OP-ED: Fixing Bangladesh capital markets: Now or never

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This is the time to implement structural changes that can create a strong foundation

Within an undergraduate course at Dartmouth College, a Finance Professor had introduced the thought of capital markets to us, in the most remarkable way possible. The idea of capital markets, he told us, is to enable average citizens of a country to become co-owners of the country’s best and brightest organizations. Picturesque? I thought so.

So, what of capital markets in the home? When you have followed the markets in a few fashion in the recent past, you should have heard mostly negative news, especially if you missed the bull runs of the past. Covid-19 was also not kind to markets, the equal opportunity offender that it's. However, despite Covid’s impact on the markets, regardless of the negative news, despite all despites, we wanted to take this opportunity, as the economy re-opens, and a new chairperson joins BSEC, to revisit issues accessible that could fix systemic issues with the markets. Enough time is nigh. 

First let’s consider recent events. Our capital markets, the Dhaka STOCK MARKET and the Chittagong Stock Exchange, were the only markets to be closed completely May. Even while Covid-19 pounded NY, two employees of the New York STOCK MARKET tested positive, and trading floors closed, their electronic trading continued with gusto. Meanwhile, peer capital markets never closed, and, actually, have rebounded by now.

If the markets have closed?

But why shouldn’t the markets have closed, you may ask? Wasn’t the complete economy under shutdown?

An important reason why anyone invests in capital markets rather than other asset classes, may be the ability to liquidate investments any moment she or he needs the money. Liquidity, ie, the ability to sell, is inherent to the thought of capital markets. It is no not the same as you or I having to access an ATM booth because we must have cash accessible. This ability is even more important in times of crisis. 

Once Covid broke out, many small retail investors were seeking to sell shares because they needed access to emergency funds. Interfering with the essential nature of capital markets hasn't served us well. 

So, what must have been done, you ask? Let all offices and functions run as usual, and endanger the lives of people?

Certainly not. Take the exemplory case of how banks functioned. Banks functioned by keeping select branches open, and rotating staff in these branches. Similarly, our stock brokerages could have remained open, if not the branches, perhaps only the head offices with reduced workforce on roster duty. Furthermore, to mitigate Covid risks, investors could trade either through mobile software or positioned orders via email or phone, without needing to set foot in the brokerage office. A far more pressing point is that the BSEC, CDBL, and Stock Exchanges have to allow intermediaries to go paperless.

While the market was closed, international investors have expressed their frustration in public areas forums, since they rely upon the reliability and rationality of policies. Risk experts have chimed in and even suggested that DSE be rendered “non-investable” for foreign investors. Foreign investors certainly are a critical component of our investment landscape. 

Three explanations why foreign investors matter 

First, the cumulative foreign investment, or foreign portfolio investment (FPI), could be very large. Consider the fact that foreign investors have about $2.2 billion invested in Bangladesh ($3bn at its peak). With regard to comparison, by 2019, our leather exports accounted for $1.2bn; frozen fish (including shrimp) exports at $0.5m, and pharmaceutical exports, $0.13bn. Although FPI and exports aren't an apples-to-apples comparison, it really is worth underscoring the prospect of scale of the former. 

Second, because foreign investors invest for the long-term, they add essential stability to markets. This stability is vital if we are to inspire our best and brightest companies to go public, and in a virtuous cycle, motivate other complex investors to get, whether institutional or retail. 

Third, foreign investors constitute an unbelievable base of buyers for future capital raising initiatives of not simply private companies, but the government as well, in case we ever reach actualize sovereign bonds! How fantastic would sovereign bonds be, for long-term financing needs, such as for example infrastructure. Sovereign bonds would also provide a much-needed reprieve for the country’s banks, which are, unfortunately, the only way to obtain long-term capital for companies. That is a systemic problem, and an egregious one, and if we are to value growth, reliance on banks for investment growth has extreme limitations. 

At any rate, to return to the original thrust of the piece: The markets will have opened by the time this would go to press. Another burning issue remains. 

The issue of the ground price

On March 19, our market regulators developed the nifty idea to fix a floor price, intended to prevent these pesky stocks from becoming cheaper and cheaper. Consequently, while global markets were falling, DSE registered an 11.2% jump, despite practically non-existent trade volume. 

Well-intentioned no doubt, floor prices will be the enemy of trading, and by extension, liquidity, because, given that prices artificially rest on the said floor, buyers and sellers cannot acknowledge an equilibrium price. Our floor price in addition has been widely condemned by both foreign and superior local investors. Strategically, they are the investors we need to encourage if you want to increase the efficiency of our markets, and not the gamblers and the speculators. 

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Speculators and gamblers exist in every market, but the goal of market regulator must be to raise the ratio of superior retail and institutional investors to “balance” the speculators and the gamblers. The currency markets isn't inherently a casino, but behaves just like a casino, when gamblers and speculators run amuck. 

