections from expropriation. In recent years countries that have promoted political and macroeconomic stability and implemented essential structural reforms have begun to attract long-term investment flows. Despite the clear potential for solid returns over the long run, long- term investment flows have not kept pace with the region’s potential. While these efforts indicate a commitment to improving investor protection, challenges remain. The actual levels of long-term investment have remained modest compared to the potential, suggesting that there is still room for growth and enhancement in investor protection mechanisms in Sub-Saharan Africa. The region’s economic landscape is changing, with rapid urbanization, technology absorption, and a growing labour force, which presents both opportunities and challenges for investment protection and attraction.

It is fair to say, investor protection in Sub-Saharan Africa faces several specific challenges that can affect the confidence and activities of investors in the region. The main challenge remains Political risks, as they can lead to abrupt changes in investment policies or even expropriation of assets. There are inherent weaknesses in regulatory and institutional frameworks can lead to low liquidity in stock markets and hinder the development of a robust investment environment and discourages retail investors to take investment risks. Concerns about the legal framework, particularly regarding Independent Power Producers (IPPs) (private entities that generate electricity for sale) access to market, permitting, and land issues, can create uncertainty for investors.

Investor protection is a shared responsibility among various stakeholders in the capital markets. As an overarching principle government enacts legislation that provides the framework for regulation and enforcement. It also establishes regulatory agencies and endows them with the authority to protect investors.  These could be Exchanges and Self-Regulatory Organizations (SROs): Stock exchanges and SROs have their own set of rules and regulations designed to protect investors. They

monitor the market, oversee the conduct of their members, and can take disciplinary actions when necessary. For instance, in Kenya, the primary responsibility for protecting investors lies with the Capital Markets Authority (CMA). The CMA is tasked with regulating and overseeing the Capital Markets to ensure transparency, fairness, and efficiency. In more advanced economy like Australia, investor protection is primarily the responsibility of the Australian Securities and Investments Commission (ASIC). ASIC oversees business conduct and consumer protection in financial markets. There are additional government statutory bodies like the Australian Prudential Authority (APRA) that supervises deposit-taking institutions, insurance companies, and pension funds, ensuring their financial soundness and protecting the interests of depositors and policyholders. In addition, apart from the government the Australian Shareholders’ Association (ASA) plays a crucial role in advocating for the rights and interests of retail shareholders through policy advocacy, education. Corporate monitoring and, community building.

To enable investor protections Financial Service Providers: Banks, brokers, and investment advisors must adhere to strict fiduciary duties and act in the best interests of their clients. They are responsible for providing accurate information and suitable investment advice. Similarly, Companies that issue securities are responsible for providing truthful and complete information about their financial status, business operations, and risks involved in their securities. Further professional service provides (auditors and accounting firms) are responsible for verifying the financial statements of companies, ensuring that the information provided to investors is accurate and conforms to accounting standards. Lastly Investors themselves also have a role to play in protecting their own interests (similar to the Australian Shareholders Association). They should conduct due diligence, stay informed, and be aware of the risks associated with investing.

Investor protection is a key factor in increasing investor participation and stimulating economic activity. Strong investor protection laws and regulations build confidence among investors. When investors are confident that their rights are protected and that there is a lower risk of fraud or mismanagement, they are more likely to invest. This increased participation can lead to a more dynamic market with a greater variety of investment products and services. Furthermore, effective investor protection measures help mitigate risks associated with investing. This includes the risk of losing money due to company bankruptcy, fraud, or market manipulation. When these risks are reduced, more individuals and institutions are willing to invest, leading to increased capital inflows.

The added benefit of Investor protection contributes to market efficiency by ensuring that all participants have access to reliable and timely information. This transparency allows investors to make better-informed decisions, which in turn leads to more efficient pricing of securities and allocation of resources.

The cumulative effect of strong investor protection is . it increases investor participation. So does the availability of capital for businesses. This capital can be used for expansion, research and development, and other activities that contribute to economic growth. A well-functioning capital market is essential for economic development, as it facilitates the transfer of funds from savers to those who can invest them productively. By encouraging a broader base of investors, investor protection helps to distribute risk more widely across the economy. This diversification can contribute to financial stability, as the impact of a downturn in any one sector or asset class is less likely to have a systemic effect. We have seen time and again, countries with strong investor protections are more attractive to foreign investors. This integration into global financial markets can lead to an influx of foreign capital, which can be a significant driver of economic activity

Finally, with better protection, investors are more likely to fund startups and innovative projects that could be too risky without such safeguards. This fosters an environment of entrepreneurship and innovation, which is vital for economic progress.

In summary, investor protection is fundamental to creating a conducive environment for investment, which is a precursor to increased investor participation and enhanced economic activity. It helps to establish a virtuous cycle where secure investments lead to more investments, driving economic

growth and prosperity.

Mengistu Weldemariam is Senior consultant in business and finance. He was previously a lecturer in corporate finance and accounting and currently works in consumer and investor protection. – Senior Program Manager. He can be reached via weldemariammengistu@gmail.com

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