Lifeline looms

Brokers and regulator are scheduled to meet later this week to firm up the way forward on credit rules leading to formal approval by SEC Commissioners by mid next week, a development which most analysts confirm will be a lifeline for the struggling Colombo stock market.

The meeting between the SEC and the brokers, likely to be on either Thursday or Friday, is following the Colombo Stock Brokers Association (CSBA) making written representations to the capital market regulator with regard to what are perceived to be “very rigid” rules on forced selling and granting of credit.

The discussion is also likely to find consensus on the thorny issue and the recommendation will be studied for a final decision by the Commissioners of the SEC, who are scheduled to meet mid next week.

The Daily FT only Tuesday, 26 July, exclusively reported about an emergency meeting by CSBA members the previous day. Thereafter the CSBA followed up with a letter dated 26 July to SEC Chairperson Indrani Sugathadasa, who however was on an official visit to India.  

Following her return the SEC has studied the proposals in detail positively and Daily FT learns that a meeting between the regulator and CSBA is on the cards this week where specific recommendations from the broking community will be further discussed.

At the emergency meeting, three proposals won support from the brokers and the CSBA had provided the SEC with options – a move which analysts viewed as “reasonable”.

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.

Analysts who are well versed with the situation opined that brokers have made valid recommendations whilst the SEC is likely to extend conditional support. After consultation with brokers this week, a more win-win regulatory regime with regard to credit extension and compulsory forced selling is expected to go before the SEC Commissioners.

Analysts said that when all macro indicators and developments point to 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”.

They also opined that the mid-2010 credit bubble has been brought under control by now, with some estimating the outstanding credit to be below Rs. 2 billion as opposed to Rs. 8 billion. Deadlines for debt clearing as well as price band, according to most analysts, has brought improved discipline in the market, hence it was high time for regulators to reward the market by way of relaxing its rigid stance.

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