FE Today Logo

Reforms address structural deficiencies in capital markets

Bruno Carrasco and Syed Ali-Mumtaz H. Shah | June 21, 2015 00:00:00

Bangladesh has had its share of stock market booms and busts. Following a bull run in 2010, the Dhaka Stock Exchange (DSE) crashed in December 2010 and by March 2011 the index had fallen by half from its all-time high, wiping out large share value gains. The crash resulted in bankruptcies, loss of employment and disruption to the economy. It also underscored the vulnerability of Bangladesh's capital markets and confirmed the pressing need for reforms.

Policymakers seized the moment and in 2012 the Government of Bangladesh partnered with the Asian Development Bank (ADB) to undertake a comprehensive programme of structural corrective measures, including institutional development actions, under the ADB-financed Second Capital Market Development Programme (CMDP2).

The government's rationale for reform was based on a two-track approach that recognised that: (i) the capital markets had to play a greater role in financing the development requirements of the economy and; (ii) liberalisation of the capital markets had to go hand in hand with measures to not only promote development of the markets, but also to ensure overall stability of the markets.

Indeed, if GDP (Gross Domestic Product) growth in Bangladesh was to attain its annual target of 10 per cent by FY2021, the government had to address structural deficiencies in the capital markets by deregulating the financial system to promote private sector investment and to better support the real economy. More specifically, capital market development is critical to addressing the current infrastructure investment gap in Bangladesh, and to serve as a vehicle for long-term sustainable growth.

By the end of 2014, CMDP2 was successfully implemented and completed. Three factors account for its success, namely (i) strong ownership of the reforms by the government; (ii) effective policy dialogue and communication with key stakeholders in both the government and the market and; (iii) a willingness of all parties to work together for a greater cause.

While market reforms are largely viewed as a process that takes time before the impact is noticed, under CMDP2 there have been very important and visible achievements in both market development and stability in a relatively short time frame. The following presents a few of these achievements.

Demutualisation of the stock exchanges in Dhaka and Chittagong: This serves to counter, at times, the more narrow interests of brokers and dealers for the overall benefit of the expansion and development of the stock market.  Under the able leadership of the Ministry of Finance (MoF), in conjunction with dedicated efforts by the Bangladesh Securities and Exchange Commission (BSEC), and the stock markets, demutualisation is well on its way to completion. Demutualisation of the stock exchanges has segregated ownership, management, and trading rights of members, and converted the two exchanges into commercial, and more professionally run organisations, while still enabling them to pursue their strategic interests, including market development, more effectively.

Bond market development: A corporate bond market that is able to effectively mobilise funding and price competitively against a yield curve based on the trading of risk-free government securities is the goal of bond market development. As the market develops it allows for financing of long-term investments and addresses re-financing risk and maturity mismatches traced to alternative bank financing.

With strong collaboration between MoF, Bangladesh Bank (BB) and BSEC to promote a more liquid bond market, an efficient primary dealer system is being developed through the fostering of a more competitive auction system for government securities. This is expected to support an improved price discovery process for treasury bills and bonds, in line with demand for these securities. The corporate bond market is being promoted by implementing a fast-track BSEC regulatory process for private placements, which balances investor protection with ease of approval. Tax distortions were removed to trigger bond market activity such as the elimination of transaction taxes for bonds.

Strengthening and empowering institutions: In a modern economy with more sophisticated financial markets, developmental and regulatory objectives cannot be the exclusive domain of MoF. Instead they should devolve to specialised institutions such as BSEC, and the Insurance Development and Regulatory Authority (IDRA).  

Over the past three years, BSEC was given a stronger mandate together with resources. The amendment of the SEC Act in November 2012 paved the way for BSEC to have unhindered access to its own BSEC Fund. The amendment also removed the need for government approval of the BSEC budget, and provided benefits to BSEC staff comparable to those at BB.

The operationalisation of a real-time market surveillance system is also helping BSEC to detect trading irregularities as they occur. The installation of such a state-of-the-art surveillance system is increasing transparency of market transactions and contributing significantly to enhanced investor confidence. The enforcement capacity of BSEC has also been significantly enhanced through the creation of a capital market tribunal in January 2014, which can expedite resolution of securities cases pending in Bangladesh's court system.

The impending enactment of the Financial Reporting Act will, equally, play an integral role in upgrading accounting and auditing standards to enhance market confidence.

On the institutional investor side, effective coordination and cooperation between MoF, as well as IDRA, ensured that integral reforms were carried out to promote the insurance industry with a focus on enhancing insurance industry participation in the capital markets. The government's national insurance policy paper was approved by the cabinet in June 2014, and implementation of the policy paper was initiated in July 2014. The insurance regulations regarding CEO appointment and management of the IDRA Fund have been implemented since January 2013.

As part of this strong government commitment, reforms have been rolled out, and there is increasing confidence in the stock market as the new policies and regulatory incentives gain traction. The market has stabilised, as evidenced by the 25 per cent increase in market capitalisation to $41.1 billion (as of June 07, 2015), from $33.0 billion in February 2011. The contribution of the banking sector has shown a well-received significant reduction of exposure to the stock market, declining to 13.5 per cent at the end of March 2015 from 28.8 per cent in December 2010. The turnover ratios in 2014-2015 are comparable with levels recorded from 2004-2006 when the market was functioning in a relatively stable environment. DSE's average daily turnover as a percentage of market capitalisation during January 2014 to May 2015 was 0.15 per cent as compared to 0.71 per cent from October 2010 to November 2010. A total of seven companies have floated initial public offerings (IPOs) so far in 2015. There were 17 such offerings in 2014, 17 in 2013, and 14 in 2012.

It is important to note that these reforms are not piecemeal but form part of a comprehensive long-term national capital markets master plan approved by the government. The master plan sets the direction for transitioning from a nascent to an emerging capital market.

There has already been resoundingly positive recognition of the efforts undertaken by the government over the past few years, with the awarding to BSEC of category A status by the International Organisation of Securities Commissions (IOSCO), the international body that oversees securities commissions.

ADB is set to continue its full support for ensuring a smooth transition in the development of the capital markets reform process, in line with the capital markets master plan and CMDP2 reforms. The proposed CMDP3 represents a continuation of previous work carried out.

Further structuring of the capital markets will require continuation of the technical approach adopted under CMDP2 and close collaboration with the coalition of stakeholders to crucially maintain the momentum of reforms.

The proposed programme will deepen and broaden the outreach of the CMDP2 reforms by: (i) extending the government yield curve, promoting more liquid government securities and eventually creating a corporate bond market; (ii) catalysing institutional investor demand by broadening, deepening and diversifying the investor base, as well as (iii) enhancing supply of alternative financial instruments. Examples of reforms planned under CMDP3 include increased liquid benchmark issues through introduction of floating rate notes, enhanced insurance industry participation in the capital market by issuing of investment guidelines by the Insurance Development and Regulatory Authority (IDRA), improvements in the settlement and clearing system, as well as promotion of alternative financial instruments to develop a deeper and broader capital market.

The writers work in the South Asia Department of the Asian Development Bank.

Share if you like