The country’s capital market regulator, the Securities and Exchange Commission (SEC), on the recommendation of the Colombo Stock Exchange (CSE) has resorted to bring in risk-based capital adequacy requirement (CAR) on stockbroker firms with effect from March 1, 2017.
Accordingly, each stockbroker will be directed to maintain a capital requirement—measured as liquid capital—of 1.2 times the total risk it undertakes, subject to a minimum liquid capital requirement of Rs.35 million.
The SEC said CAR rules are applicable to all stockbroker firms excluding those licensed to deal only in debt securities. Also, the proposed CAR rules mandate stockbrokers to report their CAR to the SEC and CSE on a daily basis.
Currently, the net capital positions are reported by the stockbrokers to the SEC and CSE at month-end.
According to the SEC, the current rules on the minimum net capital applicable to stockbroker firms do not address the different risks these firms are exposed to.
“In the light of the foregoing limitations of the present rules and in keeping with the international standards a dire need to establish a risk-based capital adequacy requirement was felt.
Having considered the capitalization of stockbroker firms, their current activities and CAR regimes implemented in the regional markets, the CSE together with the SEC developed the methodology for the rules,” the SEC said in a statement.
The market regulator pointed out that the International Organisation of Securities Commissions (IOSCO), which is the global standard setter for the securities sector, sets out principles of securities regulation and its members, including the SEC Sri Lanka, are expected to implement these principles in order to achieve the objectives of securities regulation, i.e., protect investors, ensure that markets are fair, efficient and transparent and reduce systemic risk.
The IOSCO regulatory ‘Principle 30’ states, “There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake.”
This principle identifies that capital must be sufficient to protect a financial institution’s customers and counterparties from various risks.
SEC brings...
In addition, an efficient capital adequacy structure is able to send timely warning signals to intermediaries to reassess their risk management practices, as a decline in the capital base can expose the intermediary to significantly higher levels of risk.
Moreover, in order to ensure efficient functioning of capital markets, it is imperative for all participants to have confidence in each other’s stability and the ability to effectively manage risk.
The inability of an intermediary to honour its commitment can lead to serious market disruption and result in decline in investor confidence.
According to the SEC, the proposed CAR requirement will meet the IOSCO ‘Principle 30’ by defining and enabling the monitoring of risk on a daily basis and linking the capital required to be maintained to address risk.
Also, the implementation of the CAR will enable the SEC and CSE to set up trigger points and prompt brokers to proactively monitor and manage their CARs before they breach the minimum threshold. The CAR will also aid in the development of a risk-based supervision framework.
This proactive approach is expected to encourage stockbrokers to conduct their business operations more professionally and thereby help foster investor confidence in the capital market.
n addition, an efficient capital adequacy structure is able to send timely warning signals to intermediaries to reassess their risk management practices, as a decline in the capital base can expose the intermediary to significantly higher levels of risk.
Moreover, in order to ensure efficient functioning of capital markets, it is imperative for all participants to have confidence in each other’s stability and the ability to effectively manage risk.
The inability of an intermediary to honour its commitment can lead to serious market disruption and result in decline in investor confidence.
According to the SEC, the proposed CAR requirement will meet the IOSCO ‘Principle 30’ by defining and enabling the monitoring of risk on a daily basis and linking the capital required to be maintained to address risk.
Also, the implementation of the CAR will enable the SEC and CSE to set up trigger points and prompt brokers to proactively monitor and manage their CARs before they breach the minimum threshold. The CAR will also aid in the development of a risk-based supervision framework.
This proactive approach is expected to encourage stockbrokers to conduct their business operations more professionally and thereby help foster investor confidence in the capital market.
