DIRECTOR GENERAL’S REVIEW 2021
It is with much satisfaction that I review the work undertaken by the Securities and Exchange Commission of Sri Lanka (SEC) in the year 2021.
THE MARKET IN BRIEF
Looking back at the year 2021, it could be said without doubt that it has been a year of extraordinary sucess for the securities market of the country. Let me begin by saying that the All Share Price Index (ASPI) witnessed a significant growth of over eighty per centum (80%) in comparison to the year 2020. The growth signified by the ASPI has been the highest growth rate witnessed since 2011. The same could be said about the S&P SL 20 index which indicated a growth rate of over sixty per centum (60%). All of this growth led to the Colombo Stock Exchange (CSE) being recognised as the second best performing market in the world. To add to this, the daily average turnover of the country’s securities market amounted to Rs. 4.8 billion in comparison to Rs. 1.8 billion recorded in the preceding year. The two fold increase in the daily average turnover could be attributed to both the new CDS account openings which took place in the market as a result of the digitalisation initiative carried out by the CSE together with the SEC and the renewed interest shown by local investors in the securities market.
Furthermore, Exchange Market capitalisation as a percentage of GDP surpassed thirty five per centum (35%) for the first time in the past ten years thus signifying the contribution made by the securities market to the country’s economy. Due to the increase in the daily average turnover levels of the market, the turnover to market capitalisation grew upto forty per centum (40%) in comparison to the sixteen per centum (16%) recorded in the year 2020. The rapid increase in activity levels could be largely attributed to local investor contributions which approximately amounted to ninety five per centum (95%).
As you may be aware, capital markets play a pivotal role in ensuring that issuers meet their fund raising requirements. As such, the year 2021 witnessed a rapid increase in Initial Public Offerings (IPOs) in the equity market which amounted to thirteen (13). Such a surge in equity IPOs was last seen in the year 2011. The surge in equity IPOs was a result of the proactive role played by the SEC by introducing several proposals to the Government Budget such as the proposal to grant a fifty per centum (50%) tax concession for local companies which are to be listed on the CSE before 31st December 2021 and the introduction of the corporate tax rate of fourteen per centum (14) for the subsequent three years for such companies. All of these resulted in equity IPOs raising over Rs. 12.7 billion from the market. It is not only the equity market but also the debt market which contributed to the raising of capital via debt IPOs amounting to over Rs. 84 billion for the year under consideration. Over the past year, we have witnessed an increased interest shown by small and mediumentrepreneurs to utilise the Empower Board. With all of these statistics indicating a growth mindset, the market also witnessed a foreign net outflow, the negative impacts of which were mitigated by the role played by local investorswho stepped upto the occasion. Upon examination of the market, one cannot disregard the positive influence of the low interest rates prevalent in the economy on the market and its performance.
However, as I write this review, the country is facing renewed economic and social pressure, which is amply reflected in the market. To live up to the challenge and overcome this financial and economic predicament, it is critically important to understand what needs to be done and take swift and drastic action to make them happen. Yet, it is important to stress that the country’s stock market alongside the listed companies have returned record growth last year despite the uncertainty. In fact, the uncertainty in the ongoing turbulent economic condition can be an opportunity for the country to push forward policies that will revitalize the private sector. This will enable the country to build back better with stronger measures to attract much needed foreign investments.
Therefore, once again the stock market has a critical role to play to boost the economy and to raise capital to revitalize the private sector. Thus, it is the time to pick the winners from our dollar earning listed companies by looking at their potential, drive and commitment. Secondly, we need to incentivize and nurture such winners. Thirdly, we need to free such winning companies to go out and compete with global giants to make headway in economic development, which would change the whole complexion of our country; it will convert us to a dynamic entrepreneurial state and will help the country to realize its true potential. Therefore, SEC can no longer be restricted to its traditional role of market regulation and take the conventional approach to boost the confidence of investors.
In this backdrop, I consider it an honour to recount in the following parts of this review, the successes of the SEC achieved in extraordinary circumstances.
THE ENACTMENT OF THE SECURITIES AND EXCHANGE COMMISSION OF SRI LANKA ACT, NO. 19 OF 2021: A PARADIGM SHIFT
On 21st September 2021, the much awaited Securities and Exchange Commission of Sri Lanka Act, No. 19 of 2021 (SEC Act) came into force after being certified by the Speaker. By it, the Securities and Exchange Commission Act, No. 36 of 1987 was repealed and replaced.With the enactment of the SEC Act, the SEC enables effective regulation aimed at achieving efficiency, predictability and consistency in regulation and market development. The SEC Act is futuristic. It envisages developments in keeping with those of other developed markets. The regulatory regime brought about by the SEC Act provides greater clarity in terms of the law applicable to the market and is inclusive of numerous salient features.
