Fast-tracked DVP likely after NSB-TFC fiasco

The stock market is likely to step up the migration to Delivery Versus Payment (DVP) system in a more robust risk management regime following the fiasco triggered by the default of National Savings Bank (NSB).

Daily FT learns the DVP as well as a more robust risk management system came up for discussion at a joint meeting between Securities and Exchange Commission (SEC), Colombo Stock Exchange (CSE) and Colombo Stock Brokers Association (CSBA) officials on Friday.

In place of the current Trade+3 market days (T+3) settlement system, the DVP has been proposed and has been on the cards for several years.

During the bizarre events connected to NSB’s purchase of a 13% stake in The Finance Plc (TFC) from a consortium of sellers via Taprobane Securities Ltd., most capital market stakeholders were unanimous that DVP could have minimised the damage to the credibility of the stock market and integrity of the settlement system.

At present, CSE is getting technical expertise from the National Stock Exchange (NSE) of India, which already has a DVP system.

Analysts said that there needs to be a robust risk management system in place and proper procedures as well as rules as a precursor to the DVP with a Clearing House acting as a Central Counterparty (CCP). Furthermore, all market participants including brokers need to be aligned and ready as well.

A joint committee of the SEC and CSE has been working on this for some time, but analysts expect all stakeholders to move faster towards DVP. Previously expectations were that it would be in place this year but fresh indications are early next year.

At Friday’s meeting the issue of recourse to the SEC’s Settlement Guarantee Fund in the event of a development such as the NSB-TFC deal was also discussed.  As at end 2010 the balance lying credit to the Fund was Rs. 332 million.

The Rs. 390 million deal on 27 April saw firstly NSB, despite being a Custodial Bank, failing to reject the 13% buy within the permitted T+1 window, in which case the shares would have devolved back to the selling broker and secondly Sampath Bank settling sellers without having confirmed receipt of funds from the buyer NSB. Though NSB didn’t pay, TFC shares had gone in to its Custodial Account.

The bizarre development was after NSB withdrew from the trade, subsequently reversing its previous decision to buy and go ahead with the investment in TFC. NSB’s decision to purchase 7.8 million shares of TFC at Rs. 50 each drew widespread flak as it was tantamount to paying a hefty premium for a share which has a negative net worth of Rs. 23.

Triple A credit rated and Rs. 400 billion asset-rich NSB’s default, irrespective of reasons cited for backing out of the deal, remains contentious and a thorny issue in the financial services industry.

However, the settlement risk of the transaction was resolved on Friday via off the floor private transfers (nearly three weeks after the original trade), by the SEC as per provisions within its Act. This was after all parties to the transaction expressing in writing their willingness.

SEC said this approval was granted under exceptional circumstances for the smooth functioning and the system stability of the payment and settlement cycle of the capital market.

“It is stressed that the SEC will not consider this instance of granting approval to conduct a trade of this nature off the Floor of the CSE as creating a precedence,” it added.

Whilst some stakeholders including the UNP had suggested that NSB pay for the transaction and conclude the deal and re-sell later on, even if it meant back to the original sellers, legal experts said that given the complexity and sensitivities, the private transfer method on Friday was the best option.

“Technically there was no other way,” they claimed. Great care was taken to ensure minimum impact to the ordinary course of trading as well as settlement and clearing market.

Friday’s resolution was preceded by a spate of assurances in writing among involved parties to the transaction. It was pending approval until SEC Chairman Tilak Karunaratne returned on late Thursday from his trip to International Organization of Securities Commissions (IOSCO) annual conference in Beijing.

SEC in its statement on Friday said Taprobane Securities (Pvt) Ltd. (TSL) and the National Savings Bank (NSB) by letters dated 11 May 2012 made an application to the Securities and Exchange Commission of Sri Lanka (SEC) seeking prior approval under Section 28 (1) of the SEC Act to transfer The Finance Company PLC (TFC) shares purchased by NSB on 27 April 2012 on the Colombo Stock Exchange (CSE) to persons identified by TSL outside the Trading Floor of the CSE.

TSL in its application undertook to pay Sampath Bank PLC the consideration due on this transaction including the interest due thereon in settlement of the monies due to Sampath Bank for the settlement services rendered by Sampath Bank on the share purchases done by NSB of TFC on the Trading Floor of the CSE on 27 April 2012.

NSB in its application also agreed to transfer TFC shares purchased on 27 April 2012 in its entirety to the persons identified by TSL outside the Trading Floor of the CSE. NSB agreed to allow TSL to pay Sampath Bank the consideration sum due on this share transfer in satisfaction of the amounts due to Sampath Bank for the settlement services rendered on the share purchases transacted by them on the CSE on 27 April 2012.

Sampath Bank too intimated to SEC that the bank would discharge NSB and all parties connected with the impugned transaction, if TSL as undertaken by its letter paid Sampath Bank all sums due to them including interest/levies due thereon.

In terms of Section 28 (1), the SEC has the discretionary power to approve transfers outside the trading procedure of the CSE.

In this backdrop the SEC has granted approval to allow NSB to transfer TFC shares purchased on 27 April 2012 in its entirety to the persons identified by TSL outside the Trading Floor of the CSE.

The SEC also said it is separately investigating the NSB-TFC transaction and the parties involved in it. “Firm action will be taken against all those who are found to have violated the SEC Act,” it added.

The SEC is also currently studying this entire issue and expects to take a series of appropriate measures, rules and procedure changes to prevent such incidents in the future. The SEC will also intensify its efforts in implementing the Central Counter Party (CCP) for the CSE which will be the final solution to address settlement failure risk.

At the joint SEC, CSE and CSBA meeting on Friday afternoon, the outcome of which was described as positive, an anomaly in the broker credit rule, greater promotion of stock market via local and international road shows were also discussed. Prior to meeting with SEC, brokers had their routine dialogue with CSE earlier in the week as well.

The Colombo stock market is besieged by low activity whilst the 14% year-to-date negative return and rising interest rates on fixed income investment options along with scepticism over future prospects for the economy and corporate earnings have dampened the outlook for the Colombo Bourse.