Capital Market Development plans for 2011 to 2013

Monday, 17 January 2011 00:01 -     - {{hitsCtrl.values.hits}}

The Securities and Exchange Commission (SEC) on Friday held its first stakeholders forum where its plans for capital market development for 2011 to 2013 were revealed. Here are excerpts from the presentation made by the SEC Chairperson Indrani Sugathadasa

We are gathered here today when our stock market has been ranked the 2nd best performing stock market in the world for two consecutive years. The market created history in 2010 by establishing new records in almost all aspects of trading from total market turnover, indices to the market capitalisation.

Sri Lanka’s capital market has developed faster and more extensively in the last 18 months than any other period in history. In a relatively short span of time, the capital market’s role in funding and mobilising savings has become more comparable to that of the banking sector. The capital market has also firmly established its profile as an indicator and facilitator of growth within the Sri Lankan economy. This promising growth in the stock market was mainly backed by peace prevailing across the country. The economy has continued to benefit from stability after the 26-year conflict. The phenomenal growth in the stock market is a positive sign that Sri Lanka’s business landscape is changing for the better. The effects of growth will, no doubt, spill over into the national economy. The government’s stability has given investors a positive outlook. The positive growth momentum of the country so far has factored into the capital market through continued gain in the indices.

With the 26 year old war that overshadowed Sri Lanka coming to an end, Sri Lanka is poised to embark on an accelerated development process. In the medium term the government is targeting an economic growth in excess of 8% and anticipates market capitalisation to increase to Rs. 3 trillion.

The SEC remains resolute in its efforts to add depth and breadth to the capital market as well as support the country’s development drive by facilitating capital formation within a regulatory framework which is fair and transparent.

In 2010, the SEC implemented some key measures in order to develop the market. The SEC granted licences to 5 Stock Brokers, 5 Investment Managers, 9 Margin Providers,  3 Under writers and 1 Stock Dealer. Also the SEC directed the CSE and the CDS to mandate the lodging of certificates pertaining to all listed securities at the CDS and thereby implement a system of dematerialisation of all listed securities. During the course of the year the SEC completed the regulatory framework for exchange traded funds, updated the Code for Unit Trusts, finalised the rules pertaining to Employee Share Option Plans, simplified and reduced transaction cost, reduced the tick size to 10 cents and conducted a consultation on the minimum public float. With the aim of enhancing the surveillance function, the SEC procured a state-of-the-art surveillance system in 2010. The new system has capacity to provide enhanced solutions that will enable us to monitor the market more effectively and eliminate misconduct in the capital market.

The year 2010 also saw the introduction of price bands to arrest volatility in the market and formalisation of credit arrangements to clients. The price band came into effect after prices of certain stocks were seen rising without being backed by sound fundamentals. These reforms are indeed reflective of the positive steps that SEC has taken to bring about a strong level of confidence as well as add further liquidity into the market. We acknowledge the cooperation and assistance extended by the stock broking industry and would like to thank them for the confidence and encouragement during challenging times.

The proposals outlined in the Budget 2011 will provide further impetus to the development of the capital market of Sri Lanka. The Budget 2011 incorporated many important proposals the SEC had made thus eliminating the impediments that prevailed in the market. In order to promote Unit Trusts to mobilise savings several significant proposals were included in the budget. The turnover of the Unit Trust industry is to be exempted from Economic Service Charge whilst foreign investment restrictions placed on Unit Trusts investing in Government Securities was relaxed. To encourage companies to list on the Colombo Stock Exchange, expenses on listing a company will be deductible subject to a limit on the value of the Initial Public Offering and the anomaly which existed in the treatment of withholding tax on corporate debt securities was also addressed. These incentives will further create a supportive environment for the SEC to achieve its overall goals and objectives. We would like to thank President Mahinda Rajapaksa and the Secretary to the Treasury Dr. P.B. Jayasundera for including SEC’s proposals in the budget.

These initiatives are consistent with the government’s strategic priorities and strive to ensure that the SEC continues to play a significant role in the securities regulatory landscape. Aided by favourable market conditions we have recognised the following five key strategic goals to be achieved in the next three years and in pursuit of these goals we have identified supporting initiatives.

Key strategic goals

1.Facilitate improvements in the capital market infrastructure

2.Facilitate improvements in liquidity and introduction of new products in the capital market  

3.Encourage and facilitate the widening and broadening of ISSUER BASE

4.Facilitate widening and broadening of INVESTOR BASE

5. Enhance the SEC’s performance through effective alignment and management of human, information, and financial capital

To attain these goals we intend to amend existing regulations, develop new products, obtain advance technology and infrastructure and improve practices. Successful implementation of these initiatives can only be achieved through extensive support of the stakeholders and therefore we look forward to their continuing support.

