Ladies and Gentlemen,
The objective of today’s forum is to share some thoughts with you as to how we envision the future of the capital market of Sri Lanka, particularly in relation to the next 6 years. In other words, we would like to discuss our vision for 2020.
Sri Lanka is a country with a long history, of which, 2600 years have been recorded. The country has seen good times as well as bad times. For example, Sri Lanka was going through one of the darkest periods of its history when we entered the new millennium. But we were fortunate to witness the most significant event of the new millennium for Sri Lanka on the 19th May 2009. On that day, the 30 year long battle with terrorism came to an end. Following the war victory, the much awaited peace returned to Sri Lanka.
The end of the war meant a lot to our country. The biggest obstacle to the development of the country no longer existed. The country found a fresh opportunity to leap frog into the future. All we needed was the undivided focus of the government and the citizens on economic development.
The government promptly declared that economic development was going to be its main focus. The vision was that Sri Lanka should evolve into the main economic hub of the South Asian region. Five specific sectors were identified as areas of focus under the new development strategy of the government. That included the creation of a naval hub, an aviation hub, an energy hub, an education hub and a commercial hub. Responsibilities were assigned to different government ministries, institutes and individuals to work towards achieving the desired outcome.
The government also identified creation of infrastructure as a prerequisite for the economic development. Accordingly, timelines were agreed and funds were allocated to expedite a number of major infrastructure development work which had been delayed for decades. Construction of highways, railway lines, ports, airports, power plants, irrigations projects, new schools all started happening at an unprecedented speed with this objective in mind. City beautification programs completely transformed the metropolis, giving it a clean look.
The Government also did some thing unprecedented. It announced an economic growth target; A USD 100 Bn economy and USD 4000 per capita income by 2016. These targets were repeatedly referred to at various forums.
Now as a member of the financial industry you should reflect what was the reaction of the capital market in this new post war environment? Where were we placed in this equation?
Most countries consider the capital market as a vital contributor to the economy. It is because the capital market is one of the main channels through which the funds available with retail and institutional investors are mobilized for long-term capital formation. The capital so raised is then used for further wealth creation and redistribution, infrastructure development and employment generation. The Capital market also provides an opportunity for savers to manage their finances better in the short and medium term through diversification of risks.
To understand the impact of the capital market on an economy, one could compare its size with the national GDP. Statistically in developed markets the average market cap to GDP ratio is around 122%. In emerging markets the average would be around 44%. The average market cap to GDP In the frontier markets is around 24%. It is important to remember that market cap of Colombo Stock Exchange to GDP when the war ended was only about 11%. We were one of the smallest capital market in south Asia with a market capitalization of around USD 5.2 bn.
Ideally we should have taken a cue from the Central Bank and set our own capital market development targets immediately after the war. We should have developed a master plan to achieve those targets. Unfortunately none of these happened. Interestingly, when the war ended CSE had hired the Mackenzie Group of consultants to carry out a study and make recommendations on a suitable go forward strategy. But due to some strange reason the study report prepared by Mackenzie Group was never used for any productive purpose.
I assume that the probable reason would have been that the CSE got off to a really good start immediately after the war. Within a span of one and half year period the ASPI reached record high levels touching almost 7800 points, The main concern at that time would have been the challenge of managing this rapid growth. The need for long term planning wouldn’t have got the due attention.
But then in early 2011 the growth came to a halt and the market started going through a correction. This then turned into a market decline which continued for almost 18 months bringing the ASPI as low as 4,700 points.
This was the time that the industry approached His Excellency, President Mahinda Rajapaksa, seeking his personal intervention to restore the market. It is this request that prompted. His Excellency to make changes to the hierarchy of the SEC. President Mahinda Rajapaksa gave a fresh mandate to the Commission in August 2012, not only to put the market back on track but also to align the capital market with the economic development strategy of the government.
The restructured Securities and Exchange Commission diverted most of its energy to formulate a long term strategy. We consulted the key stakeholders of the industry and obtained their views. We studied frontier and emerging markets in other parts of the world. We also revisited the proposals that had been made by the Mackenzie consultants to the CSE sometimes back. The final outcome of these deliberations was a 10 point capital market development road map which was unveiled jointly by SEC and CSE in November 2012.
