Problems and Reforms of Secondary Capital Markets in Nepal
Capital Market refers to the places where saving and investment are moved between suppliers of capital and those who are in need of capital. Capital Market plays vital role for the development and growth of the countries economy. Now a days individual investors, mutual fund, pension fund and insurance fund place their money in the various instruments of the Capital Markets. The Capital market instruments are equity shares, debentures, sweat equity shares, warrants, preference share, and bonds. Capital Market Consist of the Primary Markets where new securities are issued and sold, and the secondary market where already issued securities are traded between investors. With globalization of economy the role of capital market regulators assume more significant and the regulator has to be dynamic and responsive to challenges and changes. Regulation is not a static Subject; it is a dynamic one so the interest of the trader and the investor should always be kept in mind. Therefore there is frequent review of Securities laws to develop secondary Securities Market and protect interest of traders and investors. Market themselves are in the state of continuous development so the contents of the regulation must also change to facilitate proper regulation of the secondary Capital Market. Keeping in view the above objectives and principles Securities Board of Nepal (SEBON) has been framing regulations, guidelines and also changing them from time to time to make Nepalese Capital Marks a modern, safe, fair and efficient one. The article is based on the problems and constraints suffered by the Secondary Capital Market in Nepal since its inception. Then the reforms and its subsequent impacts are discussed.
Major Problems of Secondary Securities Markets in Nepal
The problems or the barriers of the secondary securities markets may be political, socio-economic, or administrative in nature. Throughout the various phases, the secondary capital markets in Nepal has experienced growth and at same time some bottlenecks were also experienced. Nepal Stock Exchange (NEPSE) is the only stock exchange located at Singhadurbar, Kathmandu and the stock exchange is not allowed to have branches at different locations. Majority of the shares of NEPSE is owned by Nepal Rastra Bank and Ministry of Finance. NEPSE accounts for all the trades in the stock exchanges. This hampers the general belief that capital market is perfectly competitive market. In the stock exchange the number of hours for which trading is open for participants is very less 4 hrs. in a day; 11 a.m. to 3 p.m. Other public holidays makes investors difficult to have liquidity throughout the month.
General public beliefs that Share prices in the Market are determined by the speculative forces and these prices have very low references of fundamentals or performance of the economy, industry or company. The dealers, merchants, insiders, fund manager try to speculate prices of share. This reduces the presence of genuine investors and thereby increases this speculative motive among the other market participants also. The regular investors also filed a complaint in SEBON regarding artificial increase in Prices of Shares before right issue by circular trading due to which they have to suffer and lose their money as the prices of such shares drop greatly. Investors Claim that Funds are raised from investors promising investment in projects yielding high returns. But some promoters divert the money to speculative activities and other personal purpose. Due to which ultimately they have to lose their wealth. Price rigging is the phenomena where Companies planning to issue securities artificially try to increase the share prices to make their issue attractive as well as enable them to price their issue at high premium. Promoters enter into the secret agreement with the brokers and plays in the price. Payment Crisis due to brokers default, Quick profit at the expenses of the Shareholder due to Insider Trading, low prices of odd lots in the lack of odd lot dealer, dominance of single sector restricting choice to diversify investment portfolio, underdeveloped debt markets and no room for trading in debentures are some general problems of Secondary Securities Market.
In the recent phase the Secondary Securities Markets encountered problem at the policy level and its implementation. Government of Nepal in its FY 2018\19 Policy and Program made the compulsory provisions for PAN while buying shares from the secondary market. It created huge debate and conflicts among the investors and they protested against it. The issue was finally solved by making optional provision for PAN up to the transactions not exceeding 5 lakhs at a time in a day. In the Fiscal year 2017/18 Capital gain tax was increased by 50 percent and reached to 7.5 percent which was initially 5 percent. Investors’ wants confirmation whether the capital gain tax is final or not. Ministry of finance and revenue office in time to time brings new concept in imposing Capital gain tax which has always been debatable. Investor forums and Securities businessperson keep on pressuring the regulator to settle these issues permanently. Trading halts are enacted by the investors and the Market remained negative with low turnover for a longer period due to issue of capital gain Tax. On the other hand, NEPSE introduced the online trading System in the secondary market to modernize the capital market but the software encountered serious problems. The investors weren’t attracted towards online trading system. Common Problems like automatic log out, bank integration, Order can’t be placed and cancelled, not matching buy and sell order, no display of floor sheet and market depth, software malfunctioning due to over transactions were faced.