Facilitate improvements in the capital market infrastructure

One of the main objectives of the SEC is to create and maintain a market in which securities can be issued and traded in an orderly and fair manner. In order to achieve this objective, it is the duty of the SEC to ensure that suitable infrastructure is in place.  During the next three years, the following areas have been identified as vital areas that need development within the capital market in Sri Lanka.  

nAmendments to the SEC ACT

The SEC has identified that the amendment to the SEC Act as a priority to create a conducive infrastructure to the capital market. Rulemaking is often required to remedy abusive practices and facilitate changing economic conditions. In general, rulemaking and policies are designed to improve disclosure, facilitate the flow of important information to investors and the public, improve governance, promote high-quality accounting standards, enhance the accountability of market intermediaries and other market participants, and strengthen the structure of the trading markets.

The present SEC ACT was introduced in 1987. Though there were 03 amendments thereafter, an overall review of the provisions to align it to the global market trends has not been done.

The SEC Act will be amended to incorporating the following:

  • To regulate demutualised exchanges
  • Provisions to effectively regulate a Central Counter Party/ Depositories  
  • To introduce civil sanctions and administrative sanctions to deal with capital market offenders and the introduction of provisions that will provide for restitution for investors
  • To licence and regulate derivative exchanges including a Commodities Exchange
  • Provisions incorporating legal duties on Auditors in respect of capital market offences  
  • Other relevant provisions that will enhance protection to investors

Apart from that, introduction of the new Takeovers and Mergers Code, new market intermediary rules, guidelines to register auditors of listed companies will strengthen the functioning of the Capital Market in Sri Lanka.

Demutualisation of CSE

The governance structure of the CSE is modeled on that of a “not for profit, mutually owned” organisation.  Influenced by increasing competition many exchanges have opted to demutualise the governance structure and make the Exchanges commercially focused business organisations. Some of the other reasons that have influenced the change in governance structure are the need to make a distinction between ownership rights and trading rights and enable management to make strategic decisions looking at the perspective of the Exchange rather than being limited by the interest of members.

Demutualisation of CSE will make it more dynamic and efficient and will increase the confidence of the foreign investors as well as the local investors in the Sri Lankan capital market.

The amended SEC Act will have legal provisions that will provide expressly for Demutualised Exchanges, profit sharing, listing of a Demutualised Exchange, limitation of shareholding, Government appointees to the board of a Demutualised Exchange and public interest mandate.

The Act will also include provisions to effectively regulate a Central Counter Party (CCP)/ Depositories. Establishment of a Central Counter Party will reduce the amount of counterparty risk that market participants are exposed to.

Facilitate improvements in liquidity and introduction of new products in the capital market liquidity

A liquid market is a market where securities can be sold, with minimal loss of value at any time within the market time. Liquidity is the key characteristic of a developed or an emerging capital market in the world. Liquidity is a function of many attributes such as number of listed companies listed on the exchange, maintenance of a minimum public float of listed companies, new products available in the capital market and number of active investors in the exchange etc.

Liquid equity/bond markets make investment less risky and more attractive, because they allow investors to acquire securities and to sell it quickly, if they need to access their savings as well as alter their portfolios. At the same time, companies enjoy permanent access to capital raised through equity issues.  By facilitating longer-term, more profitable investments, liquid markets improve the allocation of capital and enhance prospects for long-term economic growth. Furthermore, by making investment less risky and more profitable, stock market liquidity can pave the way for more investment.

Corporate Bond Market

The Per Capita Income in Sri Lanka is expected to double in 2016. It is estimated that Rs 1 Trillion of this will be generated from sectors other than the Banking Sector, a significant portion of which will be generated from the corporate debt market. The anomaly which existed in the treatment of withholding tax on corporate debt securities as well as the anomaly of the risk reward structure was addressed and we expect the debt market to develop rapidly. In this regard the SEC will follow up on the Corporate Bond market Development Implementation Plan approved by the Commission. Also the SEC will liaise with the CSE on encouraging trading on the DEX System.

Apart from the above, steps have been taken at present to frame suitable guidelines to encourage the introduction of new funds namely Real Estate Investment Trusts (REIT’s) and Exchange Traded Funds. This will undoubtedly give rise to more investment opportunities for investors and will contribute to the expansion of the number of investors in Unit Trusts.