When we unveiled the capital market development road map, the market cap to GDP ratio was less than 30%. So we agreed that our first target should be reaching a market cap to GDP ratio of 50% possibly by end 2016. This was indeed a very ambitious target given our GDP was also growing at around 7.5% per year. We had already lost time. We were 3 ½ years behind, to kick start the engine as far as capital market was concerned.
The 10 point market development road map actually covered 7 areas of importance. We appointed 10 teams representing both SEC and CSE to take responsibility for each project. Each team included two SEC Commission Members and two Directors of CSE. These teams were responsible for setting the objectives under each project, developing the respective strategies and following up on the implementation.
Despite the 18 month setback during 2011-2012 period, the capital market of Sri Lanka has made significant progress during the post war era. Let us just consider the December 2014 figures and compare them with 2009:
• The main Price Index ASPI has gone up by 255%
• Market Capitalization has grown by 535%
• Rs 97 Bn net foreign inflow in 3 years
• The average daily turnover has gone up by 205%
• Corporate Debt market has appreciated by 6,390%.
• Capital raised during the last 3 years, Rs 178 Bn
• The market capitalization to GDP has increased from 11% to 36%
So we must have done some thing right !.
Let us see what has been the journey since we unveiled our 10 point capital market development road map in November 2009.
One thing we got right this time was clearly understanding and accepting that the SEC has a dual mandate according to the SEC Act. One, to protect the investors, the other to develop the market. Both needed equal attention.
A lot has been accomplished from a regulatory perspective during this period.
We were able to replace the culture of implementing ad-hoc policies with a culture of seeking long-term solutions. We introduced a series of new regulations over the last two years to bridge the gaps we found in our regulatory framework to ensure greater protection of investors whilst creating a fair and transparent market. Some of the new regulations introduced are; streamlining disclosure requirements on related party transactions and directors dealings. re-instatement of Introduction as a listing mechanism with enhanced Investor Protection, Lock in period for pre IPO private placements,, enhanced disclosures on the IPO mechanism inclusive of independent valuer’s opinion, introduction of a panel of valuers for transparent financial reporting purposes, Introducing minimum free-float requirement of 20% for all listed companies by 2016, altering the corporate debt market tick size to address prevailing market dynamics, widening the public shareholder participation by increasing the minimum number of public shareholder requirement for Diri Savi Board at the time of listing, increasing the minimum number of unit holders for unit trust funds, finalizing the SEC Act amendments, finalizing the drafting of Demutualization Act provisions, completion of the revisions to the Takeovers and Mergers Code which is currently at public consultations and launching of two company director training courses to name a few.
From market development perspective also a lot has been achieved. For example; enhancing global visibility via road shows in Mumbai, Dubai, Singapore, Hong Kong, London and New-York, Tax concessions for unit trust industry and newly listed companies, impetus for developing the corporate bonds market through removal of withholding tax, creating an enabling environment for primary dealers to trade corporate debt, introduction of a fundamentally driven S&P SL 20 index with a global focus, a ready to implement BOI Board to support foreign direct investments, continuous emphasis on investor education and market awareness activities, marketing support for the unit trust industry and most importantly the timely execution of the 10 point market development road map it self.
We have already begun to see the positive results of these initiatives. Over the last two years the All Share Price Index of Colombo Stock Exchange has been growing steadily. It is a realistic and sustainable growth. We are in control of the market with up-to-date surveillance support and we can very confidently assure the investing public that 2009-2011 scenario cannot get repeated.
By 2014, both the ASPI and S&PSL20 indices are back on track. They have been indicating good returns to the investors. As a result of our focused off-shore promotional activities during the last two years in HK, Singapore, India, Dubai, UK and USA, we are now on the radar of many global fund managers. Net foreign inflow to the market is now in the positive territory. Our average market returns are ahead of most of our regional counter parts. The ASPI has once again begun to out perform MSCI Emerging & MSCI Frontier indices
With that review of the past and the present ladies and gentlemen, it is time now for us to discuss the future.
The question now is how do we migrate from current frontier market status to an emerging market status ? This should happen sooner than later for us to be a recognized player in the global arena .
The future we envision for 2020 is a capital market , global in scale, possessing a multi asset class, multi product based, equipped with a risk management system on par with the most advanced markets and comfortably placed within the emerging market sphere.
We have some key targets for that market.
