Strategy in Action: Colombo Stock Exchange accelerates steps to transform

Gearing up for an optimistic 2018, the Colombo Stock Exchange is on an ambitious drive to transform

Peaks and troughs are nuances of any market the world over. Closely linked and influenced by geopolitical and economic implications, markets often have a story to reveal. Understanding the dynamics and forging ahead with game-changing new initiatives is what will take Colombo’s stock market to the next level of competitiveness, both locally and internationally.

The Colombo Stock Exchange team’s mission is to usher in a promising 2018, inspired by the trends on Wall Street and other markets across the world. Embarking on a transformation has been the cornerstone in driving the initiatives taken by the management of the Colombo Stock Exchange (CSE), as the bourse’s long-term growth potential depends on its ability to attract new companies, infuse liquidity and diversify its product range. Several initiatives in areas of market development, risk management, market infrastructure, market regulations and human resources have been already initiated. CSE Chairman Ray Abeywardane and Chief Executive Officer Rajeeva Bandaranaike spoke to Echelon about their plans to transform the exchange.

Excerpts from the interview are as follows:

Sri Lanka’s stock market has seen some exciting times and also had its fair share of lows, post-war; 2017 has been a year of mixed sentiments. What are your views on this?
Ray Abeywardane: There was a lot of hype and expectations soon after the war; everyone expected and believed the landscape would change and sustain. So, the Bull Run in 2011/12 strongly reflected expectations of accelerated growth.

CSE Chairman Ray Abeywardane

In 2017, we had a comparatively better year. Daily average volumes increased by over Rs200 million per day to Rs930 million per day on average. The declining trend in indices over the last two years was reversed, with both indices moving into positive territory. Foreign investment hit an all-time high, with foreign purchases over Rs110 billion, the highest in any given year. Net foreign inflows were in excess of Rs39 billion when both the primary and secondary market inflows are considered.

To offer some regional perspective, markets like Korea, Vietnam and India are doing exceptionally well. In terms of daily turnover, approximately, Vietnam does around $80 million, while Malaysia is at $200 billion and Singapore around $800 billion. We are at $6 million. True, we are a smaller market and economy in comparison, but we believe we have the potential to grow much more, and we are aiming at doubling this figure to over $12 million over the next year. We have the vision and the strategies to grow our size and volumes.

What do you think we as an exchange need to get right if we are to be as competitive and attractive as other exchanges in the region?
Abeywardane: The Colombo Stock Exchange’s vision is to play a competitive role and be among leading regional markets. CSE developed a solid infrastructure well ahead of others in the region. In fact, we were the first in the South Asian region to implement a Central Depository System. However, market size and inadequate liquidity restrained CSE from offering new products and achieving market growth. Currently, we are aligned in the right direction with the setting up of the Financial City, which serves as a catalyst to position the CSE as a financial services center.

“The declining trend in indices over the last two years was reversed, with both indices moving into positive territory.”
Ray Abeywardane

Another advantage is our geographic positioning, as there aren’t any other financial centers within the region. As an initial step, we need to increase market capitalisation and liquidity, and diversify our product portfolio. There is limited scope for growth or competitiveness if we remain as a single equity market while others speed up on multiple tracks. We need to work on certain drawbacks, even though we have adequate infrastructure, knowledge and passion for what we do. The CSE was formed in 1985, and it’s now time to change the way we have been doing things. We need to move ahead with the times, and leverage the learnings and advancements happening globally. Having been in this industry for the last 30 years, I have immense attachment and passion for the equity market, and am keen to see the CSE becoming an outperforming market like others.

Is market size a constraint? How can this can be addressed?
Abeywardane: Yes, indeed. Market size is our fundamental problem. We need to increase market capitalisation. Listing state-owned enterprises and attracting large private sector companies will improve the size of our market, and also impact market liquidity favourably. If we are able to increase the size, then we will be able to attract more institutional funds. Second, our goal is to get ourselves into the MSCI Emerging Markets Index. This is important for us to attract foreign inflows. Recently, the Pakistan market was elevated from frontier to emerging market status. I believe we too can aspire for this if we implement our planned strategies.

What do you think is holding the CSE back from advancements?
Abeywardane: We have a well-defined, ambitious action plan based on a strategic plan recommended by Mc Kinsey and Co. But for this to work, all stakeholders need to come together to implement it. People keep asking why we cannot develop our stock market like those in other countries. But, the CSE cannot do this journey on its own. We have studied how others have developed their capital markets. We can learn from their experiences.

