The Future of Stock Exchanges in Emerging Economies: Evolution and Prospects

FINANCIAL MARKETS, and especially stock markets, have grown considerably in developed and developing countries over the past two decades. Better fundamentals (higher economic growth, more macro stability), structural reforms (notably privatization of state-owned enterprises), and specific policy changes (notably domestic financial reform and capital account liberalization) have aided in their growth. Globalization has also advanced, with increased cross-border capital flows, tighter links among financial markets, and greater commercial presence of foreign financial firms around the world.

An element of the globalization trend has been the migration of stock exchange activities abroad, particularly from emerging markets. Many firms from emerging economies now cross-list on international exchanges. Depository receipts (DRs), for example, are increasingly popular instruments. ¹ According to data provided by the Bank of New York, $533 billion in DRs were recorded on the New York Stock Exchange (NYSE) alone in 1999. And some $29 billion in new equity was raised through DRs in 2000 through 115 offerings in the U.S. and European markets, a 32percent increase over 1999. Trading has also migrated abroad, and liquidity on some local stock exchanges has diminished. Trading in American depository receipts (ADRs) amounted to almost $1.2 trillion in 2000, or some 17 percent of trading in corresponding local exchanges.

Advances in technology have further accelerated the globalization trend. In particular, remote access to trading systems is ubiquitous, implying that the services offered by stock exchanges can be accessed from anywhere, with firms even having the ability to trade their stocks on both international and local exchanges. Given the network properties of stock exchanges, high liquidity further increases the value of additional transactions at exchanges such as New York or London, leading to more concentration of order flow and increasing liquidity at these exchanges. Migration of trading abroad is putting pressure on many local exchanges, especially in Latin America, but also elsewhere, such as in Central Europe, as both volume and income from trading activities risk declining.

Going forward, these global trends are likely to accelerate as access to information improves, standards—concerning corporate governance, listing, and accounting—are further harmonized, technology further advances, and intermarket linkages increase. These trends are raising questions about the emphasis that countries need to place on developing their own stock exchange as a means to ensure efficient mobilization and allocation of resources for their corporate sectors. To shed light on the costs and benefits of these trends, it is necessary to address a number of related questions. How have stock markets developed around the world, and what factors drive their development? Are the trends of internationalization common across all regions and countries? Which factors affect internationalization in particular? Is the increased migration a function of improved fundamentals or a reflection of corporations fleeing domestic financial systems that are institutionally weak and have a limited base of investors? Does the degree of migration depend on the size of the local market?

The answers to these questions require an analysis of the determinants of stock market development across the globe, the causes of internationalization, and the effects on local exchanges. This paper investigates some of these questions by describing and analyzing the patterns and determinants of market capitalization and domestic trading for seventy-seven countries between 1975 and 2000. Using data on individual firms starting in 1983, we aggregate for each country and year individual capitalization, trading, and capital-raising figures of all international companies to obtain different measures of the degree of internationalization. We then analyze the three components of the internationalization process—listing, trading, and capital raising—for a large cross section of countries, report on the factors driving these components, and compare these factors to those driving the development of stock markets in general.

We find that a (small) number of...