Sri Lanka’s stock market which has come under considerable scrutiny over the past few months is not over regulated, but the ‘rush’ to regulate has to be stopped, according to a corporate lawyer.
"The regulations put out by the Securities and Exchange Commission (SEC) in the recent past had issues as there was no consultation with the industry. The regulations weren’t consistent and predictable. You can’t rush to regulate – you must consult and then regulate,” former Director General of the SEC and now Precedent Partner of Nithya Partners Arittha Wikramanayake told the Business Times on the sidelines of a high-level two day capital market development workshop organized by the SEC last weekend outside Colombo.
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| At the conference |
He pointed out that the recent introduction of price bands has not stopped manipulations. “The industry is smarter to find a way over it. You don’t put price bands - it’s fundamentally wrong and they may have resulted in over regulation,” he said.
Addressing the gathering as the keynote speaker on ‘Is the stock market overregulated?’ he added that the biggest dilemma the industry currently faces is that there’s no standard to judge the level of regulation in the Colombo stock market. Mr. Wikramanayake pointed out that the more the laws, the more regulation there is but at times the number of regulations increase, without any enforcement. According to him, the ease of regulation, formal costs of compliance, etc are some gauges to measure the level of regulation by SEC.
Shot-gun
Mr. Wikramanayake noted that there’s a huge transaction cost and in this retail – driven market the regulations pose a serious issue. He said the shot-gun approach to stockbroker credit regulation which was imposed by the regulator a couple of months ago is an example.
“Trading in penny stocks and price movements are worrisome, but there should be market awareness and also enforcement of existing regulation, as the existing laws is sufficient. The credit rules should be based on the exposure levels of each stockbroker,” he added.
Another point he made was whether there is transparency and fairness in the regulations which were put out by the SEC. “Good regulations must be facilitators. Many regulations are seen with resentment by the industry. SEC’s nitpicking is overbearing on some share market participants." He said that in as much as the market participants should be governed by a code of conduct, the same has to be applied to the regulator (in terms of SEC decisions being leaked to the media before formal announcements).
Ray Abeywardhana, CEO Acuity, said for broader rules and regulations there should be a consultative committee to look at issues that are not confidential in nature so that a more thoughtful process can be given before the rules are implemented. “For example, as an investment banker I have reservations about the allocation for Initial Public Offerings and on brokers not being permitted to lend. We need to look at the high cost of transferring client portfolios' to margin trading,” he said.
Don’t be a dampener
Hiran de Alwis. Director Colombo Stock Exchange (CSE) noted that there’s enough regulation, but effective enforcement is what is needed. “The regulator should be a facilitator, not a dampener."
Dhammika Perera, Director Investigations SEC pointed out that the recent regulatory measures were mainly due to what transpired in the market. “With the support of the industry, there was a bubble being created in the market. The regulator was reluctantly compelled to bring about these rules to immediately arrest this situation," he said, adding that this was the remedial action. He added that these are no 100% merit or disclosure based jurisdictions in the world. “The regulations in the past were situational,” he said, adding that at the time, the market witnessed rampant manipulation.
Pump to dump
Posing a question to the panel, Tushan Wickramasinghe, Managing Director, Capital TRUST Securities asked the panel to properly define what the much talked about phrase "pump and dump" is so that investors and stock brokers know exactly what they can do and what they should not do. “There seems to be over 16 million mobile phones in our country, but in our stock market there are only about 30,000 investors who actively invest in shares. Therefore, if the necessary steps are taken, then one million investors will be in our stock market and then no one can manipulate it,” he said.
Dhanushka Samarasinghe, Director TKS Holdings told the Business Times that total freedom in financial markets would lead to a “survival of the fittest” scenario, at the expense of ill informed and less knowledgeable market participants. Most often the affected party would be the relatively less wealthy retail investors albeit part of their losses could be attributed to demerits of speculation and gambler instincts of their own.
Let the fools burn
“Therefore the free market advocates are quick to say that let the fools burn and learn and if not get burned again! However the regulator is forced to the middle with the uphill task of creating freer markets whilst ensuring equality to all market stakeholders. As such rules by the SEC would not always be rosy to all market participants and hence lead to criticism of the regulator,” he said, noting that the SEC has taken many initiatives to develop and sustain the capital markets in the recent past.
He pointed out that it’s always better to have an active regulator as opposed to an SEC which prolongs its action and maybe in the worst case take no action at all. “With large monetary considerations at stake and market reacting every second the SEC would have to take swift action to mitigate the formation of undue risk in the system. So in hindsight one could view such action taken by the SEC as stop gap measures to avoid market chaos, though in reality it is arguable whether any better alternative existed to manage the risk posed by herd mentality in selected counters. The regulator action has moved from being situational to more strategic and preemptive in nature. Such indication by the SEC is most welcome by the market participants and improves confidence on the Sri Lankan market,” he explained.
