Legal Update: Establishment of a Capital Market in Ethiopia
Introduction
Capital formation or real investment is an essential ingredient for economic development and growth. It is also widely believed that capital markets have the potential to be powerful engines of economic growth in developing nations such as Ethiopia. Efficient capital market provides the public with investment opportunities and mobilizes savings, as well as international capital, for productive corporate financing.
One aspect of the Ethiopian Government’s recent reform measure aims to correct imbalances and bring about macro-financial stability in the country, inter alia. With this in mind, the reform program provides improvements to access to finance and the development of a capital market, where securities such as shares, bonds and derivatives are bought and sold. As a result, the Capital Market Proclamation No. 1248/2021 was adopted with the goal of establishing a capital market to support the development of the national economy through mobilizing capital, promoting financial innovation, and sharing investment risks.
Consequently, actions are being taken by the government to operationalize the Ethiopian Capital Market Authority and such actions manifest themselves in the fact that the Government has setup a project team which has been working to draft proper directives for approval by the Board of Directors of the Capital Market Authority to supply detailed guidance and requirements to enable the effective implementation of the Capital Market Proclamation (cited as the proclamation hereafter).
The Concept of Capital and Capital: A General Overview
The term capital can be defined as “the stock or principal fund raised by a corporation through subscribers’ contributions or the sale of shares”. Stock represents a share of ownership in a corporation. By and large, such kinds of stocks could be identified as security representing equity claims on the earnings and assets of the corporation. In this update, the terms stock and capital are used interchangeably. It is also noteworthy that the proclamation encapsulates the words shares, equities, bonds and derivatives under the category of securities.
Stocks are generally traded in stock market. Generally, speaking, stock market refers to capital market in which stocks of corporations are sold to investors. Under the proclamation, “capital market” is defined as a market where securities are bought, sold, issued, publically offered, deposited, taken custody of, cleared, settled, lent, pledged, or transacted in any other form which the capital market authority considers dealing in securities (see article 2(5) and (18) of the proclamation) . In simple terms, it is a market place where equity interests are exchanged either at par value, premium value or for less than the par value – also called discount stock. Thus stock market allows stockholders (shareholders) to transfer to another investor when they want to sell their stocks. It should be noted that stocks could be sold and bought in primary capital market. In primary markets, new business can start by obtaining funds directly from households in which new stocks are sold to investors via the mechanism of underwriting. The selling of capital to the public through Initial Public Offering in the primary market is an instance whereby widely held share companies under formation offer new shares to the investors (article 2(49)).
On the other hand, it is vital not to lose sight of the fact that secondary markets play an important role in the regulation of initial public offering of shares through the listing standards, subject to the discretion of stock exchanges. Secondary markets are markets where investors buy previously issued securities from other investors as opposed to the primary market, where investors buy new securities directly from the issuer or an intermediary (article 2(61)). In the secondary market, existing stocks are sold and bought among investors or traders in the stock market through stock exchange. Furthermore, secondary market could be either auction market or dealer market or as some would call it exchange based market. While the stock market is part of an auction market, over-the counter (OTC) is part of the dealer market. The difference between stock market and OTC is that the former exchange market operates in a structured manner and physical facility with a trading floor to which all stock transactions are supposed to be directed. However, OTC market traditionally operates in unstructured manner without any physical facility in which any qualified firm freely engages in the transactions of stocks.
At this juncture, it is also vital to differentiate bond and stock. Bond is a security instrument which is used either by the government or any other corporation to raise funds in the bond market. Unlike stock which as indicated before is an equity instrument, bond is a debt security evidencing that a promise has been made by a government such as Treasury Bills (T-Bills) or by corporation such as debenture to pay a specified amount of money in recognition of a loan to the business. Like stock, a bond is another way of obtaining funds but this time “representing funds borrowed by the corporation or the government from the holder of the debt obligation”. It should be noted that both stock markets and bond markets are categories of capital market. Like stock market, bond market helps bond holders to transfer their bond to third party when they want to sell it in the secondary market or use it as collateral to get loan from banks.
In a nutshell, a stock market is an open market place which provides facilities for stock brokers, investors and corporations to trade in stocks. Stock markets generally provide the means by which companies raise capital to start new business or expand the existing business by offering new stocks to the public. It also provides a trading facility for investors to sell their share
ownership in corporations. Unlike the bond market, stock market provides an opportunity for companies to finance their business through equity investment.
What has the New Proclamation come up with?
a) The Regulatory Aspect
The Ethiopian Capital Market Authority (ECMA), an autonomous government regulatory body that is accountable to the Prime Minister has been established (article 3). The ECMA is tasked with protecting investors, ensuring the existence of capital markets eco system in which securities can be issued and traded, ensuring the integrity of the capital markets and transactions in order to reduce systemic risk, and promoting the development of capital markets by creating an enabling environment for long term investments.
