Leading the positive change in finance
Shaping a trustworthy, forward-thinking finance industry
Following is the keynote address delivered by SEC Chairman Dr. Nalaka Godahewa at a CFA workshop on 16 August 2013
Friends, I thank you for inviting me to speak at this CFA event on the subject ‘Leading the Positive Change in Finance and Shaping a Trustworthy, Forward-Thinking Finance Industry’. A very appropriate topic indeed given the current circumstances of our industry.
I am thankful to CFA for organising this event in line with their mission of ‘leading the investment profession globally by promoting the highest standards of ethics, education, and professional excellence for the ultimate benefit of society’.
I understand that today’s event is the culmination of a series of workshops conducted by the CFA’s Standards and Financial Integrity team currently visiting Sri Lanka. I have personally experienced the high professional standards of CFA international seminars, having attended your 66th Annual conference in Singapore, so I have no doubt that these workshops made valuable contributions to the industry.
History and industry
Let me start this speech quoting a bit of history about our country and the industry.
Sri Lanka in the context of historical significance has never been out of contention. It was the island’s strategic location that prompted the then merchant powers to establish Colombo as a trading port of operation. It was its striking beauty which enabled it to earn the title the pearl of the Indian Ocean.
At the time of Independence in 1948 from great Britain Sri Lanka with its superior socio economic indicators was prospected to be next Asian growth story only to be obstructed by non conducive macro policies and a devastating ethnic war which concluded in 2009. In 2010 the IMF declared Sri Lanka a middle income emerging whilst the Dow Jones affirmed it a frontier market.
We are all familiar with the declaration by the Central Bank that Sri Lanka is targeting to be a US$ 100 b economy by 2016, which would put it within range of an upper echelon middle income emerging country. In this context we are also expecting the per capita income which is around US$ 2,900 today to reach US$ 4,000 by this time.
In order to reach these ambitious targets the government is pursuing a multi pronged ambitious economic development plan with its initial focus on infrastructure development.
In fact the Government’s commitment to infrastructure development has been commended in a recent report of HSBC’s global research arm, which says: “Despite being one of the smaller economies in emerging Asia at US$ 60 b in 2012, Sri Lanka’s infrastructure development contribution is greater than many of its neighbouring countries.”
The Government has clearly mentioned in its ‘Mahinda Chinthana – Vision for the Future’ policy document that it would like to see Sri Lanka emerging as a regional economic hub. In line with this strategic vision I believe Sri Lanka has an opportunity to achieve the following:
(a)A transportation hub which would fully capitalise Sri Lanka’s strategic geographic location both as naval and aviation hubs.
(b)A commercial centre serving the South Asian region and beyond focusing on not just manufacturing and services but also international trading.
(c)A vibrant finance market that can cater to local as well as international needs.
(d)A major tourism destination with a wide gamut of tourism products from the traditional leisure seeking to tourism to MICE tourism
Further I believe what is of interest to our industry of course is the opportunity to become a regional financial centre. We already have most of the ingredients required to achieve that goal. The rest we need to build.
Let us see what requirements we need to create a regional finance centre where international financial businesses can be conducted profitably and efficiently:
- A sound, well-regulated banking system – which is already in place.
- A deep, liquid and a sophisticated capital market. More effort is required here.
- A competitive tax regime that would encourage foreign investment and offshore business flow. Currently in progress.
- Up-to-date telecommunications network and IT capacity. Tactical advantage as Sri Lanka is way ahead of most regional counterparts.
- A skilled and qualified workforce who could meet the industry expectations. Sri Lanka’s literacy rate is over 90% which ensures that the labour force is trainable.
- An attractive place for living and doing business. Sri Lanka’s ranks comfortably versus the peers in the World Bank’s doing business index.
- A clear Government policy framework concerning financial infrastructure and financial intermediation
- Regulatory regime that would aim to mitigate risks, increase efficiency and enhance market transparency and liquidity, thus supporting the safety and soundness of the financial system. The system is partially in place as the country’s banking system was not exposed to toxic assets. But greater effort is required here.
Creating a vibrant capital market
Let me now draw your attention to the task of creating a vibrant capital market. How do we lead the positive changes and shape a trustworthy forward thinking industry?
Our market does possess inherent strengths. The CSE was the first in South Asia to introduce scrip less system way back in the early 1990s. It is also a member of World Federation of Exchanges (WFE), and SAFE. Despite these attributes the market during the war remained dull as a whole except during periods when there was a ceasefire.
But there is hope and propensity for future growth. With the conclusion to the war the market enlarged by a whopping 125% in 2009 and again by a commendable 96% in 2010 thereby earning the title the world’s best performing stock market.
The past record itself, ladies and gentlemen, speaks for itself. With this kind of historical vibration we can embark on a wide array of achievements in the years to come. To stay in tune with changing market dynamics the CSE introduced a global index called the S&P SL20.
The potential the market has is further highlighted by the interest of foreign funds like the Wasatch Fund, BBH Mathews Asia Fund, Malaysia’s Sovereign wealth fund Kazana and the Aberdeen Group to name a few who have invested in the Large CAP stocks like JKH, COMB, SPEN and CTC.
Our long term goal is to grow the market – a market that will reflect the country’s 100 b economy target by 2016.