Amongst the numerous infrastructural reforms, the establishment of a Central Counterparty System (CCP) intended to mitigate counterparty risks is key, and the enabling provisions provide for better risk management in the securities market. The progressive provisions in the Act such as those that enable structured borrowing and lending, regulated short selling mechanisms would undoubtedly cater to the much needed liquidity requirements in the market. Additionally, the Act would enable the introduction of a vast array of new products to the securities market. For instance, the introduction of Market Makers would ensure that the market has adequate levels of liquidity.
I believe that you all are already aware of the salient features of the SEC Act given that there has been a great amount of discussion revolving around it. However, it would be remiss on the part of this review if I do not briefly touch upon some of its key features in addition to what has been said above. The SEC Act comprising of VII parts among others provide for market intermediaries which now include several new categories, market institutions and supplementary service providers whilst it also provides for an enforcement mechanism that enables criminal offences to be dealt with differently in comparison to the previous Act. Why I say this is because now, the law embodies all offences whilst the conduct that would amount to an offence have been spelt out with clarity. The exceptions and defenses available too have been specifically stated, thus taking away any ambiguity that prevails at present. All offences categorized as ‘Prohibited Conduct’ (false trading and market rigging, stock market manipulation, false or misleading statements, fraudulently inducing persons to deal in securities, use of manipulative and deceptive devices) and ‘Insider Trading’ are now to be tried by the High Court. As per the provisions of the Act, a person convicted of such an offence is liable to a fine no less than 10 million Rupees or to imprisonment for a term not exceeding 10 years or to both such fine and imprisonment.
Having said this, it is pertinent to note that the Act also enables the imposition of civil remedies in the Commercial High Court to recover damages or to seek the imposition of a penalty. Such proceedings could be instituted against a person who has committed a contravention under the part titled ‘Market Misconduct’. This being said, it is of utmost importance to keep in mind that the decision of the Commission to institute such proceedings ultimately depends on the prerequisites set out in the Act itself, i.e., ‘the nature and manner of the contravention, the impact it has on the market and the extent of the loss caused to any investor’.
Another noteworthy feature that has been provided for by the Act is the power conferred on the Commission to impose ‘Administrative Sanctions’. Thus, the Commission has now been given the discretion to impose a wide array of administrative sanctions that can be imposed on any person, once again depending on the nature and manner of the contravention, the impact it has on the market and the extent of the loss caused to any investor’. To add to the above, the Commission has also been vested with the power to protect assets of investors by issuing freezing orders valid for a period of seven days subject to the subsequent confirmation of court during the course of conducting investigations or an inquiry and the power to apply to court seeking certain orders in situations of imminent violations (for a declaration that a securities transaction is void, directing a person to dispose of any securities etc.)
The new law facilitates different risk return profiles for investors. For example, the introduction of accredited investors would enable issuers to issue high risk securities while allowing investors who are able to bear higher risks to reap the benefits of such issuances. The introduction of provisions relating to whistle blowers is also worthy of attention as it would act as a safeguard to those who come out with information capable of shedding light on market offences. By this, what would ultimately be achieved is the smooth application of the present law.
STATE OF THE ART INFRASTRUCTURE FOR AN EFFICIENT AND RELIABLE MARKET
The introduction of the Delivery vs. Payment System (DVP) would enhance the risk management framework of the depository. The mitigation of asset commitment risk via the DVP would result in the growth of investor confidence in the market. It is with much satisfaction that I say that the establishment of the DVP would result in the country’s securities market fulfilling one aspect/requirement unique to emerging markets. In order to venture beyond, the SEC together with the CSE formed a joint committee to facilitate the establishment of the Central Counterparty (CCP) System. Significant headway has been made with this initiative and it is my belief that the establishment of the CCP would come to fruition in the near future.
The introduction of the multi-currency board which allows local companies to meet their funding requirements by issuing foreign denominated securities would allow those companies which have a significant exposure to export/import businesses to hedge their currency related risks. Given the current situation “Another noteworthy feature that has been provided for by the Act is the power conferred on the Commission to impose ‘Administrative Sanctions’. Thus, the Commission has now been given the discretion to impose a wide array of administrative sanctions that can be imposed on any person, once again depending on the nature and manner of the contravention, the impact it has on the market and the extent of the loss caused to any investor.”
