CAPITAL IN ACTION

Until recently, the securities market was considered perhaps the weakest part of Azerbaijan's financial sector. True, it was the youngest segment, but rather poorly developed and attracting no special interest. However, the last couple of years saw intensive qualitative changes taking place in the securities market, which naturally reflected in the growth of quantitative indicators. According to Chairman of the State Committee for Securities (SCS) Rufat Aslanli, quite ambitious tasks are being set for the near future, the fulfilment of which can significantly affect the share of this segment in the formation of income of the country's financial market.

The capital market vs. challenges

Until 2014, up to two-thirds of revenues of the Baku Stock Exchange (BSE), the Depository Centre and other major financial intermediaries was formed by means of public instruments, which means that the state indirectly supported the development of these institutions. The income was mainly derived from transactions with government securities, including repo and reverse repo transactions with notes of the Central Bank of Azerbaijan.

As of 2014, transactions of the private corporate sector began to dominate and reached two-thirds of the volume of transactions in the securities market. "This resulted in a situation where the capital markets, as an element of private enterprise or a market economy, began to reproduce the values that ensure financial stability and stable functioning of these institutions," SCS Chairman R. Aslanli said.

In his opinion, the development of the market was greatly influenced by the launch of a platform trading in derivative financial instruments (i.e. contracts such as options and futures the price of which is derived from the price of the covered financial asset). As a result, the volume of transactions in commodity and foreign currency derivatives reached 4.3bn manats, which is one-third of the total volume of transactions in the securities market. "Furthermore, last year we finally managed to launch mechanisms ensuring liquidity in the secondary market and competitive pricing on the stock exchange. This means that during the past year, we created a market maker institution where big players and big financial companies take the obligation to buy and sell specific tradable securities at market prices," said Aslanli.

Ambitious plans

With regard to strategic plans, they naturally include the expansion of margin trading, which allows investors to buy and sell securities and financial instruments purchased under special terms from a broker at the expense of a temporary trading limit. According to the SCS chairman, the BSE may switch over to margin trading of shares in 2015.

"It is essential that the underlying instruments are the shares already traded on the country's market. It is for this reason that the exchange was somewhat delayed with issuing derivatives whose underlying assets are securities. However, a decision is going to be taken this year that will allow financial intermediaries to back margin trading with securities too. But this will only happen after the adoption of the new Law on Securities Market," Aslanli said.

As for the shares, a much welcomed initial public offering (IPO) will also take place in Azerbaijan this year. However, the intention of a number of companies to lead this IPO may fail to materialize. After all, it is not enough just to have a three-year audit report drawn up by one of the Big Four audit firms. It is important that the company has a vision of its corporate goals and objectives after entering the open market. In other words, business owners must envision their strategic objectives for at least three years. "I do not wish to imply that the companies which have taken such a strategic decision as to make a public offering do not know what they want. The point is that the companies must address a number of tactical objectives including the establishment of a clear corporate structure and governance and representation of their corporate objectives and financial expectations to the market. These objectives should be communicated to potential investors in clear and, most importantly, convincing terms so as to enable the latter to take an informed decision," said Aslanli.

All this is going to take some time. "Certain companies have set specific dates. However, we do not wish the first IPO to bring about some inappropriate results," the SCS chairman said. "We are quite restrained in our attitude towards the first IPO and do not cherish unrealistic expectations. An IPO is a serious strategic decision that has already been taken by several national companies. The implementation of such problems and solutions requires a lot of hard work."

It should be noted that to stimulate the IPO, the SCS has developed a set of proposals concerning, in particular, the application of tax holidays for a certain period of time.

Tax incentives

Meanwhile, with regard to the scope of taxation of securities, it should be mentioned that the tax regime for transactions in this market is specific all over the world even in relation to other segments of the financial market, i.e. in relation to the taxation of banks and insurance companies. It took Azerbaijani specialists almost two years to explore this issue, and last year the SCS jointly with the Ministry of Taxes developed a tax regime for transactions and instruments in the securities market. Discussions on this subject may be initiated within the budget process for next year. In the meantime, it is proposed to improve the tax treatment of transactions in bonds. Bonds yield two types of income: the accrued interest and the price difference between buying and selling. The accrued interest on bonds is taxed at a rate of 10 per cent; other incomes are taxed at 20 per cent. There are several specific issues when dealing with securities including derivatives; therefore it is proposed to refine and improve the taxation of transactions with debt instruments.

It is also proposed to include the service of securities safekeeping in the base of financial services and exempt securities from VAT (the country's tax rate is currently at 18 per cent).

A special tax regime will also be developed for investment funds because, as noted by Aslanli, the legal basis for the activity of investment funds in Azerbaijan has been in place since 2010, and their taxation has certain specifics. Thus, in accordance with the legislation, an investment fund is controlled by a management company. As of today, the SCS has issued licences for asset management to three companies (Invest Az Asset Management, Az Finance Asset Management and Trust Asset Management). Now they are preparing rules for the operation of funds to be created, following which they will be able to apply to the SCS for the licensing of the funds proper. The SCS chairman believes that the process of adopting a specific tax regime for transactions in the securities market will intensify by that time.

Will there be a petroleum exchange?

In the meantime, another interesting question that is also on the agenda is the possibility of organizing trade in Azerbaijan oil and oil products through the stock exchange. "In debating the issue of going over to margin trading of goods, the SCS held discussions on the subject of what we should start with - oil, in which Azerbaijan trades extensively, or precious metals. Our position was clear: as the price of oil is very volatile, we have chosen to start with precious metals," Aslanli said.

However, the reason for this was not the fall in oil prices on world markets since last summer. The SCS chairman believes that the oil price is not the determining factor in the availability of this tool in margin trading. We are talking about the condition of a particular segment of the global economy or the market where processes are not quite predictable but can be understood by logic and explained by economic laws. When there are certain factors still not fully explored, such as the behaviour of the players or pricing in a particular sector, one should not wait but rather study them deeper and only then take decisions.

Thus, margin trading through the stock exchange first began in the summer of 2014 with convertible currencies, as trading in currency pairs has a certain history and is more understandable for speculators. Note that speculators are not a negative concept, though some people may have recollections from the time of the socialist economy that speculation is something bad. The capital market always involves investors and speculators as its participants.

Investors are those participants who invest for a longer period of time and expect long-term returns, whereas speculators trade within much shorter periods. They give certain impetus to the market and support pricing and liquidity on it. However, speculators' behaviour sometimes leads to not so positive results. For this reason, there are regulators. "As for margin trading on the basis of currency pairs, it should be noted that, historically, the currency was the most traded commodity in our economy since the early days of independence. That is why we started with the margin trading in currency, as people understand how it works," Aslanli said.

Meanwhile, trading in gold and silver began on the stock exchange in October-November last year. Of the total amount of 4.3bn manats traded on margin at the BSE last year, 4bn manats were traded in foreign exchange instruments and 300m manats were traded in precious metals.

Thus, due to the growing attention to the diversification of the economy and the development of the non-oil sector, the importance of alternative sources of raising capital will continue to increase in Azerbaijan, which can be accomplished through the securities market. Hence, qualitative growth in this market will make it more attractive to local investors.