We would like to see our market capitalization reaching USD 100 Bn by 2020. Quite ambitious given our market capitalization as at end 2014 was only USD 24 Bn and 36% of the GDP. Since the Central Bank is predicting a USD 150 Bn economy by that time, USD 100 bn market capitalization would mean a market cap to GDP ratio of about 66%. Apart from this we would also like to see our corporate debt market growing to about USD 20 Bn by 2020. We also like to see at least 33% of the working population of the country involved directly or indirectly in the capital market.
Please remember that no one is forcing us these targets. We do so only because we like all of you in this industry to grow and prosper. By 2020 we like to each company in this industry to grow at least 4 times and our wish is to support you. Yes, these targets are ambitious. But we believe that we need to aim high and work harder with absolute commitment if we are to compensate for the time this country has lost due to the 30 year long conflict.
In the present scenario we have a narrow market with a linear Product line comprising equities, warrants and debentures. But the market we envisage by the year 2020 will be a broad based Capital Market. We like to see greater market participation of both local and foreign investors. A noticeable component of the daily turnover should be generated by retail investors. Unit Trusts companies should be migrating to mutual fund status. We like to see a good mix of large corporate as well as SME companies listed.
We also like to see a significant improvement in our risk management systems. A CCP equipped with multi asset class & multi currency capabilities along with advance broker back office systems in operation. These improvements to the risk management systems will help us introducing more sophisticated financial instruments such as Derivatives, Futures, Options etc to the market.
We have completed most of the tasks in the 3 year capital market development road map. It is fair to say that almost everything which was totally within the control of SEC has been completed. But there are a few critical structural upgrades which cannot be handled alone by SEC. We need the involvement of other institutes such as the Ministry of Finance, Central Bank, CSE etc to complete them. However considering the complexities involved we have allocated more time for these activities in the project planning stage. Yet there are a few things we could have finished earlier. One such example is the amendments to the SEC Act which was drafted and handed over to the ministry of finance in July 2013. A special committee has been reviewing our proposals since then. We hope once this election period is over this committee will complete its work and the new amendments will be presented to the parliament. These amendments are essential for the capital market of Sri Lanka to move on to the next phase of development. Some of the key improvements expected through these amendments involve; enhanced investor protection, aligning SEC governance principles with IOSCO standards, facilitating of compensation to investors through disgorgement, regulation of a demutualized exchanges , implementation and regulation of a CCP and the introduction of civil and administrative sanctions strengthening the ability of SEC to take enforcement action.
Another important structural upgrade that is scheduled to commence in 2015 is demutualization of the CSE. Following the global trend that started with the demutualization of Stockholm Stock Exchange in 1993, most of our regional counterparts have already demutualized their respective exchanges. For example, Singapore demutualised its Stock Exchange in 1999 followed by Hong Kong in 2000, Philippines in 2001, Malaysia in 2004, India in 2007, Pakistan in 2012 and Bangladesh in 2013. Both Asian and International experiences show that after demutualization, the market capitalization, turnover, and products and services offered by Exchanges have greatly increased to the benefit of all stakeholders. Brokers have benefited from demutualization through higher commission earned on increased trading volumes, and also by making capital gains on the shares they received as a result of demutualization. It is very important that no one should misinterpret demutualization as privatization. The current Stock Exchange is not owned by the government. It is a company limited by guarantee with some broker companies as members. Through demutualization we are actually broad basing the ownership which will serve the interest of all stakeholders. There is also an opportunity for the CSE to seek a strategic partner if required. Right strategic partner could provide technical expertise and bring greater recognition to the Exchange. They can also play a key role in attracting reputed international funds to invest in our market.
The third structural upgrade still pending is the implementation of a CCP for enhanced risk management. The establishment of a CCP would address the counterparty risk and the asset commitment risk prevalent in the market currently. It is the lack of a CCP or DVP which has limited us to basic linear product range comprising only equity, warrants and debentures. With the implementation of the CCP we can introduce more sophisticated financial instruments to this products range. This would reflect the CSE well in terms of evaluation parameters established by foreign investors and also enable the launching of new products in the capital market. But remember, you as industry stakeholder also have a responsibility to start training your staff. The skills that will be required in ear future will be far more advanced than what is required today.
