Document of
The World Bank

Report No:ICR00004007

IMPLEMENTATION COMPLETION AND RESULTS REPORT
(IBRD-80240)
ON A
LOAN
IN THE AMOUNT OF
US$ 12 MILLION EQUIVALENT
TO THE
Republic of Azerbaijan
FOR A
Capital Markets Modernization Project (CMMP)
January 25, 2017
Finance & Markets Global Practice
Europe and Central Asia Region

CURRENCY EQUIVALENTS

(Exchange Rate Effective October 11, 2016)

Currency Unit=Azeri New Manat (AZN

1.00 AZN = US$ 1.599

1.00 SDR = US$ 1.382

FISCAL YEAR

ABBREVIATIONS AND ACRONYMS

ABS Asset Backed Securities MoF Ministry of Finance

ADB Asian Development BankMoT Ministry of Taxes

AZN Azerbaijan New Manat NCB National Competitive Bidding

BSE Baku Stock ExchangeNDC National Depository Center

CAS Country Assistance Strategy ORAF Operational Risk Assessment

CMMPCapital Markets Modernization Project Framework

CPS Country Partnership StrategyPAD Project Appraisal Document

EBRD European Bank for Reconstruction and PID Project Information Document

DevelopmentPIU Project Implementation Unit

ECA Europe and Central Asia POMProject Operation Manual

EU European Union PQ Prequalification

FIRST Financial Sector Reform and StrengtheningPPP Public-Private Partnerships

Initiative RVPRegional Vice President

FIMSAFinancial Markets Supervision Authority SBD Standard Bidding Documents

GDP Gross Domestic Product SCS State Committee for Securities

IBRDInternational Bank for Reconstruction and SECOSwiss State Secretariat for

Development Economic Affairs

ICR Implementation Completion and Results TALTechnical Assistance Loan

Report USAIDUnited States Agency for

IC SSS Individual Consultant Single Source International Development

SelectionWBT World Bank Treasury

IDA International Development Association

IFC International Finance Corporation

ISDSIntegrated Safeguard Data Sheet

Senior Global Practice Director:

/

Gloria Grandolini

Sector Manager:

/

Rolf Behrndt

Project Team Leader:

/

Angela Prigozhina

ICR Team Leader:

