The creation of exchanges in countries with communist histories
This chapter considers the stock markets that have emerged during the transition from centrally planned to market economies. The transition occurred over the last 20 years and covered a wide geographical area spreading from Central and Eastern Europe (CEE) through Central Asia to China and Vietnam. A complete description of the different paths of transition in each individual country would be too voluminous for this forum. Instead, this chapter concentrates on the common features and most important differences in the development of stock markets in the more than 30 countries that underwent transition.
The following analysis identifies the most important factors that contributed to the success or failure of individual stock markets that were re-established from a fresh start in the early 1990s.
2. Historical background
During the pre-Communist period, practically all countries described below had functioning commercial exchanges that dealt both in commodities and securities. Most exchanges were established as formal institutions in the 19th century (St.Petersburg 1816, Warsaw 1817, Moscow 1839, Budapest 1864, Prague 1872, Bucharest 1882). They provided facilities for trading government loans, corporate bonds and shares, promissory notes and other instruments. The proportion of traded instruments differed across markets. For example, in Warsaw, securities trading clearly dominated, but in Moscow, securities trading was small in comparison to commodity trading.
In 1912, 275 Russian companies were listed at the St Petersburg Exchange, with one third of them cross-listed in Paris, London or Brussels. At the Budapest Commodity and Stock Exchange at the time, 177 companies were listed, many of which also traded in Vienna. The Warsaw Exchange listed 130 companies and 82 bond issues in 1938, a number of which also listed on western exchanges.
The operations of exchanges in the CEE were, in most cases, interrupted during the World Wars and finally terminated when the communist political system was installed (Russia 1917, Central Europe 1945).[i] In the following decades of central planning, the human experience in stock markets was largely lost. However, the recorded rules and practices of exchanges were not forgotten. When political conditions changed after 1989, memories of local stock exchanges influenced the transitions to market economies.
3. Privatization strategies as drivers of capital markets
Political events of the 1980s triggered the process of transition in Central and Eastern Europe. Among the more important movements and events were the Solidarity (Solidarnosc) movement in Poland, the Russian perestroika, the June 1989 elections in Poland, and the tearing down of the Berlin Wall later that year. During the next few years the governments and political systems changed dramatically in most of these countries.
Concerning the economic dimension, the transitions were based on liberalization, i.e., the removal of the commands and restrictions typical of centrally planned economies. Structural reforms included also privatization which involved the sale or distribution of state-owned enterprises as well as the establishment of new private companies.
In many countries -- particularly those in Central and Eastern Europe (CEE) -- speed was an essential element of transition. Privatization, being always politically controversial, was carried out relatively quickly to reach a point of no return to the previous regime. In the early 1990s, the scope of privatization carried out in CEE was unprecedented in economic history. Privatization transformed thousands of state-owned enterprises (in Russia alone more than 30,000). The public debate during 1989-91 concentrated on how to privatize as rapidly as possible large numbers of companies, while taking into account shortages of available capital.
Examples of previous privatizations carried out in some Western countries in the late 1980s were available, but these privatizations (for example, British Telecom and British Steel in the UK and Paribas in France) were more similar to the IPOs of individual companies, rather than privatization of whole economies.
The challenge in CEE was much bigger: privatization of whole industries and economies. Case-by-case offerings would take dozens of years to carry out the privatization process. Hence, the idea of mass privatization through coupons or vouchers distributed among citizens. The concept of coupon privatization, discussed in Poland in the late 1980s, was effectively introduced in Czechoslovakia during the early 1990s. It was followed -- with many modifications -- in Russia, Ukraine, Romania, Bulgaria and other countries. Mass privatization was adopted, to a limited extent, in Poland and not at all in Hungary. Those countries sold most of their large state-owned enterprises either through public offerings or through direct sales to strategic -- mainly foreign -- investors.
The adopted privatization strategies (coupon privatization, employee ownership, IPOs, sale to strategic investors) were crucial factors in determining the future shape of securities markets in the transitioning economies. The framework of the securities markets that emerged in each country was to a large extent a by-product of the privatization method.
In the debate of the early 1990s, coupon privatization was considered to be most conducive to the development of domestic stock markets. Theoretically, before the process started, nobody could deny the best opportunities for the securities markets would arise when thousands of companies were readily available to millions of potential investors. The critical mass of liquidity would be easily achieved. In contrast, employee ownership was not considered as economically efficient and conducive to the development of public markets. Although politically popular, employee ownership was implemented mainly in the former Yugoslavia.