Catch me if you can
Adding that market manipulation is part and parcel of capital markets, he was more critical on advocates who look upon to developed (or so defined) markets such as the USA for answers to mitigate manipulation. "The level of manipulation in so called developed and sophisticated markets is many fold compared to ours and it’s a disgrace for us to be compared with that. The question of manipulation arises due to part of the market participants ending up in the losing end while a few become victorious on a given day. Such volatility and vulnerability exists because people would want to make a quick buck and become blind followers and worshippers of speculation. Therefore it is no doubt that part of the blame should be borne by the parties who were affected whilst initiating organized speculation and false buying pressure are aspects which should be punishable," he said, lauding SEC for trying to educate the public on investing wisely whilst seeking to amend the rules and regulations in order to bring about controls to speculation and organized manipulation.
Malik Cader Director General SEC said that there’s a ‘catch me if you can’ attitude (by some players in the markets) and it will be ‘unpleasant’ if these things come up. “The surveillance system the regulation has recognized (some erratic behaviour) and all I can say (to those responsible) is to be careful,” he warned.
Credit cost
On the topic of credit where SEC had granted until the end of this year for broking houses to clear their credit lines offered to clients (they will be able to offer credit through margin trading instead), brokers complained that extending credit was essential for business and that the cost to transfer to margin trading was large. Heraymila Director/ CEO Ravi Abeysuriya told the Business Times that it is illegal for a stockbroker in any country to lend money; however, brokerage firms all over the world allow clients if they wish, to trade "on margin" up to a maximum of 50% of the value of the clients existing portfolio value of stocks (collateral) and charge interest on the funds lent. Buying on the margin is simply a brokerage firm lending money based on collateral value.
Margin lending is a core part of a broking business and a legitimate revenue opportunity for broking firms, similar to giving credit facilities on any trading business. "SEC, to avoid a potential systemic risk (the damage that may cause to the whole industry if a broker goes bankrupt, due to excessive margin lending) completely prohibited brokerage firms in Sri Lanka from margin lending and encourage margin lending to be carried out through a separately owned company other than owned by the brokerage firm,” Mr. Abeysuriya explained, adding that the decision to completely prohibit brokerage firms in Sri Lanka from margin lending had a huge cost.
Market decline
He added that curtailing retail trading had a negative impact on the market where the market has been on the decline since. Moreover the cost of moving margin facilities to independent margin trading providers are burdensome to clients and costly as they attract stamp duty and a higher risk premium as independent margin providers are less knowledgeable about the quality of brokerage firm’s clients as well as the quality of the stocks in their clients portfolios compared to brokerage firms.
Mr. Abeysuriya said that allowing brokerage firms to engage in margin lending based on value at risk (VaR) principles where the level of margin lending is limited to meeting certain capital adequacy standards, which are monitored by SEC on a daily basis electronically. “Brokerage firms, on their part will have to adopt superior risk management and back office systems to monitor and provide pertinent information to SEC,” he added.
The forum titled "The Right Moves: Capital Market Development Workshop" was jointly organised by the Colombo Stock Brokers’ Association and Unit Trust Association of Sri Lanka.
High networth investor K.C. Vignarajah, a protector of the rights of minority shareholders, was critical of the role of independent directors saying they were not independent as they should be and often go along with board decisions without debate.(Also see above)
Speaking during one of the panel discussions, he suggested that such directors, who play an impartial role in the board, should have a stake in the company (for them to be effective and be concerned about how well the institution is run) and should be elected by minority shareholders, not the controlling interests.
Some aspects of Corporate Governance of PLCs
By K.C. Vignarajah
There has been a progressive attempt to codify rules and best practices of Corporate Governance (CG). Many of them are routinely implemented and accepted. Some others could be acceptable, if Controlling Interests (CI) and the directors genuinely implement the spirit of the codes. Only controversy and abuse happens when the CI incorrectly interprets the codes to their advantage. The matters under the glare of the investing public as unwarranted perversion of the concept of good codes are:
a. Rampant insider trading in CSE – this is the cry of many who are knowledgeable and interested in the health and sustainability of the CSE. Genuine investors, senior editors, journalists, analysts, stockbrokers, parliamentarians, and economists are interested in encouraging the rapid growth of the economy with necessary local and foreign investments. These investments channelled through widely held PLCs, would spread production and prosperity to the larger mass of investors and population. The effect of synergies of this widespread enthusiasm and confidence throughout the country is immeasurable.
b. Lack of transparency and material information in a timely manner to make informed investment decisions.
c. Lack of effective action to curb errant CI creating “Shareholder Fatigue” and stealthily acquiring more shares through related parties (Insider trading).
d.(i) Denial/suppression of Real and Intangible Assets and Fair values thereof.
