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Securities market regulation and ethics

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Current Status of the Stock Market in Sri Lanka, IOSCO Principals of Securities Regulation, Self Regulation in Securities Markets, Importance of Market Integrity & Ethics and how the proposed new SEC Act will help regain Investor trust & confidence

Current Status of the Stock Market in Sri Lanka, IOSCO Principals of Securities Regulation, Self Regulation in Securities Markets, Importance of Market Integrity & Ethics and how the proposed new SEC Act will help regain Investor trust & confidence

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Securities market regulation and ethics

  1. 1. Page 1 CONFIDENTIAL AND PROPRIETARY Any use of this material without specific permission of Candor is strictly prohibited SECURITIES MARKET REGULATION AND ETHICS: HOW THE PROPOSED NEW SEC ACT WILL AFFECT YOU Ravi Abeysuriya, CFA Group Director Candor Group Capital Market Education and Training Naomal Goonewardene, CFA Partner Nithya Partners
  2. 2. Page 2 Table of contents 1. Current status of the stock market 2. Alleged reasons for current state of affairs 3. Importance of trust & confidence 4. Factors contributing to lack of trust 5. The cost of failure of trust 6. Actions needed to improve investor trust 7. Importance of market integrity & ethics 8. Self regulation 9. IOSCO objectives and principles of securities regulation 10.Enforcement action thus far taken by SEC 11.Objectives of the proposed new SEC Act 12.Conclusion – vaccination to protect you
  3. 3. Page 3 ASPI declined by 16% vs regional peers since Oct 2014 75 85 95 105 115 125 135 145 155 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Sri Lanka - CSE Pakistan - KSE Vietnam - Ho Chi Indonesia - Jakarta Comps
  4. 4. Page 4 Daily turnover levels have comedown by 62% (50 day moving average) 0.00 200.00 400.00 600.00 800.00 1,000.00 1,200.00 1,400.00 1,600.00 1,800.00 - 2,000 4,000 6,000 8,000 10,000 12,000 14,000 12/14 01/15 02/15 03/15 04/15 05/15 06/15 07/15 08/15 09/15 10/15 11/15 12/15 01/16 02/16 03/16 04/16 05/16 06/16 07/16 08/16 09/16 10/16 11/16 12/16 01/17 02/17 Millions Millions TURNOVER SMA(50)
  5. 5. Page 5 Stock Broker industry PBT declined by 112% (and Turnover by 76% in 6 years) -2 -1 0 1 2 3 4 5 6 7 2010 2011 2012 2013 2014 2015 2016 Rs.Millions Turnover Profit Before Tax
  6. 6. Page 6 Some alleged reasons for current sate • Auditors • Lack of Auditor independence and competence • Needs to be more effective watchdogs • Failure by listed company auditors to detect misleading financial information, i.e. Accounting Shenanigans • CSE • Lack of size and liquidity – not in the radar of Emerging Market Investors • Slow in implementing reforms • Financial Press • Publishing negative stories about the capital market • Reproducing Co. press releases without being analytical and even distorting the true financial performance • Government • Lack of policy consistency & apathy with regard to the stock market • Confusing messages on implementation of Capital Gains Tax • Looming inflationary pressures and increasing interest rates • Contradictory views on economic policy by CBSL & MOF • Poor track record of policy implementing
  7. 7. Page 7 Some alleged reasons for current sate Conti… • Investors • Institutional investors not investing until completion of investigations • Related party transactions favoring majority shareholders • Market Manipulation & Pump & Dump by high net worth investors • Circumventing mandatory offers using loopholes in the SEC Act • Using un-listed holding companies to gain control of listed entities • Retail investors lack financial literacy - gambling rather than investing • Listed Companies • Poor Corporate Governance Practices • Discriminating minority shareholders • Lack of timely disclosure allowing insiders to make money • SEC • Too many stock broker licenses issued • Ongoing investigations of high net worth investors for pump & dump • Slow progress, no defined time lines in implementing pertinent reforms • Market Intermediaries • IBs - Over pricing of IPOs, i.e. Soft Logic & Expo Lanka IPO funds used for other purposes than originally declared • Fund Managers – Looking after their interest and not interest of members who contribute the pension/provident funds • Stock Brokers - Spreading false rumors to induce trading, front running, market manipulation, bribery & rebating
  8. 8. Page 8 Domestic investor participation rate in the Sri Lankan stock market is one of the lowest Source: Investor Protection, Equity Returns, and Financial Globalization, JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS
  9. 9. Page 9 The industry has lost investor trust
  10. 10. Page 10 We must restore “Trust” in our capital market
  11. 11. Page 11 Factors contributing to lack of trust
  12. 12. Page 12 The cost of failure of trust - miss out on the “The power of investing”
  13. 13. Page 13 Firm level actions required to improve investor trust
  14. 14. Page 14 Importance of market integrity • Market integrity– extent to which a market operates in a manner that is, and is perceived to be, fair and orderly and where effective rules are in place and enforced by regulators so that confidence and participation in the market is fostered • FELT – Fairness, Efficiency, Liquidity and Transparency (do I know what is going on in this market) • Problems with information asymmetry – One party has more or better information than others – extreme case can lead to market failure. Issuers have an information monopoly thus the need for greater disclosure • Negative network externalities and/or pecuniary externalities– problem of lemons – the bad drive out the good.
  15. 15. Page 15 Compliance versus ethics
