Behind dividends and increased price: What is the role of the stock exchange in the modern economy

This article was originally published on this site

Mikhail Khanov

In early September 2021, Chinese Presid-ent Xi Jinping annou-nced plans to create the Beijing Stock Exchange in China. The very next day, September 3, the new trading floor was registered as a joint stock company. It will start operating on the basis of the already existing organization NEEQ (National Equities Exchange and Quotation), which is a specialized system for the sale of shares of small and medium-sized enterprises not listed on the exchange.
It is assumed that entering the Beijing Stock Exch-ange will be the main opp-ortunity to raise capital for innovative small and medium-sized enterprises. The next generation of Chinese high-tech companies sho-uld be able to raise finance in the face of deteriorating accessibility to the North American stock market.
Thus, communist China, officially proclaimed a socialist state, is launching its third stock exchange in the country – the other two are already successfully operating in Shanghai and Shenzhen. Let’s not forget about the Hong Kong Stock Exchange with its territorial and regulatory features.
This is “socialism with Chinese characteristics.” As we can see, economically developed countries cannot do without the institution of exchange trading. Of course, in this case we are talking not only about stock exchanges, but also about organized platforms where currencies and derivatives are traded. Even such an economically backward country as Afghanistan could not do without its own currency exchange. The fact that almost all payments on it are carried out in cash does not change the essence of the matter. However, attempts by enthusiasts to launch trading in shares of local companies in this country have failed.
This is a confirmation of our thesis that the urgent need for stock exchanges appears within fairly large and developed economies. In turn, countries such as the United States, China, Great Britain and Japan have the largest stock markets in the world in terms of capitalization. The share market of the eurozone countries belongs to the same category, which can be considered as a whole.
The most important
In the most simplified sense, a stock exchange is a mechanism that makes it easy to buy shares in businesses that an investor cannot or does not want to create on his own. The owners of large enough enterprises can sell their shares in part or in full, and the very redistribution of shares is directly carried out through the mechanism of exchange trading.
In addition to shares, bonds can also be traded on stock exchanges. The economic sense of this tool lies in the fact that organizations have the ability to raise the necessary funds at interest and flexibly manage the amount of their debt. At the same time, the owners of the issuing company do not lose control over their business, provided that the loans are properly serviced. An additional issue of shares often becomes an alternative form of financing for joint-stock companies. New shares can also be traded on the stock exchange on a par with existing securities.
At the everyday level, these theoretical constructions are quite obvious. Investors buy shares with the expectation of receiving dividends or in the hope of an increase in the exchange price. Well, for many entrepreneurs, the path to great success is associated precisely with the listing of th-eir companies’ shares on th-e stock exchange. In fact, t-his is one of the real ways t-o become a truly rich person.
Secondary but necessary
A large number of secondary details and functions are inevitably superimposed on the indicated economic meaning of the stock exchange, the role and significance of which cannot be diminished.
First of all, let us pay attention to the fact that the emergence of stock exchanges has given rise to a wide class of trading participants, called stock speculators, and as participation in exchange trading via the Internet becomes more and more accessible, it continues to expand.
It is obvious that the stock speculator does not want to take part in the long-term financing of the activities of enterprises, the shares of which he buys and sells. Nevertheless, it still carries out its useful function, increasing the liquidity of trading. Moreover, representatives of such an important class of trading participants as market makers are even ready to pay rewards for the flow of orders from speculators. Therefore, the sale of exchange liquidity itself has become an independent business.
For example, the already well-known brokerage company Robinhood Markets, Inc. (HOOD) does not take commissions from its clients for making trades. Its revenues and profits are mainly formed through the sale of “exchange traffic”. This business scheme proved to be quite viable. And in mid-2021, the company even held an IPO on the North American NASDAQ stock exchange in order to reduce debt and finance further activities. The shares were placed at the lower border of the announced price range. Nevertheless, the issuer raised $ 2.1 billion on the exchange and received an initial market valuation of about $ 32 billion.
This example well demonstrates the fact that not only exchanges and stock brokers make money in exchange trading. In fact, in developed countries, a huge service industry has developed around the stock market, which can even be described as an ecosystem. It includes asset managers, financial advisors, news agencies, analytical and software companies, topical media, Internet service providers, specialized equipment suppliers, etc.
As an important positive function of the stock exchange, it should be noted that it acts as a natural accumulator of monetary liquidity at times of its surplus in the economy. But if necessary, this liquidity is able to flow back into the real sector. This applies not only to stocks and bonds of commercial enterprises. In many countries, the practice of placing and subsequent secondary circulation on the exchange of government debt obligations has long been firmly established.
Another significant function of the stock market is that it provides an opportunity for long-term investment of funds in the framework of savings and investments, including with the aim of forming pension savings. Traditional alternative opportunities in the form of bank deposits, buying real estate or investing in your own business are clearly not enough for this. The advantage of investing in stocks and bonds is the fact that these instruments, in the case of long-term investment, do not require constant attention and the application of any additional efforts.
I would also like to note the phenomenon of the wide development of the market for derivatives such as futures and stock options. Trading turnovers for them often exceed the volume of transactions with underlying assets many times. Such trading activity has nothing to do with financing the activities of the companies – issuers of shares. One way or another, but trading in derivatives has long and irrevocably turned into a serious independent sphere of activity, very far from the real sector of the economy. A very striking example of such a disconnect from reality is the short-term collapse of WTI crude oil futures to the area of negative values in April 2020.
Russian features
As for Russia, its stock market has some specificity due to historical factors. A large number of public joint stock companies in the country were not formed as a result of placing their shares on stock exchanges. They were created from state-owned enterprises in a hasty privatization in the early 1990s. The remaining controlling stakes of the state in a number of strategically important and infrastructure enterprises, such as Gazprom, Sberbank, Aeroflot, and others, became the legacy of that time.
In parallel with the privatization process, a large number of exchanges of various profiles, including currency and stock exchanges, appeared in the country. At that stage, the role of stock exchanges was to accumulate large stakes in recently privatized enterprises. In fact, they have become a mechanism for the redistribution of shares in many companies from a large number of small shareholders in favor of strategic investors. Professional buyers of shares collected them on the over-the-counter market in order to resell them on exchanges at a higher price.
Now it can be stated that the Russian stock market in its current state is quite successfully performing the economic functions traditional for this institution. This is evidenced by the explosive growth in the number of accounts opened on the Moscow Exchange. Not only stocks, but also corporate bonds, as well as federal loan bonds (OFZ) have become very popular ruble-denominated investment instruments.
It should also be noted that the local stock market has become interesting for the placement of securities for young Russian companies that have nothing to do with the legacy of the USSR economy. Yandex clA (YNDX), TCS-adr (TCSG), OZON-adr (OZON), FIVE-adr (FIVE), FIXP-adr (FIXP), iHHRU-adr (HHRU) and others are good examples of this new generation.
It is obvious that the Russian stock market still looks like a “toy” against the background of the “flagship” US stock market. Its value is quite consistent with the share of modern Russia in the world economy. However, the high rates of its development give rise to hope that such a gap will narrow.