Capital market wish list for the New Year
View(s):Yet again we are in the dawn of another New Year. The Sri Lankan capital market’s wish list for Santa is long. So what’s in store for us?
The good news is that the new Santa, the Finance Minister Mangala Samaraweera has pointed out the importance of building a vibrant capital market to provide lower cost funding to the economic activity of the country in the 2018 Budget. For this purpose, it has been proposed that the two state banks, Bank of Ceylon and People’s Bank, evaluate options of tapping international capital markets without diluting the controlling ownership of the Government as done by state banks in several countries, including India and China. This is the number one wish for next year.
The Securities and Exchange Commission Bill will replace the Securities and Exchange Commission of Sri Lanka (SEC) Act, No. 36 of 1987, and it is expected to be presented in Parliament on January 24. “The previous Act is 30-years old, weak and is limited in its scope over listed securities and few market intermediaries. The SEC could take action against wrongdoers only through criminal proceedings and has not changed with the times compared to the rest of the world. If the new bill is passed it will lead to major reforms in the capital market,” Ravi Abeysuriya, immediate past president – Colombo Stock Brokers Association told the Business Times.
It is aimed at regulating market institutions, public offers of securities, market intermediaries, deal with market misconduct, and create a fair, efficient and transparent securities market in keeping with international standards.
“The bill will facilitate the establishment and regulation of demutualised exchanges, clearing house, central depository, issue and trading of listed and unlisted securities, protection of client’s assets, etc and also provides for directors and chief executive officer of a listed public company to comply with the fit and proper criteria,” Mr. Abeysuriya added.
In this law, auditors of listed public companies are expected to report any issue that “may adversely affect the financial position of the listed public company to a material extent” immediately to the audit committee “and if no remedial measure is taken within two weeks thereof refer the matter to the board of directors”.
Market sentiment
This year recorded an all-time high foreign investor interest with a net foreign inflow of Rs. 17.7 billion as of Boxing Day this year compared to a net foreign outflow of about Rs.2 billion for same period last year.
Mr. Abeysuriya added that the Sri Lanka market continues to trade at a discount compared to the regional peers and offers a great opportunity for investors — with a market P/E that is at 10.6 compared to say Vietnam 18.5 and Bangladesh 23 and a majority of listed companies trading below book value Sri Lanka is attractively priced.
“Attractive market valuation, encouraging performance among listed entities, dividend payments and capital gains tax exemptions offered to share transactions and low depreciation of the rupee are some of the reasons for the foreign interest.”
Work at the Cinnamon Life project which will create a buzz in the stock market once completed. Pic by Indika Handuwala
But the same cannot be said about the local investor sentiment. “We have not yet seen local institutional, high net worth and retail investor interest in the market. EPF, ETF, NSB, SLIC not active due to ongoing investigations,” he added.
Mr. Abeysuriya added that what needs to change from tomorrow is the smaller size and lower liquidity in the local equity market. “Solving this ‘size and liquidity’ issues is imperative to unlock the potential of the Sri Lanka capital market and requires very bold and visionary supply and demand side reforms by the Government.”
Sri Lanka could easily attract a significant amount of foreign funds and increase the depth and breadth of CSE if Sri Lanka is included in the MSCI Emerging market Index, which is tracked by investors managing US$9.5 trillion of assets. When Sri Lanka is in the index, MSCI Emerging Market Index tracker funds will be required to invest in Sri Lanka as they need to replicate the index.
For Sri Lanka to be included in the MSCI Emerging Market Index, it must have, among other requirements, at least three firms with a full market capitalisation of $1 billion and $516 million of listed stock. So the mantra should be to list SOEs. “Listed SOEs will be able to raise more funds by way of both additional equity and debt offerings to the public and further reduce the budgetary burden of the Government,” Mr. Abeysuriya added.
The efficiency at which the institutions in the financial system mobilise savings, allocate funds to finance productive investments, monitor the operations of the entities and transform risk will largely govern the economic performance of Sri Lanka. Mr. Abeysuriya stressed that there’s an urgent need to establish a Financial Sector Oversight Committee (FSOC) to coordinate and implement financial sector reforms in Sri Lanka to deliver what has been promised in the Government’s Economic Policy Statement – Vision 2025.