Major Reforms of Secondary Capital Markets in Nepal
Several reforms have been introduced beginning with those in stock exchange administration, securities trading, settlement, delivery versus payment, securities transfers, trading in derivatives, risk reducing measures, screen based trading, concept of investor protection fund and many more. The major reforms in the last few years have been analysed.
1. Legal Measures: Securities Related Act 2063, Commodities Exchange Market Act 2074, Assets Laundering Prevention Act, 2008 are prevailing acts of Capital Market. Beside these there are by laws, regulation and guidelines to operate securities Market. In the Fiscal Year 2016/17 SEBON drafted, reviewed and amended regulations and directives related to service charge to be received against stock brokerage, Securities registration and Issue Regulations,2016, Corporate governance guidelines and listing and Transactions regulations.
2. Surveillance system: Nepal stock exchange was asked to set up independent surveillance cells under the executive directors (who is directly responsible) of NEPSE. Exchange was asked to develop online monitoring system. Online surveillance system generates alerts including real time alerts to indicate abnormal activity in trading.
3. Improvement in the Securities Clearing and Settlement: Board Issued Directive to CDSC to execute pay-in in the T+2 with securities in the buyers account and payment in the sellers account, and the securities be deposited in the account and the payment to be deposited in the seller account in T+3 days.
4. Dematerialisation of Shares: Traditional settlement of Shares on Stock Exchange gave rise to settlement risk due to the time that elapsed before trade settled by physical movement of certificates. Theft, mutilation of certificates and other regularities were rampant and in addition the issuer had the right to refuse the transfer of security. All these added cost and delays in settlement, restricted liquidity and made the grievance redressal of investors time consuming and time intractable. All these problems have been solved by setting up depositories. From Mid-January 2017 DEMAT was mandatory in public offering all over Nepal.
5. Allowing large Variety of Participants: Capital markets are said to be more efficient when they have more participants, instruments, process and other alternatives. Nepalese capital market is dominated by banks and financial institution in the earlier phase. Now there are entries of many new participants to the Capital Market. SEBON permitted private sector and joint sector mutual fund and debentures. A Committee is form to study the entry of Non Nepalese Residents, foreign institutional investors to trade in secondary Market.
6. Concept of Derivative Trading: All the developed economies and capital markets have financial derivatives trading on their exchanges that provide risk management tool to hedge the risk in the underlying market. In Nepalese Capital Market the derivative trading are in the process of getting permitted. SEBON issued and implemented Commodity Exchange Market regulations,2017 on 25th November 2017 which includes licensing procedure for exchange, paid up capital, requirement of shareholders, type of commodities, investors protection fund, settlement guarantee fund along with cease of approval, dismissal of Exchange, penalty etc.
7. Corporate Governance Code: To maximize shareholders value and increase investor’s confidence SEBON has introduced corporate governance code for listed companies. Corporate governance helps to minimize the insider trading in the market, makes company’s information more transparent and well managed and contributes in developing fair, transparent and credible securities markets.
8. Investors Empowerment: Timely availability of quality and reliable information increases the confidence of the investor in the market place. Over the past one decade many regulatory requirement have been imposed on issuers, mutual funds and other constituent of the market to disclose relevant information to the public. Listed companies have to publish quarterly, half yearly and annual financial results as a condition for continued listing. Mutual fund publishes monthly Net Assets Value, portfolio composition, and other information. This disclosure contributes to improve market efficiency.
9. Establishment of Credit rating Agencies: Two Credit Rating agencies namely ICRA Nepal& CARE Ratings Nepal Ltd. were set up in order to assess the financial health of different financial institution and agencies related to the stock Market activities. It is also the guideline for the investor to evaluate the risk of their investment.