/

Stephen Pirozzi

Republic of Azerbaijan
Capital Markets Modernization Project (CMMP)
CONTENTS
Data Sheet
A. Basic Information
B. Key Dates
C. Ratings Summary
D. Sector and Theme Codes
E. Bank Staff
F. Results Framework Analysis
G. Ratings of Project Performance in ISRs
H. Restructuring
I. Disbursement Graph
1. Project Context, Development Objectives and Design...... 11
2. Key Factors Affecting Implementation and Outcomes...... 15
3. Assessment of Outcomes...... 19
4. Assessment of Risk to Development Outcome...... 25
5. Assessment of Bank and Borrower Performance...... 25
6. Lessons Learned...... 29
7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners....30
Annex 1. Project Costs and Financing...... 31
Annex 2. Outputs by Component...... 32
Annex 3. Economic and Financial Analysis...... 33
Annex 4. Bank Lending and Implementation Support/Supervision Processes.....34
Annex 5. Beneficiary Survey Results...... 36
Annex 6. Stakeholder Workshop Report and Results...... 37
Annex 7. Summary of Borrower's ICR and/or Comments on Draft ICR...... 41
Annex 8. Comments of Cofinanciers and Other Partners/Stakeholders...... 50
Annex 9. List of Supporting Documents...... 50
Annex 10. Borrower ICR...... 52
Map (IBRD 33365)...... 97
A. Basic Information
Country: / Azerbaijan / Project Name: / Capital Markets Modernization Project
Project ID: / P120321 / L/C/TF Number(s): / IBRD-80240
ICR Date: / 01/10/2017 / ICR Type: / Core ICR
Lending Instrument: / TAL / Borrower: / REPUBLIC OF AZERBAIJAN
Original Total Commitment: / USD 12.00M / Disbursed Amount: / USD 11.96M
Revised Amount: / USD 12.00M
Environmental Category: C
Implementing Agencies:
Azerbaijan State Committee for Securities
Cofinanciers and Other External Partners:
B. Key Dates
Process / Date / Process / Original Date / Revised / Actual Date(s)
Concept Review: / 12/09/2010 / Effectiveness: / 11/07/2011 / 11/07/2011
Appraisal: / 01/19/2011 / Restructuring(s): / 05/06/2015
Approval: / 03/17/2011 / Mid-term Review: / 01/20/2014 / 02/03/2014
Closing: / 12/31/2015 / 07/01/2016
C. Ratings Summary
C.1 Performance Rating by ICR
Outcomes: / Satisfactory
Risk to Development Outcome: / Substantial
Bank Performance: / Moderately Satisfactory
Borrower Performance: / Satisfactory
C.2 Detailed Ratings of Bank and Borrower Performance (by ICR)
Bank / Ratings / Borrower / Ratings
Quality at Entry: / Moderately Satisfactory / Government: / Satisfactory
Quality of Supervision: / Satisfactory / Implementing Agency/Agencies: / Satisfactory
Overall Bank Performance: / Moderately Satisfactory / Overall Borrower Performance: / Satisfactory
C.3 Quality at Entry and Implementation Performance Indicators
Implementation Performance / Indicators / QAG Assessments (if any) / Rating
Potential Problem Project at any time (Yes/No): / No / Quality at Entry (QEA): / None
Problem Project at any time (Yes/No): / No / Quality of Supervision (QSA): / None
DO rating before Closing/Inactive status: / Satisfactory
D. Sector and Theme Codes
Original / Actual
Sector Code (as % of total Bank financing)
Public administration - Financial Sector / 7 / 7
Capital Markets / 93 / 93
Theme Code (as % of total Bank financing)
International financial standards and systems / 36 / 36
Other Financial Sector Development / 22 / 22
Regulation and competition policy / 42 / 42
E. Bank Staff
Positions / At ICR / At Approval
Vice President: / Cyril E Muller / Philippe H. Le Houerou
Country Director: / Mercy Miyang Tembon / Asad Alam
Practice Manager/Manager: / Rolf Behrndt / Sophie Sirtaine
Project Team Leader: / Angela Prigozhina / Michael Edwards
ICR Team Leader: / Stephen Francis Pirozzi
ICR Primary Author: / Stephen Francis Pirozzi
F. Results Framework Analysis
Project Development Objectives (from Project Appraisal Document)

Increase the use of equity and corporate debt as financing and/or investment instruments through the adoption of an effectivecapital markets regulatory framework and infrastructure