The ECMA is empowered to regulate persons who are engaged in the exchange of securities, derivatives, depositing of securities and clearing company or undertake any other professional activity within ECMA’s jurisdiction, including activities of securities brokering, investment advisory, collective investment scheme operation, investment banking, securities dealership, custody, market making, and credit rating agency. One should keep in mind that this excludes activities of legal practitioners, public accountants or public auditors.
b) Collective Investment Scheme (CIS)
CIS is an arrangement formed for the purpose of providing facilities for persons to participate in or receive profits or income arising from the acquisition, holding management or disposal of securities or any other property or sum paid out of such profits or income. The scheme’s assets are managed by a person who is responsible for management of the scheme’s assets and client accounts. Investors who participate in the arrangement do not have day-to-day control over the management of the scheme’s assets (Article 2(11) and 85-91).
CIS may be established as investment companies such as mutual funds, limited partnerships or other forms under the Commercial Code. The CIS has to be registered by ECMA. CIS can be managed by collective investment scheme Operator. The Operator is a legal entity that has the overall responsibility for management and performance of the functions of the CIS.
c) Prohibited Trading Practices
Insider trading, market manipulation, false trading, fraudulent transactions, front-running and similar other trading practices are some of the prohibited trading practices listed in the Proclamation (Articles 95-101). The proclamation also lists violations that entail criminal punishments as well as administrative measures (Articles 106 and 107)
d) Compensation Fund
Compensation fund is established by the Proclamation for the purpose of granting compensation to investors who suffer pecuniary loss resulting from the failure of a capital market service provider or securities exchange to meet his contractual obligations and paying beneficiaries from collected unclaimed dividends when they resurface (article 103).
e) Capital Market Tribunal
The Capital Market Tribunal is established by this Proclamation to hear appeals against decisions of ECMA (articles 64-73). The Tribunal has the jurisdiction to hear and determine Appeals over the decisions of the authority or persons exercising the functions and powers of the authority. A party who is dissatisfied by the decisions of the authority may within 28 (Twenty Eight) days after being served with notice of the decision, file an appeal to the Tribunal. A party to a proceeding before the Tribunal who is dissatisfied with decision of Tribunal may within 30 (Thirty) days after being served with the notice of the decision, file a notice of appeal, on questions of law only, to the Federal High Court.
f) Settlement of Disputes
Without prejudice to the Tribunal’s appellate jurisdiction over matters arising from the decisions of the authority or other persons exercising the powers and functions of the authority and the federal high court’s power to review the Tribunal’s decisions on questions of law, disputes among parties involved in the capital market concerning any civil matter arising under the Proclamation shall be resolved by mediation first and then by arbitration. The decision of the arbitration panel shall be final and binding on the parties.
Capital formation or real investment is an essential ingredient for economic development and growth. It is also widely believed that capital markets have the potential to be powerful engines of economic growth in developing nations such as Ethiopia. Efficient capital market provides the public with investment opportunities and mobilizes savings, as well as international capital, for productive corporate financing.
One aspect of the Ethiopian Government’s recent reform measure aims to correct imbalances and bring about macro-financial stability in the country, inter alia. With this in mind, the reform program provides improvements to access to finance and the development of a capital market, where securities such as shares, bonds and derivatives are bought and sold. As a result, the Capital Market Proclamation No. 1248/2021 was adopted with the goal of establishing a capital market to support the development of the national economy through mobilizing capital, promoting financial innovation, and sharing investment risks.
Consequently, actions are being taken by the government to operationalize the Ethiopian Capital Market Authority and such actions manifest themselves in the fact that the Government has setup a project team which has been working to draft proper directives for approval by the Board of Directors of the Capital Market Authority to supply detailed guidance and requirements to enable the effective implementation of the Capital Market Proclamation (cited as the proclamation hereafter).
The Concept of Capital and Capital: A General Overview
The term capital can be defined as “the stock or principal fund raised by a corporation through subscribers’ contributions or the sale of shares”. Stock represents a share of ownership in a corporation. By and large, such kinds of stocks could be identified as security representing equity claims on the earnings and assets of the corporation. In this update, the terms stock and capital are used interchangeably. It is also noteworthy that the proclamation encapsulates the words shares, equities, bonds and derivatives under the category of securities.
Stocks are generally traded in stock market. Generally, speaking, stock market refers to capital market in which stocks of corporations are sold to investors. Under the proclamation, “capital market” is defined as a market where securities are bought, sold, issued, publically offered, deposited, taken custody of, cleared, settled, lent, pledged, or transacted in any other form which the capital market authority considers dealing in securities (see article 2(5) and (18) of the proclamation) . In simple terms, it is a market place where equity interests are exchanged either at par value, premium value or for less than the par value – also called discount stock. Thus stock market allows stockholders (shareholders) to transfer to another investor when they want to sell their stocks. It should be noted that stocks could be sold and bought in primary capital market. In primary markets, new business can start by obtaining funds directly from households in which new stocks are sold to investors via the mechanism of underwriting. The selling of capital to the public through Initial Public Offering in the primary market is an instance whereby widely held share companies under formation offer new shares to the investors (article 2(49)).
