Clearly, an enhanced flow of insurance funds to a capital market will increase the demand for volumes of bonds and equity and if that demand is fulfilled result in increased market capitalization which is a positive contribution. It does improve the level of liquidity of the investment instruments in the market as the increased demand will attract a greater number of equities and bonds to be issued to the markets. An issue that often retards a market is when issuers of investments are reluctant to do so because there is an inadequate supply of funds into the market to absorb the new issues resulting in a fall in prices. This situation can be arrested if a greater supply of funds is channeled to the markets and insurance funds do play a key role because of the quantum of such funds. Asset Liability management is a key issue for many asset managers. As insurance funds can be invested for the longer term it has the benefit of stimulating the development of longer term investment instruments such as long term bonds. Thus, there are benefits in terms of developing a long term yield curve and ensuring a more even interest rate spread across the yield curve. From a growth perspective the availability of such funds will benefit long term investments and project financing. Another advantage of such funds is that they do lead to innovation and the development of new investment products. If you speak to a fixed income trader one would be amazed by the sheer variety of the lingo. Many western institutions had "financial engineers" whose responsibility was to develop "exotic" products. I believe that this aspect needs to be pursued with caution. Often due to the longer term nature of insurance funds there can be tendencies to experiment with various financial structures disregarding the levels of risk being run on such instruments. The credit risks as well as the liquidity risks of not being able to dispose of such investments in a market. As mentioned previously the objective of such funds must be kept as a central focus.

The above discussion leads me to identify a few key pre requisites that should be in place for a successful and sustainable development. It is critically important that there must be an enabling legal framework that supports the development of the capital markets. The legal framework that governs the overall management of insurance funds and the rules that are set in place for the management of funds must support this process. For example the rules pertaining to permitted investment assets, admissible assets for solvency etc must be framed so that it provides asset managers with the required legal space to effectively diversify their portfolios but must also place the required restrictions that manage the levels of risks being taken. These rules must be clearly defined and enforced so as to ensure transparency and effective governance. In this respect the Insurance Board of Sri Lanka has taken steps in the right direction by proposing a revision to the present legislation that allows for insurance funds to be invested in a wider variety of asset classes and allowing for a greater diversity in managing the portfolios. For example the proposed rules allow insurance funds to be invested in Asset Backed Securities and Gold which were previously restricted. In terms of risk controls, maximum exposure levels have been introduced together with requirements for varying levels of investment grade ratings.

Rules and regulations must not be restricted to asset classes and risk exposures alone but must be extended to regulate and define who can manage such funds. I believe that institutional funds such as insurance funds can contribute towards the development of the capital markets only if such funds are managed by professionals with defined qualifications and competencies or entities that are regulated as well. I believe that managing investments is a disciplined process. As such these funds must be managed within the scope of defined investment objectives, investment mandates and clearly defined specifications of risk tolerance. One may feel that all of this will restrict the scope of investments and innovation in the market. However, I believe that the above will help in ensuring a sustainable relationship between institutional funds and the capital market where the integrity of that relationship is sustained over time. These funds should be funds that stabilize markets and limit the scope for wild speculation that we often see in emerging markets which are often dominated by retail investors.

An important aspect is that the regulators too should build technical capacity to regulate these industries so that meaningful changes can be made from time to time taking into consideration the stage of development of markets and the levels of risks involved.