Regulating institutional investments for capital market development
Barrister
Tureen Afroz
1996
Share Market Crash still remains as a bad memory for today's capital
market regulators as well as the investors of Bangladesh. Over the last
8 years, the Government of Bangladesh has taken a number of regulatory
measures to boost the capital market of the country. The Government
even sought assistance from various international agencies to suggest
necessary capital market reforms for Bangladesh. The main international
agencies that have been working in the capital market reforms projects
in Bangladesh today are : Asian Development Bank (ADB), the International
Monetary Fund (IMF), The World Bank, the United States Agency for International
Development (USAID) and the United Nations Development Program (UNDP).
However, the capital market of Bangladesh is yet to make a steady growth.
The investors are still very scared to return to the market as they
have lost their confidence in the market and specially, the regulatory
body after the 1996 incidence.
The
Government recently realised that increasing the base for institutional
investors would help the steady growth of capital market in Bangladesh.
It is now believed that developing the institutional sources of capital
in Bangladesh would in turn increase the demand for securities in the
market. As a result, the capital market would revive with more active
investor participation. Therefore, the Government has amended a number
of relevant laws to facilitate increasing investments in capital market
instruments by institutional investors.
For
example, Section 27, Insurance (Amendment) Act 2000 restricted the mandatory
investments limits of investment companies in government securities
and government approved securities to only 30% of their total investable
funds. Earlier the insurance companies in Bangladesh could invest their
insurance funds only in Government and Government approved securities.
In particular, the insurance companies used to invest their funds in
National Savings Certificates (NSCs). However, since the reduction of
interest rate on the NSCs, the insurance companies have been looking
for alternative channel to make profitable investment. Therefore, after
the enactment of Insurance (Amendment) Act 2000, the insurance companies
are permitted to invest up to 70% of their funds into any other investments,
including securities market products.
Similarly,
earlier the private pensions and the provident funds were required to
fully invest their funds into government securities only. However, the
Section 20B Trusts (Amendment) Act 2000 permits private pensions and
provident funds to invest up to 25% of their total investable funds
into listed securities.
Having
realised that the mutual funds are one of the major sources of capital
that can be invested in securities market, the Government decided to
promote floating of private mutual funds in the capital market. By formulating
the Securities and Exchange Commission (Mutual Fund) Regulation 1997
and later replacing it by the Securities and Exchange Commission (Mutual
Fund) Rule 2001, the Securities and Exchange Commission (SEC) encouraged
private sector-sponsored mutual funds to operate in the securities market.
As a result, the first private mutual fund (AIMS First Guaranteed Mutual
Fund) was licensed in January 2000 and listed on the stock exchanges
in May 2000. The second private mutual fund (Grameen Mutual Fund) was
registered with SEC in August 2001.
All
these recent regulatory measures were undertaken with a view to increasing
the institutional investment in capital market. However, it is stated
that even after making all of the above regulatory moves, securities
market in Bangladesh still suffers from various setbacks. The market
is yet to recover from the 1996 shock. Domestic investors continue to
exhibit lack of confidence in the market, especially in the secondary
securities market. Only a limited number of foreign investors is showing
interest to venture the capital market of Bangladesh. It is estimated
that from 1997 to July 2003 the total foreign investment in the initial
public offerings in Bangladesh stood at very poor level - on an average
less than $ 1 million a year. Currently, shares of a large number of
listed companies are being traded far below face values at the two stock
exchanges. According to market sources, as of July 2004, shares of 42.33%
listed companies in Dhaka Stock Exchange and shares of 50% listed companies
in Chittagong Stock Exchange are priced below par for long. It has also
been reported that almost 50% of the brokerage houses at Dhaka Stock
Exchange are currently remaining dormant.
In
this background, it is stated that the growth of institutional investments
in capital market of Bangladesh has been far below the expectation.
The market is still dominated by unsophisticated retail investors. Even
after enactment of Insurance (Amendment) Act 2000 and Trusts (Amendment)
Act 2000, the participation of insurance companies and pension and provident
funds in the capital market remained very limited. (Asian Development
Bank 2003)
It
is stated that the Government is yet to reform, develop and strengthen
the relevant sectors under an appropriate legal and regulatory framework.
