Inside
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The Case for a New Regulatory Framework
RASHAD HAQUE examines the problems, solutions and prospects of capital markets in Bangladesh.
After much dilly-dallying, it was indeed good to see the much awaited appointment of a new Securities and Exchange Commission (SEC) head. The market obviously reacted very positively to it and pushed the indices up 200 points thereafter. However, we should be cautious that unless the new head takes measures to reorganise the organisation to bring more transparency and competency to the SEC, whatever confidence resulted from his appointment will be very short lived.
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AMRAN HOSSAIN |
The market probe committee, which highlighted many scenarios and cases studies that highlights the disregard for the regulations by some key market participants and in some cases just gaping holes in the current regulations should be commended for delivering findings within the stipulated time. It was unfortunate however that the finance ministry itself was not very forthright in releasing the findings of its own mandated report. Even some actions that resulted in dismissal of some alleged honest members of SEC as reported by some daily newspapers were contrary to the spirit of the findings of the probe report. To many observers, it would not be capricious to question “whose interest do the administration and finance ministry serve?”
Despite all the missteps and dilly-dallying, I hope good sense will prevail and the administration with the new SEC head takes the necessary steps to restructure the regulatory body to one that actually works to serve the interest of the investors. Additionally, with foreseeable uptick in capital markets activities, I think further thought should be given to set up a new regulatory framework since it's clear that the current framework is not very effective.
Securities Exchange Commission:
The following is the opening exerpt from the US Securities and Exchange Commission:
“The mission of the US Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”
And the following is from the Bangladesh Securities and Exchange Commission:
“The Securities and Exchange Commission (SEC) was established on 8th June, 1993 under the Securities and Exchange Commission Act, 1993. The Chairman and Members of the Commission are appointed by the government and have overall responsibility to administer securities legislation. The Commission is a statutory body and attached to the Ministry of Finance.”
Mission of the SEC is to:
* Protect the interests of securities investors.
* Develop and maintain fair, transparent and efficient securities markets.
* Ensure proper issuance of securities and compliance with securities laws.
* Members perform the following functions:
* Serve as the members of the Commission and supervise its management.
* Provide policy direction to industry and staff and promulgate legally binding rules.
* Act as an administrative tribunal for decisions on the capital market.
A further reading of the responsibilities
1. Regulating the business of the Stock Exchanges or any other securities market.
2. Registering and regulating the business of stock-brokers, sub-brokers, share transfer agents, merchant bankers and managers of issues, trustee of trust deeds, registrar of an issue, underwriters, portfolio managers, investment advisers and other intermediaries in the securities market.
3. Registering, monitoring and regulating of collective investment scheme including all forms of mutual funds.
4. Monitoring and regulating all authorised self regulatory organisations in the securities market.
5. Prohibiting fraudulent and unfair trade practices relating to securities trading in any securities market.
6. Promoting investors' education and providing training for intermediaries of the securities market.
7. Prohibiting insider trading in securities.
8. Regulating the substantial acquisition of shares and take-over of companies.
9. Undertaking investigation and inspection, inquiries and audit of any issuer or dealer of securities, the Stock Exchanges and intermediaries and any self regulatory organisation in the securities market.
10. Conducting research and publishing information.
Bangladesh Securities Exchange Commission remains bewildered by its goals and responsibilities. With so many responsibilities which include regulating the exchanges, regulating the business of stock-brokers, sub-brokers, share transfer agents, merchant bankers and managers of issues, trustee of trust deeds, registrar of an issue, underwriters, portfolio managers, investment advisers and other intermediaries in the securities markets, registering, monitoring and regulating collective investment scheme including all forms of mutual funds, monitoring market activities, setting policy directions etc., one has to wonder what kind of priority is given to protecting investors interest.
While all of the above is necessary, I believe that some of the burden of responsibilities should be transferred to another regulatory entity.
I propose setting up a new regulatory entity; Financial Regulatory Authority (FRA). SEC's main responsibility is and should always be to protect the interest of the investors.
Financial Regulatory Authority (FRA):
I believe this separate regulatory body, Financial Regulatory Authority (FRA) to bring the Exchanges and Financial Institutions under a new regulatory framework in the medium term is needed in light of failure of the SEC and supervisory role of Bangladesh Bank to monitor the bank's exposure in the capital markets throughout much of 2009 and 2010, all of which contributed to the sorry state of affairs that we are in.
The Exchange and the various banks and brokerage houses were great beneficiaries of the recent boom in the markets and they need to share more responsibility as stakeholders. Many banks and financial institutions made hefty profit both as direct market investors while also making commission of retail investors through their brokerage houses. However, they cannot absolve themselves of their responsibility for many of the manipulations cases presented in the market probe report. Much of the manipulation happened through trading accounts within their brokerage houses. Though they might not have known what was happening,as an intermediary in the marketplace, it was certainly their responsibility to know their customers and their dealings. Collecting detailed background information on each customer to “Know your customer -- KYC” to ensure there is no potential conflict of interest in their trading is clearly a responsibility of the brokerage houses. Failure to do so should have adverse consequences. Additionally, the brokerage houses themselves should take greater responsibility for educating the retail investors as they are the direct intermediary between the market and investors
As a starting point, the FRA should:
1. Regulate the business of the Stock Exchanges or any other securities markets.
2. Register and regulate the business of stock-brokers, sub-brokers, share transfer agents, merchant bankers and managers of issues, trustee of trust deeds, registrar of an issue, underwriters, portfolio managers, investment advisers and other intermediaries in the securities market.