On the other hand, it is vital not to lose sight of the fact that secondary markets play an important role in the regulation of initial public offering of shares through the listing standards, subject to the discretion of stock exchanges. Secondary markets are markets where investors buy previously issued securities from other investors as opposed to the primary market, where investors buy new securities directly from the issuer or an intermediary (article 2(61)). In the secondary market, existing stocks are sold and bought among investors or traders in the stock market through stock exchange. Furthermore, secondary market could be either auction market or dealer market or as some would call it exchange based market. While the stock market is part of an auction market, over-the counter (OTC) is part of the dealer market. The difference between stock market and OTC is that the former exchange market operates in a structured manner and physical facility with a trading floor to which all stock transactions are supposed to be directed. However, OTC market traditionally operates in unstructured manner without any physical facility in which any qualified firm freely engages in the transactions of stocks.
At this juncture, it is also vital to differentiate bond and stock. Bond is a security instrument which is used either by the government or any other corporation to raise funds in the bond market. Unlike stock which as indicated before is an equity instrument, bond is a debt security evidencing that a promise has been made by a government such as Treasury Bills (T-Bills) or by corporation such as debenture to pay a specified amount of money in recognition of a loan to the business. Like stock, a bond is another way of obtaining funds but this time “representing funds borrowed by the corporation or the government from the holder of the debt obligation”. It should be noted that both stock markets and bond markets are categories of capital market. Like stock market, bond market helps bond holders to transfer their bond to third party when they want to sell it in the secondary market or use it as collateral to get loan from banks.
In a nutshell, a stock market is an open market place which provides facilities for stock brokers, investors and corporations to trade in stocks. Stock markets generally provide the means by which companies raise capital to start new business or expand the existing business by offering new stocks to the public. It also provides a trading facility for investors to sell their share
ownership in corporations. Unlike the bond market, stock market provides an opportunity for companies to finance their business through equity investment.
What has the New Proclamation come up with?
a) The Regulatory Aspect
The Ethiopian Capital Market Authority (ECMA), an autonomous government regulatory body that is accountable to the Prime Minister has been established (article 3). The ECMA is tasked with protecting investors, ensuring the existence of capital markets eco system in which securities can be issued and traded, ensuring the integrity of the capital markets and transactions in order to reduce systemic risk, and promoting the development of capital markets by creating an enabling environment for long term investments.
The ECMA is empowered to regulate persons who are engaged in the exchange of securities, derivatives, depositing of securities and clearing company or undertake any other professional activity within ECMA’s jurisdiction, including activities of securities brokering, investment advisory, collective investment scheme operation, investment banking, securities dealership, custody, market making, and credit rating agency. One should keep in mind that this excludes activities of legal practitioners, public accountants or public auditors.
b) Collective Investment Scheme (CIS)
CIS is an arrangement formed for the purpose of providing facilities for persons to participate in or receive profits or income arising from the acquisition, holding management or disposal of securities or any other property or sum paid out of such profits or income. The scheme’s assets are managed by a person who is responsible for management of the scheme’s assets and client accounts. Investors who participate in the arrangement do not have day-to-day control over the management of the scheme’s assets (Article 2(11) and 85-91).
CIS may be established as investment companies such as mutual funds, limited partnerships or other forms under the Commercial Code. The CIS has to be registered by ECMA. CIS can be managed by collective investment scheme Operator. The Operator is a legal entity that has the overall responsibility for management and performance of the functions of the CIS.
c) Prohibited Trading Practices
Insider trading, market manipulation, false trading, fraudulent transactions, front-running and similar other trading practices are some of the prohibited trading practices listed in the Proclamation (Articles 95-101). The proclamation also lists violations that entail criminal punishments as well as administrative measures (Articles 106 and 107)
d) Compensation Fund
Compensation fund is established by the Proclamation for the purpose of granting compensation to investors who suffer pecuniary loss resulting from the failure of a capital market service provider or securities exchange to meet his contractual obligations and paying beneficiaries from collected unclaimed dividends when they resurface (article 103).
e) Capital Market Tribunal
The Capital Market Tribunal is established by this Proclamation to hear appeals against decisions of ECMA (articles 64-73). The Tribunal has the jurisdiction to hear and determine Appeals over the decisions of the authority or persons exercising the functions and powers of the authority. A party who is dissatisfied by the decisions of the authority may within 28 (Twenty Eight) days after being served with notice of the decision, file an appeal to the Tribunal. A party to a proceeding before the Tribunal who is dissatisfied with decision of Tribunal may within 30 (Thirty) days after being served with the notice of the decision, file a notice of appeal, on questions of law only, to the Federal High Court.
f) Settlement of Disputes
Without prejudice to the Tribunal’s appellate jurisdiction over matters arising from the decisions of the authority or other persons exercising the powers and functions of the authority and the federal high court’s power to review the Tribunal’s decisions on questions of law, disputes among parties involved in the capital market concerning any civil matter arising under the Proclamation shall be resolved by mediation first and then by arbitration. The decision of the arbitration panel shall be final and binding on the parties.