International organisations, like Asian Development Bank (ADB), have
made quite a few recommendations to update the current regulatory regime
of insurance industry and the pension and provident fund sector in Bangladesh.
However, the Government is very slow to adopt such recommendations in
their full capacity. Government also at times lacks regulatory prudence
to properly encourage institutional investments in capital market. For
example, according to a recent statutory order of the Department of
Insurance, the insurance companies in Bangladesh are allowed to invest
in the state-owned Investment Corporation of Bangladesh (ICB) funds
and those floated by its subsidiaries. However, it is not understood
why the insurance companies are still not allowed to invest in private
mutual funds.
Since
2001, The World Bank has been providing necessary expert assistance
to the Government to update the age-old Insurance Act of 1938 and finally
prepared a draft Insurance Act 2004 for Bangladesh. However, the Government
has recently abandoned the draft act for the reasons it not being compatible
with local needs of reform.
It
is further stated that until the state-owned Investment Corporation
of Bangladesh (ICB) is brought down to the level playing field with
other private asset management companies in Bangladesh, there would
remain an unfair competition in the market between public and private
mutual funds and that would impede the growth of private mutual fund
market in Bangladesh. ICB had been acting as the sole asset management
firm in Bangladesh until November 1999. In order to develop an institutional
base of the ICB and to bring it to a level playing field with private
asset management companies the ICB (Amendment) Act 2000 was enacted.
Following
the said act, ICB was restructured to create three new subsidiaries
to carry out merchant banking, mutual fund operations and stock brokerage
functions separately. The ICB subsidiaries are : (a) ICB Capital Management
Ltd. (merchant bank); (b) ICB Asset Management Ltd. (manager of trusts
and funds, including mutual funds); and (c) ICB Securities Trading Ltd.
(Stock Broker and Securities Ltd.). Though these subsidiaries were formed,
no asset was transferred to the ICB Asset Management Company. Besides,
the parent ICB, which does not come under the regulatory framework of
the SEC, continued to manage the existing mutual funds. Therefore, these
funds can borrow unlimitedly without any quantitative restriction on
their investments in a particular company, group or sector like the
private funds. Also, in violation of the mutual fund rule, the ICB or
the ICB Asset Management Ltd. does not publish net asset value or submit
any report or pay any fees to the SEC. This, therefore, creates an unfair
competition between public sector and private sector mutual funds.
It
may also be stated that the SEC at times lacks regulatory insights in
regulating financial products. For example, in August 2004, the SEC
approved the prospectus for public float of an Islamic Mutual Fund by
the stated-owned ICB Asset Management Company. It is appreciated that
approval to such Islamic mutual fund would encourage the institutional
investment component in capital market. However, it is doubted that
in a capital market where about 40% capitalisation is held by banks
and financial institutions that are shariah non-compliant, how risk-freely
the portfolio of Islamic Mutual Fund would be constructed?
It
is stated that to revive the dormant capital market of Bangladesh, the
Government needs to channel in domestic large funds from their currently
less-earning investment portfolios to better-earning financial products
of capital market. Also, more private mutual funds should be generated
to increase the institutional base for capital market. To have a prudent
regulatory framework for encouraging institutional investment in the
capital market, the Government and the capital market regulatory body,
SEC should take the following regulatory measures immediately:
removing regulatory barriers to enable contractual savings funds (such
as, insurance company funds, pension and provident funds etc.) to invest
substantial amount of their collections into capital market instruments
with better earning capacity;
enforcing a level playing regulatory measure for public and private
mutual funds;
proper restructuring of ICB and making it more answerable and transparent;
and
reforming current regulatory regime into one where more co-ordination
is guaranteed among various regulators (SEC, the Bangladesh Bank, the
Department of Insurance, Ministry of Finance, Ministry of Commerce,
other concerned ministries etc.) who directly or indirectly influence
capital market mechanism for institutional investments.
The
author is currently doing her PhD at Monash University, Australia.
