In the backdrop of the Colombo Stock Exchange (CSE) celebrating its 35th year in operation earlier this month, its newly appointed Chairman Dumith Fernando sat with Mirror Business to discuss his views and the upcoming plans for the country’s capital market operator, while recalling the key challenges and developments during the year. The following are the excerpts from the interview:
What was the main challenge that you had to face when you assumed duties as Chairman of the CSE in July?
There was a huge amount of work that was done when the markets opened in May, until the launch of the digitalised stock market in September. That was primarily to mitigate the possibility of another shutdown in the case of further curfews and pandemic-related challenges. In fact, it worked out really well.
We worked on an incredibly difficult and tight timeline. We were fortunate that there weren’t any curfews until all the work was done.
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CSE Chairman Dumith Fernando
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After launching the digitalised exchange, we have been able to operate as an exchange without any disruptions, despite having shutdowns across the country, starting from October. Even when the World Trade Centre (WTC) and CSE premises were placed in complete isolation, the CSE operated without a hitch and without having any staff member in any of our offices.
How has the market performed through the pandemic period?
When the market was reopened in May, there was very heavy foreign selling. By the time we shut the market on March 20, there were Rs.5.5 billion of net foreign outflows. However, over Rs.40 billion net foreign outflows took place after the market reopened in May. Fortunately, the interest rates went down about 400 basis points at the same time period. So, the local investors have stepped into fill that space the foreign investors had left behind.
Consequently, the daily market average turnover has exceeded Rs.1.8 billion, compared to the little over Rs.700 million daily average turnover seen in 2019.
What are the key initiatives that the CSE administration has undertaken under your leadership?
We were busy since July with our strategic plan with four key strategic priorities. We have been working on identifying actions within those four focus areas. We worked on things that would get our valuations up through marketing efforts as well as looking for tax-related incentives for investments.
We also worked on getting more listings into the CSE. We are also working on developing some of the market infrastructure, which will enhance the trust on the market.
What are the key developments that can be expected during next year?
Firstly, there’s big change in terms of infrastructure of the CSE, which is the introduction of delivery vs payment (DvP) mechanism. That’s basically the ability of the market to settle trades in real time, where the cash settlement from the buyer and the stock settlement from the sellers basically move at the same time. Once this happens, there will be products that can come from that.
Any particular products that the CSE is planning to roll out with the introduction of the DvP mechanism?
Once this infrastructure put in place in the first quarter of next year, we are looking at stock borrowing and lending, which is where people can borrow stocks and trade instead of holding them as seen in many other markets. It’s the first step towards creating derivative market products as well.
Then, we are also looking at introducing gold-related trading products. We have had the first concept paper discussed at board level and we have been asked for more refinements. We are hopeful that we will have products that we can propose to the approval of the SEC. Those are some of the near-term developments that we are looking at within next year.
Beyond that, we are also looking at introducing other products such as mortgage-backed securities, which we feel that would help this market to go well beyond the equity assets class.
Hopefully, we will also look at the secondary trading of US dollar bonds such as SLDBs. However, that will require much more discussions with the authorities and the Central Bank.
Are you also considering to introduce any other commodities?
Since we are an agri-based economy, if we can bring some agricultural commodities to the market, we will be happy to do that but I wouldn’t say it’s on the cards for delivery or introduction in 2021. We will probably study those in 2021.
But, firstly, we want to look at gold-backed securities and depending on the success, we will look at other commodities.
Are there plans to introduce any new products to the corporate bond market?
We have already approved the framework and rules for over the counter REPO corporate bonds. We have sent these rules to the SEC for approval. If it gets approved, we should be able to launch it fairly soon.
There are quite a lot of debentures in the bond market but they are not very liquid and they do not trade that often, partly because the REPO market doesn’t exist.
The Securities and Exchange Commission (SEC) introduced the framework for Real Estate Investment Trusts (REITs) in August this year. Have there been new developments since then?
We have lobbied for REITs for quite a few years. The current SEC administration turned positive in trying to enable this. We are very thankful for them. The initial legislation was passed and when it was passed, there was quite a large interest among property developers and other property owners in issuing REITs.
However, there were a couple of issues on the tax front; one was the capital gains tax on the initial transfer on the property and the second was the stamp duty and thirdly, there were concerns on any taxes on the REIT-generated income.
We, along with the SEC, successfully lobbied to the government to make certain changes in Budget 2021. Firstly, we proposed the capital gains tax be removed on REITs and secondly, we sought to exempt dividend from income tax in terms of REITs and lastly, we asked to reduce the stamp duty on first transfer of property to a REIT, from the standard 4 percent to 0.75 percent.
We have had conversations with many large real estate firms. However, I don’t think we would get any proposals until the REIT-related tax proposals in the budget turned into law. From the interest seen so far, I expect to see few REITs coming to the market within the next year.
Are there any issues related to REITs that are yet to be rectified?
The biggest issues are with the taxes. We should see some clarity at the end of this year or early next year.
For an example, when property owners basically transfer their property into the REIT, will there be a capital gain event for them? That’s something some of the property owners are still trying to get clarity on.
How long would it require to process a REIT application from the beginning?
Our plan is to limit the processing period to one to three months. However, initially, it could take three to six months because it will be a learning experience for everyone and there could be pandemic-related delays at state entities.