Encourage and facilitate the widening and broadening of ISSUER BASE

Another important strategic goal of the SEC is the widening and broadening of the listed companies in the CSE. It is vital for an exchange to increase the number of companies listed on the exchange as it directly affects the liquidity of the market as well as the confidence of the investors. As a generally accepted practice, the size of the capital market is measured by the market capitalisation of the exchange. New listings will increase the market capitalisation.

Sri Lanka’s capital market contribution is around 40 percent of the country’s GDP compared to markets of developed countries which is over 100 percent of the GDP. By attracting more companies to list on the stock market we can increase this contribution. The CSE needs more large scale companies to list to generate volumes to cater to large scale foreign investors. That will serve as a positive indicator of the growth momentum of an economy.

From the year 2011 onwards, Market Capitalisation is expected to increase at least by 20% per annum. Within a macroeconomic environment of high GDP growth and low inflation supported by fiscal discipline and political stability in Sri Lanka, more companies and infrastructure projects will consider financing their projects through the equity market. It is expected that 50 to 60 new companies (of which approx 25 finance companies as directed by the Central Bank of Sri Lanka), will be listed on CSE in 2011. Hence, it is anticipated that Market Capitalisation will increase to Rs 3 Trillion by 2011 from the current Rs 2 Trillion. The SEC is also exploring the possibility of introducing Cross Boarder Listing on the CSE.

 Facilitate widening and broadening of INVESTOR BASE

A total of 554,000 securities accounts have been opened with the CDS as at December 2010 and only 72,000 account holders have traded at least once during the year. This is 13% from the total number of securities accounts registered.  Also approximately 7,000 account holders trade on a daily basis. This number will increase when we can service more investors. This will depend on our brokers in providing access to clients. This could be achieved by providing clients with internet trading facilities which we encourage.  We think it is important to increase the number of active investors in the CSE as well as to increase awareness among the investors on the stock market.

We think that it is important to increase the number of active investors in the CSE as well as to increase awareness among the investors. The importance of this goal is to broaden the investor base to increase the liquidity of the market to minimise market manipulations and other market abuses.  

The stock market should venture into rural areas further in order to achieve our objective of widening and broad basing of investor base.  More investors in the stock market will create more liquidity. The liquidity of the stock market provides investors the ability to quickly and easily sell securities. This is an attractive feature of investing in stocks, compared to other less liquid investments. The CSE has already ventured into 4 provinces. The development projects that are underway in the Northern and the Eastern provinces has shown a full swift where the society is very interested in knowing the latest development at the stock market and to invest in it.

It is noteworthy to mention here that all 5 existing branch offices of the CSE have performed exceptionally well during the year 2010 and the SEC would like the CSE and stock brokers to venture into other areas such as the East in the near future by establishing branch offices.  

The Unit Trust industry, a vital segment of the capital market of Sri Lanka is the best conduit to mobilise savings of the less sophisticated small investors. Therefore, the SEC encourages small scale investors to start their investment through Unit trust as it is less risky than investing in the market directly.  To achieve this goal, the SEC already has suggested a marketing plan to promote Unit Trust within Sri Lankan community.  

The goal of the SEC’s investor education programme is to guide the investors to make informed decisions by evaluating current and potential investments, while providing critical insights to emerging trends. Some of the activities planned by the SEC in this regard include a TV series and a radio series on stock market investing, both local and foreign road shows, workshops for industry participants and regular seminars for investors.

Enhance the SEC’s performance through effective alignment and     management of human, information, and financial capital

The SEC is committed to being an employer of choice by consistently attracting, hiring, developing, and retaining a high-quality, diverse, and results-oriented workforce. The expertise and specialised skills necessary in the field of securities regulation are a significant factor shaping the SEC’s human capital planning efforts.

The SEC is placing great emphasis on bolstering its processes and systems in information technology, budgeting, accounting, and internal control functions. In addition, the SEC continues to focus on delivering complete, concise, and meaningful information about the financial and operating performance of the SEC that supports government decision making.

Successful implementation of all these initiatives can only be achieved through extensive support from the stakeholders and therefore we look forward to your continuing cooperation and assistance.  

Sri Lanka is undoubtedly poised to take off in 2011. The stock exchange, as an indicator, speaks for the economy’s health and prospects for the local and foreign investors. President Mahinda Rajapaksa has opened the door for foreign investors to invest in Sri Lanka and the political stability of the country provides immense confidence to both local and foreign investors. Let me reiterate our resolve to build our capital market and set it on a strong foundation over the next few years and to contribute towards the President’s efforts of placing Sri Lanka as “the emerging wonder of Asia”. Let us work together as an industry to achieve this.