  16. 16. Page 16 Why ethics matters • Investment professionals manage other people’s money • Capital markets are information driven • A viable market hardly gets under way in the absence of investor confidence & trust • Adherence to ethical practices instill investor trust in markets & development and sustainability of the market • Investors will be reassured only if investment professionals act with the their clients’ best interests in mind • Actions by a few unscrupulous individuals have had a terrible toll on investors’ trust • Trust is hard earned and easily lost
  17. 17. Page 17 Self regulation Some countries have abandoned self-regulatory organizations (SROs) altogether, others are actively exploring the benefits offered by a system that provides a “front-line” regulator, such as an SRO. National Securities Dealers Association (NASD) in USA is one of the first registered SROs since 1938 Several countries have SRO models: i.e. Brazil, Canada, China, Colombia, India, Japan, Malaysia, Philippines, Romania, Thailand, Turkey Emerging markets are more likely to use the SRO model to oversee and police their own members
  18. 18. Page 18 Advantages of self regulation • Technical and Hands-on Expertise – SROs better understand technical & practical aspects of market regulation • Flexibility – SRO have greater ability to adapt to new innovations & developments • Greater Acceptance of Rules – SRO members elect their directors and participate in rulemaking; may cause greater willingness to comply with rules • Cost Savings to Government – More than 100 market intermediaries of varying complexity – Over 300 registered investment advisors
  19. 19. Page 19 Disadvantages of self regulation • Conflicts of Interest - make money AND serve the public interest? – Securities exchanges are both business ventures and regulatory bodies; may not enforce rules if detrimental to business – demutualization creates additional conflict regarding profit motive of a shareholder-owned SRO • Antitrust Implications – Members of an SRO are collectively regulating their own behavior; danger of collusive behavior that hurts clients • Due Process Concerns – Members regulated by individuals exercising a form of governmental power, may not follow a due process that would apply if the government were the disciplinary body
  20. 20. Page 20 New paradigm for self governance • Enhance current SRO system • Strengthen CSBA governance, enhance disclosure and reporting requirements • Enhance SEC´s ability to regulate CSBA members market trading activity • Peer Review - Get practitioners involved in fostering an ethical culture and championing ethical behavior in investment markets • Mandated SRO internal restructuring • Increase CSBA regulatory independence, e.g., by requiring all Members to regulate their members’ market operations • Adopting principles-based regulation to replace detailed prescriptions that add to compliance costs but not to stability or efficiency • Practitioners know all the tricks in financial crimes, so involve them in the drafting of rules and regulations
  21. 21. Page 21 IOSCO objectives and principles of securities regulation - 38 1. Protection of Investors 2. Ensuring that markets are fair, efficient and transparent 3. Reducing systemic risk
  22. 22. Page 22 Protection of investors 1. From misleading, manipulative or fraudulent practices: market manipulation, mis-selling, insider trading, money laundering, front running and misuse of client assets 2. Ensuring full disclosure of information material to investors’ decision, a key part being accounting and financial forecast information 3. Ensuring only qualified persons are allowed as intermediaries by a system of prior authorization 4. Exercising adequate supervision over intermediaries 5. Enforcing the rules effectively
  23. 23. Page 23 Ensuring fair, efficient and transparent markets 1. Ensuring prior authorization of marker operators 2. Ensuring fair competition in the operation of markets 3. Ensuring timely and widespread dissemination of trading information and that such information is fully reflected in the securities prices 4. Ensuring transparency of all trading information
  24. 24. Page 24 Reducing systemic risk to the financial system 1. Reduce the risk of failure of intermediaries 2. Knowing at all times the risks undertaken by firms and ensuring that they have adequate systems to manage risks 3. Ensuring that there are workable procedures to isolate single failures from contaminating the whole financial system
  25. 25. Page 25 Enforcement action thus far taken by SEC • Insider Dealing – Offences against 17 individuals pertaining to 7 cases. • Market/Price Manipulation – Offences against 17 individuals and 1 entity • Front Running – offence against 1 individual • Failure to Disclose Material Information – Offence against 20 individuals and 2 entities • Provision of False/Misleading Information – Offences against 3 individuals • Submission of False Financial Information – Offences against 2 individuals • Violating M&A Code – Offence against 1 person.
  26. 26. Page 26 The new SEC Act will help regain Investor trust & confidence • Provide full and fair disclosure of all securities (listed & unlisted) sold • Regulation of the exchange, central counter party and of over-the-counter market • Facilitate the introduction of new financial products i.e. Short Selling, Derivatives, ETF, REITS • Promote financial literacy • Protection of consumers of financial services • Reduction of financial crime through effective surveillance and enforcement action against unauthorized activities of auditors, listed company directors, market intermediaries and all investment practitioners
  27. 27. Page 27 Opportunity to establish a facility to check out the integrity of RIAs & Market Intermediaries
  28. 28. Page 28 Conclusion • Develop long term relationship of trust • Always put your client’s interests ahead of you and never let your personal interests and temptations get ahead of doing the right thing for your clients • Have a unblemished compliance record • Satisfied clients will put more money & provide referrals once the relationship of trust is established • Relationship built on trust takes time to earn, but once established, it’s priceless • Safeguard your reputation - because it takes 20 years to build reputation and a minute to ruin it