Other developed stock exchanges have come forward to assist us. We believe we have the skills, the knowledge and the capability to do it. But we need support. We need an enabling environment and we all need to move in one direction. We need to form a high-level multi-stakeholder committee consisting of the CSE, regulators like the SEC and CBSL, the government, investors, market intermediaries, and listed companies. We need this collaborative effort by all stakeholders to drive these initiatives to successful completion. Such an apex committee can have a defined time period with a specific mandate for market development to clear bottlenecks and get things moving.

What will be immediate launches in 2018?
Abeywardane: On the market development side, we are looking at launching a multi-currency board. The new Foreign Exchange Act is the boost we needed. We are hoping to launch it during 1Q of 2018. Additionally, we will also launch an SME Board to support the growing small and medium-sized enterprises sector. These are the two key initiatives we plan to implement during the 1st quarter of 2018. We are continuing our foreign and local investor promotion activities.

In 2018, we have planned road shows in Singapore and London, as these are two longstanding investor destinations for our market. Locally, we will continue our very successful regional investor forums in principal towns and the weekly seminars conducted by the CSE branch network. We do these in partnership with the SEC and stockbrokers.

On the risk management side, the regulator introduced minimum capital requirements for member firms and moved to risk based-capital adequacy. We plan on implementing a Delivery vs Payment (DVP) system for the market. This has been a long time coming, but will finally be done during the course of 2018. The market can expect a few new products like stock borrowing and lending with DVP. We are quite optimistic here.

Can you elaborate on CSE’s plans to launch a multi-currency board?
Abeywardane: The plan is to provide a platform for foreign issuers and local companies to raise equity and debt capital in foreign currency. In respect of foreign companies, we are looking at dual listings. The board will be open only to those who are permitted to invest in foreign currency. We are targeting Maldivian and Chinese companies, and encourage firms in India, Pakistan and Bangladesh to capitalise on the strong relationship we share. We are also targeting local companies, listed and unlisted, to make use of this platform to raise equity and debt capital in foreign currency. We are already developing the necessary technology platform for this and are in the process of getting regulatory approvals.

“Capital markets globally position themselves as important economic centers. Sri Lanka is no different.”
Rajeeva Bandaranaike

Are there any plans to attract a younger generation of investors and expand the market base?
Abeywardane: We need to work on them from a young age. We are working towards introducing ‘Investing in Markets’ as a subject for Advanced Levels, focusing on stock markets and the benefits of investing. In countries like Thailand, children are taught about investing in equity markets from a very young age. For example, there is educational material for children of all ages developed by the Thailand Stock Exchange. This is something we could do here as well. We also conduct over 500 seminars per year to create awareness and expand the domestic investor base. Numerous workshops were conducted at several principal towns and in the outskirts of Colombo. We have held these investor forums in areas like Negombo, Galle, Jaffna, Colombo and Kandy, with a commitment to increase investor awareness.

There is a noticeable increase in foreign activity, indicating that international investors have identified opportunities in Sri Lankan stocks. Has this impacted the number of domestic investors?
Abeywardane: We had over $100 billion in foreign inflows. However, we did not see the same kind of enthusiasm among the local investor community. Local institutions and retailers are not as active as they ought to be. It’s a pity, as foreigners have been the first movers, and they will benefit.

We also need to increase local retail investor penetration. I think many people are not attracted to the market as they don’t understand the market dynamics. You need to understand the risk-reward principle. Another reason is the high interest rates that provide a stress-free sleep. People feel it’s safer to invest in fixed income instruments because the returns are fixed and it’s perceived as less riskier.

Investing in equities is for the long term, and that’s what many don’t understand. What small scale or individual investors should do is look at unit trusts. This is fairly common in India, and a significant number of people have invested in the equity market through unit trusts. This is an ideal entry point for individuals. We need to make unit trusts to be more accessible and serve as a suitable vehicle for those with funds less than Rs100, 000 to gain exposure to equity markets. They can gradually come directly to equity markets thereafter.

Individual investors are more focused on short-term gains. Why is this?
Abeywardane: People are used to short-term investments and gains, primarily due to high interest rates. Domestic investors prefer relatively or entirely risk-free investments, generating higher returns. If you look at other countries with lower interest rates, within the range of 1-2%, investors would turn towards equity markets, generating around 5-6% returns. Risk takers consider it an ideal investment. The stock market is for long-term investors looking at a 5-10 year horizon. In fact, long-term funds are essential to stabilise the market. Sri Lanka lacks retirement plans where a part of your money is invested in the stock market. In the US, pension funds are huge investors in the stock market, simply because the contributor has a say in where the funds are being invested.

