How To Get More Of It

High road to market capitalisation

Dr. Mirza Azizul Islam

The expression “capital market” is frequently used interchangeably with securities market. This article also follows the widely practised convention. The development of capital market has been receiving heightened attention from the policy-makers in recent years. One explanation lies in the fundamental shift of development strategy reflected in the nearly universal embrace of the private sector as an engine of economic growth. The governments in both developed and developing countries, the international financial institutions which exert tremendous influence on the policy-making apparatus of developing countries and, to a great extent, the intelligentsia have all joined together as ardent advocates of private entrepreneurship. Capital market can play an important role in accelerating economic development through efficient intermediation of savings into productive investments and in fostering the growth of private entrepreneurship.

Capital market and economic development
As elsewhere, capital market of Bangladesh consists of two interdependent segments, the primary market and the secondary market. The primary market is the channel for issuing new securities. These securities can be issued by public limited companies or government agencies through public issue or through private placement. If members of the public can freely apply for subscription to a security, it is a public issue. If the security is available to a selected group of subscribers, the issue is termed private placement. From the point of view of public interest, it is the public issue that is of primary concern. In the remainder of the paper, therefore, any reference to the primary market is limited to public issue.

The new securities issued in the primary market are subsequently traded in the secondary market after listing with the stock exchanges. There are two stock exchanges in Bangladesh, located in Dhaka and Chittagong. Many of the securities traded in the secondary segment are listed on both stock exchanges. There are, however, quite a few which are not listed with Chittagong stock exchange. As of June 2005, 277 securities were listed with Dhaka stock exchange, the corresponding number in Chittagong was 198.

Both primary and secondary markets contribute to the growth of private entrepreneurship. The primary market does so by enabling entrepreneurs to raise funds from surplus savers and thus finance investments in a cost-effective manner. An entrepreneur with a viable new investment or an expansion proposal, but unable to finance it out of his own resources, can issue securities to meet the required deficit. In Bangladesh, the most frequently issued and traded security is in the form of shares which allow virtually cost-free access to investible resources. The shares have the added advantage that they do not create fixed charges for the company issuing them irrespective of business conditions and thus provide a better option than, say, financing through bank loans. However, share issues generally entail greater accountability to the regulatory authorities and also to those who invest in shares. Moreover, there is a dilution of ownership because shareholders who were not associated with the initial establishment of the company become part-owners of the company through acquisition of shares from the primary and / or secondary market.

A vibrant secondary market also contributes to economic growth in several ways. If the company is well-managed and the secondary market prices are higher than face value, subsequent rights share issues can fetch premium. The company can thus finance its expansion plans in a cost-efficient manner, as is the case with initial public offering. The secondary market provides an exit option for the original founders and can these lead to restructuring of ownership and management of the company and thereby higher productivity. Besides, the secondary market enables shareholders, including many small investors, to adjust their portfolios in consonance with their preferences and assessments of risks, returns and liquidity. Such portfolio adjustments, in turn, facilitate more efficient deployment of savings.

The regulatory scenario
The development of a healthy and vibrant capital market requires, among others, the following :
(a) That the prospectus or the offer document for issuance of securities contains comprehensive information disclosure, including those relating to the financial health of the company so that investors are not misled in their investment decisions;

(b) That the issuers comply with regulatory requirements administered by Securities and Exchange Commission (SEC), including those relating to holding annual general meetings and audit of accounts as well as by other regulatory authorities such as Bangladesh Bank, Registrar of Joint Stock Companies, Controller of Insurance in so far as these impinge upon investors' interests;

(c) That all capital market intermediaries comply with regulatory requirements administered by SEC. The market intermediaries include stock exchanges; stock brokers and dealers; merchant bankers who perform security issue management, underwriting and portfolio management functions; central depository system; depository participants most of whom are stock brokers as well (but there are a few non broker depository participants also) and mutual funds managers.

There are a host of laws, rules, regulations and administrative orders to enable the SEC to meet the above requirements in Bangladesh. Broadly speaking, the regulatory framework designed by SEC is primarily intended to ensure equitable treatment of the investors, disclosure by all market actors (the issuers, stock brokers and dealers, stock exchanges, merchant bankers and other intermediaries) and adherence to certain aspects of business ethics. SEC derives its regulatory authority from three pieces of legislation, namely, Securities and Exchange Ordinance, 1969. Securities and Exchange Commission Act, 1993; and Depository Act, 1999; as amended from time to time and various rules, regulations and administrative orders issued under them.

It is widely known that Bangladesh is riddled with extensive violations of regulatory requirements in virtually all areas of governance. Many economic agents are loath to voluntary compliance. In this overall scenario, SEC has to deal with multiple forms of violations.

As regards issuer companies, the violations usually are : (i) Default in holding annual general meetings in time (ii) Default in submission of annual audited financial statements and half yearly audited / unaudited financial statements in time (iii) Non payment or delayed payment of declared dividend or obligations against debentures (iv) Delays in transfer of shares.

As regards brokers, the violations usually involve failure to deliver shares purchased on behalf of clients and procrastination in making payments to the clients, including for sale proceeds of shares.

A long way to go

Among other market intermediaries, particular mention should be made of merchant bankers and stock exchanges. Most of the merchant banks do not exercise due diligence in issue management role. This poses a major problem in that the applications for initial public offering of securities suffer from a large number of deficiencies. Similar statements also hold with respect to rights share offer documents. In consequence, decisions are delayed with adverse implications for capital market development.

As regards the stock exchanges, one important problem relates to their responsibilities to exercise supervision over their members, mostly brokers. The inadequacy of stock exchanges in this respect partly stems from human resource limitations. The conflict of interest (arising from the fact the exchanges are owned by the very same members whose activities have to be supervised by the management) may also play a role. The real separation of ownership and management roles remains a far cry in the corporate universe of Bangladesh the lack of such separation is not unique to stock exchanges.

