Friday, July 12, 2024

Capital Markets 101


What image comes to mind when you hear the word “market”? Do you picture a grocery store, a produce market in your neighborhood, or maybe a shopping mall? These are indeed all examples of markets, but you might be surprised to learn that some important markets aren’t stores at all. Although it is only for the first time in Ethiopia, there is a new type of market – a place where buyers and sellers are unlikely to meet but still trade, that is where they can buy and sell like all marketplaces these places are known as Capital Markets.
For a few years now the Ethiopian financial sector has been going through rapid transformation. This sector, which has been dominated by banks, microfinance institutions, and insurance companies offering traditional products, is now transitioning to a modern financial system with the introduction of Capital Markets – for the very first time!
The government of Ethiopia has been laying the groundwork for these capital markets since the House of Peoples Representatives enacted the Capital Markets Proclamation (No. 1248/2021) on June 10, 2021. The Proclamation lays down the legal foundation for the establishment of key institutions, issuance, and transaction of securities, as well as the regulation and supervision of capital markets. It is expected to significantly enhance the diversity and dynamism of the sector. Most recently, the Ethiopian Capital Market Authority (the “Authority or ECMA”) has been established and is setting up the necessary institutions, policies, legal instruments (directives and regulations), as well as the market infrastructure required for the development of a well-functioning and robust capital markets.
Although commonplace in many countries, the Capital Market is a novel and promising opportunity in Ethiopia. As the regulatory body it is imperative that the ECMA educate the populace about what Capital Markets are and the regulations under which these markets operate.
So, what are Capital Markets? They are financial markets that bring buyers and sellers together to trade stocks, bonds, currencies, and other financial assets. More specifically, Capital Markets include the stock market and the bond market. Capital Markets help people with ideas become entrepreneurs, and help small & medium businesses to grow into bigger companies. They also give the general public like you and me, opportunities to save and invest for our own and our children’s future. In short, the primary function of the Capital Market is to bring together investors who buy securities with those who sell them.
Here’s a simple example. Meet Sofanit; Sofanit has an idea for a new business—delicious ice cream that’s healthy enough to eat anytime of the day; Yum! She saved her money in the bank, earned interest, and used that to start her business. Sofanit tested the market, and BANG, her ice cream is a hit. In fact, there’s so much demand that she can’t fill ice cream cups fast enough; the business is growing! Sofanit needs to hire people to help her make, sell, and deliver her ice cream. She needs more ingredients from her suppliers, like the fruit seller and the milk distributor. Sofanit doesn’t have the money to pay for all of this right now, but according to her business plan and test market results, she’s going to make millions in the first year. Enter: Capital Markets.
Financial capital is money entrepreneurs like Sofanit and businesses in general use to buy resources and supplies. These are then used to make products or provide services to buyers. So, Sofanit must raise financial capital to expand and grow her business. She is now able to raise financial capital through Capital Markets. Financial capital is raised in Capital Markets in two principal ways—by selling bonds, which are like loans that the business (like Sofanit Ice Cream Shop) will repay at a later date with interest, or by selling stocks, which are sold in exchange for the partial ownership of a business (be a part-owner of Sofanit Ice Cream Shop). These are two ways that Sofanit can get some needed capital for her business which she would have never been able to do before the starting of the Capital Markets in Ethiopia.
Selling stocks takes place through what is known as an initial public offering (IPO), also called “going public”. Unlike a loan, which has to be repaid, issuing an IPO allows others to buy a share or a portion of a business (like Sofanit Ice Cream) and become a partial owner. The person or institution with the most shares at any time is the company’s main owner.
IPOs are a fantastic way for people like Sofanit and other small businesses to become large companies, expand across the country, and create thousands of jobs. They also stimulate the economy by creating opportunities to other businesses such as those in supplies, production and delivery.
So, what is in it for the regular citizens who buy stocks? We, the people, buy stocks hoping that the value of the stocks we buy will increase in value, enabling us to sell it at a reasonable profit or higher value than we bought it for. One thing that must be said here is that like everything else in life, this very opportunity to profit comes with a reasonable risk. The risk is that the specific stock we buy could actually decrease in value, resulting in loss. I argue here that ECMA has a daunting responsibility to educate investors on the benefits and risks of trading on the Capital Markets and to enforce all associated regulations to protect investors from some nefarious individuals or agencies.
To date, small businesses like Sofanit Ice Cream and other startups in Ethiopia had few options to bring innovative ideas to life or expand their small businesses; they could either wait until they had enough savings or put fixed assets as collateral to borrow from banks. Thanks in part to the Economic Transformation agenda, soon we will have our own markets for stocks and bonds – Capital Markets – where business owners can obtain the needed financial capital to build successful companies, and members of the public have the opportunity to become investors.
Capital markets bring borrowers and lenders together in efficient ways and help channel resources into creating new jobs and improving our nation’s economy.
They provide essential funding that affects people’s lives in many ways, from starting a business or expanding a current one, to providing investment opportunities for people planning for their future, like you and me.
One day, you and I might come up with an idea—like Sofanit’s healthy ice cream—that we want to turn into a thriving business. Thanks to the government of Ethiopia and its economic transformation agenda, Capital Markets will be there to help make it happen. And that’s just one of the positive economic changes we can expect in the future! Next time we’ll explore more of the policies that can help you, your family, and Ethiopia become more financially secure and prosperous.

Saron Woldegebriel is a Sr. Officer of Communications and Investor Education at the ECMA, and Dr. Tefera Gezmu is a Sr. Advisor at the ECMA working on Professional Development and Organizational Culture.

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