Business Times

SEC mulls regulating bank guarantees to stop casino culture

By Duruthu Edirimuni Chandrasekera

The Securities and Exchange Commission (SEC) is mulling some directives on proliferation of low cost bank guarantees backing investors to purchase Initial Public Offerings (IPOs) following complaints that the degree of over-subscription in public listings does not represent 'genuine' demand.

“We received some representations (from the market) on bank guarantees and discussed it at the SEC meeting on Wednesday. This is receiving our attention,” Indrani Sugathadasa, Chairman SEC told the Business Times on the sidelines of a press conference to inform media on important decisions taken at this particular meeting.

She said the SEC is awaiting certain IPOs be completed to announce their decision. Malik Cader, Director General SEC said issues (a decision) on IPO subscriptions through the bank guarantees is under serious consideration.

Sources close to the SEC said that the market regulator wants to allow ‘preferential allotment’ to small shareholders/retailers as they feel that in an IPO, large shareholders get an unfair advantage over the small shareholders. “They want to allow small shareholders more shares,” a source said, adding that the allotment will be more skewed towards the smaller investors.

He said that the problem lies in the fact that it is the small retail investor who gets crowded out by bank guarantees and a possible solution will be to allocate a certain portion of the IPO specifically for small investors (as in the case of ODEL and HVA). He added that the SEC is trying to bring in rules such as the minimum allotment of IPOs for retailers to be 30% or so of the issue size.

He said there have been some representations pertaining to subscriptions to IPOs through bank guarantees encouraging ‘casino’ culture, with clients looking to exit immediately upon listing. “Certain banks issued bank guarantees for recent IPOs with as low as 5% collateral
which means that for a bank guarantee of Rs 10 million, the client only had to give security worth Rs 5 million. Such guarantees are unthinkable under conventional banking,” the source said.

He said this kind of situation is a win-win for both bank and (high net worth) clients where the bank enjoys fees on the entire guarantee value (varying from 0.2% to 1.0% depending on bank and client relationship) while the client enjoys extensive leverage and buying power.

“There is little chance of the bank being asked to honour entire guarantee value (in excess of security) as public issues tend to oversubscribe several times and the more the number of similar guarantees given by a bank, the less the chance that it will have to honour same (i.e. self perpetuating),” he explained.
An analyst agreed, saying that low cost bank guarantees is an issue when it comes to IPO’s with heavy levels of oversubscription seen. He said that this is generally more hot air than anything else.

However, some others don’t see this as anything to do with the ‘casino culture’. “Generally, a larger segment of the retail investors always applied with the intention of exiting on the first day. With the market having appreciated by 200% over the last 2-years, we have to come to terms with the fact that the retail investors also are fairly big now and hence a force to be reckoned with. The low cost bank guarantees serve to spiral this process but is not the cause of it,” Deshan Pushparajah, Manager Corporate Finance Capital Alliance Holdings Ltd pointed out.

He explained that without the bank guarantees someone wanting 1000 shares of a particular IPO would have applied for 5000 shares. “With low cost bank guarantees, this same person would have applied for 100,000 shares but would still have ended up with 1000 shares. So the net effect is still the same, only the banks are richer in the process,” he said.

He also noted that this is the same credit market seen in the secondary market extending itself to the primary market. “What would be worrying about however is changing the mindset of the retail investors into a long term view instead of a ‘quick buck’ attitude,” he said.

Proponents of high risk taking say that Sri Lanka is still mired in poverty because we have an acute shortage of 'risk seeing’ investors. They point out that there is a fundamental principle in finance which says 'higher the risk, higher the expected return'. “We are always waiting for foreigners to come and take 'business risks' here because in our country 'risk aversion' is a chronic disease. There is no pleasure without pain. There is no high returns if we are not willing to take higher risks. What is required is not risk aversion but 'risk management',” Sarath Rajapakse, Director Capital Trust said.

He said that bank guarantees will become even cheaper in the future as interest rates come down, which will see more risk takers.

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