Longer wait for market for relaxed credit rule

The anxious Colombo stock market will have to wait a little longer for relaxed credit rule as Commissioners of the SEC who met yesterday deferred a final decision for want of more facts and further study, the Daily FT learns.

The much-awaited SEC Commissioners’ meeting took place yesterday and proposals from the Colombo Stock Brokers Association (CSBA) were part of an exhaustive agenda.

The deliberations by the Securities and Exchange Commission, which took a long time, did consider the pros and cons for relaxed credit rules, but given their critical nature the Commissioners had wanted more time to make an informed final decision.

Officials at the SEC Secretariat weren’t available for comment following the late evening meeting, but sources close to the Commissioners said a fresh meeting was likely next week to assess new facts and information sought to make a final decision.

The move by the SEC Commissioners may cause a damper to investor sentiments when market opens today after it bounced back yesterday in anticipation of positive decision leading up to regulatory support.

Following an emergency meeting, the CSBA via written representations on 26 July suggested three proposals for the consideration of the SEC.

One is that all brokers be allowed to lend their net capital, which is in excess of Rs. 35 million (minimum net capital requirement) leveraging zero times. The other option is that all brokers be allowed to lend two times the net capital, which is in excess of Rs. 35 million (leveraging one time).

Under both options, the compulsory force selling on Trade + 5 (market days) or T+5 rule has to be removed. The basis for this includes (under first option) broking firms being able to gradually force sell when they are fully utilising their excess funds and can do same when reaching one time leverage.

CSBA has argued that for the first option, brokers in any case can take their excess funds out of the company in the form of dividends or do anything they wish to do with it. With regard to the second option, CSBA has said it would be safe considering the fact that broking firms are able to leverage 10 times up to 2010 whilst presently finance companies are allowed to leverage 10 times and leasing companies allowed seven times leveraging.

Another proposal is that brokers be allowed to transfer excess net capital in the broking company to the wholly-owned margin trading company licensed and regulated by the SEC without deducting from the net capital.

CSBA had emphasised that most broking firms presently have proper systems and procedures in place to monitor debtors.

The Daily FT on Friday reported that following the new credit rules introduced last year, the estimated outstanding credit within broking industry had declined to Rs. 2 billion from Rs. 8 billion originally as per analysts. Given the deferment last night, analysts speculated that perhaps the SEC Commissioners had wanted specific data and breakdown of actual debtor positions to make a proper judgement.

Though CSBA did make written submissions, there has been market talk to the effect that a few broking firms weren’t overly keen on relaxed credit rules and that CSBA was divided on the whole issue. However, there had been majority consensus that brokers should have freedom to extend credit to clients subject to a more relaxed criterion since much of debt issue had been resolved and greater discipline and risk systems and procedures were in place.

Analysts said that when all macro indicators and developments point to a favourable environment for equities investments, the Colombo stock market has been struggling. A key reason for this is said to be some of the regulations being considered “too rigid”.

CSBA in its case for a review of existing rules had told the SEC that the ASI had declined by 16.8% since its mid-February 2011 peak and the MPI had plunged by 24.3% from October 2010.

“Each market day has become a T+5 force selling day for all stock broking firms, which has amounted to a large number of clients’ shares being forced sold daily to the buying quotations, which in turn is moving lower and lower and thereby precipitating a continuous drop in the market prices,” CSBA had pointed out.

“The main reasons for the market drop in our opinion are these on voluntary sales, which result in prices going down, cascading margin calls and more forced selling,” it added.

According to CSBA, local individual investor contribution to market turnover rose from 22% in 2008 to 44% in 2010 and large number of local individual investors with share portfolios of less than Rs. 1 million who were unable to obtain margin trading facilities have been force sold or have left the equity market.

To add to this problem, from 1 January 2010 to date, there has been a net foreign outflow of Rs. 34.6 million and from 1 January 2011, IPOs, Rights Issues and private placements have absorbed over Rs. 50 billion.

“These are the natural mechanisms by which an expensive market becomes an inexpensive market, thereby eliminating the need for any regulatory restrictions,” CSBA argued.