All change...

These are interesting times for the Prague Stock Exchange. After many years underperforming, the prospects for the institution look more positive, with talk of rejuvenation, reports David Creighton

While the number of initial public offerings (IPOs) is still very low, particularly in comparison with its Warsaw counterpart, the Prague Stock Exchange (BCPP) has clear ambitions for the future, including bidding for a share in the Sofia-based Bulgarian Stock Exchange.

Industry players note that introducing futures and derivatives trading – steps in the modernisation of BCPP – has helped its prospects, as have further innovations, making the BCPP more attractive to investors, and analysts say there the Exchange has great potential. ‘More small investors are entering the market, and more large investors are coming from abroad,’ says Markéta Sichtarová, director of the Prague-based financial consultancy Next.

This upturn in prospects is welcome for the institution. The BCPP was re-established in April 1993 and enjoyed a high trading volume in its early days, when a large number of state companies were sold off in the first half of the 1990s under the coupon privatisation scheme, in which sold-off companies were listed on the Prague Stock Exchange and members of the public received coupons that they exchanged for shares in the firms. Many shares were then snapped up by newly-founded investment funds, whose managers swiftly asset-stripped them. The Exchange’s credibility, and that of the coupon privatisation scheme, were severely damaged. At the same time, companies were leaving the BCPP, and the lack of IPOs led industry players to question its very existence.

Petr Koblic, general director of the Prague Stock Exchange, has plans for developing the BCPP, and he has presided over a number of innovations at the institution in recent months. October 2006 was a busy time at the BCPP. On 4 October two investment certificates were launched on the official free market, the first such investment instrument on the Exchange. A day later, trading in two series of PX index futures began. Trading in two and three-month contracts was introduced, and three market maker contracts were concluded. ‘Derivatives give investors the chance to hedge their positions against the spot market and it brings some stability to their portfolios, and stability is always the key issue for any market participant – no matter if it is retail or institutional,’ explains Koblic.

Although it is relatively new on the BCPP, there have been plans for derivative trading for almost 10 years, with three attempts to launch it over this period. ‘All three of them were not successful due to different reasons. The market was unprepared for such an action, or there was disagreement from the regulator,’ Koblic adds.

Further innovations included the launch of the Prague Energy Exchange (PXE) in trading in July which was set up by the BCPP, its parent, and is the first power trading exchange in central and eastern Europe. Its aim is to give greater transparency to the electricity market.

Responses to these innovations have been positive, although analysts stress that given that they are in the initial stages, it is early days yet. Industry insiders also point out that since there is low liquidity on the BCPP, and currently a limited number of market makers at the moment, the impact of further futures trading on the Exchange would not be hugely significant. ‘If the liquidity of futures remains low then we wouldn’t see any impact,’ says Jan Krejãí, an equity researcher at Patria Finance, a Prague-based investment bank.

‘Introducing futures can increase the liquidity of the trading. However, it is unlikely to increase the importance of the Stock Exchange from the international point of view,’ says Sichtarová, pointing out another effect of futures trading. She explains that it is more about expanding the supply of instruments so that players on the market have more possibilities, i.e. choices of where to invest.

Sichtarová also questions whether the BCPP needs any rejuvenation in the first place. ‘The Prague Stock Exchange lures foreign capital, prices are increasing and trading is liquid. So nearly all the definitions of a stock exchange that is working well are fulfilled.’

But although Petr Koblic has ambitions for the Prague Stock Exchange, the institution is still seen as hampered by a lower number of IPOs compared to the BCPP’s rivals in Central Europe such as Warsaw. ‘The Prague Stock Exchange needs IPOs – the derivatives markets for five or six blue chip companies are not enough,’ argues Jan Procházka, an analyst with Cyrrus brokerage house. In 2006 the Warsaw Stock Exchange saw 38 new IPOs, a record figure, and the number of its annual listings has been consistently high. In contrast, the BCPP still lags far behind the Warsaw Stock Exchange in terms of the number of IPOs, with five predicted by the end this year. However, the big difference is partly due to the fact that the Czech Republic is much smaller than Poland, and importantly, pension reform resulting in private pension funds investing part of their premiums on the local stock exchange.

Part of the problem is not because of the Prague Stock Exchange itself but because of the ways the firms are raising capital. ‘Companies do not come for new capital on the Stock Exchange. Only a few companies are listed,’ says Sichtarová.

Czech firms are used to acquiring money through the banking system rather than through the Stock Exchange as bank loans are advantageous and the bureaucracy in applying for an IPO, particularly for smaller companies, can be cumbersome. ‘This approach cannot be changed by introducing new instruments,’ Sichtarová adds.

This situation is likely to change over time, as the BCPP becomes more popular as a means of raising finance, and as more firms become listed on it others will be attracted to it. ‘Despite the fact that the Czech financial system is bank-based, I expect the Stock Exchange to play an increased role for companies raising capital,’ explains Miroslav Singer, vice governor of the Czech National bank. And a business climate of greater certainty and more business-friendly policies, such as lower corporate tax and proposed privatisations of state-owned companies, could help too.

Among the firms proposed for privatisation in the coming years are Czech Airlines, Prague Airport and brewer Budejovicky budvar. And, according to the Czech Business Weekly, several major property developers are considering listing on the BCPP as the local stock exchange is increasingly attractive for developers, who are increasingly eager to use IPOs for creating income so that they can expand. ‘We believe that the number of IPOs is going to increase in a couple of years,’ says Krejãí.

The Prague Stock Exchange could be boosted further by a possible expansion eastwards. In March 2007 it announced it was participating in the privatisation of the Bulgarian Stock Exchange. The Bulgarian Government announced that it was offering its 44% stake for sale. ‘We see great potential in a dynamically growing Bulgarian counterpart that can be based on our experience,’ said Koblic in March. ‘The Prague Stock Exchange benefited from our own, tailor-made trading system that, aside from the standard trading method, also offers trading with the participation of market makers,’ he added, explaining that applying the same logic of a similar system to the BCPP would result in ‘desired benefits to the Bulgarian markets’.

Some analysts have made positive noises about the bid, but there is doubt about the lack of experience of the Prague Stock Exchange. Another doubt is expressed by Procházka, who questions the bid in the light of the slow growing volumes on the Prague Stock Exchange and its main core function of bringing capital via an IPO. ‘The acquisition plans are unreal in my point of view,’ he says.

Whatever the outcome of the privatisation, it is likely that there will be future consolidation on the stock exchange markets in the future and as the new EU member states approach euro adoption. The BCPP will probably merge with other stock exchanges in the region in a couple of years, when the euro is accepted in central Europe, says Sichtarová. ‘The so-far fragmented market would be integrated, liquidity would significantly increase and the importance of the “United SE” would [rise] significantly,’ she adds.

David Creighton is a freelance journalist and regular contributor to Czech Business Weekly.