We Should Never Bring Down the Credibility of the Market We Regulate

CEYLON TODAY | Published: 2:00 AM Sep 19 2020
FT We Should Never Bring Down the Credibility of the Market We Regulate

Sri Lanka’s Capital market regulator, the Securities and Exchange Commission of Sri Lanka (SEC), on Thursday (17), presented its Year 2019 Annual Report themed  “Striking the Right Balance” to  Prime Minister and the Minister of Finance  Mahinda Rajapaksa. 

In this Annual Report SEC Chairman Viraj Dayaratne PC stated that “The main thrust of the work undertaken during the past year has been aimed at addressing regulatory gaps and coverage, adopting appropriate risk mitigation measures, strengthening the supervision of intermediaries and enhancing financial literacy .

Following are  key highlights of the SEC Chairman’s and Director General’s  Reviews of the Annual Report:

SEC  Chairman Viraj Dayaratne’s Review

Capital markets represent an important source of financing for businesses to meet their funding requirements and better wealth creating opportunities for investors. Taking into consideration the important role played by the capital market, the SEC is required to ensure that appropriate regulations are in place to meet the demands of both businesses and investors. Therefore, while we remain steadfast in our commitment to delivering on our mandate, we intend to strike a balance between ensuring strong investor protection and providing the flexibility required to maintain a thriving capital market. 

In this review, I take the opportunity to both reflect on the main areas which defined our work in 2019 and present our vision for the coming years. The main thrust of the work undertaken during the past year has been aimed at addressing regulatory gaps and coverage, adopting appropriate risk mitigation measures, strengthening the supervision of intermediaries and enhancing financial literacy. Firstly, let me highlight a few of our key achievements in 2019.

Robust Regulatory Framework

We believe that regulation is necessary to strengthen and ensure the integrity of the capital market and not stand in the way of its development. To that end, promulgation of the new Securities Exchange Act was considered as a priority in order to provide a better and more efficacious regulatory framework in line with international best practices. Considerable work has gone into drafting the new Act and it contains many salutary provisions. 

The draft law seeks to achieve improved governance standards, provide for the establishment of a clearing house acting as a central counterparty (CCP), make provision for the  regulation of a demutualised exchange, recognise new categories of market intermediaries and introduce a wide range of enforcement mechanisms to deal with market misconduct.  The SEC is confident that the Government will take steps to have it enacted early enabling balanced, effective and proportionate regulation.

Proactive Risk-Based Supervision

The SEC continued to adopt a risk- focused approach to supervise regulated entities and identify, monitor and contain risk with special focus on financial soundness and business efficacy. Given the potential money laundering and terrorist financing risks posed to the securities sector in Sri Lanka, we conducted guidance and awareness sessions for our regulated entities aimed at strengthening the industry’s understanding of the Anti- Money Laundering and Countering the Financing of Terrorism (AML/CFT) Regulations. 

Widening Fundraising for SMEs

For capital markets to be inclusive, it is imperative that Small and Medium Enterprises (SMEs) are able to obtain market-based financing. Hence, the SEC together with the Colombo Stock Exchange (CSE) launched the “Empower Board” to create a platform for SMEs to list. 

External Stakeholder Engagement

During 2019, we regularly had consultations with industry participants, especially Listed Companies, auditors, stockbrokers and unit trust management companies in order to discuss and gather feedback on issues regarding policy and regulatory matters. Since we received valuable inputs through this dialogue, we will ensure that steps are taken to further strengthen our relationship with them. This will not only help formulate major capital market policies and streamline the regulatory regime but also understand and appreciate the respective professional roles and responsibilities.

Moving forward

The new Commission appointed in January 2020 commenced a series of meetings with industry  stakeholders and obtained their views on developing the capital market as well as listened to the difficulties faced by them. These deliberations brought out some valuable suggestions and insights to develop infrastructure, strengthen and simplify market regulation, develop new products and enhance awareness for both investors and issuers. We expect to appoint joint committees of the SEC and the CSE to look into and make recommendations to address these challenges expeditiously.

