Session V. Financing for development: Innovative sources of financing
(substantively serviced by ESCAP)

A. The major issues involved in accessing and using innovative sources of finance

Characteristics of innovative sources

• Do such innovations make it easier or more difficult for developing counties to have access to international finance?
• If easier, what does it involve in terms of having matching institutional and human resource capacity in the developing countries to ensure proper utilization?
• If more difficult or more expensive to access, how are developing countries to improve their risk profile?

Lessons on management of risks from the Asian crisis

• The financial system is critical to the smooth functioning and development of an economy. A principal lesson from the Asian crisis is that financial institutions have to be prudently managed, i.e. they must be able to perceive, incorporate and manage the risks inherent in their businesses.
• How can more use of market-based risk management tools be encouraged?
• How can better management of exchange rate risks and use of hedging tools be encouraged?

Broadening and deepening capital markets

Individual domestic stock markets lack breadth and depth. The issues that arise are:

• Is there is a demand for NASDAQ-style intermediate markets in the region where new smaller companies might go to raise capital?
• For countries without active stock markets, are small domestic markets desirable or is the use of more established, deeper markets in other countries in the region preferable?
• How can the independent auditing function be strengthened to improve the credibility of company reports and balance sheet information?
• How can the functioning of domestic credit rating services be fully integrated into the capital markets of the region?

Enhancing regional cooperation in financial markets

Given the present limitations of domestic capital markets, there appears to be a need for enhanced regional or subregional cooperation. The main issues in this regard are:

• What are the forms of developing viable inter-market linkages among capital markets, including by electronic means?
• What are the impediments to greater cooperation?
• What are the possible mechanisms for sharing market-sensitive information?
• Is technical assistance required and available for these purposes?

B. New ways of mobilizing domestic savings of, and providing finance to the poor

Outreach modalities

In many developing countries, financial markets do not cater to the needs of the poor or rural households adequately. This gap raises the following issues:

• How can savers in the poor and rural areas be better served?
• How can reasonable returns and ease of access be combined?
• How can credit be made affordable for both borrowers and lenders?
• How can repayment discipline be instilled amongst borrowers?
• How can lenders be helped to assess the true risk of lending, given a lack of adequate security and collateral?
• Are cooperatives or microfinance schemes the best answers?

Making microfinance sustainable

Many microfinance schemes receive subsidies either from governments or from donors. When these funds are no longer available, they collapse.

• How can the financial sustainability of a microfinance scheme be increased and how can this be judged?
• What is an appropriate level of supervision for microfinance schemes and who should do it?
• How can individual users of microfinance graduate into formal banking arrangements with access to savings instruments with better returns and to more long term and larger volumes of loan finance?
• How are microfinance institutions themselves to graduate to a larger role within the financial system?

Addressing the needs of farmers and SMEs

Efforts at cost effectiveness and risk aversion on the part of financial institutions also tend to deprive SMEs and farmers of adequate access to financial resources. The issues that arise are:

• Can such lending be cross-subsidized by other borrowers and thus justified on commercial grounds?
• Should the government subsidize such lending? How?
• How can the effectiveness of special public sector institutions set up for these purposes be improved?

C. Capital markets as a source of finance for development, particularly in light of the Asian crisis

Domestic stock markets in countries of the region, experience and future prospects

Some capital markets had been a robust source of long-term funding in the East and South-East Asian countries. In the wake of the crisis, stock markets have performed quite bearishly; rights issues have virtually dried up, except for a few of the best corporate names. Some of these are now exploiting opportunities overseas, on NASDAQ or on the New York and London Stock Exchanges. The future of stock markets in the region as a source of development finance is directly linked to their ability to cater to the needs of less well-known names. The immediate issues are:

• How can the recovery of exports and GDP growth be translated into a revival of the capital markets?
• How can technical features such as custody, settlement and delivery be improved?
• Which mechanisms should be used to link domestic corporate rating and share issuance?
• Which modalities can encourage greater use of convertible bonds and of equity dilution through the participation of minority shareholders?
• What are viable ways to encourage the use of stock holdings as a domestic savings device for a wide public?

