09th November 1997


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Boost for equity but blow for debt market

The lop sided development of the local capital markets may continue with more incentives being given for equities while a much needed encouragement to the quoted debt market has once again failed to materialize, according to budget analysts.

"The long-term debt market has not received sufficient attention," top business magnate and Vice Chairman of Ceylon Chamber of Commerce, Ken Balendra said.

Securities experts had been calling on the government to eliminate stamp duty on corporate debentures to encourage their issue.

"We had recommended the abolition of the stamp duty for the last three years," CCC Deputy Chairman and Managing Director of CTC Eagle Insurance Chandra Jayaratne said.

Though Sri Lanka's quoted equities market had seen substantial development in the last decade, the quoted debt market had been bogged down in a quagmire of stamp duties and withholding taxes.

Unlike equities which can cope with substantial issuing expenses as they are non-interest bearing or (zero cost), debt issues are much more sensitive to issuing costs.

Even the unquoted debt market received a blow in the last budget with the government doubling stamp duty on certain instruments.

So far only Vanik Incorporation has come forward with a quoted debenture issue.

"As there is no quoted debt market to speak of, the government would not have to forego any revenue," Vanik Vice President Ajith Fernando pointed out.

However there were several measures to help the OTC debt market. The budget had proposed the removal of capital gains on quoted debt which Deputy Finance Minister G. L. Pieris said was aimed at encouraging more companies to list debt.

Withholding tax on Central Bank securities has also been abolished and stamp duty on repurchase transactions has been reduced from Rs 100 to Rs 10.

Stamp duty on commercial paper has also been reduced to 25 cents per Rs 1,000 for three month paper and 50 cents for six months paper from Rs 1 per Rs 1,000. Bills of exchange have also been given the same benefit.

Mortgage backed securitization however has benefited from the stamp duty on housing mortgages being brought down from Rs 20 per Rs 1,000 to Rs 10. A similar reduction was also made in respect of leases.

The equity markets however had received more benefits with stamp duty on IPO's being reduced, and an expected 5 per cent corporate income tax bonus being given to listed companies.

Listing expenses have been made a deductible expense for tax purposes and purchase of IPO shares could also be deducted from up to one third of an individual's assessable income.

EPF and NSB would be permitted to invest in equities. Listed companies would be allowed to operate their own provident funds. A reduction on SEC levies has also been recommended.

Unit trusts will also be exempt from taxation, preventing unit income from being taxed twice at the hands of the company and unit holders themselves.

"Government views such taxation as a disincentive for the growth of this industry, which has the potential to play a crucial role in mobilizing resources for the development of equity and debt markets," Minister Pries said.

Unit holders however will be required to distribute at least 70 per cent of taxable income generated.

To increase small investor confidence a settlement guarantee fund and a compensation fund have been proposed with the government chipping with Rs 150 mn. "I expect the industry to make reciprocal contributions to these funds," the Minister said.

CIMA takes measures to win faith on corporate accounts

By Mel Gunasekera

In making recommendations, CIMA says it has ensured that there would not be any additional cost in information generation, assemblingand publishing the disclosures. The Institute would like the recommended ratios be published for the previous four years and the current year on one page of the annual report.

The Chartered Institute of Management Accountants (CIMA) has recommended that a number of financial ratios be included in quoted company results for the ordinary public to better understand corporate accounts.

The majority of Sri Lankan investors are very conservative in that they seek secure homes for their savings. Hence, they look for safe havens like Treasury Bills, savings and fixed deposits in banks.

The entry of foreign funds in the Sri Lankan capital market in the wake of privatisation and liberalisation has spurred on the financial service industry. Hence, the stock market is now often considered an alternate form of investment.

But an investor needs relevant, pertinent and easily comprehensible information for decision making.

It is only when an investor is armed with such information that he could take a decision in a confident manner, says Angelo M. Patrick former CIMA President, who was one of the prime movers behind the proposal.

Confidence is certainly required in large measure if the majority of our investors, who are conservative, are to consider investing in the share market.

A large proportion of the participants in our share market, the technocrats, the investors, the brokers, are based in and around Colombo.