Once we get passed such pandemic-related delays, we should be able to process it under three months.
Could you elaborate on the mechanisms in place to protect investors from the potential frauds related to property transfers?
There will be REIT managers; that is going to be a SEC-regulated function. That’s a new class of SEC-regulated intermediary being created under the REIT framework. The REIT managers will have certain responsibilities to make sure such risks are studied and proper due diligence is followed to understand and to get rid of any legal risks in terms of property transfers.
Within the REIT manager, you need to have people with legal, real estate background, etc. to ensure that they are functioning at a professional level with right subject matter expertise. We have put those structures in place and when the listing approval comes to the SEC and CSE, we will go through a checklist to ensure that everything is in order.
The SEC together with the CSE launched the ‘Empower Board’ in mid-2018, targeting SMEs. However, there seems to be lack of interest among SMEs. In your opinion, what are the reasons for such a lacklustre interest?
We developed a framework and new set of rules under the Empower Board, which significantly changed the listing requirement. In the past, we had listing requirements that were more suited to larger companies with larger assets, longer operating histories and profitability. With the Empower Board, we changed those rules and regulations, so that a new class of companies that has much smaller assets and operational histories could come and list, with slightly less stringent requirements.
However, we haven’t had a listing so far. There are several reasons. Small companies may still think that the listening requirements are still challenging or onerous for them. Unfortunately, we, as the CSE, have to maintain minimum standards; we can’t minimise the requirements further. We can be flexible but we need to maintain standards.
There have been a lot of discussions. Along with the SEC, we have marketed the Empower Board among SMEs across the country. However, it didn’t surprise me that some of these smaller companies being reluctant to come on board when valuations were low, even for larger firms.
There’s a more favourable environment for equity capital raising. We are working with SMEs as well as various other stakeholders, including accounting firms and investment banks to push this ahead.
With the largest frontier market, Kuwait being upgraded to the emerging market status, analysts expect two more Sri Lankan entities to be added to the MSCI Frontier Markets 100 Index. What are your thoughts on this?
Anytime when markets move from the Frontier Market Index to the Emerging Market Index, the remaining frontier markets find that favourable because there’s a pool of assets raised by frontier market funds internationally that has to be generally invested in frontier markets. When a market moves from frontier to emerging, the weighting of each remaining frontier market in the index does go out. When Pakistan moved to the Emerging Market Index, we saw investment flows coming into other frontier markets.
Having said that we have to wait and see because in the times of elevated risk internationally, especially as we are going through with the pandemic, some investors prefer not to be in more volatile markets. That’s why frontier markets have seen a lot funds coming out of them during this period.
However, if you get passed that situation, with more and more frontier markets moving to the Emerging Market Index, we become a bigger fish in the small pond of frontier markets. We should stand to benefit from that.
Former CSE Chairmen were keen on moving to the Emerging Market Index. What is your take on this?
It’s definitely a target but not in immediate term. We would like to see six to 10 companies when we move to the Emerging Market Index.
What is the current approach to get more firms listed on the exchange?
We have started conducting surveys of unlisted companies by working with the Export Development Board (EDB) and we are also working with industrial associations such as the Federation of Information Technology Industry Sri Lanka (FITIS). Further, we are also trying to work with the Board of Investment (BOI). We know all these associations/agencies have a large group of unlisted firms.
We are going back to understand why they are not listed. Just throwing incentives won’t help, if we are throwing incentives at wrong areas. We are also trying to make the listing process easier. We will reduce redundant documentation required and streamline the process, where we can minimise redundancies. We are working with the SEC to move away from the current dual approval (the SEC and CSE) to create one single approval. We are going to introduce a single window concept at the CSE. Further, we are going to introduce an online tracking tool for companies to track where they are in the listing process.
Can you briefly talk about the recent changes made to the Listing Rules of the CSE?
We got the approval to change the Listing Rules, so that a new class of companies comes and lists on our existing board. We have changed some of the requirements such as minimum operating profit track records, etc. as there are other ways of measuring the strength and size of a company.
In particular, we know that IT-related firms and e-commerce firms are not necessarily focusing on profitability during the first few years of operations but the market share. As long as they have minimum assets size and revenues, they can be very valuable. For an example, a local company such as PickMe should make many people interesting to go and invest. Under the old criteria, they might not have qualified for a listing on the CSE.
How many listings are currently in the pipeline?
There are two equity instructions, two equity IPOs and two debt IPOs in the pipeline. In addition, five rights issues and two private placements are also in the pipeline. We expect two to three e-commerce companies to list their shares next year.
How about the progress in getting state-owned enterprises (SOEs) listed on the CSE?
We are going to actively engage with the government as to how we can provide the CSE solutions to the government. Even if the government doesn’t want to privatise or lose control of the SOEs, there are many methods to raise capital.
We want to provide opportunities for the government to explore new capital-raising avenues through the CSE.
You have spoken of issuance of non-voting shares of SOEs as a way to get more listings on the CSE. Can you elaborate on this?
That’s one option. The CSE board is already deliberating on whether to lift the cap, where we say non-voting shares can be 15 percent of voting shares of a company. We are considering to be more flexible with that, maybe making some special exemptions for SOEs, if that’s something workable and more agreeable with the government.