“The objective of FSOC should be to fast-track the implementation of financial sector reforms by inter-regulatory coordination with the key stakeholders including the Ministry of National Policies and Economic Affairs (MoNPaEA), Ministry of Finance, Ministry of Public Enterprise Development, SEC, Insurance Board, Colombo Stock Exchange (CSE) and the Central Bank by submitting proposals to the Cabinet Committee on Economic Affairs for approval through MoNPaEA. To assist the FSOC in the implementation, a ministry-level Central Project Coordination Unit (CPCU) should be formed which will be housed at MoNPaEA,” he said.
The stock broking industry is facing a precarious financial situation today with dwindling turnover, mounting costs and heavy losses, with little or no hope of a turnaround. Stock broking companies are facing a multitude of financial problems, which may not only undermine the orderly workings of the industry but also the sustainability of the stock brokerage industry. The issuance of seven new stock broker licenses since 2010, in addition to the six trading member licenses issued previously, further exacerbated the industry situation.
To address this situation, the SEC needs to offer a package of incentives to promote amalgamation and consolidation among stock broking companies in keeping with industry consolidation incentives offered by countries such as Malaysia and India, according to Mr. Abeysuriya. “In order to revitalise the market activity, brokerage companies that satisfy good governance standards and fit and proper criteria of directors as per SEC should be allowed to adopt the universal brokerage model and allowed to offer discount brokerage for on-line only transactions using funded accounts i.e. direct debit of client’s bank or Money Market account.”
The SEC should allocate a portion of the Cess fund for the Colombo Stock Brokers Association to promote the securities and investment industry and the establishment of a sound industry structure, promote education and training in all aspects of the securities and investment industry so as to upgrade the expertise and professionalism of members and to implement a self-regulatory mechanism, institute by-laws and regulations for members in accordance with constitution and take such action as may be necessary to enforce member discipline, similar to industry associations of countries such as Australia and Singapore, he added.
Interest rates down
Next year will see banking interest rates adjust downwards in 1H2018 similar to 4Q2017 to be in line with the dip in yields of Government Securities which is generally a positive sign for equity market as investors may look at alternative investment opportunities for bank FDs, analysts say.
“As long as bank FDs remain at or above 13 per cent-15 per cent is likely to be considered an attractive safe return for most investors diverting funds into fixed income instruments which were the cast throughout 2017,” Dimantha Mathew Head of Research First Capital Holdings PLC said.
He added that with the dip in government securities yields bank interest rates would follow a similar course supported by the expected reduction in the ceiling of the interest rates on FDs for finance companies by December 31. “Ceiling rates for one year which is currently at 13.55per cent is expected to come down by at least 130-140 basis points to about 12.2 per cent. These rates is primarily for finance companies and bank interest rates we believe are likely to trickle down and hover around 10-11 per cent during 1H2018 and be maintained around the same level during 2H2018 as well.”
With equity markets having higher risk premium which is around 8 per cent to the risk free rate, it currently provides an expected return of around 16 per cent-17 per cent down from around 20 per cent-21 per cent about six months ago, he added.
“However, the current tight monetary policy has slowed down the economy significantly reducing earnings growth for most companies. This situation is expected to ease off towards 2H2018. Therefore it is likely to have slightly better earnings performance in 2018/19 compared to the weak performance we are currently seeing in 2017/18. We believe overall market earnings are likely to grow by a modest 5 per cent-7 per cent during 2018/19 supported by a recovery in economic performance in the 2H2018. This is likely to accelerate to 10 to 12 per cent towards 2019/20 backed by further improvement in economic health of the country and also easing of the monetary policy with more stability in the system.”
Market returns are likely to be slow but stay positive in the 1H2018 due to attractive valuations prevailing in the economy and is likely to improve in the 2H2018 supported by expectations of a better economic outlook and earnings performance, analysts say. “We expect overall market returns are likely to be 10 to 12 per cent above the expected earnings performance with some re-rating with an expected better earnings outlook in the future. In terms of the ASPI index it is only likely to reach 7000 (+650 points) towards end of 2018. Market returns are likely to accelerate towards 2019 to about 15 per cent with the actual earnings performance and renewed investor confidence. Index is likely reach 8000 level (+1000 points) towards 2019. These targets however are highly dependent on the current stable outlook and reform agenda continuing during 2018 as well,” Mr. Mathews added.
Analysts say that the key sectors that are likely to outperform the market and expected provide high returns are the banking sector, building materials sector and apparel sector while the energy sector also may turnaround depending on the implementation of the pricing formulas.