Privatization through IPOs was seen as very positive for the market, but too slow given the large volume of the planned privatizations. The direct sale of privatized assets to strategic, mostly foreign, investors seemed to be most effective from the productivity point of view. Future developments proved this point. However, it was the politically least popular method of privatization. Unfortunately, the positive externality effects on the local securities markets proved to be very limited. International strategic owners in most, but not all, cases are not interested in local public listings of their affiliated companies. This is particularly true, if the local markets are in early stages of development, but already impose additional local reporting and compliance costs.[ii]
4. Mass privatization markets
In those countries that opted for coupon privatization, securities markets were seen as mechanism for secondary trading of the coupons and/or shares in privatized companies. In Czechoslovakia, the nationwide RMS system -- used initially for coupon privatization -- was subsequently transformed into a secondary trading platform. It started with periodic auctions and then moved later to continuous trading. More than 1,600 companies were registered for trading on RMS in 1993. Registration should not be understood as listing, as no disclosure and reporting requirements were imposed. In the early 1990s, thousands of newly privatized companies in CEE were not ready for disclosure standards similar to those used in mature markets. When speed and scale of transformation were essential, standards had to be compromised.
Regulation of the post-voucher-privatization markets was deliberately light. The slow process of regulation was not accidental. The idea behind light regulation and supervision of securities markets was to facilitate the concentration of ownership. Less informed investors were expected to sell their shares more readily and at lower prices to potential strategic investors. In Russia, this phase of development (until 1998) was nicknamed “the vacuum-cleaner market”.
When millions of accidental, first-time investors became -- free of charge -- owners of securities, most of them wanted to sell out as soon as possible. Hence, all sorts of “investment funds” became popular. In Czechoslovakia, one such fund very quickly accumulated two thirds of distributed vouchers. In non-regulated environments, pyramid schemes spread quickly (Russia, Romania, Albania), destroying investor confidence and hampering the development of regulated markets. The price paid for mass and quick privatization, with very low standards of disclosure and reporting, was high.[iii]
Only a small fraction of people who received privatization vouchers became individual shareholders in the following years. Mass privatization -- which initially looked very promising from an investor’s perspective -- has not produced a shareholder society. The markets originating from coupon privatization turned out to be transitional and have not transformed themselves into significant regulated markets. In Czech Republic, the RMS market accounts for only 2 % of total equity trading in the country.
Equally transitional was the development of unregulated or loosely regulated “stock and commodity exchanges” in CEE. Liberalisation and deregulation of economic activity in the early 1990s produced a legal environment where an enterprise called “commodity and stock exchange” could be easily established without any licensing process. This was in line with simplified liberal ideology of removing all “communist” restrictions of economic activity. The idea of free markets was initially understood in a literary sense. In Poland, before the first securities law was introduced in March 1991, more than 60 “commodity and stock exchanges” were established during 1989-90. The corresponding figure for Russia was more than 600 establishments. Most of those “exchanges” dealt with all sorts of wholesale goods and some early issues of securities, including shares in the exchanges themselves. The period of spontaneous, unlicensed activity in securities markets was short lived in Poland, ending effectively in 1991. In other countries, some loosely regulated exchanges operated throughout 1990s. Practically, all of them subsequently disappeared.
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[i] Some failed attempts to re-establish exchanges were made in Soviet Russia in the 1920s, as well as in Budapest in 1946.
[ii] The concurrent debate on the basic model of financial market to be adopted was less political than that on privatization, but it was still controversial. One of the most frequent topics of discussion was whether to adopt a German bank-oriented model or an Anglo-Saxon market-driven financial sector modle. This debate soon proved to be more academic than practical. The financial sector in CEE was underdeveloped in every respect: banking and insurance had to be transformed and expanded, and securities markets were non-existent. Nobody denied the need for securities markets to be established, but opinions differed on priorities, urgency and their significance in national economies.
[iii] When speed and scale of privatization are politically accepted as priorities, the quality of market infrastructure has to be sacrificed. Unfortunately, quite often low standards and bad practices, initially meant to be transitional, persist and become permanent.
About Wieslaw Rozlucki
Wieslaw Rozlucki, PhD graduated from the Foreign Trade Faculty of the Warsaw School of Economics in 1970. He has a PhD in economic geography. Between 1973 and 1989, he worked as a researcher at the Polish Academy of Sciences. During 1979-1980 he studied, as a British Council scholar, at the London School of Economics.
Between 1991 and 2006, during five terms, Dr.Rozlucki was the President of the Management Board of the Warsaw Stock Exchange. He was also the chairman of the Supervisory Board of the National Depository for Securities and a member of the governing bodies of the World Federation of Exchanges (1994-2006) and the Federation of European Securities Exchanges .
Dr. Rozlucki is a member of supervisory boards of large listed companies including Telekomunikacja Polska, TVN, BPH Bank. He runs a strategic and financial consultancy, acting as a senior adviser to Rothschild and Warburg Pincus International.