Revised Project Development Objectives (as approved by original approving authority)
(a) PDO Indicator(s)
Indicator / Baseline Value / Original Target Values (from approval documents) / Formally Revised Target Values / Actual Value Achieved at Completion or Target Years
Indicator 1 : / Increased issuance of corporate bonds
Value
quantitative or
Qualitative) / 1.9% / 3.8% / 14.1%
Date achieved / 10/04/2011 / 12/31/2015 / 07/01/2016
Comments
(incl. %
achievement) / Outstanding amount of corporate debt to 2010 Non-oil GDP
Indicator 2 : / Increased number of listed companies
Value
quantitative or
Qualitative) / 2 / 8-10 / 5
Date achieved / 10/04/2011 / 12/31/2015 / 07/01/2016
Comments
(incl. %
achievement) / Number of listed companies
Indicator 3 : / Improved price transparency
Value
quantitative or
Qualitative) / 0% / 90% / 100%
Date achieved / 10/04/2011 / 12/31/2015 / 07/01/2016
Comments
(incl. %
achievement) / Ratio of competitive transactions / total equity (non-block transactions)
(b) Intermediate Outcome Indicator(s)
Indicator / Baseline Value / Original Target Values (from approval documents) / Formally Revised Target Values / Actual Value Achieved at Completion or Target Years
Indicator 1 : / Ratio of market participants electronically linked to market infrastructure (trading, clearing and settl
Value
(quantitative
or Qualitative) / 0% / 100% / 100%
Date achieved / 10/04/2011 / 12/31/2015 / 07/01/2016
Comments
(incl. %
achievement) / Ratio of market participants electronically linked to market infrastructure
Indicator 2 : / Enactment of new Capital Market Law
Value
(quantitative
or Qualitative) / No / Yes / Yes
Date achieved / 10/04/2011 / 12/31/2015 / 07/01/2016
Comments
(incl. %
achievement) / Law enacted
Indicator 3 : / Promulgation of capital markets regulation required upon enactment of Law
Value
(quantitative
or Qualitative) / No / Yes / Yes
Date achieved / 10/04/2011 / 12/31/2015 / 07/01/2016
Comments
(incl. %
achievement) / Regulations promulgated
Indicator 4 : / Number of companies involved in the listing advisory program (debt and equity)
Value
(quantitative
or Qualitative) / 0 / 15 / 16
Date achieved / 10/04/2011 / 12/31/2015 / 07/01/2016
Comments
(incl. %
achievement) / Number of companies involved in the listing advisory program
Indicator 5 : / Increased of the threshold pass rate of the Financial Certification examination for market participants
Value
(quantitative
or Qualitative) / 50% / 75% / 75%
Date achieved / 10/04/2011 / 12/31/2015 / 07/01/2016
Comments
(incl. %
achievement) / Measures financial literacy level
Indicator 6 : / Consumer Awareness of Capital Market Instruments
Value
(quantitative
or Qualitative) / 24 / 45 / 59.38
Date achieved / 10/04/2011 / 12/31/2015 / 07/01/2016
Comments
(incl. %
achievement) / using the Capital Markets Awareness Index
G. Ratings of Project Performance in ISRs
No. / Date ISR
Archived / DO / IP / Actual Disbursements
(USD millions)
1 / 07/09/2011 / Satisfactory / Satisfactory / 0.00
2 / 02/09/2012 / Satisfactory / Satisfactory / 0.00
3 / 10/08/2012 / Satisfactory / Satisfactory / 0.45
4 / 01/09/2013 / Satisfactory / Satisfactory / 1.96
5 / 10/24/2013 / Satisfactory / Satisfactory / 3.41
6 / 06/11/2014 / Satisfactory / Moderately Satisfactory / 4.24
7 / 11/22/2014 / Satisfactory / Moderately Satisfactory / 4.75
8 / 05/18/2015 / Moderately Satisfactory / Satisfactory / 6.18
9 / 11/10/2015 / Satisfactory / Satisfactory / 8.38
10 / 06/29/2016 / Satisfactory / Satisfactory / 11.74
H. Restructuring (if any)
Restructuring Date(s) / Board Approved PDO Change / ISR Ratings at Restructuring / Amount Disbursed at Restructuring in USD millions / Reason for Restructuring & Key Changes Made
DO / IP
05/06/2015 / MS / S / 6.18