As you know our current market capitalisation is only US$ 20 b, which converts to only 30% of the GDP. We would like it to be at least US$ 50 b or 50% of GDP when the national GDP reaches US$ 100 b, which will be more in tune with other markets. But right now we are facing a chicken and egg situation. Our market is considered small and therefore not attractive enough for foreign investors. If we don’t make it attractive to the foreign investors the market cannot be expected to grow.
So we are putting in building blocks to address and rectify the situation, to catch up with lost time. Do things that we should have done perhaps 10-15 years earlier. But as we all know, it is never too late to do the right things. Rome was not built in one day. If there is a will there is always a way.
Six areas of importance
Our plans to develop and regulate the capital market focus on six areas of importance. Let me explain these one by one.
1. Like in everything else infrastructure is the starting point. Though we were way ahead of our regional counterparts in the early ’90s in terms of infrastructure, today we are not. Most of the market development opportunities are hampered by the lack of a clearing house or a CCP. Our broker back office systems need upgrading. Trading platforms needs to be enhanced particularly to handle the debt trading requirements. We have been taking some important decisions during the last few months and now they have been put to action to address these limitations within the next one year.
2.Increasing market liquidity is a critical requirement to support growth. Of the 288 listed companies we currently have, 140 or almost 50% do not have a public float of even 25%. Some of the largest listed companies have very little public float. The other issue is the size of the existing listed companies. The market capitalisation of 93% of our listed companies is less than US$ 10 m. We lost the ‘Emerging Market Status’ in MSCI index in 2001 and we need at least three companies with market cap of more than US$ 1,033 m with a US$ 516 m free float to qualify for MSCI emerging market status and only one company in our market currently meets that criteria. These are the main reasons why our market is not yet attractive to large scale foreign funds. So we have to approach this problem from different fronts. On one side we are working closely with CSE to encourage more private companies to be listed. We have been requesting the Government to list some large state agencies. On the other hand following the example of many of our global counterparts we are also considering introducing a minimum public float requirement for the listed companies.
3. Education and awareness is a continuous task. A financially literate investor is self-protected. So we engage ourselves on number of fronts to educate existing as well as potential investors. But education and awareness is not limited to investors. We must continue to educate the other industry stakeholders as well. That’s the only way we can increase the market sophistication and also promote good governance, best practices and ethical standards. We are thankful to the media who are supporting us in these efforts.
4. Increasing global participation is the fourth task. As a developing country we need to attract foreign investment. The capital market is one path foreign investments can flaw in to the country. The Colombo Stock Exchange has already started a series of overseas road shows to attract global fund managers. Along with the Central Bank we have taken many regulatory initiatives to encourage foreign investments in to the capital market. We work very closely with other international regulatory bodies so that we understand and adhere to the latest international standards and best practices. The existence of a robots regulatory mechanism is essential to promote foreign participation in our market.
5. Our product portfolio also has to be enhanced. Right now we have only equity and debt instruments available and equity is almost 98% of the securities market. As you know in many other countries the bond market is much bigger than the equity market. Last year we took several initiatives including tax concessions to promote the corporate debt market. We are happy to note that companies have seen the potential and during the first six months of the year there had been 10 issues of listed debentures raising Rs. 24 b. That’s more than what was raised by all IPOs combined during the last three years. We expect this trend to continue. But we need more products in the market such as derivatives. When markets fortunes are fluctuating, solutions such as short selling, futures, options, etc., are necessary to keep the market alive and expand. However all these are currently limited by infrastructure as I mentioned earlier. We have now agreed with the Central Bank to work together and set up a common CCP for both debt and equity. If everything goes well, the target is end 2014 or early 2015. That’s the time we will be able to introduce most of these instruments which we are currently holding back.
6. Last but not least there is a requirement to further strengthen the regulatory framework. I am happy to announce that the SEC has now handed over the new SEC Act amendments to the Ministry of Finance to obtain Cabinet approval. Next it will go to the legal draftsman and if everything goes well within the next six months the new bill will be presented in Parliament. The new amendments will give more teeth to the SEC to take prompt enforcement actions by creating provisions for civil and administrative sanctions following global practices. The Act will also provide for the functioning of a demutualised exchange and a clearing corporation. Invariably the amendments to the 25-year-old SEC Act will bring about the policy shift to strengthen enforcement activities, enhance market transparency, increase market efficiency and liquidity, thus supporting the safety and soundness of the financial system.
The 10 project initiatives in our capital market development road map are in fact activities focusing on these six areas.
As the regulator, the primary function of SEC is the protection of investors. At the same time we are also expected to facilitate market development. If we don’t understand the fine line between these two objectives and strike the correct balance, we cannot progress. We must open our eyes to the reality that despite all the noise we may have made in the past, we are still a small and less sophisticated market in the region. We have to think futuristic and move forward. In this regard we still have a long way to go.
Ladies and gentleman it is said that the ‘necessity is the mother of invention’. We have come to a point where we have no choice but to move fast and catch up on lost time.
But the need of the hour is collective optimism, drawing inspiration from US civil rights leader Dr. Martin Luther King who said, “Everything that is done in the world is done by hope.”That’s what we are trying to do right now.
But for those who are impatient of the speed at which we move or critical of what we do, I can only remind you of the old English proverb: “Before criticising a man, walk a mile in his shoes.”