Moreover, to promote agility and operational efficiency in the capital market, the SEC along with the CSE will take steps to offer investors a fully digital onboarding experience, enable seamless post-trade and settlement and adopt e-contract notes and e-statements. The process of reviewing and amending the Stockbroker Rules, Central Depository Systems (CDS) Rules and Listing Rules is already underway to drive innovation and greater capital market development.

SEC Director General Chinthaka Mendis’ Review

How the Capital Market Can Promote Economic Growth,Employment, Income and Living Standards. 

Like in many other spheres in the country, our capital market has also missed many opportunities and has not performed according to its true potential. In fact, as a country, we have been dreaming of becoming a developed nation cascading with prosperity and benefits. To fulfil that vision, we need to work with commitment and diligence to reach the required competence.

Given the fiscal and monetary constraints our economy is faced with, the pivotal role of the private sector in repositioning the growth trajectory of the country is obvious. Accordingly, the dire need for a robust capital market that will provide impetus to the growth of  the private sector is felt more than ever before. The SEC as the apex regulator is entrusted with the profound task of regulating all sectors relevant to create a robust and sustainable capital market.

Economic Growth of the Country: How the Capital Market Can Promote Economic Growth, Employment, Income and Living Standards.

As Mariana Mazzucato memorably argued in her book The Entrepreneurial State, it is the duty of the State to take the lead in innovation and economic transformation. In fact, Mazzucato tells us that the meteoric rise of China, South Korea, Singapore, Taiwan and Malaysia was due to the right involvement of the State in the business world, not as a meddler in the private sector but as a key partner in growth and innovation through a well-designed, consistent and successfully implemented state intervention.

Further, Prof. Ricardo Haussmann of Harvard fame has also remarked that Sri Lanka’s main problem is the inability of the private sector to move from the production of comparatively simple products like apparels into high value added goods and technologically advanced sectors. The success of certain Asian countries was the capacity of their private sector to move from apparels to valued sectors such as electronics and industrial productions, even though they had started with apparel production at the same time as Sri Lanka.

It is disheartening to see investments bypassing us and going elsewhere. I’d say, lessons from the financial and securities law reforms of South Korea, Singapore and Vietnam provide evidence that successful reforms intensify rising inflows of direct investment. Most recently, bolstered by an improving  economy and a wave of new listings, Vietnam has been able to draw funds from big foreign investors. Vietnam equities have racked up the best gains in Asia in the recent past, making the Ho Chi Minh Stock Exchange one of the worlds’s best performing bourses. Its turnover has doubled over the past two years although the exchange is still classified as a “frontier” market.

Analysts say global funds and top investors are drawn to the economic success narratives of these countries, that of integrating themselves into the global trading system, and positioning themselves as a hub for foreign manufacturing. Interestingly, these countries are now benefiting from the escalation of tensions between China and the US, whereas, top companies consider dual listings and have shifted a lot of production out of China and US and have set up value adding factories and are now contributing to the enhancement of the economies of these countries.

Thus, I would say unless the numerous myths on the conventional views of the Government’s passive role in economic growth and transformation are challenged, we cannot hope to address the structural economic challenges that our country is faced with. Similarly, the SEC can no longer be restricted to its traditional role and conventional approach. It is imperative for the SEC to recalibrate its role with a view to provide impetus to capital formation while striking the right balance between market regulation and market development.

To cut a long story short, my aim is to highlight how the governments of those countries have created an enabling environment for the private sector to flourish, and how they have helped their companies to become global players and why we should support our private sector, to reach that level.

In fact, our markets have been waiting for the State to support its growth and expansion but we have been extremely slow to help. For instance, we just introduced Real Estate Investment Trusts (REITs) to the market, which should have been done at least ten years ago.

Capital Market Can Support National Endeavours

The CSE has the market infrastructure to support the fundraising requirements of the Government as well, especially  in terms of tapping public markets for funding development projects and the private participation in initiatives of national significance. Very much like private entities, we expect that the Government will also look at versatile and alternative sources of funding in marching forward.

