Broker, margin credit rules to be relaxed to mitigate pressure on forced selling

Dumith Fernando

• According to CSE, around Rs.14bn worth of broker credit has been extended to investors
• Margin credit extended by banks exceeds broker credit
• CSE officials say five-day market closure will allow stockbrokers and banks to amend credit agreements with their clients
• But investors will have to bear interest charges on broker and margin credit despite market closure
• Assure that no intention to extend market closure beyond this week

By Nishel Fernando
With a view to mitigate the pressure on forced selling, following Sri Lanka’s decision to opt for a pre-emptive default on its external debt, the Colombo Stock Exchange (CSE) and Securities and Exchange Commission (SEC) are in the process of relaxing the rules on broker credit and margin credit limits temporarily when the market opens next week, top officials said.

“We are in the process of relaxing some ratios with regard to forced selling. We are trying to relax the loan-to-value ratio or margin coverage ratio to mitigate the pressure on forced selling,” CSE Chairman Dumith Fernando told reporters in Colombo, yesterday.

The CSE, which regulates broker credit, has submitted a proposal to the SEC to relax the loan-to-value ratio temporarily and the SEC, which regulates margin credit provided to investors by the banking sector, is expected to introduce similar measures. 

According to the CSE, there are around Rs.14 billion worth of broker credit extended to investors while margin credit extended by the banks exceeds broker credits.

The SEC last weekend decided to close the market this week, based on the advice of the CSE, citing the difficulties of conducting market operations in an orderly and fair manner following the announcement of a pre-emptive default on the country’s external sovereign debt.

Fernando noted that the five-day market closure would also allow the stockbrokers and banks to amend the credit agreements with their clients, as per the proposed amendments, which would come out within this week. However, the investors will have to bear the interest charges on broker and margin credit, despite the market closure.
“The stockbrokers can discuss with their clients on interest charges and reach a decision. The benefits of the proposed relaxation by far outweighs the interest charges during these five days,” he remarked.

The CSE also defended the temporary market closure, citing concerns on sustainability and safeguarding investors under the current uncertain environment.

“Even 10 days before this happened, the Central Bank (CB) assured that this is not going to happen. Unless you are a professional investor or with an institutional investor, which has a very good research team, it’s very difficult to say that everyone had information to predict this.  A lot of questions also remain to be answered as to what happens next. There is an information asymmetry that we can’t ignore. We are more concerned of sustainability and investor protection. Theretofore, this is the best decision we were able to make with the available information,” Fernando said.

In particular, he highlighted that one of the key objectives of the market closure was to retain the retail investor-dominated 62,000 investor base, which has grown from 15,000 two years ago, while noting that the retail investors have been the key reason for the strong and vibrant market for the past two years.

Commenting on the impact on foreign investors, Fernando opined that the market closure is unlikely to impact foreign investors, as already foreign investors have to wait for months to repatriate their investments in equities, due to the forex shortage. Meanwhile, the CSE is also planning to introduce fresh guidelines to the stockbroker firms to minimise systematic risks, which could intensify with the proposed relaxation of the broker credit rules.
The CSE assured that it doesn’t intend to extend the market closure beyond this week.