The finalization of a policy structure pertaining to Repurchase Agreement Transactions on corporate debt securities through an Over The Counter (OTC) platform of the CSE would provide a wider choice to investors in making their investments. Moreover, it is with much pleasure and satisfaction that I state that the expansion of the listing framework applicable to IPOs has become fruitful as we witnessed a wide array of companies with diversified business interests being listed.
MOVING FORWARD WITH END-TO- END DIGITALISATION
Moving onto the subject of digitalization, during the year under consideration,the joint committee appointed by the Chairman of the SEC under the direction of the Commission Members Messrs. Naresh Abeysekere and Manil Jayasinghe have taken steps to revolutionize the market and the CSE has gained significant headway in terms of end-to- end operations of the CSE. I say this because we have now reached the third phase having completed phase two, which led to the introduction of the CSE mobile application to open new accounts for local companies, CDS e-connect and e-Initial Public Offerings. Furthermore, Chat Bot and Google Assistant intended to enhance investor experience were also introduced under phase two. I believe that these initiatives would enhance the accessibility of the market given the ease by which an investor would be able to invest in securities.
Under phase three of the digitalization initiative, it is envisaged that the CSE mobile app would enable foreign individuals and companies open to investing in the country to open CDS accounts devoid of any inconvenience via the app. Further to what I have said before, let me expand on some of the other features which are to be introduced
under phase three. They are e-rights issue, e-repurchase/mandatory offer, margin trading (seamless transfer of funds between asset classes) etc.
AN ARRAY OF CHOICES FOR INVESTORS AND ISSUERS
It is well known that the Sri Lankan investor in general gives much value to gold and real estate. In recent times, the Commission granted in-principle approval to facilitate the trading of paper gold through the CSE’s OTC platform. Currently, the framework to implement this initiative is being formulated by the CSE and the intention behind this initiative is the generation of a source of income to investors while simultaneously acting as a new source of revenue for the country.
The SEC by way of Gazette published the Rules on Real Estate Investment Trusts (REITs) giving it the force of law. As a result, stakeholders have been given yet another opportunity to make most of this investment avenue. Expanding on the Unit Trust Code of 2011, the Collective Investment Schemes Code (CIS) is being drafted to provide for a wider array of schemes such as Exchange Traded Funds, Hedge Funds etc. Once again, investors and issuers would be able to reap the benefits of the numerous investment avenues which would come into being upon the Code’s enactment.
Special Purpose Acquisition Companies (SPACs), a policy framework intended to enhance new listings in the market was launched by the SEC in consultation with the CSE and other stakeholders. At present, the CSE is in the process of formulating the regulatory policy required by it.
With the objective of increasing capital raising avenues for small and medium enterprises and for start-ups via the capital market, the Commission has granted in-principle approval for equity crowd funding platforms. Technical assistance required for this initiative is being provided by the Asian Development Bank (ADB). These platform providers are capable of being recognized by the SEC as market operators and as such, rules will be drafted to facilitate such entities.
In order to achieve sustainability and drive the nation towards attaining the goals revolving around sustainability, the Commission has also granted in-principle approval for Green Bonds to the securities market. Like in the case of SPACs, the ADB will be providing the required technical know-how to ensure the implementation of the said initiative and the proceeds emanating from such Green Bonds are to be exclusively used for the promotion and development of renewable energy, sustainable waste management projects, sustainable land use (forestry and agriculture), clean transport systems, clean water projects etc.
Additionally, the SEC is also in the process of developing the policy and regulatory framework for the introduction of Structured Warrants and Islamic Capital Market Products with the assistance of the ADB.
THE SEC’S ENFORCEMENT MECHANISM
By now, it is apparent that the number of investors willing to invest in the country’s securities market have increased resulting in a remarkable rise in the number of transactions. This in turn has resulted in the need for a more stringent surveillance and supervision mechanism. In keeping with this requirement, the SEC has taken all possible efforts to strengthen the surveillance, supervision, and investigations divisions where enforcement was made through a lens of pro-action, prevention and prudence with a view to eliminate any possibility of the occurrence of any market misconduct that has come to its attention. For instance, surveillance flagged over hundred observations on day-to-day trading and took enforcement action ranging from including referrals, informing the compliance officers or a higher authority, issuing warnings to investment advisors, suspension of online trading facilities, calling parties to show cause and instituting criminal suits or proceedings. Such pro-active measures proved to be highly effective in significantly reducing market misconduct.