Editor's Notes

  • 50 day moving average of Daily Turnover have come down by 62% from Rs. 1.6 bn to around Rs. 600 m
  • We can argue who has done wrong, however we have to accept all or some of the above actions have resulted in the consequences we just saw
  • We have to accept all or some of the above actions have resulted in the consequences we just saw
  • We have one of the lowest participation rates of domestic investors in our capital market. Although we have today around 765,000 CDS accounts (or around 583,000 if you exclude duplication due to joint accounts) a recent study has revealed that, around 350,000 are plantation worker accounts and another 100,000 are student’s accounts that are dormant. So in actual fact actively trading happens in only about 25,000 CDS accounts.

    Let me pause and let you ponder why is this so?
  • Investors have lost confidence and trust in our Capital Market. To restore investor confidence and trust and attract more investors to the capital market we need a paradigm shift in way all capital market intermediaries and market practitioners look after their clients.
  • In the investor trust study carried out in 2013 and in 2016 it was found financial services industry globaly is one of the least trusted.
    I encourage SEC or CSE to carry out a similar market study to find out the level confidence domestic investor have on our stock market
  • Significant legislation has to take place to curb market malpractices. The large scams and frauds have taught us that growth without a robust governance structure falls short of global expectations. The regulators has to be active in responding to such events and in certain cases have undertaken proactive measures to stop such events from recurring.

    AMER – Americas
    EMER – Europe, Middle East
    APAC – Asia Pacific
  • The true purpose of finance “is to put resources to productive use, to transform maturity, thereby contributing to economic growth and stability — and ultimately, to the wellbeing of people. In other words — to enrich society

    To restore trust in the broader financial system, financial institutions need to rediscover their values.” Company leadership (boards, senior management) needs to “promote a culture of ethical business” practices. Employees of the financial institutions need a sense of broader purpose, grounded in strong connections to their clients and their communities. “Integrity cannot be legislated, and it certainly cannot be bought. It must come from within.”
  • Strict adherence to a moral code, reflected in transparency, honesty and complete harmony in what one thinks, says, and does.
  • Ethics and the law attempt to restrict behavior and practices.
    The law is enforced by the government.
    Ethics are enforced by moral code - personal judgment and conscience that you will act in a way that produces the greatest possible good for the greatest number
  • No stock market anywhere in the world is a perfect market. However, companies and investors need capital markets to be efficient and to offer fair prices and good regulatory environment so they can make reasoned investment and financing decisions.