3. Registering, monitoring and regulating collective investment scheme including all forms of mutual funds.
4. Monitoring and regulating all authorised self regulatory organisations in the securities market.
5. Regulate IPO and private placement activities to ensure fairness and transparency in the process.
6. Mandate minimum investors education courses to all existing and new investors to the market by the brokerage houses and investors sign off confirmation to ensure investors understand risk associated with investments, margin loans, etc.
7. Perform periodic review of brokerage transactions to check for anomalies.
The FRA can also serve as a buffer between SEC and the Central Bank. As shown by the Central Bank's inability to provide sufficient monitoring investment activities of banks, BB clearly lacks the manpower to do it properly. Additionally, putting the onus on the Central Bank to monitor the activities of financial institutions in capital markets can distract it from its main goal of setting monetary policies. But a closer eye on the capital markets of the financial institutions is a must for the central bank and monthly data collected by the FRA can serve that future oversight to mitigate any untoward incidents.
I also believe some of the recent abuse by individuals and financial services organisations in Bangladesh such as artificial swelling of Stock Prices can be tackled with proper oversight from such an organisation as the FRA. If the Bangladesh capital market is to propose longer term, proper regulatory oversight of the Financial Institutions to ensure fairness is a must. One should be conscious however that in order to make this self regulatory organisation effective, there must a clear distinction and coordination with other regulatory bodies such as the SEC and the Central Banks. Also, however well thought out a framework, it's nothing without competent and genuine leadership and workforce to make it effective. The framework recommended is no exception.
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AMRAN HOSSAIN |
Investor Rights and Judiciary:
While SEC itself remains institutionally inept and also inconsistent and often arbitrary in its policy making, there is also lack of recourse for investors to pursue their case of any exploitation through the current legal system since the judiciary is backlogged with years' worth of cases to be considered. And even if a gripping investor is lucky enough to have his day in court then the fellow would have to contend with undue influence from outside the ruling party members or other influential people. Though these types of cases are pretty much nonexistent, it's more than likely the defendants in these cases are always individuals or companies with powerful connections. Unfortunately, this major systematic flaw of the judiciary is not only a hindrance to development of the capital market but development of Bangladesh as a whole.
While economists and everyone else discussing infrastructural deficiencies in Bangladesh mainly focus on hard infrastructure (roads, transportations, electricity, etc.) weakness of Bangladesh, the soft infrastructure (Judiciary, ACC and other independent oversight organisations) is just as important a deterrence to foreign investments. Time and again successive administration have come to power and actually weakened the soft infrastructure, case in point is the recent “reform” of the Anti Corruption Commissions despite common citizen's aspirations.
This institutional weakness is one of the main reasons foreign investors are hesitant to put their money into the Bangladesh bourses. One cannot blame the private investors for such hesitation, since Bangladesh has the dubious distinction of consistently being labeled as one of the most corrupt countries in the world. So for the immediate future Dhaka Stock Exchange will stay a mostly local affair, unlike the exchanges in our neighborhood. India, Sri Lanka, and even Pakistan to some extent continue to greatly benefit from foreign investments in their capital markets. If the government is serious about protecting investors and the further developing the capital market then an avenue for investors to protect their interest outside of SEC oversight is a must. A serious display of commitment can be shown in the form of perhaps a separate court that deals with corporate and securities litigation so cases can be disposed off in timely manner.
Despite all the prevailing gloom and doom, I am hopeful market regulators and stakeholders will take the necessary steps to protect the market from any untoward situation. It benefits no one when confidence in the market mechanism is destroyed while ensuring confidence and fairness will benefit everyone when a prospering market will be looked at as an investment destination by foreign investors. However, corrections along the way are inevitable as market prices will adjust to reflect its true value from time to time.
Bangladesh is counted among the next frontier (pre-emerging) markets in Goldman Sachs Next 11 countries that can potentially rival the BRICS (Brazil, Russia, India, China, and South Africa) in economic growth. Bangladesh is also part of the JP Morgan Chase's frontier five market countries. These are great recognitions and a vote of confidence from two of the most distinguished investment banks that combined to manage over a trillion dollars of asset under management. That's more than 10 times the whole GDP output of Bangladesh. I am confident that the prospect of them investing some of the trillion dollar under management in Bangladesh is not so far away as the market becomes more mature and market cap increases. We must work hard to sustain that confidence by taking all the necessary steps along the way to ensure that when the time is right, foreign investors will look at our market as one of the main destinations where they can invest their money.
Rashad Haque is a management consultant serving the financial services industry in New York. He can be reached at Rashad.Haque@gmail.com or http://www.linkedin.com/in/rashadhaque.