Progress of the capital market

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Economic growth hinges on an efficient capital market that mobilises savings for productive investments. From the perspective of Sri Lanka’s fast emerging economy status the role played by the capital market as an integral driver of the overall macro economy is constantly evolving. To this effect the Securities and Exchange Commission of Sri Lanka (SEC) believes whilst regulation is fundamental to ensure the capital market mechanism is fair and transparent, it has to facilitate market development. The Sri Lankan Capital market is one of the key areas which witnessed impressive growth in the post war period and it is in view of this that the SEC in consultation with key industry participants put forward a three year Capital Market Development Road Map in October 2012 to reposition the market to play an important role in capital formation and development of the economy.

Apart from Road Map in order to develop the capital market the SEC together with the CSE implemented several important initiatives in the recent past. These initiatives were implemented in order to increase the liquidity and strengthen the regulatory framework. Some of the important initiatives undertaken in the recent past are given below:

n Upgrading of the Takeovers and Mergers Code
Introducing a lock-in period for Pre-IPO Private Placement
Streamlining Related Party and Directors’ Disclosures
Replacing ad-hoc policies with long-term initiatives
Re-instating Introduction as a listing mechanism with enhanced Investor Protection
Introducing a Panel of Valuers for transparent Financial Reporting purposes
Enhancing disclosures on the IPO mechanism inclusive of Independent Valuer’s Opinion
Enhancing global visibility via Investor Forums in Hong Kong, Mumbai, Dubai, Singapore London and New-York,
Creating an enabling environment for Primary Dealers to trade Corporate Debt
Maintaining a minimum number of unit holders for each unit trust

Execution of the Road Map has progressed steadily over the years and most of the initiatives have reached substantial completion. The broad objectives of the Road Map are both structural and functional in nature covering many areas such as Regulation, Investor Protection, Market Development, Infrastructure Development and Enhancement of Financial Literacy, Risk Management etc. A summary of the progress made so far is given below. Development of corporate bond market To complement the economic growth plans of the government it is deemed important to broaden the capability and capacity of the bond market to supply financing to a wider spectrum of industries and projects. Towards this end, the SEC is in the process of requesting issuers to include the rating rationale in the issue prospectus to enhance transparency and disclosures. In addition, an upgrade to the CSE trading system for debt securities as well as upgrades to the surveillance system of the SEC to accommodate corporate debt trading is being finalised. Furthermore, in order to improve debt trading on the CSE Member Rules for stock dealers/brokers are being finalised. Development of Unit Trust industry The unit trust industry is viewed as a vital segment of the capital market of Sri Lanka since it is considered the best conduit to mobilise savings of the less sophisticated investors. Over the years the unit trust industry has played a pivotal role in

developing the capital market by channelling capital into the real economy. To develop the unit trust industry the SEC initiated a unit trust campaign as part of the Marketing Campaign for the capital market. In this regard a reality Quiz Program titled ‘Danno Dinanno’ and a media campaign comprising of newspaper advertisements and radio trailers were initiated to attract investors to unit trusts. In addition, SEC took steps to publish the performance of the unit trust funds in daily newspapers and is in the process of compiling a brochure to be given to EPF recipients. Furthermore, the SEC successfully made representations to the Central Bank of Sri Lanka to include unit trusts that invest exclusively in Government securities within the definition of ‘Government securities’ for the purposes of calculating Statutory Liquid Assets by banks and finance companies and also to be eligible to be considered under mandatory investments in Government securities category by pension funds and provident funds. Attracting new funds (local & foreign) In order to showcase investment opportunities in the country and attract institutional and high net-worth investors from across the globe the SEC and the CSE conducted investor forums in a number of select foreign destinations namely; UK, USA and Singapore. Subsequent to the hosting of international forums, data was obtained from the CSE and analysed in order to assess the movement in foreign trading flows. It was identified that there have been a significant number of new Central Depository System (CDS) accounts opened by foreign investors and that there are improvements in foreign trading activity levels from the countries where road shows were held.