I need not say much about the pandemic and its effects. It is indeed a blessing that we, as a country, have been able to curtail the spread of the virus with the assistance of the vaccination programs carried out in the country. We at the SEC, like everyone else, were made to experience its effects, thus, engaging in some of the activities to enhance the knowledge and had to adapt according to the change in times and thus embrace virtual platforms to ensure the continuity of its programs. Such platforms were used to raise awareness among market participants and the SEC continues to do so even to date.
RULES AND GUIDELINES FOR THE REGULATION OF MARKET PARTICIPANTS
As per Section 183 of the SEC Act, the Commission has been empowered to ‘make rules on any matter in respect of which rules are authorised to be made under this Act’. Such rules are to be ‘published in the Gazette and shall come into operation on the date of such publication or on such later date as may be specified’. In keeping with this provision, steps have been taken to draft rules applicable to market intermediaries and market institutions. I am very pleased to say that these rules have now reached
the final stage prior to its publication in the Government Gazette so that they may have the force of law, subsequent to them having been approved by the Commission at its 461st Commission Meeting. The process of drafting these rules had been a tedious process given that much thought had to be put into the drafting of the rules, whilst the feedback of multiple stakeholders subsequent to numerous stakeholder consultations had to be accommodated where possible.
Having said this, it is important to shed light on the contents of such Rules as they would be crucial to the operation of key entities of the securities market just as much as it would be vital to the overall development of the market. The said rules cater to the processes applicable to the relevant entities from the time an application is submitted to the Commission for a license up until its cessation.Unique to these rules are the Rules on Fitness and Propriety of a Market Intermediary/a Market Institution, aimed at ensuring that Key Management Persons of such entities are fit and proper to carry out the responsibilities associated with the roles they play in such entities. By this, the intention is to protect investors and their assets, thus making our market accountable and reliable. Similarly, it is also pertinent to note the inclusion of the minimum contents for a compliance manual and a compliance report. As I have stated many times, the ultimate objective is to raise the integrity of our market so that it would be appealing to both local and foreign investors.
Another category of service providers that come under the purview of the SEC is Supplementary Service Providers. As per the Act, the Commission has been empowered to make guidelines or rules which would apply to them. Hence,the SEC is presently in the process of formulating these guidelines by which such Supplementary Service Providers would be governed.
THE STAFF OF THE SEC: ITS MOST VALUABLE ASSET
As this review ends, I cannot hide my satisfaction over the contribution made by the staff of the SEC. Their dedication and commitment was of utmost importance in achieving the numerous milestones in the year 2021. As always, we are committed to safeguarding the health and wellbeing of our employees, whilst nurturing them to become future leaders in this field. I take this opportunity to thank the staff for extending their utmost cooperation and commitment throughout this journey despite the many obstacles we faced as an institution. In conclusion, I have no doubt in saying that the SEC as a whole, would continue to be committed towards ensuring the betterment and the sustenance of the country’s securities market.
As the regulator of the market, we are aware of the perils of over regulation and thus we continuously strive to strike the right balance while we remain committed to integrating sustainability into Sri Lanka’s capital market. I wish to thank His Excellency the President, the Hon. Prime Minister, the Hon. Minister of Finance, the Secretary to the Treasury and other officials of the Ministry of Finance for their support and cooperation. I am pleased to recognize the excellent work of the CSE team, particularly the Chairman of the CSE, Mr. Dumith Fernando, Chief Executive Officer Mr. Rajeeva Bandaranaike and Chief Regulatory Officer Mr. Renuke Wijayawardhane for their confident leadership as the CSE has ensured the close partnership of the two institutions and I look forward to working together continuously.
My gratitude is extended to Mr. Viraj Dayaratne PC, the Chairman of the SEC, for his wise counsel and unfailing support extended at all times. I thank him sincerely on behalf of the Secretariat and also on a personal level for the and confidence placed in us. I would also like to thank the Members of the Commission for their unwavering support, sound advice, collective expertise and for the sacrifice of their personal and professional commitments in the process and the members of the Commission for their guidance extended at all times and for the encouragement given to the Secretariat in its efforts to achieve the mandate of the SEC. Once again, the country’s securities market has a critical role to play to boost the ailing economy and to raise capital to revitalize the private sector. Therefore, I take great pleasure in inviting everyone to engage with the market as it has the capability of transforming and enriching our country in numerous ways.