Why local power and self-interest can be good for transparency

Think of your local Indian, South African, Mexican or Russian investor looking for guaranteed profits; pool them all together and you could have community of millions to leverage for demanding transparency in the extractive industries. It would be hard for their respective governments and companies to ignore the calls of seven million shareholders who have investments in the firms.

Zara Rahman Johnny West Lila Caballero
6 August 2012

A global transparency movement has followed the waves of democratisation that have taken place around the world during the last few decades. Some activists demand public accountability in general; others focus on transparency of public budgets and contracts. But at the core of their demands is access to information. At the moment, the extractive industries are a hot topic for transparency activists, with resistance from Big Oil holding up EU legislation to introduce project by project reporting, and similar problems in the US surrounding Dodd Franks legislation. But is a crucial constituency being ignored?

While transparency activists have initiatives such as the Extractive Industries Transparency Initiative (EITI) to get their teeth into, other potential groups that could have an interest in better governance and transparency of oil, gas and mining industries around the world have not been so assiduously cultivated. Many countries where extractive industries dominate now have emerging stock markets with wide local ownership. In a few cases the extractive industries themselves have been at least partially opened to direct private ownership, creating the possibility that there is a shareholder class, likely to have emerged from the growing middle classes, which would have a direct material interest in more regular and reliable information about these industries – think Brazil's Petrobras and Colombia's Ecopetrol.

In many more cases, while upstream and core operations remain in state control, ancillary industries like engineering, transportation and many forms of service companies are in private hands and some of those firms are publicly listed.

How big is this group of shareholders cum potential activists? Preliminary data suggests it could run into millions of people across the emerging markets of the world. Engaging them could mean significantly increasing the power of bottom-up demands for information.

Millions of shareholders

Taking a look at India through raw data available on the National Stock Exchange website, for example, reveals that companies in or related to the extractive industries are responsible for a total market capitalization of 259 billion euros represented on the NSE of India, or in other words, 29% of the total domestic market capitalization.

Nearly 22 million individual Indians have shares on the NSE India. Knowing that 29% of the domestic market capitalisation is taken up by the extractive industries, we can estimate that roughly 6.2 million individuals have money invested in companies related to the extractive industries. This number is huge; last year’s global summit of EITI - the biennial event of the biggest global public initiative around extractive industry transparency - attracted just about 2,000 delegates.

In South Africa, the percentage of total market cap from extractive industries is even higher, with these companies bringing 43% of the total domestic market capitalization. Using the same proxy method of applying this proportion to the total percentage of individual investors on the Johannesburg Stock Exchange, we come up with an estimate of 560,000 investors.

This trend can be seen in a number of countries with emerging stock markets, purely through publicly available data either from the stock exchanges themselves, or through financial media reports. Due to India's size, the amount of individuals is largest there, but even in smaller emerging markets such as Ghana and Indonesia, a total constituency of 95 thousand people (Ghana) and 58 thousand people (Indonesia) were calculated using the same method.

In total, taking the emerging market stock exchanges of BM&FBOVESPA Brazil, NSE India, Johannesburg SE, MICEX Russia, GSE Ghana, BVC Colombia, and the IDX Indonesia, we are left with a potential constituency of over seven million individual shareholders.

Seven million people, in just these seven countries, who all have a real self-interest in improving governance around these companies. It would be hard for their respective governments and companies listed on these exchanges to ignore the calls of seven million shareholders who have investments in the firms.

Secrecy around extractive companies

An example of how secrecy around extractive companies has led to negative investment decisions can be seen in Russia. Surgutneftegas (Moscow stock exchange: SNGS), created in 1993 by merging several previously state-owned companies with large oil and gas reserves in Western Siberia and led by Vladimir Bogdanov (who has close ties with the Kremlin), is the most secretive company in the country, unwilling to disclose capital, ownership, shareholders or hardly anything. Other than the Bank of New York and ZAO ING Bank Evraziya, no other shareholders have been disclosed and it seems that not everyone wants to do business with a mysterious firm.

Surgutneftegas recently made a bid to buy a 21.2% stake of Mol, a Hungarian refining group, which was declined due to lack of clarity of ownership – problem number one. Plus, the acquisition had been motivated by Russia’s attempts to strengthen its position in the European energy market, rather than by the shareholder’s strategies and goals – problem number two. But their inability to take an active role in the company’s decision-making stopped them from preventing the bid from happening. Investments and strategies seem to be out of reach for private shareholders of Surgutneftegas, whoever they may be.

Let's consider an example of a smaller company; Mexichem, a national player in the Mexican petrochemical industry, with reasonably good risk assessments across financial reports and likely to attract local investors. Its production and profits can be strongly affected by the performance of Pemex’s petrochemical complex (Pajaritos), since the state-owned company is the sole producer of VCM - a key consumable for Mexichem. It has thus for years been keen on obtaining a concession to operate Pajaritos, as this would not only allow Mexichem to control its supply of VCM, but would also give it a stronger position in the Mexican petrochemichal industry. But materialising an association with Pemex has proved to be difficult, full of deal-breakers, opacity and scandal.

This preliminary research outlines the shape of a potential constituency of shareholders possibly driven by values of class. The next step to exploring the possibilities for the governance agenda would be to find out who they are and how they are constituted.  Are these shareholders part of a middle class with shared world views that lend themselves to the transparency agenda? Can they be accessed through aggregator channels such as local brokerage houses or led by the example of key, local equity funds?

Strong motives

For the shareholders, it's not a question of thinking transparency is a good moral cause to get behind. It is a question of reducing the risk and looking after their own personal investments via improving the investment climate; some would say a much stronger motive. For companies, disclosure of information is a simple and clear way to encourage investment. In both cases, this self-interest could be an incredibly powerful tool to empower investors to encourage companies to make decisions that are both commercially sound and socially responsible. As activists struggle to get maximal transparency regulations on the books in both the United States and Europe via Dodd-Franks and a similar EU directive, the largest single constituency for more transparency in the global South might be sitting there, unaddressed.

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