Over the years, our problem was that we could not sustain a growth rate over 6% continuously for a considerable period of time whereas the success stories in Asia, countries that achieved developed status in the recent past underwent over 7-8% growth continuously for a significant period of time. The Secretary to the President, Dr. P.B.  Jayasundara in his recent interview to the Daily FT has expressed his confidence by stating a post pandemic subdued economic environment can be a great opportunity for Sri Lanka to prepare and achieve that elusive 7-8% growth, by becoming smarter, agile and more resilient to produce sustainable socio-economic growth.

On the other hand, Dr.Jayasundara has stated that from 2021 onwards the Government will get back to the fiscal consolidation path. Therefore, it is the ideal time for our capital market to step in and make every effort to empower the entrepreneurial community in realising this key goal as the situation has opened up a host of new opportunities.

Regulation Required to Promote Sri Lanka as an International Financial Centre

On the regulatory side, enacting the new SEC Act is the highest priority in order to strengthen the regulatory powers and market activity. Thus, the new Commission is currently engaged in the process of reviewing the provisions of the Bill.

The criticism of the Bill is centered on two impediments; a lack of clarity or ambiguity as to the meaning of the certain provisions, and the impracticality in the range of enforcement sanctions, that there could be problems within the Act, which could pose problems for the SEC to implement the enforcement process. In fact, with the new Act, it should not become more challenging for the SEC to conduct enforcement actions.

Therefore, I believe that the present sensible drafting approach will form a practically workable law, which will enable swift and clear enforcement,that does not unnecessarily impede the market activities without a reasonable policy or a practical justification and will clear the criticism attracted to the Bill.

The growth of a securities market as a whole, reflects the trust and confidence placed in a market and in the country as a whole. However, we have seen how a deficit of trust and confidence has affected our markets as we have witnessed a number of issues in the recent past. I would say this is associated with the absence of adequate enforcement actions and lack of professionalism, which has severe ramifications to the market and the financial system.

I would also like to stress that, we should never bring down the credibility of the market we regulate, as we need to protect the interests of the investors, at the same time we need to ensure that the SEC strikes a right balance in regulation since over regulation can stifle growth and discourage active stakeholder participation in the market.

On the other hand, in line with our mandate, we continue to monitor, mitigate and manage risk with the aim of promoting integrity in the market, as well as making certain that investors are protected through the dissemination of full and accurate information. By uaranteeing disclosure, we increase the ability of investors to make informed investment decisions, improve investor confidence, as well as deter management from engaging in improper behaviour. Thus, the SEC will continue to impose stringent rules and undertake rigorous enforcement action against non-compliance.

Need to Facilitate the Entry of a Strategic Investor

We need to accept the fact that over the last few years, the capital market in Sri Lanka was not performing well. Without a doubt our capital market should be positioned to complement the banking sector and support the growth targets of the country. The strengthening of markets has been critical for sustaining rapid economic expansion in many countries and to achieve this end, investor and public confidence as well as the integrity of markets and their participants is essential.

As Charlie Munger says, we need to figure out “what works, what doesn’t and why.” In fact, Charlie Munger strikes me as someone who knows his strengths and weaknesses and who found a business partner in Warren Buffet whose strengths complemented Munger’s. Likewise, we need to facilitate the entry of a “strategic investor” to the CSE, as a shareholder who will be committed to the development of the securities market of Sri Lanka as such collaboration could lead us to the next level.

I recognise the value of having a close dialogue with the CSE and our stakeholders. I hope that together, we can foster a culture that goes beyond mere compliance. We are keen to facilitate initiatives with a focus on developing new products and market infrastructure to ensure that the securities market of Sri Lanka competes effectively by boosting fund flows to the country. Our market has essential prerequisites that investors look for in an investment destination, such as attractive valuations, well governed and strong regulatory framework, modern infrastructure and listed entities that are compliant with International Financial Reporting Standards (IFRS). Therefore, we are confident of the potential and resilience of our capital market.

CEYLON TODAY | Published: 2:00 AM Sep 19 2020

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