Occasionally other problems arise. Among these are insider trading, attempts to manipulate the market through aggressive buying or selling, inappropriate use of funds raised from the public and attempts by sponsors to grab shares offered for public subscription by using fictitious names.

Notwithstanding the above enumeration of problems which are, by no means exhaustive, it should be emphasized that the recent developments bear unmistakable signs of improvement. For example, with respect to holding annual general meetings, there were only two cases of new default during January 2004 June 2005 period and both occurred because of legal complexities. In the current year as many as 17 issuer companies held all their defaulted annual general meetings and seven more have either already declared dates or have given commitment to hold defaulted meetings by the third quarter of the year. Delayed transfer of shares has been virtually eliminated with the introduction of central depository. The incidence of complaints relating to other forms of violations by issuer companies mentioned earlier has also considerably declined. Similarly, fewer complaints have been lodged against brokers during the current year.

Recent market developments
The reduced incidence of violations has left clearly discernible mark on the revival of confidence in the capital market. Several objective indicators bear eloquent testimony to this proposition. Between July 2003 and June 2005, general share price index of Dhaka Stock Exchange more than doubled from 823 to 1727. Over the same period , market capitalization rose from Taka 71 billion to Taka 225 billion and average daily turnover from Taka 60 million to Taka 233 million.

The stellar performance of the secondary market has been helped by more rigorous screening of the proposals for initial public offering of securities by SEC. The shares of nine companies for which public subscriptions closed between 15 November 2003 and 18 May 2005 are now being traded in the secondary market. The market price of all of them is well above the initial offer price excepting in two cases. In one case, the market price as of 31 July 2005 was Tk 99.75 and in the other case, it was Tk 90.75 against the initial offer price of Taka 100 in both cases. In contrast, out of 10 immediately prior issues, the shares of as many as four companies fetched market price well below the initial offer price (ranging from under 10 per cent to 60 per cent of the offer price). The primary market has also elicited strong response from the investors with very large oversubscriptions of the nine issues noted above.

The above developments bode promising prospects for the capital market in Bangladesh. Among factors which should help in sustaining improved performance are (i) Considerable improvements in the regulatory framework (ii) Strengthened human resources in SEC (iii) Acquisition of greater skill by SEC staff in enforcing regulatory requirements through on-the job experience as well as foreign training (iv) Introduction of automated trading system by the stock exchanges (v) Operationalization of the Central Depository System which has eliminated circulation of fake shares (vi) Somewhat greater consciousness of the investors, helped partly by past experience and partly by investors' education programmes conducted by SEC and (vii) Closer collaboration and dialogue between SEC and other regulators and market actors, particularly the stock exchanges.

The way forward
Despite significant recent improvements, Bangladesh still has a long journey on the road to the development of a capital market which is comparable to other countries of the region. Some actions required in this behalf are suggested below.

A sound capital market requires depth with a wide range of products and instruments to cater to varying risk return liquidity preferences of investors and also to ensure that the adverse effects arising from disturbance in some part do not assume systemic proportions. In this regard, SEC, in collaboration with Bangladesh Bank has made long term government bonds tradable on stock exchanges. But, not much of trading has been actually taking place. SEC and Bangladesh bank need to mount joint efforts in collaboration with stock exchanges to activate trading in government bonds. Similarly, recently introduced asset-backed securities which are now being issued only on private placement basis need to be brought into the mainstream secondary market.

At the initial stages of capital market development, privatisation of state owned enterprises can make a signification contribution. In Malaysia, for example, the Privatisation Master Plan resulted in many government-linked firms being listed with Kuala Lumpur stock exchange. Seven largest firm listed with the exchange belong to this category. Government linked firms account for 34% of total market capitalisation. SEC's proposals submitted quite a while ago to the government for offloading government shares through stock exchanges, with or without full privatisation, need urgent attention.

Over the past few years, there has been a substantial expansion of the regulatory outreach of SEC. The number of issuer companies listed on the stock exchanges has increased and so has the number of market intermediaries. But the sanctioned strength of human resources required to monitor and initiate enforcement actions against breaches of regulatory provisions remains woefully inadequate. A closely related issue is the complete lack of autonomy of SEC in the creation of posts, determination of compensation structure and devising a system of rewards and incentives (including promotion beyond a certain level) to encourage a high level of performance. These problems should be expeditiously addressed by the Government.

A healthy capital market requires engagement of competent professionals by a wide range of market actors. Among the positions which require the services of people with adequate knowledge of the principles of corporate governance as well as security laws and regulations are the members of company boards, company secretaries, officials of the share departments of companies, authorised representatives of brokers, compliance officers of market intermediaries etc. Academic institutions or the professional bodies in the country do not produce enough people to fill up such positions. In so far as they are available, many of the market actors, particularly small ones, are unwilling or unable to pay requisite remuneration. SEC is in the process of examining the feasibility of setting up a capital market training institute to bridge the gap.

No regulatory agency can be fully effective in ensuring orderly development of the capital market acting on its own. Spontaneous cooperation and prompt action by other governmental agencies and professional bodies is an important prerequisite. In this regard, prompt execution of warrants of arrest by the Police, expeditious disposal of civil and criminal cases, writ petitions, injunctions and stay orders by the relevant courts, effective oversight by self-regulatory organizations such as the stock exchanges and Institute of Chartered Accounts and exercise of moral influence by professional bodies such as chambers of commerce and industry, association of bankers and merchant bankers' association merit priority consideration by all concerned.

(The views expressed in this article do not necessarily reflect those of the Commission.)

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The author is a former Director of UNESCAP, Bangkok and presently chairman, Securities and Exchange Commission of Bangladesh.