The past, present and future of the securities market of Sri Lanka
* Key Note Address by SEC Chairman Dr Nalaka Godahewa at the ‘Issuer Relations Forum’ on 11th Oct 2013October 14, 2013, 7:48 pm
It has been 4 years since our country ended the war on separatism in 2009. We have achieved lasting peace and political stability. Today the country has an undivided focus on economic development. With the war coming to an end more funds are available for economic development. There are business opportunities everywhere both local and international. The initial few years has been spent laying the foundation and getting the policy framework geared to support the ambitious economic growth plans of the country.
In 2010 the International Agencies of the IMF and the IFC declared Sri Lanka a middle income country and an emerging market. We are all familiar with the declaration by the central bank that Sri Lanka is targeting to be a USD 100 Bn economy by 2016. According to government forecasts the per capita income which is around USD 2900 today, is expected to reach USD 4,000 by this time.
In order to reach these ambitious targets the government is pursuing a multi pronged ambitious economic development plan. We are all familiar with the 5 hub economic development strategy the government is pursuing under Mahinda Chinthana - vision for the future. The 5 hub concept will include an aviation hub, a naval hub, a energy hub, a knowledge hub and a commercial hub.
During the last 4 years so much has been done in developing infrastructure to support the expected economic growth. In February this year a HSBC Global research publication stated that "Despite being one of the smaller economies in emerging Asia at US$ 60 b in 2012, Sri Lanka’s infrastructure development contribution is greater than many of its neighboring countries"
You would agree with me ladies and gentlemen that an essential prerequisite for the creation of an economic powerhouse anywhere in the world is a Vibrant Capital Market. A market that can cater not only to the local investor community but also to the needs of the foreign investors.
Let us see where we stand today with regard to this requirement.
Though small in size, the Colombo stock market has a long and an eventful history of over 115 years that dates back to the era when the island was still a British Crown Colony. It was in 1986 the Colombo Brokers Association commenced share trading amongst plantation companies. The CSE in the current form was set up in 1985. The Securities and Exchange Commission which regulates the market came in to existence in 1987. This was also the same year India set up its Securities Exchange Board as well which is popularly known as the SEBI. By mid 90’s CSE was one of the most technologically advanced modern stock exchanges in the region. In fact CSE was the first South Asian exchange to introduce a scrip less trading system in 1991.
However due to reasons that we all know, the market didn’t reach its full potential during the next 20 years while the rest of region moved forward. Market capitalization of the Indian securities markets today is 1.0 Trillion dollars. Singapore is $ 578 Bn, Australia is $1.3 Trillion, Tokyo $4.4 Trillion, Hong Kong is $3.3 Trillion, Malaysia is $488 Bn, Indonesia is $381 Bn and Thailand is $389 Bn. Unfortunately we couldn’t benefit from this tremendous growth phase of securities markets in the region. By 2009 when the war ended, market capitalization of Colombo Stock Exchange was only $ 5.2 Bn and the number of companies listed was only 235.
Somebody can point out here that we must compare market capitalization with the size of the GDP. Still when we compare with our regional counterparts we have a long way to go. Our market capitalization is currently 30 % of GDP. The regional average is 168% where as the world average is 74%.This clearly shows that we are not exploiting the full potential of the capital market to support the financing needs of the corporate sector.
However there were some good news after the war. Since the end of the war over the last 4 years market has grown up by 189% reaching a market capitalization of $ 18.6 bn. 58 new companies got listed during this period with total no of listed companies reaching 288.
Ladies and Gentleman we have reached a very important juncture in the development of our capital market. We have lost time and we need to catch up. We need to make a meaningful contribution towards the ambitious growth plans of the country.
Vision and strategy…
We need a vision and a strategy to achieve that vision.
As the starting point we would like to see how we can increase our market capitalization to 50% of GDP. This is an extremely ambitious target given that our GDP is also growing at a healthy rate of 7-8%.
Last year the industry took some important initiatives in this regard. Through a consultation process which involved all industry stakeholders we introduced a 10 point action plan for the development of the capital market of Sri Lanka. In fact these 10 projects cover 7 different areas of importance. Let me explain them one by one.
1. Obviously the infrastructure is the starting point. Though we were way ahead of our regional counterparts in early 90’s in terms of infrastructure, we fell short during the last two decades. We are currently in the process of upgrading our broker back office systems for better management of information. Trading platforms are being enhanced particularly to handle the debt trading requirements. By mid 2014 we hope to complete the implementation of a CCP system. We have been taking some important decisions during the last few months and now they have been put to action to address these limitations within the next one year.
2. Starting in the early 1990s, stock exchanges around the world have been undergoing major organizational and operational changes. One of the most visible change has been the trend towards demutualization- the process of converting exchanges from not for profit, member-owned organisations to for-profit, share holder owned corporate entities. International experience suggests that increasingly, demutualised structures are preferred to mutual structures as a mechanism to improve the efficiency of exchanges. Starting with Stockholm Stock Exchange in 1993 over the next 20 years every leading stock exchange in the world went through a Demutualization process. The first ADB study to demutualize the Colombo Stock Exchange was done in 2002 but since then it had not made much progress until last year. As part of the 10 point market development initiatives the process has already been set in motion to demutualise the CSE which should happen in 2014. Demutualization bill is ready to be submitted to the parliament and CSE is in the process of finalizing the valuations for government approval.