Junk and overvalued stocks stand to benefit from the floor price ruling. Losers are stocks with better fundamentals; institutional investors awaiting price discovery; retail investors holding margin loans; brokers, who overlook commissions; and exchanges, deprived of tax earnings. 

The elephant in the area, so far as brokers of foreign investment is concerned, may be the MSCI Frontier Market 100 Index. MSCI is the short form for “Morgan Stanley Capital International.” It is the gold standard of indexes for investors ready to put money in frontier or high-risk markets such as Bangladesh’s. 

The said index represents the performance of 100 leading and most liquid companies in 28 countries, eg, Bahrain, Bangladesh, Croatia, Estonia, Jordan, Kenya, Kuwait, Lebanon, Lithuania, Kazakhstan, Mauritius, Morocco, Nigeria, Oman, Romania, Serbia, Slovenia, Sri Lanka, Tunisia, and Vietnam. 

Persisting with the floor price signifies that stocks cannot become cheaper, although sometimes, they should, since stocks represent overall monetary confidence. The monetary confidence, or the shortage thereof, in cases like this, is due to Covid-19 no other reason. By sticking with the floor price, price discovery cannot happen, and complex investors cannot trade at prices that reflect reality. This may bring about the worrisome outcome that capital markets could be downgraded from the MSCI Index.

A downgrading would bring about an exodus of foreign investor funds, put us on the map of non-investable countries, and damage the development of the markets for a long time to come. Sticking with the ground price may comfort stakeholders in the near term, but damages can be significant. 

If you want to understand from history, Pakistan attempted an identical asymmetric floor price policy in August 2008, through the global financial meltdown. Karachi Stock Exchange regulators tried to force a floor price, to stop stock charges for falling continuously. This not only froze trading, but even following the floor price was removed, local and foreign investor confidence have been thoroughly eroded. 

What is just how out? 

If the regulator is convenient with a gradual approach, there are means of easing the ground price and exit strategies that are pragmatic. For just one, the regulator may use a moving average of share prices, rather than the fixed average currently in play. Second, rather than stock-specific floor prices in place, the regulator could deploy a trading halt for 20-30 minutes, predicated on a daily percentage change limit. Not ideal, but less intrusive than the current floor price that was fixed for every stock by averaging close prices in some week. Meanwhile, a floor price rule for block market transactions can be waived as block trades are privately negotiated, thus allowing investors to trade at previous limits if they wish to. This will not impact close price of the stock.  

This can be the right time not only to believe through these current immediate changes required but also more structural changes, since Covid is forcing all sectors to do a hard reset and think long-term, with a view towards sustainability. Enough time can be right given a fresh chairperson reaches the helm of BSEC, a development that is received positively by private sector stakeholders. 

Of course, there are various possible changes, but below are some quick ideas for the chairperson to consider:

1. Expanding electronic trading: Although DSE uses Flextrade, a real-time trading platform which allows remote trading from any suitable device, only 5% of trades are executed online. For comparison, 95% of trades happen online in Chinese exchanges. Online trading helps maintain social and physical distancing in brokerage firms, and there can be an urgent have to incentivize brokers and their customers to undergo the transition to digital.

2. Revisiting capital gains tax: Considering that we need an image makeover locally of foreign investors, and capital gains tax is a long-standing impediment to overseas fund flow, it is now time to consider “tax loss harvesting.” India and Pakistan both allow this facility. It basically enables taxing at an aggregate level, rather than taxing investors on each trade. 

This is also enough time to implement structural changes that may build a strong foundation for the markets. They are less Covid-related but more critical now than previously:

Enhancing financial disclosure: BSEC should initiate the preparation of a uniform database including the SEC filing system in the US. This entails the hosting of a common server to which companies submit financial statements, that allows investors to easily access quarterly and total annual reports, and drives a culture of transparency, and subsequently, informed investing. That is no longer a good-to-have, but a must-have.

Corporate access: In the same vein, since value discovery is inherent to advanced investing, BSEC should make mandatory, online quarterly earnings disclosure programs where in fact the leadership of listed companies host presentations on the performance. Fund managers, investors and analysts listen in, observe, and have questions. This is an international best practice and already accompanied by Grameenphone, BRAC Bank, IDLC, and Prime Bank in the home. This dramatically increases confidence in the markets. If this is resisted by local companies that are listed, maybe blue chip organizations should be encouraged to get started on this practice, in substitution for listing on our blue chip index, the DSE30. This also offers the result of elevating the profile of the DSE30 index, and subsequently, of our overall markets.

There are also other changes necessary to inspire more IPOs of high-performing companies, however the above will have an overall impact of strengthening and deepening our markets. Investor literacy programs are also important because it isn't only foreign investors for whom our markets need a graphic makeover, but local investors aswell.

The best type of makeover happens when change takes place from within, and at a substantive level. We no longer have the choice of cosmetic changes, if this market is to satisfy its potential. The Bangladesh economy certainly deserves it, as do the people.
Source: https://www.dhakatribune.com

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