Implementation of Central Counter Party (CCP) mechanism Stock markets globally are assessed on the basis of their ability to offer a stable environment in the form of efficient trading, clearing and settlement systems apart from market returns. The CSE is proposing to introduce a central counter party (CCP) with a view to implementing a robust risk management framework. A CCP is an entity that acts as a buyer for all the sellers and acts as a seller for all the buyers in the secondary market transactions thereby ensuring negligible counter party risk for involved parties. The SEC embarked on setting up an integrated CCP jointly with the CBSL and the CSE to effectively manage risk. Expression of Interests were called and upon evaluating the proposals a suitable party was selected as the Consultant cum Project Manager for the implementation of the CCP in view of their thorough understanding of the CCP framework and satisfactory hands-on experience in implementing a fully-fledged CCP. Thereafter, the SEC, CSE and CBSL signed a Tripartite Agreement outlining the responsibilities of each institution. At present the CSE is in the process of finalising the contract to be signed with the Consultancy firm. Education and awareness The SEC plays an important role in conducting financial literacy programs for existing investors as well as potential investors. The SEC is also committed to producing a pool of competent and knowledgeable market professionals by delivering licensing examinations and conducting continuous learning opportunities for professionals in the securities industry. Awareness initiatives in 2014 Awareness through print and electronic media Television series on capital formation A one hour pre-recorded television program titled ‘Going Public’ comprising of 13 episodes was telecast on MTV. This TV series was telecast in order to educate the corporate sector and top business executives of potential listed companies on the benefits of investing in the CSE. Radio chat show in Sinhala A live radio chat show titled ‘Ayojana’ comprising of 18 programs was aired on Lakhanda Radio to discuss various aspects of investing in the capital market to enhance investor education and broad base the investor base. ‘Danno Dinanno’ – Quiz program on Sirasa TV As part of the joint Marketing Campaign the SEC and the CSE together with Sirasa TV successfully conducted a Reality Quiz television program titled ‘Danno Dinanno’ comprising of 12 programs to disseminate comprehensive knowledge on investing in the stock market as well as unit trusts. This was Sri Lanka’s first ever Reality Quiz on the capital market. More than 250 News paper articles pertaining to the capital market of Sri Lanka was published during the year 2014. Awareness through seminars and forums

In 2014 with a view to strengthening cooperation and enhancing knowledge sharing among regulators the SEC in association with the Asia Pacific Economic Cooperation (APEC) Financial Regulators Training Initiative (FRTI) hosted a seminar on ‘Enforcement – Assessing, Planning and interviewing’ in Colombo successfully.
Capital Market conference 2014

