James Passin, Principal, Firebird Management, on increasing investor participation on the stock exchange

 James Passin, Principal, Firebird Management

In terms of aggregate sources of equity capital funding, the Mongolian Stock Exchange (MSE) has historically played a minimal role when compared to external stock exchanges. It has provided a useful means by which Mongolian entrepreneurs could raise capital from the local market for businesses that were not yet in shape for an international listing. Still, we have not seen very large, international-quality companies listed on the MSE, so whether or not there is a market for such securities remains to be seen. I am certainly hopeful that this is the case. However, in order for there to be demand for shares there has to be a sufficient number of investors present who can provide liquidity.

One thing that may have harmed liquidity is the Millennium Information Technology (MIT) trading system. This is due to the requirement for brokers to have commercial banking partners, and also for the underlying brokerage clients to open individual bank accounts to settle trades. There are about 750,000 Mongolian citizens with accounts at the Central Depository, and numerous foreign individuals and entities. It will take time and effort before these requirements are met.

The positive side of the MIT system is that it is more technologically robust. So, in the future, if the Financial Regulatory Commission (FRC) relaxes the prefunding requirement, we might see some benefits from the new system reach underlying investors. It is important to add that the FRC’s requirement for prefunding stems from a sensible concern regarding various scams involving small brokers and other financial service firms. However, the consequences of these requirements are that there are now practical obstacles for people who want to invest without any corresponding benefits. My view is that trading will eventually be loosened up and the prefunding requirement will be relaxed (probably for institutional clients first), which will help facilitate trading. I doubt that all 80 brokers with seats on the MSE will survive, but that will not be so harmful to the market. I am optimistic that the MIT system will ultimately improve the market and boost trading volumes.

In terms of the more fundamental issues, many of the currently listed companies lack strong corporate governance and transparency standards. There are very few firms that issue financial statements, for example.

The penalty for failing to file a company’s financial statements is insignificant, and there are no real incentives for a firm to do so, since the market is so small and the penalty does not really affect the selling of stocks. Companies actually have an incentive to hide profits from tax authorities, labour unions and so forth.

This makes it quite difficult for institutional investors to make accurate evaluations, which does not promote further investment in the long run.

I think that new draft Securities Law, if it were be to approved by Parliament, would significantly improve the regulatory framework of the market and would make it easier for companies that are public or want to go public to list or issue new share capital. Overall, I believe the new Securities Law will help increase the supply of shares and will enable more product float on the MSE.

I hope that the issues of transparency and corporate governance will be taken seriously by the government in relation to projects like the Tavan Tolgoi mine, as it is crucial to investor confidence.

If these aspects are improved, I think that there is a possibility for existing firms on the MSE to evolve into competitive, internationally attractive companies. The role that the MSE can play in the social development of the country should not be understated. It is also likely that, in time, the interest rates of banks will come down and time deposits will not seem as attractive. That is going to drive owners of cash to look for alternative investment opportunities. Right now, the law prohibits Mongolian insurance companies from buying Mongolian shares. Eventually, we will see Mongolian financial entities having an obligation to make investments. This will probably generate more pressure for companies to improve their transparency standards and corporate governance, and generate more demand for shares. I believe that it is inevitable for a virtuous circle to emerge.

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The Report: Mongolia 2013

Capital Markets chapter from The Report: Mongolia 2013

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