How to cure the Polish capital market?

28.12.2018 | By Roman Gurbiel

Polish capital market is now in a difficult position, which seems odd – given the positive macroeconomic trends of recent years. One of the most visible signs of weakness of the Polish capital market is a small number of debuts on both the main market and on NewConnect (alternative stock exchange for smaller, often innovative, companies).

In October 2018, 469 companies were listed on the primary market, while in 2016 and 2017 the number was 487 and 482 respectively. The number of debuts in this period fell from 19 to 7, and the number of withdrawals increased from 19 to 20. The record number of debuts took place in 2007, when 81 new companies were floated on the primary market. A similar situation occurred on the NewConnect market, where the number of listed companies fell from 406 to 391 and the number of debuts from 16 to 12. The number of withdrawals has not changed much since 2016 and stood at 29.

There are many reasons for the fall in the number of IPOs (Initial Public Offering), and it is hard to tell which ones are key. The whole matter is additionally complicated by the fact that the number of IPOs is decreasing at many other stock exchanges around the world, even at the biggest ones.

In the literature and research papers, following reasons for the falling number of IPOs are mentioned:

  • Low cost and relatively easy access to a debt capital (loans), which applies to both the supply and transactional issue. The transactional cost of acquiring debt financing is much lower than the transactional costs of the new issuance;
  • Availability of alternative sources of investment financing, e.g. the EU funds, such as subsidies for investments and also venture capital and private equity funds;
  • Barriers and regulatory duties related to running a public company;
  • A limited supply of domestic savings, which could be directed to the securities market;
  • A limited amount of potential issuers;
  • Lack of regulations that encourage investments in securities;
  • The end of big privatisations, which is the issue specific for Central and East Europe.

The behaviour of investors and potential issuers is also conditioned by the general situation on the securities market, e.g. by the evaluation of securities (capitalisation) and their liquidity (measured in volume and value of the turnover). In this case, negative tendencies also occur, especially recently. Since October 2017, the capitalisation of the domestic companies listed on the primary market of the Warsaw Stock Exchange has been decreased by approximately 83 billion PLN. In the case of NewConnect, it was 2 billion PLN.

The high evaluation of the already listed companies stimulates potential issuers – who compare their own companies to them and expect high prices for their shares – into making a debut. The probability of a successful debut, that is of acquiring investors for the issuance, is also increased. In the case of lower valuations on the stock market, companies that seek the capital in equity funds go to venture capital funds, private equity funds, or to relevant investors. Depending on the situation and the vision of company development, these entities may offer more attractive financial conditions compared to the debut.

In the case of the Warsaw Stock Exchange, the lack of correlation between capitalisation and the GDP per capita should be noted. Poland’s GDP and household income gradually rise, but the stock exchange’s capitalisation remains intact or decreases.

According to the World Bank data, in the case of Poland, the 2017 numbers were 29.4% and 13.8 thousand USD respectively. It cannot be unequivocally stated that the high GDP per capita directly translates into the level of capitalisation (e.g. Germany, France vs Great Britain). Therefore, it can be concluded that the development of the capital market is determined not only by GDP and the level of average income.

In the case of the Warsaw Stock Exchange, when analysing the changes in capitalisation, it is worth to notice a significant share of foreign companies in these transactions. It stands at 50%. On the one hand, it shows that foreign companies recognise the potential of the Polish capital market and seek an opportunity to put their shares on this market. On the other hand, it can be said that without foreign companies Polish stock exchange would be a lot smaller. For many of these companies, Polish stock exchange is a secondary market within the framework of a dual or multi-listing. It shows a slight weakness of the Warsaw Stock Exchange concerning acquiring domestic issuers.

The weakness of the Polish capital market is also linked to the liquidity of securities. The volume of turnover on the shares market for the first quarter of 2017 – first quarter of 2018 intervals fell by almost 46 billion PLN. At the same time, the most prominent companies have the highest liquidity. This is similar to the situation on other stock exchanges, but it is advisable to look for ways to increase the liquidity of small and medium issuers.

What is to be done?