The SEC together with the CSE successfully conducted the aforesaid conference under the patronage of His Excellency the President Mahinda Rajapaksa with approximately 400 local and foreign participants. The objective of the conference was to provide a global audience of fund managers as well as high net worth investors an excellent opportunity to study and understand the potential of the capital of market Sri Lanka. Education initiatives The education and training arm of the SEC continued to successfully implement the qualification framework which is aimed at offering a minimum level of proficiency for trainee investment advisors of stock broking companies whilst assisting practitioners to progress to more advanced qualifications through the development of continuous professional development programmes. In addition in the year 2014 a Certificate Program in Unit Trusts was inaugurated for the sales and marketing staff of the Unit Trust Management Companies. The SEC also awarded an assignment to a Market Research Company to evaluate the reasons as to why investors and potential investors are still not fully active in the stock market. New listings (public sector and private sector) With a view to developing the capital market of Sri Lanka the SEC took steps to encourage private sector and state owned enterprises to fulfil their funding requirements by listing on the CSE. In this regard the SEC conducted listing promotion forums for commercial ventures in many parts of the country to create awareness on the possibilities of raising capital via the capital market and address any apprehensions faced by potential listed companies. Discussions were also held with indentified State Owned Enterprises (SOE) in an attempt to encourage them to list on the CSE. In addition the SEC together with the CSE published a Guide to Listing on the CSE in all three languages. It is also envisaged that increased listings will lead to capital formation, improve liquidity and spur economic growth. On the regulatory side the SEC re-instated the mechanism of listing by ‘introduction’ with necessary safeguards to address any shortcomings and to protect the investors and the integrity of the market. The SEC also introduced a mandatory minimum public float requirement for listed companies following a practice that has already been adopted by a large number of international and regional jurisdictions. Develop infrastructure – Broker back office systems With the expansion of the capital market, broker firms require a uniform robust back office system that could handle the volume, improve the trading and settlement efficiency with necessary risk mitigating and management mechanisms. In order to facilitate this initiative the SEC called for Expression of Interests (EOIs) and upon evaluating the proposals shortlisted technically compliant vendors. Thereafter the brokers have been requested to contract with a technically complaint vendor by 31 December 2014 and to implement the system ending 30 June 2015 Development of new products A vibrant capital market is measured by the depth and breadth of the market with a wide variety of instruments that can cater to the different needs of issuers and varying risk return appetites of investors. It is also important that the capital market provides a viable alternative to conventional market products that will expand the capital market activities and help the economy grow. During the year the SEC licensed the country’s first ever Dollar Denominated unit trust in order to internationalise the investment industry in Sri Lanka which has been so far restricted to Rupee investments. This venture will undoubtedly support Sri Lanka’s effort to become a regional financial hub. SEC is also currently focusing on introducing Real Estate Investment Trusts (REITs) and Exchange Traded Funds (ETF’s) to the Sri Lankan capital market. At present SEC is studying REITS in regional markets and the regulatory framework necessary to protect potential investors. Demutualisation of the CSE At present the Colombo Stock Exchange (CSE) operates as a member owned, not for profit company limited by guarantee. It is envisaged that demutualisation of the CSE will lead to a more flexible governance structure, separate trading rights from ownership; ensure shareholder accountability and greater transparency. It will also give rise to facilitation of improved services to its customers and make a greater contribution to the economy as a whole. To facilitate this process the SEC obtained cabinet approval to demutualise the CSE. Thereafter the final draft of the Demutualisation Bill was forwarded to the Ministry of Finance and Planning and the translation of the Bill into Sinhala and Tamil is currently being finalised. The CSE obtained the services of Ernst & Young to conduct a proper valuation of the CSE and propose a fair distribution of ownership among the initial stakeholders of the demutualised Stock Exchange. The valuation report is expected to be forwarded to the SEC in the near future. SEC Act Amendments The overall development of the capital market requires modern infrastructure, a wide range of financial products and a robust legal framework to access and mobilise capital. The securities law in Sri Lanka was enacted 25 years ago and is not equipped to deal with future needs and emerging challenges facing modern capital markets. The proposed SEC Act amendments are aimed at providing the necessary toolkit to facilitate effective regulation. The SEC with the technical assistance from the FIRST initiative of the World Bank drafted the policy papers for the identified amendments to the SEC Act and sought comments from the public on the same. Thereafter, after having obtained the approval from the Members of the Commission of the SEC the consolidated draft of the proposed amendments to the SEC Act was finalised and forwarded to the Ministry of Finance and Planning (MOF). The MOF has convened a high level special committee consisting of 14 members, representing the Central Bank of Sri Lanka, corporate sector, the Bar and the Ministry to review the proposed amendments prior to submitting it to the Cabinet of Ministers. Implementation of these initiatives together with Capital Market Development Road Map has undoubtedly contributed towards fostering a fair robust and efficient market to support and complement Sri Lanka’s economic development program. It is heartening to note that during the post war era the market has grown steadily and given below are the milestones achieved during that aforementioned period.