3. Increasing market liquidity is a critical requirement to support growth. That’s the reason we are encouraging more public and private sector companies to make use of the listing route to raise necessary capital. The 2013 budget offered a 50% tax concessions for companies who list before April 2014 and maintain minimum 20% public float for the next 3 years. This is a significant benefit that companies coming up with new IPOs can make use of as it’s a tax concession that can be obtained by already a profit making company. Two major policy decisions that have been approved by SEC recently will also help those considering listing. One is reintroducing the practice of listing by way of Introduction. Secondly we have agreed to allow BOI companies to list on a separate board without having to wait 3 years to list on the main board. Both these policy papers have been extensively discussed both at CSE and SEC to address all possible concerns.
4. Education and awareness is a continuous task. A financially literate investor is self protected. So we engage ourselves on number of fronts to educate existing as well as potential investors. But education and awareness is not limited to retail investors but also the issuers. In fact a TV series discussing listing issues is scheduled to commence in November 2013. We continue to educate the other industry stakeholders as well. That’s the only way we can increase the market sophistication and also promote good governance, best practices and ethical standards. We are thankful to the media who are supporting us in these efforts.
5. Increasing global participation is the fourth task. As a developing country we needs to attract foreign investment. During 2013 we have conducted 3 foreign road shows jointly with CSE and the response has been quite encouraging. Having completed road shows in Mumbai, Dubai and Hong Kong our next road show is scheduled to be in Singapore in November. The significant increase in foreign inflows to our capital market and the number of new entrants amongst foreign funds show that we are on the right path. In fact some of the recent IPOs benefited significantly from foreign participations. As at end September the net foreign inflows have exceeded Rs 21 Bn (USD 160 Mn).A significant development is the new found interest of foreign funds in the activities of Colombo Stock Exchange where foreign funds currently contribute almost 37% of trading. Wasatch Fund, BBH Mathews Asia Fund, Malaysia’s Sovereign wealth fund Kazana, Aberdeen Group are some of the leading foreign funds who have invested in our market
6. Our product portfolio will be enhanced. Right now we have only equity and debt instruments available and Equity is almost 98% of the securities market. As you know in many other countries the bond market is much bigger than the equity market. Last year we took several initiatives including the removal of the 10% withholding tax to promote the corporate debt market. We are happy to note that companies have seen the potential and during the year there had been 16 issues of listed debentures and several others are in the pipeline. But we like to see more products in the market such as derivatives. When markets fortunes are fluctuating solutions such as short selling , futures , options etc are necessary to keep the market alive and expand. All these are possible once we introduce a CCP next year.
7. Last but not least there is a requirement to further strengthen the regulatory framework. We have already drafted a new SEC Act which was submitted to the Ministry of Finance in July 2013 to obtain the cabinet approval and the Ministry is currently studying the same. If everything goes well within the next six months the new bill will be presented to the parliament. The new amendments will give more teeth to SEC to take prompt enforcement actions by creating provisions for civil and administrative sanctions following global practices. The Act will also provide for the functioning of a demutualized exchange and a clearing corporation. Invariably the amendments to the 25 year old SEC Act will bring about the policy shift to strengthen enforcement activities, enhance market transparency, increase market efficiency and liquidity, thus supporting the safety and soundness of the financial system.
Ladies and Gentleman we are on verge of an economic transformation. Our strategic location, emerging opportunities in North and East, potential for gas and oil, lasting peace and the political stability all point towards growth. So who should capitalize on these opportunities. Why only foreign direct investment ? Our local companies should also capitalize on this opportunity. If we want to be a regional economic powerhouse we need some strong local actors too. The window of opportunity may not last long. In a few years time there will be intense competition in many business sectors. But those who expand now and chase new opportunities will definitely have an edge over others.
But exploring new opportunities or expanding your existing businesses in a larger scale requires capital. You need financing. We believe there is an opportunity for you in the capital market. Today you can raise bonds without the 10% withholding tax. You can list your company and be entitled for a 50% tax waiver if you maintain 20 % minimum free float over 3 years. You will be able to use listing by Introduction as an entry mechanism if you would like to delay your IPO. Like wise there are several new policy decision that can help your entry into the market. The speakers after me will talk about these things in detail.
Some times you may not have a need for raising additional financing. Yet listing can offer you other benefits. It will create an exit opportunity for some of your investors. It provides a basis for valuing your company. It can help you diversifying your financial risk by providing access to long term capital.It will enhance the image of you company further and make it more appealing for all stakeholders.
Listing of course has certain disadvantages depending on how you look at it. Some people might not like to be regulated. Disclosure requirements and accountability towards public shareholders could be seen as unnecessary burden. But at the end of the day listing is all about better governance. It demands your management team to be compliant with best practices. Also there is a misconception of losing the controlling interest of the company by going public. All these concerns will be addressed by the speakers who will follow me and also during the panel discussion. Detail explanations are provided in the listing guidelines booklet that CSE has published.
In my humble opinion you are more likely to gain than losing by listing. But at the end of the day its you who is in the best position to make the call.
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