(ii) Periodical “Restructuring” - changing the shareholding structures of subsidiary/associate companies to favour the CI and related parties while the other shareholders (IMS) suffer dilution and loss of value, thus negating the fundamental right of equality and ranking “pari pasu” in the venture for equitable share of the profits and growth potential.
e. Lack of independence of the “independent directors”, the external auditors and even the company secretaries. The latter do not correctly record the minutes of meetings of shareholders, invariably taking the dictates of the CI in a manner prejudicial to the rights of other shareholders.
f. Lack of action to ensure “minimum Public Float” in PLCs. Liquidity and marketability of shares are further adversely affected by moves to delist, which is a fraud on the IMS.
g. Lack of fair and equitable dividend payout policy to satisfy all groups of shareholders. It also militates against ethical and moral concepts. In the ultimate interpretation of natural law, “current net profits belong to current shareholders” which is fair. In many cases, the controlling interests in a very unfair manner, deny the profit-share to the current shareholders, and try to amass them for their future generations. Under the guise of creating “shareholder wealth”, they actually create “shareholder fatigue” and “shareholder impoverishment”, if dividend yields are poor compared to inflation/ interest rates. High dividend payouts would, inter-alia, greatly encourage steady investors to the stock market. If capital is required by the company, a Rights issue to voluntarily bring back some of the dividend payouts would be the best form of offering shareholder choices as well as increasing the liquidity of shares This also contributes a fair share to the state as withholding taxes (WHT). A “win –win” situation for the company, shareholders and the government!!
h. Lack of adequate information on financial performance and on the correct valuation of all the assets of the company. This denies the IMS and the investing public a true and fair view of the true net assets value (NAV) of the company. It also denies the fair comparison of performance and of Return on Assets (ROA), etc, to make vital make decisions on investments. The financial statements should be presented in standard format for each sector; otherwise shareholders have to go on voyages of discovery to collect basic information. The controlling interests are always aware of the hidden values of the assets and the future true growth potential of the company. Unless independent shareholder (IMS) directors are also present to ensure transparency and timely information, there will be great injustice done to the IMS and investing public.
i. All above have caused much disillusionment in the minds of knowledgeable local and foreign investors who are outside the circle of the groups of CI and their related parties.
How do we ensure the goals of good corporate governance, particularly where it is perceived to have failed?
a. Election of truly “Independent Directors” and Independent Auditors. In practice the CIs and related parties (who are in actual control of the corporate management), appoint and call them independent - glibly achieved by the mirage of shareholder majority/democracy!!! \
a. The direct and easiest manner of correcting this convoluted scenario, is to have the “independent directors and auditors” elected by the independent minority shareholders (IMS)! This would ensure good checks and balances by persons who are working towards the same goals of maximizing efficiency, accountability, profitability and transparency in achieving the most desirable goals. This would also entail, the necessity to jettison the idea that the independent director should not have a significant shareholding in the company! The so called independent directors without a meaningful shareholding in the company, has invariably turned out to be mere mercenaries in the context of current status of the professions and institutions (Very rare exceptions noted)!! Artificial criteria suggested by different bodies , and/or nominations by them, will not be successful. They are only self serving and not acceptable. Giants of corporates, who created great shareholder wealth, would have been eliminated, ab initio, by their criteria. E.g. Iconic Ken Balendra of JKH, Lal Jayasundera of Hayleys, Ratna Sivaratnam of Aiken Spence and A.Y.S. Gnanam (who paid 300% dividend by the “grace of god” fame), etc in the local scene or Bill Gates, Richard Branson and many others overseas.
No director should be appointed if it can be shown with evidence that he/she has conflicts with the interest of the company.
b. A salutary convention in earlier years, (sometimes incorporated in the Articles of Association of the company), is when a shareholder reaches 10% or 12% shareholding to be invited to the Board as Non Executive director. The independent directors may be deemed to have sufficient stake in the company, (say for example) if he/she has Rs. 5 million worth of shares or 0.01% shareholding. These can be varied for Small, Medium and Large companies catagorised on the average of the last three years market capitalization.
It is anticipated that the SEC and the CSE will take necessary steps to correct the anomalies and bad practices prevalent in above areas of the system. It will then create a win-win situation for all the stakeholders and the country.
(The writer is a well known protector of the rights of minority shareholders.) |
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