    Ethics, and Integrity are basic building blocks for building Trust that is required for the efficiency in the Capital Markets. Sound ethics is fundamental to capital markets and the investment profession.


    So ladies and gentleman ethics genuinely matters!
  • Self Regulation is built on the premise that If market intermediaries voluntarily behave in the right way, enforced regulations would not be needed.

    If self-regulation is to be viable in a climate of distrust, it must prove that it is a system with integrity and with credible and fair procedures. It also must demonstrate that self-regulators can significantly contribute to the market—by providing needed help to primary or statutory regulators, such as the SEC, and by supporting, rather than unduly restricting, market innovation.

    Strick regulations globally have produced a few real benefits and carry huge costs. These costs come not only from the hard costs of compliance requirements, but also hindering capital formation and innovation in capital markets and taking time and attention away from servicing clients. Regulation may also seem irrelevant when it is not aimed at addressing major issues such as size and liquidity issues in our stock market. Most importantly effective surveillance and enforcement action against wrongdoers.

  • SROs understand the risks better than the primary regulator, an SRO may be able to identify and propose rules more quickly than a primary regulator and thus provide some supervision and safety before a crisis occurs.
  • Keys to the success of an SRO is its ability to maintain effective surveillance, supervision, and enforcement powers. Without an active surveillance program, a commitment to investigate questionable activities by its members, or an impartial enforcement process—including a method for due process—an SRO will lose credibility among investors, regulators, and the marketplace.

    SRO’s effectiveness is that it have the authority to create and enforce its policies and rules. The source of its authority affects the perception of an SRO. An SRO that was established through legislation or otherwise formally recognized by the primary regulator is likely to carry more weight than an organization that was only voluntarily organized

    Unfortunately, CSBA is only a informal membership association and do not function as a SRO, we have code of ethics but have no enforcement mechanism to discipline our members The Colombo Stock Exchange is a SRO providing certain self-regulatory functions but still rather week in disciplining it’s members
  • Where possible, self-regulation is a preferred method of regulatory oversight. primary regulator (i.e. SEC) may lack resources to resolve complaints and disputes, compliance issues, registration and oversight of investment advisors and will be challenged to keep ahead of technology and market innovation – new financial instruments, practices, etc.

    The Industry always know before the regulator about a wrongdoer, so do we get rid of the rotten egg as a cake maker, before the whole cake has to be thrown away, because of one rotten egg
  • Money Laundering Top Financial Crime
    Which of these four financial crimes — insider trading, market manipulation, misselling, and money laundering — were most commonly observed in your market? Money laundering was the top pick, with more than 4 in 10 (41.6%) votes. Mis-selling was next with just more than two thirds (36%) of votes, and slightly more than 1 in 10 (13%) cited market manipulation. Finally, less than 1 in 10 (9%) chose insider trading.

    You may ask, why Money laundering? “The definition of money laundering is dealing with any proceeds of crime. Once you have committed any of the other three crimes [insider trading, market manipulation, or misselling], you will have to deal with the proceeds of that crime, and that would be money laundering.”
  • Facts speak for themselves- Enforcement Action taken as per SEC Website – most of them are Compounding
  • We have to agree that the existing law needs to be amended and supplemented to meet the goals of expanding the regulatory purview of the law to areas which have grown since the enactment of the original Act 30 years ago in 1987; enhance the regulatory powers of the Commission to enable it to effectively enforce the law; to give clarity to offences; and strengthen sanctions which can be imposed for contraventions of the law

    I must say the process of drafting the new law has been one of the most transparent allowing the stake holders and Chamber of Commerce to make representations & submissions to SEC at several meetings.

    CSBA invited Dr. Arittha Wickramanayake, President Partner of Nithya Partners, who was a former Director General of SEC and well versed in establishing the regulatory framework and practical aspects of capital markets in Sri Lanka to make submission to SEC on the proposed draft Act.

    We are very positive the concerns and practical problems raised by the public on a number of issues in the draft act will be properly addressed, when the Act is finalized.

  • The reality is that whatever is measured is what gets managed.

    Stronger regulations are imperative to regulate “Registered Investment Advisors” RIAs in keeping with other countries!

    The New SEC Act will have a similar mechanism to enforce rules to weed out the bad eggs!

  • Developing a relationship of trust is a foremost priority for finance professionals. Warren Buffett once said, "Lose money for the firm, I will be understanding; lose a shred of reputation for the firm, I will be ruthless"
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