I. Disbursement Profile

1. Project Context, Development Objectives and Design

1.1Context at Appraisal

  1. From 2004 – 2008 Azerbaijan experienced an average annual increase in GDP over 20 percent and decrease in poverty, due in large part to rising oil and gas production and prices. However, given the exhaustive nature of oil and gas production, it was believed that Azerbaijan may have reached its peak, as production was estimated to remain steady over the next decade and decline thereafter, thereby leaving limited window to create an economic environment to support growth in the non-oil economy. The challenge for Azerbaijan was the ability to transforminto a sustainable higher middle income country with a more diversified economy.
  1. At the time of appraisal, Azerbaijan had made good progress on its first round of economic reforms. This includes establishing a sound macro-framework, including the oil fund. It also includes small-scale privatization, internal trade and price liberalization and a stable central banking and foreign exchange system. Improved policies to provide effective services in basic health, education and social protection had also been put into place. However, Azerbaijan continued to lag behind most other CIS countries in second generation reforms, in such areas as, large-scale privatization, competition policy, consumer protection, rural access to financial services, banking and securities market reform, and foreign trade in the non-oil sector. In addition, there was a lag in developing policies and institutions needed to support a competitive highly skilled workforce, an innovative and flexible private sector environment, and to address the environmental legacy of the Soviet Union.
  1. The Government sought to maintain progressreflected in the 2011 Doing Business Report by further diversifying the economy and making gains in areas that at the time were identified as requiring urgent attention, including business licensing, tax and customs administration and reduction of corruption. While the Country’s rankings for business entry were good at the time of appraisal, Azerbaijan ranked poorly on exit, competition and dimensions that deal with ongoing business operations, including trading across borders, paying taxes, etc. For example, Azerbaijan’s rank for “Starting a New Business” improved from 64 to 15 during the period 2008-2011. However, during the same period, the rankings for “Trading Across Borders” and “Paying Taxes” ranged from 173-177 and 141-103, respectively.
  1. During the time of appraisal, the capital market in Azerbaijan was underdeveloped, with equity and debt market capitalization of 0.5 percent and 1.9 percent of non-oil GDP, respectively, at the end 2010. Development of the capital market in the medium term was considered crucial to support economic diversification of the non-oil sector. The main activity of the Baku Stock Exchange (BSE) was to serve as the auction mechanism for the issuance of Government Securities. However, due to a number of limiting factors[1], secondary trading of treasury debt did not exist. Only two companies had listed their shares on the BSE to date, one of which was closely-held and did not trade. The most active trading surrounded shares of about 500 companies privatized in the mid-1990s, which represent the “unlisted securities market”, which was not regulated by the State Committee for Securities (SCS). As virtually all equity trades were pre-arranged, traditional exchange driven price discovery is not attained. The investor base was acutely underdeveloped and banks have had little interest of investing in low yielding existing market instruments[2]. As a consequence of the underdevelopment of the capital markets, the banking sector dominates the financial sector with more than 95 percent of total assets.
  1. A number of key benefits would result in the medium term from the development of the capital market. As a result of prior years’ high bank credit growth, both credit and related foreign exchange risks had become concentrated in the banking system. It was anticipated that over time these risks would be diffused as the nascent corporate bond market develops and more firms are able to gain access to longer term funding. Secondly, the banking system’s domestic funding structure would be enhanced through banks’ improved access to debt and equity financing. Thirdly, through a stronger capital market, holders of privatization vouchers would be able to more readily determine the price offered to sell their holdings. In sum, lenders, borrowers and investors would each have new opportunities to participate in the growth of non-oil economy through the capital market.
  1. At project design, market participants were interested in exploring more attractive financing opportunities for the private sector. At the time the project was conceived, the corporate sector was relying on expensive, short-term and increasingly scarce local financing from the commercial banks. Moreover, with the exception of IBA (which is majority owned by the State), few banks were large enough to provide substantial funding to enterprises. Market participants and the regulator alike had indicated that a number of enterprises have an interest to access the capital market for debt and/or equity financing. Equally, banks were interestedin diversifying their funding sources away from short-term deposits and find alternative sources of finance. The capital market, through both equity and debt financing, offered banks potential access to longer term funding, which was considered essential to encourage private sector development.

1.2 Original Project Development Objectives (PDO) and Key Indicators (as approved)

Increase the use of equity and corporate debt as financing and/or investment instruments through the adoption of an effective capital markets regulatory framework and infrastructure.

1.3 Revised PDO(as approved by original approving authority) and Key Indicators, and reasons/justification

The PDO was not revised.

1.4 Main Beneficiaries

  1. The main beneficiaries of the CMMP project identified in the PAD are:

• State Committee for Securities

• Baku Stock Exchange

• National Depository Centre

• Central Bank of Azerbaijan

• Ministry of Finance

• Ministry of Economic Development

• Professional financial intermediaries

• Corporate Sector

• Individual, corporate and institutional investors

1.5 Original Components

  1. The PAD defined five components or parts (as they are called in the Development Credit Agreement), as follows:
  1. Component 1: Streamlining and Automating Market Infrastructure. This

Component will address the outdated capital market infrastructure constraints by focusing on: (i) increasing automation of the market through establishing one depository center and consolidating clearance and settlement; (ii) opening the infrastructure’s inclusion/participation and access; (iii) minimizing off-market trades and improving price discovery; (iv) facilitating the operational introduction of investment funds; and (v) building better risk protection through establishing an updated trade guarantee mechanism. Market infrastructure activities supported under this Component will seek to maximize compliance with the Group of Thirty standards on clearance and settlement, IOSCO Principles 35-38 and CPSS-10 clearance and settlement principles. In this manner the Project will promote compliance with best international practices, and just as importantly, ready the reformed market infrastructure for connectivity to EU systems, when the level of Azeri market activity makes this advisable.

