Regaining Capital Market Mojo: Part 2-Integrity
“Integrity without knowledge is weak and useless, and knowledge without integrity is dangerous and dreadful” – Sam Johnson. This quote amply demonstrates all matters Sri Lankan, past and present. Initiatives to get the market on a proper direction obviously meet with resistance from a minority of a once, powerful market mafia. Such resistance must be confronted with proper arsenal. When a minority compromises market integrity superficial solutions are of no help.
In this connection, to elaborate on my previous article, there must be simultaneously 3-fold counter measures to:
- Establish “market integrity”
- Introduce “innovation”
- Apply “know-how”
Proper education will provide the required know-how to counter the mafia on a long term basis. Then the purpose of education must be to transmit know-how, the ability to think and be creative. Acquired know-how is valuable only when it is applied in the real world. However, the model what I see is that education is geared towards sitting exams and obtaining certificates and designations but lack proficiency. Getting beyond that point needs new thinking. Education to be able to provide the know-how needs to be affordable, keep pace with changing needs, and be broad-based.
The stock market must take stock of what is lacking and what needs to be done.
If the goal is the creation of a transparent stock market, then guaranteeing market integrity is the critical path to follow: Market integrity and transparency are intertwined. Stepping back, integrity and innovation derive their value from the education or know-how: education is then the common denominator. The common denominator must be affordable, effective and move with changing times. Better the quality of education and “effectiveness of delivery measures”; when default is high the degree of market integrity and high quality, needs an innovative approach. In this connection, I must highlight, that the education referred to here is not mere training to pass examinations to get certified. That model will only create a stock market full of investors with “text book intelligence” incapable of even placing a trade properly identifying the entry and exit points and proper trade management. We have already seen them enough! EPF, Hedging, Greek Bonds bear ample testimony to this claim.
The remnants of the market mafia will still resurface with the slogan “what matters is the result and not the process to achieve”! The only way they seem to know is manipulation in the absence of education taking a whole industry to the doldrums.
What is market integrity?
The objective of market regulation is the establishment of market integrity whereby protecting the market participant and the capital market.
Market integrity, is a means of protecting the participants (investors) and the market (capital market) they operate within. Creating and maintaining market integrity, the onus is on the regulator. From a regulators’ standpoint, when establishing market integrity, the focus is on:
- Best practices: Client relationship management and process transparency management
- Price validation: If a price reflects investor appetite supported by supply/demand
- Order management: Detection/aversion of price manipulation and unethical practices .
- Market efficiency: Facilitating a forum between capital “seeker” and “giver”
- Instill confidence: Market confidence (primary and secondary)
- Disclosure: Prospectus, offering memorandums sales material adhere to statutory guideline
- Ombudsman: Investor protection by means of having access to an Ombudsman
Education, its proper deliverance and its application plays a crucial role in market integrity. Regulator, investor and education are component to achieve market integrity: regulator takes a lead role.
Market Integrity Rules (MIR)
This relates to a framework of rules and policy guidelines that is designed to ensure a transparent capital market by ensuring fair trading practices to ensure market efficiency. Market integrity rules are geared towards creating and improving investor confidence in the overall capital market.
MIR assures “Best Practices” encompassing proficiencies, manipulative and deceptive trades, order management, regulatory compliance, and administration in order to bring reputation to the industry, professional in the industry and improve investor confidence. These are met with effective client relationship management.
Client Relationship Model (CRM)
Client relationship model advocates that the registrant treats and manages client relationships in a fair, honest and in good faith. Clients should not be exploited. Objective of the development of a CRM is to facilitate increase transparency, and investor confidence.
At all times the registrant must act in the best interest of the client given that the agents have a fiduciary duty towards the client. Client interest is foremost. The fiduciary must provide a complete and full disclosure: When making a disclosure, they have to ensure the material is reviewed and signed by the authorised person who is held responsible, if industry terms are used then they be explained, risk and assumption be disclosed and made understood by the client. Providing misleading information or omitting material information relating to registrants profile, investments recommended, pricing, trading ranges, or resorting unethical trading practices must be averted at all times.
The client must be informed of the protocol to follow in the event of any violation thereof and the detailed follow-up and remedial action. This information must be provided on a mandatory basis at the time accounts are opened and on an ongoing basis when changes are made.
Sales material as provided by a registered firm must comply with the statutory guidelines. Sales communication can take the form of e-mail blast, print or digital advertisement, prospectus, or oral statement made at an investor forum by a registrant or an agent of the firm that issues such promotional communication. Client account performance reporting calculations must be explained at the time of opening up of an account and all the calculation methods disclosed.
If what is originally discussed must be changed midstream as dictated by regulatory mandates or due to market changes then that must be disclosed and the new process explained. Fees, commissions all must be explained and made to understand.
MIR and CRM must be developed to suit the investor base in Sri Lanka. Taking bits and pieces from other regional capital markets and following their rules and guidelines is outright wrong as the investor psyche varies from market to market and we must develop linear solutions to suit our market conditions. The rules/guidelines must be indigenous.
In implementing the MIR and client relationship models briefly outlined herein, the regulator must ensure that all firms providing financial services have duly qualified, experienced professionals appointed. Some of the key roles to be considered are;
- Ultimate Designated Person (UDP)
- Chief Compliance Officer (CCO)
- Chief Anti-Money Laundering Officer (CAML)
The Ultimate Designated Person is mandated to supervise firm-wide activities relating to investment and client relations management that must comply with market integrity and capital market rules. Ideally, the CEO of the firm is held as the UDP with the support of the Chief Compliance Officer.
Chief Compliance Officer is in charge of regulatory compliance within the firm and reports to the UDP. One of the key responsibilities of the CCO is to document a compliance policy manual and have it approved by the regulator. Once the regulator has approved the compliance policy manual, then a copy each must be provided to the sales and operational staff and educate the need to be in compliance with guidelines outlined in the compliance manual. Individuals must immediately inform the regulator if the management expects them to perform duties that can be in violation of what is stated in the compliance manual approved by the regulator.
(Note: The first part of this article was published last week. The writer is a Sri Lankan-born investment advisor and expert in oil and capital markets based in Canada)