The analysis of the other countries’ cases indicates that there is no one way to affect the development of the capital market. It is necessary to act comprehensively, taking into account many factors. Here, it is worth to mention the quotation from the assessment of the development of the Czech capital market made by the European Bank for Reconstruction and Development: „It should be made clear, however, that there is no single “magic” solution. Instead, the Assessment indicates numerous parallel actions can be taken that should result in objective progress“.

The comprehensive approach should, first of all, take into account critical issues related to supply and demand and only then move on to the operational and technical questions.

Obtaining macro effects is possible only when the same measures are applied to investors and to issuers. If that is not the case, side effects may materialise. They can come under the disguise of redirection of the increased supply of individual investors’ money to foreign stock exchanges due to the lack of low quality of domestic issuers; lack of the issuance of new small and medium companies due to the investments limits set in the investment products etc.

Impact on individual investors

  • investment products that include tax incentives;
  • support for the pension system by the capital market;
  • support for intermediary institutions – pension companies, investment funds companies, brokerage houses etc.;
  • clear and accessible information about issuers (analytical reports);
  • multi-level education.

Impact on issuers

  • lower transactional costs;
  • simplified regulations;
  • transparent and predictable oversight system.

Taking into account the weaknesses of the Polish capital market and the solutions that already exist, some tentative proposals regarding the capital market can be made. They are described on the graph below.

The spectrum of actions that may stimulate the capital market was addressed, e.g. in the “Strategy for Responsible Development – Capital Building Programme”, a government’s programme. One of its actual effects is the bill concerning occupational capital schemes (OCS). The OCS bill may affect the development of the capital market through its influence on individual investors. Calculations presented in the Assessment of the Outcomes of Regulation indicate that the impulse induced by the bill may be a key to the development of the capital market. For example, the total inflow of savings on the capital market in the year 2021 for the contribution of 3.5% of the remuneration was estimated to be 15 billion PLN; for the contribution of 8.0% of remuneration – 32 billion PLN. Achievement of these objectives means that the value of the resources from the OCS – compared to the average capitalisation in 2017/2018 (Warsaw Stock Exchange + NewConnect) – may in the next 5-7 years exceed a dozen per cent. In this context, a high concentration of allocation around the biggest (WIG20) and medium (mWIG40) companies may constitute a drawback of this programme. Such a construction may cause an artificial rise in the value of some companies, without the new IPO-oriented stimulations of the market. The interest in the IPO may potentially rise in case of the companies that comply with the criteria of WIG20/mWIG40.

The participants in the market operations are waiting for the effects of the currently proceeded strategy for the development of the capital market. To this day, the government did not present the draft of the plan for consultations, even though it works on it from the beginning of this year. When analysing the weaknesses of the Polis capital market, people familiar with the draft point to e.g. lack of the scale of operation of the Warsaw Stock Exchange, low level of economic education, the structure of the market (e.g. the lack of adequate, or efficient treasury bonds and repo market, also an obsolete brokerage structure), legal and regulatory barriers (e.g. gold-plating, lack of proportionality, outsourcing, or the reform of the pension market), as well as those related to taxation (e.g. lack of incentives for issuers and investors, withholding tax for the euro-obligations, or bank tax on repo). Some of the solutions include tax incentives and reduction of administrative burdens to lower operative costs for the entities operating on the stock exchange, as well as a preferential system for long-term saving.

The weaknesses and proposed solutions mentioned above show the adequate comprehension of the problems of the Polish capital market. For now, however, not much more can be said. For example, limiting the gold-plating, that is the excessive transpositions of the EU directives, requires many changes not only in domestic regulations but also in the very philosophy of operation of regulatory institutions and their relations with market participants. As a consequence, the changes may be of small significance for the market. Another thing is the abovementioned economic education. Actions in this field should include not only information campaigns but de facto the revision of the curricula at different levels of school education. This, in turn, requires the review of textbooks, but more importantly, encouraging teachers to focus in greater details on the capital market.

In the press commentaries that focus on the strategy for the capital market, no initiative towards stimulation of the IPO through utilising the already existing instruments (e.g. PDF, NCR&D) has been floated. As for now, budget and the EU funds that had been allocated for the support of investments and innovations did not translate into an increased inflow of companies to the Warsaw Stock Exchange.