Though the recent spate of rules applied by the Securities and Exchange Commission (SEC) were necessary, they were applied erratically while existing rules aren't effectively implemented by the regulator, some market analysts say.
Most SEC directives have angered some and prompted others to complain to President Mahinda Rajapaksa saying these were the cause for the market's slide and pressurizing the government to remove SEC Director General, Malik Cader. However, many market participants had different opinions on Colombo Stock Exchange (CSE)’s regulation, overregulation and implementation in existing rules.
While some analysts, many of whom who spoke on condition of anonimity, agree that all regulations brought in by the SEC have been with the right intention, they acknowledge that the main actions by the SEC have been on broker credit and share price movemnts.
“I think the Commission acted in time to prevent these (the credit and share price hikes). However, the tools used by them are those that have come into question and also the fact that the stance has kept changing, leading to uncertainty,” an analyst noted.
But he was quick to admit that while not ideal, the regulators are also learning along with the market and have thereby worked with the market players in amending these as need be. "I don't think I can call the Exchange over regulated though – just haphazardly regulated," he added.
The analyst noted that going forward the SEC should be commended for putting in place the mechanism of the Capital Markets Industry Consultative Committee which should hopefully consider industry views prior to making major policy decisions.
Many analysts strongly supported the SEC’s recent crackdown on manipulators by the SEC. “This has been called upon for a long time, and it is heartening to see the ‘Body’ finally cracking its whip,” the analyst said.
So what are the ‘bad rules?’
Some 'strong' rules are:
- Specified allocation mix at the Initial Public Offering (IPO) such as for retail, unit trust etc, there are certain percentages that the IPO issuer should allot.
Analysts said that such regulations fail to take into consideration the actual demand and investor appetite in the market under each category, which may greatly vary on the risk appetite and return expectations of the investors.
- The one-year lock in rule
The challengers say that this rule delays the problem of oversupply (by the lock-in period e.g. one year) and doesn’t solve the root cause of price discrimination between IPO/private placement investors (if any).
- Price bands
These analysts pointed out that the situation now is such that some of the market participants await the imposition of a price band so that a share price could be driven much easily thereafter.
“Rather than bringing in new regulations, the regulators should look at enforcing already existing regulations especially with regard to price manipulation and insider dealing,” a stock broker noted.
CSE isn’t overregulated
But some others say that the CSE is 'not' overregulated.
Murtaza Jafferjee, CEO JB Stockbrokers noted that the existing regulatory framework in operation at the CSE is based on international best practices. He explained that whenever changes are proposed to the existing rules it goes through a structured proces – new rules are proposed to the rules committee that comprises of a wide number of stakeholders.
"The rules committee has many sittings at which the proposed rules are debated and they are in most instances put out for public comment to ascertain their practicality. Public input is then factored into the proposed rules after which they are passed on to the SEC for approval, after this they are finally approved by the board of directors of the CSE," he explained further. But he noted that what is lacking is effective enforcement of existing regulations. He said that this aspect needs to be improved upon.
Case for regulation
Mr. Jafferjee pointed out that by and large markets are the most efficient mechanism to allocate resources in an economy, the scarcity value of a resource is signalled by its price. In the case of a capital market, it is a mechanism to allocate long term risk capital. "This requires investors to make judgements on outcomes that are far in the future.
Therefore you need a large number of profit maximising entities acting independently to form judgements, the aggregation of their activity determines market prices," Mr. Jafferjee explained.
Since financial markets primarily trade on information, if investors cannot differentiate between good and bad due to distortions in the quality of information, invariably the bad drive out the good leading to market failure. Such a situation is undesirable since it will starve capital for well-behaved and productive firms that are necessary to create economic growth.
Explaining market manipulation Mr. Jafferjee explained that it includes practices that distort security prices or trading volume with the intent to deceive people or entities that rely on information in the market. Market manipulation damages the interests of all investors by disrupting the smooth functioning of financial markets and lowering investor confidence.
Pump and dump; artificial transactions
Explaining the two types of market manipulation – Information-based manipulation and Transaction-based manipulation which are both rampant in the CSE, Mr. Jafferjee explained that the first type of manipulation which is spreading false rumours to induce trading by others is aptly shown by the pumping up of a share price by issuing misleading positive information or overtly optimistic projections of a share's worth. "This will be done only to later dump the investment once the price of the stock, fuelled by the misleading information’s effect on other market participants, reaches an artificially high level.”
Explaining Transaction-based manipulation he said these involve transactions that artificially affect prices or volumes to give the impression or activity or price movement in a share showing a diversion from the expectations of a fair and efficient market. "Another way of doing so is securing a controlling, dominant position in a financial instrument to exploit and manipulate the price of a related derivative and/or the underlying asset," he added.
Rowdies in a library
He added that market manipulators are like rowdies in a library that has no rules, they go and make a lot of noise depriving other patrons from studying or reading books. They further abuse their rights and borrow excessive number of books with no intention of reading them depriving genuine people from accessing them. “This is why libraries have rules – analogous to regulation, there are signs stating ‘silence please’ and there are quotas as to the number of books that a person can borrow.”