On Thursday, 27 March 2025 officials from the Pakistan Stock Exchange (PSE), Dhaka Stock Exchange (DSE) and Colombo Stock Exchange (CSE) signed a landmark agreement to strengthen capital market cooperation. While this clearly has the potential to boost capital markets trade among the three nations, the echo has the potential to be significantly bigger on the geopolitical map as this move benefits greatly China and its plans to have greater control of the region, as well as to increase the use of the yuan for international trade.
How is this Memorandum of Understanding (MOU) among the 3 exchanges different than government actions to encourage trade? When government leaders meet and sign similar agreements, they can agree to ease taxation, visa entries, corporation establishment procedures and so on in the hope that businesses from one country would find the market in the other lucrative- be it as sellers or even better – as employers, i.e. they would turn to be investors. As markets are a zero-sum game (cash inflow in one place are cash outflow from another), such actions have the potential to benefit the smaller markets significantly, but also allow the bigger markets to bring bigger players to the smaller markets and thus exert their influence, i.e. turn the game in their favor. Trading this way is easy to understand – a rice seller exports certain amount of rice to the other country, if customers like it, they purchase it and the income goes back to the home country. This way the exporting company realizes income on home sales plus that from exports and boosts the output.
What is the difference with stock exchanges? Stock exchanges exist because they offer investors the chance to purchase ownership or debt of operating companies. While it is perfectly legal to purchase shares of a company without the presence of a stock exchange, the reason why they exist is to introduce the function of a third party.
An investor can be interested in a company and might want to become a shareholder, but what are the guarantees for him that when he pays for his share, he’d get exactly that amount or he’d get the right price? Even if he gets it, how does he know a year down the line how the company operates? Have they increased their debt, thus putting their operations at risk? How is this company compared to others? Or even the most basic one – if the company is based 1,000 km away, then does he have to make a 2,000 km journey just to purchase his desired ownership?
Stock exchanges exist exactly to regulate many of those problems. They are the third-party clearing mechanism, where the money from the buyer are met with the stock from the seller. This way the buyer does not have to trust the seller and hope that he’s given the right amount. Additionally, stock exchanges have a certain minimum of disclosure obligations of their traded companies – they have to announce regularly (usually every 3 months) their financial performance using generally accepted accounting standards, major changes of ownership or management or policies related to those. Further disclosures are encouraged but not required. This is fundamental for the existence of the markets as underperforming agents have the incentive to either alter their disclosures or postpone them as long as possible. Such mechanisms guarantee that investors will get information about their ownership and can make informed decisions to stay with it, increase ownership or part ways.
The problem with trust clearly exists in the Pakistani, Bangladeshi and Sri Lankan markets. The total market capitalization of the three exchanges is $105 billion (PSE - $51 billion, CSE - $17.8 million, DSE - $54 billion) serving a total population of 440 million people. In the same time, Bombay Stock Echange’s total market cap is $4.5 trillion pooling from a population of 1.44 billion. In other words, a 3.2 times bigger population is responsible for 42 times greater market capitalization. It is evident that India is doing something right compared to these 3 as domestic investors, be it corporations or individuals, have the guarantee from regulators that there is an acceptable degree of certainty and predictability.
Comparing market cap of listed companies to national GDP is also another measure of how spread important capital markets are for the economy. According to data from the World Bank from 2022, Pakistan is at 7.7%, Bangladesh at 9.3%, Sri Lanka at 14.3%, while India is at 107.5%, UK 99.4%, France 85.1%, Germany at 45.4% and US at 155%. Of course, this is a single ratio and can differ significantly during market booms or crashes.
Access to other markets bring opportunities, but they hide some risks too. Another major problem for international investors is having to deal with foreign exchange risks (FX risks). Large FX fluctuations can decrease the potential of great investment decisions or even turn them into losses. For example, for 2 years since 2021 the Pakistan rupee lost 45% of its value to the US dollar. Similarly, the Bangladesh taka lost 30% and the Sri Lankan rupee lost 33%. Any investor with the chance to lose so much of its capital due to macroeconomic factors unrelated to the companies of interest would be wary to pursue them. Large and professional investors can pursue such investments when they pair them with derivative instruments, which hedge against the FX risks, but they also come at cost. Needless to say, nearly none of the individual investors use such instruments because they are either forbidden for smaller portfolios (as a result of general regulation due to high risks) or do not have the knowledge to use derivatives.
If such stock exchange linkage poses so many risks to regular investors, then what was is made for?
Review of the ownership paints a slightly different picture. In 2016 Shanghai Stock Exchange together with Shenzhen Stock Exchange won the bid to purchase 40% of the PSE. Similarly, in 2018 the same buyers outbid India for 25% of the capital of DSE. While these are not the majority ownership stakes (defined as 50% + 1 share), they are still very big and influential especially if the other shareholders are multiple smaller entities. This way they have greater importance in the selection of key personnel, such as the Board of Directors and then key management positions. From there, the influence goes down to the key functions of the exchanges – approvals of new listings (stocks and bonds) and regulation of trade.
New listings – Initial Public Offerings (IPO) and Secondary Public Offerings (SPO) are a way for companies to raise capital when they offer ownership of the company by issuing shares (stocks). Another way to raise capital is by borrowing. If a company finds it hard to secure a loan from a bank or does not want to deal with banks, they can go to the capital markets and issue bonds. This way investors purchase those bonds and will get the principal and interest in the future, similar to the way a bank would get its principal and interest. As mentioned earlier, in order to list any financial instrument on any exchange, rigorous analysis are done and some base line monitoring is conducted (by required disclosures) to make sure that integrity of markets is preserved. Since this is a fairly subjective procedure, however, it is entirely possible that listings by companies, whose ownership is not liked by the government, are denied. This way the entire existence of those businesses might be threatened, which might be a sought outcome of political opponents.