10. Increase in Merchant Banking Activities: Many Commercial banks have set their Merchant Bank as subsidiary company in last few years. They provide financial services like underwriting facilities, issue organizing, corporate advisory, portfolio management, etc. It has facilitated as a helping hand to factors related to capital Market. Some Other reforms in the Secondary Capital Market includes.
i. Supervision of Securities trading, Stock’s Exchange reporting, Central Depository Company, Merchant banker’s reporting, Credit rating Company’s Reporting, Mutual Funds reporting and Stock Broker’s reporting.
ii. Stockbroker’s Capital Increase and infrastructure Requirements.
iii. Expansion of functions of Merchant Bankers and increase in capital from three to five fold for fair and competitive services.
iv. Policy Provision Regarding the establishment of New Stock Exchange
v. Code of Conduct for the Board Staff and Board Members made effective from March 2017 and July 2017 respectively that restricted to buy and sell shares in the manner general investors do.
vi. Stockbroker’s Commission Slashed down by more than 40 percent.
vii. Developing OTC Market as its trading became active since FY 2015-16 and reduction in the fee by more than 90percent.
viii. Provision of three additional clearing Banks and beginning of odd lot trading.
ix. Real Sector Companies with paid up capital of 1 billion are encouraged to enter in the Capital market. To attract real sectors Securities Issue and Allotment guideline, 2016 enable public issue only with 10percent (of the issued capital) and the existing fixed pricing public issue was replaced by free pricing with some cap. The government made provisions of 15percent tax rebate to such companies for bring listed.
x. Provision of Margin trading, Determination of Interest rate and its monitoring.
xi. Expansion of Branches of Securities brokers outside Kathmandu valley.
xii. Facilitation to apply for the auction shares from outside valley.
xiii. New Provision in the Circuit break.
xiv. Budget of FY 2019/20 as declared on May 28, reduced Capital gain tax to 5percent which was 7.5percent in the FY 2018/19.Weighted average method will be considered to calculate capital gain tax on right and bonus share. Investors were relieved by the Budget Speech of FY 2019/20 as most of their demands were addressed by the Government of Nepal
Challenges in the Secondary Securities Markets
Upgrading the market to make transparent, reliable, and competitive and investor friendly itself has been a challenge. The challenges are particularly related to policy, market, technology, structure and laws. Privatization of NEPSE in accordance with Stock Exchange Operations regulations, 2007 and segregation of government ownership
to make NEPSE more competitive and professional is a huge Challenge. Restructuring the Ownership and reform the CDSC established as a subsidiary of NEPSE is next challenge. Frequent Policy changes in short time and unclear policy is impairing the dynamic growth of market. Strengthening the regulatory and supervision Capacity of SEBON and achieving operational independence is a challenge. Making Secondary market competitive, accessible and nationwide in all 77 districts of the country needs more effort. Attracting the real sector companies in the Capital Market and aware these companies about the 15percent tax rebate for being listed seems difficult. Facilitating non- resident Nepali and foreign institutional investors, advance technology in stock exchange and brokerage business, introduction of new instruments bond and equity derivatives, good governance practices of companies, adequate participation of institutional investors, investors awareness, financial literacy and training to the general investors are challenges faced by Secondary Securities Markets.
Due to several hindrances a genuine investor has retained aloof from the market while more and more speculators and institutional investors continued to dominate secondary securities markets in Nepal. These have also resulted in the increased volatility. When financial Sectors reforms were initiated it was also emphasized to have a strong regulator for Nepalese Capital Markets. This task of regulation is being shouldered by SEBON. Following the implementation of reform in the secondary market in Nepal in the past few years, Nepalese stock Market achieved success. But, there is more scope for further reforms and development.
Annual Reports of SEBON; Fiscal Year 2016/17 Annual Report of SEBON; FY 2017/18
Annual Report of SEBON; FY 2018/19 Securities Related Act 2063
Government of Nepal Policy and Program; Fiscal year 2018/19 Quarterly Securities market Indicators; Issue 4, 5, 6, 7, 8