As part of our 10 point initiatives, the central bank, CSE and SEC have been working together for almost 6 months on the implementation of a CCP and we have made considerable progress. We have a steering committee comprising the heads of the three institutes namely; the Central Bank, CSE and SEC. We also have a working group with representatives from the three institutes. Over the last 6 months this committee called for Expressions of Interest and completed an evaluation process to identify a team of consultants who could assist CSE in the implementation of a CCP. Now we have finalized this process and CSE has already entered into contract with the selected party. The work is due to begin in January 2015 and the estimated duration for full implementation would be around18 months. CCP once implemented will be owned and managed by CSE.
Once these major structural upgrades are in place we will be on par with any another sophisticated capital market in the world. We request the assistance of all involved to expedite the pending matters. Some of these pending matters are interlinked. For example further delay in finalizing the SEC Act amendments will delay the implementation of CCP and also the demutualization of CSE.
Finally, we come to the most interesting part. How are we hoping to reach the USD 100 Bn market capitalization target?
Given the current growth rate of the economy and considering the performance of various industries, it is reasonable to estimate that the organic growth of the existing market will increase the market capitalization to USD 55 Bn by 2020. Our current market capitalization is around USD 24 Bn. The assumption is that the market value will more than double during the next 6 years.
With market performing better and with increasing appetite from both local and foreign investors, we expect more companies to consider listing as a means of raising capital. We are hoping to see about USD 7,5 bn being raised through the capital market over the next six years which will add another USD 30 Bn to the market capitalization.
We expect not only private sector companies but also some state owned enterprises to be listed during this period. For example according to the requirements of the Insurance Act , the Sri Lanka Insurance Corporation needs to be listed by 2016. There are several other entities which are also being considered for listing. But we must accept the reality that not all SOEs could be listed because many have a social role to perform within the overall economy. Such institutes must always be under 100% government ownership as they cannot be profit oriented. However, there are several commercial ventures that belong to government which are in direct competition with the private sector. If we genuinely believe in a free market economy, any commercial ventures owned by government should compete with the private sector on a level playing field. Also the general public has a right to know what is happening inside these organizations and how effectively they are managed. This is where listing could become quite meaningful. One must understand that listing an SOE is doesn’t mean privatization. Privatization means handing over of the majority ownership and the management of an SOE to the private sector. Listing has no such prerequisite. The public float requirement of a Main Board company is only 20%. For Diri Savi Board it is only 10%. Therefore an SOE can be listed by releasing only 10% -25% of shares to the market. By doing so government doesn’t lose control of the listed SOE . But on the other hand there are significant benefits when an SOE is listed. Firstly partial listing of commercially oriented SOEs will help these entities to raise additional capital required for their expansions without burdening the treasury. Secondly it will help the growth of the share market whilst allowing the investing public to benefit directly from the enhanced value creation of these SOEs. Thirdly, corporate governance within these SOEs will improve significantly as their managements will be subject to the stringent discloser requirements of the capital market.
With the CCP in place by mid 2016 we will be in position to introduce more sophisticated financial instruments to the market. Some structured products such as REITS will be introduced even before that. Industry must start training its staff now to get ready for this wider product portfolio. We estimate another USD 10 Bn to be added to the market capitalization through structured products.
Finally we are left with another USD 5 Bn gap which we hope to bridge by opening the CSE for cross border listings. This also means that before 2020 Central Banks should agree to liberalize the capital account, at least partially. With the improvements in our export sector and tourism, with the growth of foreign remittances, with the increased foreign investor interest in the capital market and with growing FDIs, our reserve position will continue to grow making it easier for the Central Bank to liberalize the capital account sooner than later. This is a must if we aspire to be a financial hub.
If we can introduce a Foreign Currency Board it is highly possible that we will be able to attract some foreign listings particularly from regional countries. Today, Indian, Pakistan, Maldivian and Bangladeshi companies are going to Mauritius , Singapore or Hong Kong to List their companies and raise capital. We can attract some of these companies. Once we demutualise the CSE, a strategic partner with international repute could also enhance these possibilities. All we need is continued political and economic stability in the country.
Ladies and Gentlemen, this is broadly our vision for 2020. One could view this as an ambitious plan. It is true that a lot has to be done if we are to achieve these targets within the given time frame. But with the commitment and support from everybody, particularly from those at policy making levels who can help expediting the pending matters, we can achieve this vision. By working together, we can make the capital market of Sri Lanka a true contributor to the national economy.
Thank you and good luck !