Steps to take to ensure a strong capital market
1April2016
Today our capital market could do a lot more to rev up our economy like in some other markets in the region. Market capitalisation to GDP currently is less than 25%; in 2010 it was around 39%. In Singapore it is over 250% and Malaysia 160%.
As a goal we would like to see market capitalisation at least around 50% of GDP in the next few years. Therefore, the question is, what do we need to do to get there? Generally, capital markets channel funds from savers to firms, which use the funds to finance projects.
1April2016
Today our capital market could do a lot more to rev up our economy like in some other markets in the region. Market capitalisation to GDP currently is less than 25%; in 2010 it was around 39%. In Singapore it is over 250% and Malaysia 160%.
As a goal we would like to see market capitalisation at least around 50% of GDP in the next few years. Therefore, the question is, what do we need to do to get there? Generally, capital markets channel funds from savers to firms, which use the funds to finance projects.
As a goal we would like to see market capitalisation at least around 50% of GDP in the next few years. Therefore, the question is, what do we need to do to get there? Generally, capital markets channel funds from savers to firms, which use the funds to finance projects. 
Informational efficiency is necessary if funds, allocated through the capital market, are to flow to the highest-valued projects. Shareholders want management to maximise stock prices and thus will attempt to ensure that their managements undertake only projects (decisions) that increase the value of their stock.
Management compensation packages tied to stock performance are one way in which stockholders align management’s interests with their own. However, maximisation of stock prices can result in the capital market directing funds to the most valuable projects only if stocks are efficiently priced, in the sense of accurately reflecting the fundamental value of all future cash flows.
Thus, for example, if capital markets are efficient, there is no reason for executives to focus on the short run at the expense of long-term projects. Additionally, efficient capital markets make it easier for firms to raise capital because the markets determine the prices at which existing and potential security holders are willing to exchange claims on a firm’s future cash flows.
The role of the government in a developed or in a developing market involves developing, implementing and promoting a consistent set of regulation, providing oversight and enforcement in order to protect all investors, maintain fair, efficient and transparent markets, and addressing any systemic risks that may exist in the market from time to time.
In order to achieve these, the regulator who is entrusted with the job should have operational independence and accountability in the exercise of its powers and functions and observe the highest professional standards and demonstrate competence. The regulator on the other hand should not overstep the responsibility instead allow the markets to evolve within the accepted parameters and support business to raise capital via the market.
The ever-increasing cost of compliance is often a big challenge for most SME businesses to grow and expand. The regulator would therefore need to continuously educate the SMEs about the benefits of listing and about the role of capital markets, because compliance has a cost but the benefits of listing outweigh those costs.
It is actually lack of awareness of opportunities that prevent most companies coming to the market. Also rebuilding public confidence and reactivating mass scale retail participation must be a priority for the regulator.
Informational efficiency is necessary if funds, allocated through the capital market, are to flow to the highest-valued projects. Shareholders want management to maximise stock prices and thus will attempt to ensure that their managements undertake only projects (decisions) that increase the value of their stock.
Management compensation packages tied to stock performance are one way in which stockholders align management’s interests with their own. However, maximisation of stock prices can result in the capital market directing funds to the most valuable projects only if stocks are efficiently priced, in the sense of accurately reflecting the fundamental value of all future cash flows.
Thus, for example, if capital markets are efficient, there is no reason for executives to focus on the short run at the expense of long-term projects. Additionally, efficient capital markets make it easier for firms to raise capital because the markets determine the prices at which existing and potential security holders are willing to exchange claims on a firm’s future cash flows.
The role of the government in a developed or in a developing market involves developing, implementing and promoting a consistent set of regulation, providing oversight and enforcement in order to protect all investors, maintain fair, efficient and transparent markets, and addressing any systemic risks that may exist in the market from time to time.
In order to achieve these, the regulator who is entrusted with the job should have operational independence and accountability in the exercise of its powers and functions and observe the highest professional standards and demonstrate competence. The regulator on the other hand should not overstep the responsibility instead allow the markets to evolve within the accepted parameters and support business to raise capital via the market.
The ever-increasing cost of compliance is often a big challenge for most SME businesses to grow and expand. The regulator would therefore need to continuously educate the SMEs about the benefits of listing and about the role of capital markets, because compliance has a cost but the benefits of listing outweigh those costs.
It is actually lack of awareness of opportunities that prevent most companies coming to the market. Also rebuilding public confidence and reactivating mass scale retail participation must be a priority for the regulator.
Expectation
The regulator should also continue to promote more liquidity for potential foreign investors to attract more FDI into the country. The approach could be threefold.
A. Maintain a minimum public float. This is expected to release more closely held stocks to the market and a strategy to promote more IPOs into the market targeting a large number of successful but non listed companies.
B. While they encourage more companies to list they also need to support to build capacity in the boardroom to safeguard the interest of the public and the investor.
C. Motivate MNCs having entities in Sri Lanka to list by offering incentives and also encouraging PLCs to have robust dividend policies.
The regulator should also study the rules imposed by regional counterparts like Vietnam and Singapore related to new market initiatives, digital strategy, board room capacity and the listing rules to assess what new initiatives are required in this area.
Some of the areas that need focus are:
A. Strategies to strengthen the corporate debt market
B. Demutualisation of the Colombo Stock Exchange
C. Incentives to get retail investors to the market.
In addition;
The regulator should also continue to promote more liquidity for potential foreign investors to attract more FDI into the country. The approach could be threefold.
A. Maintain a minimum public float. This is expected to release more closely held stocks to the market and a strategy to promote more IPOs into the market targeting a large number of successful but non listed companies.
B. While they encourage more companies to list they also need to support to build capacity in the boardroom to safeguard the interest of the public and the investor.
C. Motivate MNCs having entities in Sri Lanka to list by offering incentives and also encouraging PLCs to have robust dividend policies.
The regulator should also study the rules imposed by regional counterparts like Vietnam and Singapore related to new market initiatives, digital strategy, board room capacity and the listing rules to assess what new initiatives are required in this area.
Some of the areas that need focus are:
A. Strategies to strengthen the corporate debt market
B. Demutualisation of the Colombo Stock Exchange
C. Incentives to get retail investors to the market.
In addition;
- Strengthening the broker back office system through harmonisation amongst the brokering houses by using the latest technology
- Enhancing capital market education and improving financial literacy in the sector
- Introduction of a central counter party CCP system which is critical to broad base the product portfolio
- Changes to the SEC act to further fine-tune the regulatory framework where major emphasis would be to provide civil and administrative enforcement powers
- Create a framework to boost the unit trust industry
- Facilitate derivatives and expand the bond products, introducing ETF, introducing REITS, etc.
- Initiative to Increase the number of listed companies in the market, currently at 290+
- A clear strategy to attract new investors both local and foreign to expand the capital markets by setting up of a private public capital market development council.
- Consistency in policy implementation
- Building HR regulatory capacity
(The writer is a Senior Company Director)