Domestic bond markets in countries of the region; experience and future prospects

The development of bond markets is likely to be a long term affair as there are not yet a large pool of institutional and retail investors in the region. The issues that arise include:

• How can one diversify holding of bonds beyond the banking sector?
• Do bond markets help to overcome the problem of loss of investor confidence?
• How does one educate the public about the advantages and risks of holding bonds as a long term savings instrument?

Other domestic debt markets in countries of the region; experience and future prospects

Over the longer term, the full range of debt instruments will need to develop. For this to happen, secondary markets for debt instruments will have to develop simultaneously. There are as yet few signs that such markets are coming into being. The issues are:

• What can the authorities do to encourage the development of debt markets?
• Is it in the interest of corporate issuers to shift from bank loans to the issue of debt?

Use of more developed stock and bond markets; experience and future prospects

A few of the best-known corporate names from the region, especially those involved in 'new economy' activities (IT and telecommunications) have been able to raise capital in developed country markets. For the majority of corporations in the region, prospects remain tied to the revival of domestic stock markets. Immediate issues of interest are:

• Can domestic capital markets link up formally with stock markets in developed countries as well as with larger regional financial centres like Singapore and Hong Kong, China?
• What would be the benefits of doing so and the costs?

Prospects for the development of capital markets in the LDCs

As capital markets in LDCs will remain undeveloped for the foreseeable future, are the following initiatives worth pursuing?:

• Setting up subregion-wide or multiple country stock markets
• Listing mutual funds or venture capital funds of LDCs on exchanges in the region
• Encouraging collaboration with foreign partners to improve corporate profiles and obtain access to stock markets in and outside of the region

D. Structured finance deals: How do they work and will they work?

Projects which link trade and investment

The use of structured finance in project financing is now virtually the norm where multiple lenders join together to finance a project. Normally a lead manager will structure the financial package involving a mixture of equity, bond and loan finance. The questions that arise include:

• Do structured finance deals for large investments provide a method of participation for domestic interests in a consortia of investors that usual FDI does not?
• Do developing countries have a sufficient number of projects attractive enough to qualify for such financing modes?
• As the risk minimization inevitably involves some form of sovereign credit rating, do the countries, or the project-sponsoring entities, enjoy investment grade rating? What is required to obtain investment grade ratings?
• Is it worth for a country to develop expertise in this area or is technical advice available for the occasional arrangement?

Use of structured deals in trade finance

Trade finance now goes beyond simple self-liquidation and involves the formation of syndicates on the lender's side and some form of collateral or sovereign guarantee on the borrower's. The latter substantially raise the cost of default or delays in payment. For the riskiest customers/countries, banks may require additional third party confirmation of trade documents. The issues in this area include:

• How do countries improve their creditworthiness so that the costs of such finance come down?
• Can use of swaps, warehouse receipts and other forms of contract and hedging instruments help to maximize return from commodity exports?
• Can these include some viable forms of exchange rate hedging?

Links of structured deals to underlying markets and their robustness

Wherever possible lenders seek to minimize exposure to risk by securitizing the underlying asset and off-loading it in the debt markets; without robust secondary markets, securitization would be impossible. Apart from a few centres in the region, few financial markets have the depth to support structured finance deals in this manner. The issues that arise are:

• How do countries develop working links with the major financial centres offering such facilities?
• Is it necessary for developing countries to have their own financial institutions in the major financial centres?

How much of a solution are such deals? The conditions for their wider use.

Much of recent financial innovation has been driven by conditions in the developed countries, with pressures towards a sharing and minimization of risk. This process involves a much greater use of information, both financial and non-financial, in the evaluation and pricing of risk. The outcome has been lower costs and easier access to finance for the most creditworthy, and the reverse for others. For the latter group of borrowers/countries the issues are the following:

• Are structured finance deals a viable alternative for other forms of financing or are they inherently limited in their application?
• How can countries learn more about the new innovations and understand when to use them?