We have engaged local institutional investors like pension funds, insurance funds and state banks to invest in the stock market, as it is a suitable time to enter the market. There are fundamentally good stocks to invest in. Policymakers need to address these. For example, the management of these funds can be outsourced to professional fund managers who can decide where to invest, which will be evaluated on an annual basis with pre-defined investment targets. When professional fund managers are active, there will be confidence.

Chief Executive Rajeeva Bandaranaike

What plans do you have to increase the number of listings in the future?
Abeywardane: We are engaging the government to list state-owned enterprises. This will be a win-win for all stakeholders. It will be a partial divestiture, only while the government retains control of the enterprise. Funds for government shares for employees of those institutions, investment opportunities, for the institution itself giving them the freedom to reach out to capital markets to raise equity and debt capital, and these listings will help deepen the stock market.

We are continuously engaging companies in the private sector. We conduct workshops for family owned businesses stating the benefits of listing. We will continue to hold a series of such engagements with prospective companies.

Can you speak about how a demutualised exchange in 2018 will advance the CSE’s operations within the capital market?
Rajeeva Bandaranaike: Demutualisation would bring about a separation of ownership rights from trading rights of brokers. Presently, the exchange is perceived to be the domain of stockbrokers, although in reality, it may not be so. Demutualisation will therefore dispel this notion. Once demutualised, the exchange would operate as a more independent company on commercial terms and be listed. What it will mean to market users is that the exchange will represent all stakeholders and not be skewed towards one stakeholder group. The original 15 member firms of the CSE, who are members as at the date of demutualisation, will be allocated shares in the demutualised exchange. The Board composition will change. The brokers will form a minority on the Board, unlike now.

The majority will be independent directors who would be selected through a nominations committee of the Board. The chairman will be non-executive and independent. Since the exchange will be operated solely on a commercial basis, the regulator will impose certain controls to ensure that the exchange retains its status as a front line regulator and that it does not dilute any its regulatory functions for profit.

As far as institutional development is concerned, we have already been working on building an efficient organisation, and you don’t necessarily have to wait for demutualisation to do this. From the Exchange’s perspective, the greatest benefit of demutualisation is that we will be able to shake off the perception that this is a broker-controlled institution and the CSE will be viewed as a more independent organisation, which will have a favourable impact among all stakeholders, including investors and the government.

Expansion of the market through growth could also result in a more complex market. How do you prepare and manage this process to create a win-win?
Bandaranaike: Markets are becoming more complex. Over the years, we have built resources within the exchange. We have the requisite skills, knowledge and capabilities. But, we also need to invest in emerging disruptive technologies that are challenging the status quo. We cannot rely on traditional technology and a plain vanilla equity product any longer. Otherwise, we will become irrelevant. Sri Lanka is moving to a more relaxed investment regime and we will face competition on our home turf. We have to diversify our product offering and offer liquidity in the market. Demutualisation will push us to become lean and generate returns for shareholders.

We are already actively looking at cloud hosting solutions and blockchain technology to trim costs, as well as mobile applications with face recognition account openings and mobile-based trading capabilities for stockbrokers. We are also looking to improve our post-trade processing efficiencies to bring about a shorter settlement cycle. So, we are responding proactively to these challenges, but we cannot do this alone. Stakeholder and regulatory support is key.

We are fully committed to facilitating the important role of channeling savings to investment.

How can the capital market contribute to the larger picture in terms of national economic growth and development?
Bandaranaike: Capital markets globally position themselves as an important economic center. Sri Lanka is no different. We have established infrastructure and a name built globally over 30 years, and we must start leveraging this. The government requires massive capital, both debt and equity, and state-owned institutions must reach out to capital markets. We have access to a wide investor base globally and the capability to rapidly scale this up to required levels. Capital markets perform two key functions: price discovery and capital formation. Second, it provides wealth creation for investors as a long-term investment instrument by investing their savings.

State-owned institutions must use the capital market for their capital requirements and not burden the government. When a higher growth phase in the economy begins, corporates will soon find that bank financing or internally generated funding cannot fulfill their capital requirements and they must reach out to the capital market to fund their requirements.

We are fully committed to maintaining a fair, transparent and orderly market for the secondary trading of securities and facilitating the important role of channeling savings to investment.

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