Regulation of trade – while the buy-sell mechanism can be ensured by the introduction of the clearing house, certain behavior and information disclosure cannot be completely ruled out. This is the reason why US regulations (if we consider the US stock markets to be the most evolved and complex) have evolved since The Great Depression almost a hundred years ago and other stock exchanges have followed suit. Certain actions, which were perfectly legal then are illegal in nearly every jurisdiction and will land their practitioners in prisons because they target market manipulation. The role of the financial regulator in any country, as well as the stock exchange, is to weed out such practices. If they are compromised, then rogue participants with enough capital can have a substantial negative impact on targeted companies.
Considering the fact that Pakistan has been ruled by a military junta, which has had the policy to manipulate state institutions for their objectives, often resorting to arbitrary detentions and even imprisonment after mock trials, and which has also been monitored for money laundering, terrorism financing and financing of weapons for mass destruction, such interventions are not completely out of the picture. On the other hand, Bangladesh had a coup ousting their PM Sheikh Hasina in June 2024 to be succeeded by a so called “Chief Adviser” Muhammad Yunus, currently actively allowing the suppression of vast minorities. Such an environment is impossible to nurture trust, the fundamental requirement for growing financial markets.
Where is China is all this? As mentioned, Shanghai Stock Exchange and Shenzhen Stock Exchange, who are run by the China Securities Regulatory Commission, are a major shareholder in the PSE and DSE. The first one focuses on large-cap companies and state owned enterprises, while the later emphasizes on smaller, private companies and technology firms.
Both were founded in the early 90s and had the purpose to develop the Chinese capital markets. When Hong Kong was handed over in 1997, the problem was to incorporate the Hong Kong Stock Exchange with those in mainland China as a number of problems would arise immediately – from technical point of view (HKSE settlement was T+2, i.e. there are 2 days between a deal and cash delivery, a standard practice across many exchanges at the time, and mainland stock exchanges had same day settlement), to market abuse/preservation problems stemming from large cash flows in either direction. Additionally, China had limited cash exports to limit yuan fluctuations, possible money laundering and embezzlement. Because of this, quota system of maximum daily value of deals was introduced, which was not perfect but eliminated many of the problems. The quota system has been adjusted through the years and Pakistan being already part of the China Connect Interface is subject to such limitations. Needless to say, those limitations are decision taken unilaterally by China and can be changed any time. When the markets in Dhaka and Colombo are added, they will likely be subject to the same limitations.
China has been a proponent of expanding the international use of the yuan. The US have been reaping the benefits of having their currency as the world’s reserve currency. They can influence international trade and international payments are essentially worth the value of printing the money without the risk for domestic inflation. Bottomline, the state gets revenues without fear or rising price levels and decreasing purchasing parity.
China with their growing ambitions have been trying to go this way, but it is a slow process. The Belt and Road Initiative financings can be helpful in a way, but the real breakthrough for them will be when more international market agents seek the yuan as a reliable store of value. Currently the USD is used in 44.15% of the world payments, EUR in 16.14%, Japanese yen in 8.4%, British pound in 6.4%, Australian dollar in 3.38%, Canadian dollar in 2.52%, Swiss frank in 2.48%, Chinese yuan in 2.16%, Hong Kong dollar in 1.77%, New Zealand dollar in 1.04% and others make the remaining 11.56%. Of these, the USD, EUR and EUR are generally accepted as a reliable store of value, while the rest are largely popular because of their association with the respective markets and exports (capital markets, government securities, commodities trading, exports, etc.). Even if they want to achieve some level of international acceptance, China still has to increase the importance of the yuan at least several times (EUR to CNY is 7.47x, GBP to CNY is 2.96x). If CNY and HKD are coupled, however, the multiple to GBP would be just 1.63. Hong Kong is essentially the gateway to China for international investors, i.e. its use comes largely from mainland China and international market agents, which means that the expansion to tying stock exchanges to Chinese markets has potential for the future provided those markets continue to offer value for international investors via returns at acceptable risks.
While the MOU signed among the Pakistan SE, Dhaka SE and Colombo SE clearly has the print of the Beijing attempting to expand their influence in the region, other factors will pose significant problems for the future plans. Markets infrastructure can be established, but nobody can force market agents to trade, which is something autocratic governments fail to understand. Markets operate under rules which are directly opposite of what such economies operate. The most important feature is the presence of trust or mechanisms to eliminate it and trade as this facilitates the transactions and the transfer of value.
Investors know that in order to extract value from their investments they need to be present in a market for years, which requires stability and the ability to move financial assets. As such, jurisdictions, which do not offer such security are considered high risk and naturally require hefty premiums. One can look at the returns, which are required by government for their government bonds – Pakistan has one of the highest 10 year yields among Asian countries of 12.628%, Bangladesh – 12.055%, Sri Lanka – 11.743, while India is at 6.58% and China at 1.876%. China, however, will not rely solely on Pakistan, Bangladesh and Sri Lanka to extend their influence. Other countries will be have to be added, but Beijing will have to solve their economic problems too and currently their government is looking for ways to boost their economy.
References:
https://www.worldgovernmentbonds.com/
https://english.sse.com.cn/access/stockconnect/introduction/
http://www.cffex.com.cn/en_new/ChinaEuropeInternationalEx.html
https://www.china-briefing.com/news/foreigners-now-allowed-to-list-on-shanghai-stock-exchange
https://english.sse.com.cn/access/stockconnect/introduction/