There are only 252 companies quoted on the CSE. If the share market is to expand in depth and breadth, it would be necessary to provide an opportunity to the provincial investors to participate in the rapidly expanding capital market, in addition to the Colombo based and foreign investors who at present active in the market. This will provide them with an alternative channel to increase their wealth.

Most often, provincial investors do not have access to financial information about quoted companies. Access to investor houses and brokers is often limited.

Though a provincial investor is interested in the share market, he may find it difficult to interpret published accounts. This is the main reason we set about to formulate a set of ratios which are called management account guidelines, which will help the investor to understand financial reports, Mr. Patrick said.

Some say accounting standards that are now in force, while improving the quality of disclosure, could only be understood and appreciated by the technocrats in the market, company accountants, auditors and brokers.

Accounting standards alone do not provide information in an easily comprehensible manner for prospective investors. The standards are only a guideline as to how to prepare a set of accounts. For example an ordinary investor would not be interested in the depreciation policy of a company, nor do the research and development activities infuse confidence in the investor.

"Some think we are putting an additional burden on the companies to publish further information", he said. "But the set of guidelines that we propose can be easily computed using the existing data. Therefore, no additional figure crunching is required," he said.

In making recommendations, CIMA says it has ensured that there would not be any additional cost in information generation, assembling and publishing the disclosures. The Institute would like the recommended ratios be published for the previous four years and the current year on one page of the annual report.

Such a presentation would ensure ease of reference by the investor, CIMA President S. Nallainathaw said.

CIMA also proposed to the CSE not to make the ratios mandatory immediately. 'We would like to have the companies to do it on a voluntary basis," he said.

However, the Securities and Exchange Commission (SEC) immediately made three of the 13m ratios, mandatory. Recently, four were made voluntary.

There is no compulsion on the companies to disclose management accounting information to the investing public. There are a few companies who disclose such information, but by and large, it is lacking in annual reports.

Information disclosed are also based on different definitions of the ratios.

For instance, return on investment, value added, debt equity ratio, may all be computed differently by different companies.

Some companies, in order to project a good track record, compute the return on investment based on the net assets employed, rather than on the total assets.

Certainly, the return is greater on the basis of net assets. Even when computing value added, it has been observed that the statement is used more to spotlight the different types of contribution that the company is making towards the government coffers (income tax, turnover tax, excise and customs duty) rather that bringing out the true meaning of adding value to the materials purchased.

"These are some of the examples of the inadequacy and inconsistencies in disclosures made by companies and to continue with this trend will not provide the necessary confidence to a conservative investor," he said. Hence, CIMA has also included a set of definitions for each ratio, so that there is a sense of uniformity in the application of the ratios.

The proposed ratios were highlighted during the CIMA 16th National Conference in 1994. The conference focused on the theme, Contribution of Management Accounting Information for Capital Market Development for public quoted companies. The Steering Committee chaired by Mr. Patrick, decided to work on it further, and came up with two separate sets of disclosure in respect of the following categories: listed companies other than financial institutions and listed companies which are financial institutions (other than insurance companies).

The steering committee drew up separate sets of ratios, as the nature and operation of financial companies are different to those of manufacturing companies. "For financial companies, their main source of business is its income. For manufacturing companies, it is sales," he said.


(1) Operating Return no investments  =                             Operating Prof                                  
Total Assets employed (Averageover the period)
(2) Total Liabilities as a percentage of total assets  = Total liabilities x 100%
       Total Assets
(3) Interest cover  =  Profits before interest and tax (PBI T)
                   Total interest
(4) EPS growth as a percentage  = Year on year
(5) DPS growth as a percentage    = Year on year
(6) P/E ratio     =    Price per share    
Earnings per share
(7) Dividend yield      = Dividends per share
   price per share


(1) Dividend per share (DPS) =                       Dividend                                   
No. of ordinary shares as at balance sheet.
(2) Net asset value per share (NAV) =         Net assets as at balance sheet date            
No. of ordinary shares as at balance sheet date.
(3) Earnings per share (EPS) = Attributable Profits after tax excluding Extraordinary items
                      Total No. of ordinary shares

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