  1. Component 2: Updating and Strengthening the Legal and Regulatory Framework. To maximize the benefits of adopting an adequate legal and regulatory framework, this Component will focus on: (i) reviewing the draft capital market legislation, ensuring that the existing gaps are addressed through the forthcoming new Capital Market Act and identifying key implementing regulations needed to make the law effective; (ii) enhancing market confidence and safety by introducing minimum capital requirements for market participants; (iii) in collaboration with the Ministry of Taxes and Ministry of Finance, eliminating tax obstacles to capital formation for companies and avoiding double taxation of participants in investment funds; (iv) allowing pooled investments by insurance companies; (v) fostering competitiveness by extending market participation through new licenses and broader geographic coverage; and (vi) ensuring effective coordination with other regulatory authorities in the financial sector (e.g., the Central Bank of Azerbaijan and the Ministry of Finance Insurance Directorate) to minimize regulatory gaps and arbitrage opportunities. The EU TACIS project is currently supporting drafting of the new and approximation of the EU directives in Azerbaijan regulatory framework. This Component of the Project will largely build on the preparation of the draft Capital Market Act and be strengthened through the SCS undertaking in 2013 an IOSCO self-assessment and an independent IOSCO assessment at the end of the Project
  1. Component 3: Stimulating Supply. This Component will promote greater use of capital markets as a financing alternative by focusing on: (i) creating a more appropriate environment to encourage equity listings and the corporate bond market; (ii) actively reaching out to corporations to promote benefits of financial market as a funding alternative and working proactively with prospective issuers to assist them in coming to the market; (iii) promoting development of reliable benchmarks in the government bond market (in cooperation with IMF); (iv) supporting domestic capital market financing of the large infrastructure projects, by examining the potential for PPPs; and (v) assessing potential for introduction of new financial products (e.g., Electronic Traded Funds in the medium term).
  1. Component 4:Capacity Building.This Component will seek to overcome the low capacity of market participants and regulators through launching capacity building activities. First, as the SCS is the major force leading the CMMP reform, it is important to assure that the agency’s human and financial capacities are sufficient and effective. This Component, will aim to: (i) strengthen the SCS’ knowledge management, its policy formation processes and transparency of operations; and (ii) strengthen the institutional capacity of the SCS’ surveillance, reporting and enforcement systems. Second, investor education is a key factor to the encouraging the breadth and depth of participation in capital markets. It is therefore necessary to ensure that potential investors are well-informed as to the use, benefits and risks of securities ownership.
  1. This Component will include, inter alia, activities to: (i) improve public awareness of the capital market by carrying out a series of effective communication programs through media, outreach sessions hosted by the SCS in major cities of Azerbaijan; (ii) increase potential investors’ understanding of capital market by series of education seminars and outreach tools to nascent investment funds and insurance industry; and (iii) promoting the Azeri market to international investors. Third, skilled capital markets intermediaries are essential to the creation of efficient capital markets. The establishment of high professional standards for capital markets professionals has a direct influence on the credibility of the capital market and encourages the inflow of investment funds.
  1. The set of proposed measures regarding on-going training and certification under this Component should provide investors with confidence that the persons they are dealing with have the necessary skills, knowledge, experience and ethical standards to administer their investments This Component will support an increase in the professional knowledge base by: (i) developing a capital markets training center; (ii) gauging the current capacity of the capital markets participants; (iii) establishing curricula for qualification for licenses; and (iv) developing a sustainability plan for Training Center.

1.6 Revised Components