New SEC Act will form a sound foundation for capital market regulation: SEC chief

Following is the annual review of Securities and Exchange Commission (SEC) Chairman Thilak Karunaratne in the SEC’s latest annual report.

In the year under review, we faced many challenges which were successfully overcome and ended the year with significant achievements.

Our efforts were essentially directed towards pursuing the core mandate of promoting, developing and maintaining a capital market that is fair, efficient, orderly and transparent. In the process we embarked on a series of initiatives to strengthen the stakeholders’ trust and confidence in the capital market.
The SEC in 2006 formulated a 10-year (2006-2015) Capital Market Master Plan, funded by the Asian Development Bank (ADB) with consulting assistance provided by Ernst and Young Malaysia (E&Y). Over the years, we were able to implement some of its key proposals including initiatives to develop a vibrant bond market, establish a capital market education institute, revise transaction cost, etc. 
Moreover, a few other initiatives required extensions in timelines especially the Demutualisation of the Colombo Stock Exchange (CSE), expansion in regulatory coverage of the SEC, enactment of a Securitisation Act and reduction of systemic risk in the market. In order to successfully achieve the above-mentioned tasks as well as the current needs of the capital market, in the year 2016 we formulated a wide-ranging three-year Strategic Plan (2017-2020), which was approved by the cabinet in October 2016.

The Strategic Plan is expected to meet the interest of all our stakeholders by strengthening the regulatory framework, developing market infrastructure, encouraging investor engagement, improving risk management and providing effective supervision and enforcement.

From a regulatory perspective, we finalised an exposure draft of the new SEC Act and invited feedback from the stakeholders, including the public, to foster transparency in the law-making process and induce meaningful contributions from all. While some commended the proposed amendments, others claimed this was too draconian, stringent and not necessary for a developing market such as Sri Lanka. Some suggested that the new provisions will impede market violations and that an element of market malpractice was necessary to drive the market.

Despite these baseless arguments, we believe the new act will form a sound foundation for capital market regulation and additionally expand our scope with enhanced enforcement capabilities. Furthermore, it will introduce powers for civil and administrative sanctions and will also include more provisions to regulate hitherto unregulated capital market intermediaries and products and ensure better safeguard of investor interests.  The proposed legislation is expected to be forwarded to the Legal Draftsman by the end of the first quarter in 2017 and we are confident that it will be presented to parliament and approved to be enacted as a new act by end-2017. This will be a singular achievement as the commission has been struggling to bring in a new act since 2011. Here I wish to mention with grateful thanks the invaluable contribution made by the drafting committee headed by Kanag-Isvaran P.C.

Rapid changes in the global securities markets have caused stock exchanges around the world to examine their business models and restructure themselves. Many exchanges have responded by demutualising, which brings about major shifts in ownership and corporate governance structure. Demutualisation of the CSE is likely to allow the CSE to create a more streamlined and market-oriented exchange and respond more effectively to competitive pressure. During the year under review, we were able to obtain consultancy services from ADB to prepare a basis for value allocation, finalise the modality for demutualisation and draft regulation on criteria for a demutualised exchange. We sincerely trust the members of the CSE will cooperate with us to see a successful conclusion of this process before end-2017.

SEC’s vigilance
The present negative market sentiments underscore the importance of the SEC remaining vigilant to address the growing risks and vulnerabilities. Subsequent to obtaining the board approval and broker consultations, the CSE made recommendations to the SEC to approve the introduction of risk-based capital adequacy requirement based on international best practices to instil better financial discipline and ensure that the stockbrokers are prudent in their business conduct. 

Although a few stockbrokers criticised this move due perhaps to ignorance and misconception, this framework is expected to strengthen the stockbroking industry and enhance the protection of client assets. Unless all stakeholders work in unison we will not be able to achieve the expected regulatory outcomes and therefore I urge all parties to cooperate with us to achieve these objectives. We recognise the inadequacy of financial literacy of the investor community in general, except for a few. Therefore, we continued to explore ways of improving financial knowledge and capabilities.
With this intention we reached out to different segments of society primarily through seminars, workshops, publications and mass media. We focused increasingly on publishing articles regularly in newspapers and arguably the SEC is the only government institution that has embarked on such an initiative. These are aimed at enhancing the knowledge of investors to make informed investment decisions.

In 2016, we successfully conducted a weekly one hour television series in Sinhala titled ‘Isura’ in association with Sirasa TV. The series, which comprised of studio discussions on financial products, investing concepts and investor rights and responsibilities became extremely popular and generated over 50,000 responses for the weekly quiz. We wish to thank our eminent industry personnel who served as panellists on this programme.

The SEC was only the third country in the world to have an International Organisation of Securities Commissions (IOSCO) Country Review, which started in July 2016. The objective of the exercise is to evaluate the strength and robustness of our regulatory framework and determine the areas that require improvement. A review team comprising of five regulators from other jurisdictions assessed the capital market of Sri Lanka against 37 of 38 IOSCO principles. 

We could not be assessed on the 38th i.e. Delivery versus Payment (DvP) as we have not implemented this important mechanism. Yet after many deliberations with the secretariat and commission, IOSCO is in the process of finalising their report, which we expect to be quiet favourable and by implementing the recommendations of the report we expect to achieve an effective, balanced and efficient regulatory framework, which will assist in attracting international portfolio investments into the country.

Greater international cooperation among regulators is vital to deal with challenges faced by capital markets and enhance overall market regulation. In October 2016, in association with the United States Securities and Exchange Commission we successfully conducted a regional training conference on ‘Effective Oversight of Capital Markets: Investigation and Prosecution of Securities Fraud and Abuse’. This capacity building programme for securities market regulators was designed to address topical issues and increase the effectiveness of regulatory personnel.

The ultimate aim of a capital market is to ensure that investors and issuers alike have confidence to trade in the market. Given that market abuse poses a threat to confidence and integrity, we continued to upgrade our investigative skills in order to effectively detect and investigate potential securities law violations. During the year, the new investigation team was able to complete three investigations and four others are at different stages of completion. Moreover, being a signatory to the IOSCO Multilateral Memorandum of Understanding (MMoU), the SEC successfully sought assistance from several jurisdictions to conduct investigations.

Maintaining market integrity 
To maintain market integrity, the SEC expects relevant persons in the securities market workforce to be competent, honest and be of sound financial standing. Accordingly, we developed enhanced guidelines on fit and proper standards for those engaged in capital market activities. This framework is expected to ensure that persons of regulated institutions perform their activities efficiently, honestly and in the best interests of their customers. What is more, at the point of obtaining the initial licence or registration and also on a continuous basis relevant persons are expected to prove and demonstrate to the SEC that they comply with fit and proper criteria. In a bid to ensure the public gets a greater opportunity to invest in the capital market and to increase market liquidity, the SEC directed all public listed companies to comply with the Rules on Minimum Public Float on a continuous basis. As a result of a high incidence of non-compliance among listed entities and taking into consideration the views of the market, we decided to revise the Minimum Public Float requirements to provide listed companies with a wider range of options to comply with the rules effective from January 2017. We expect the revised criteria will encourage more listings on the CSE.

In 2016, the SEC successfully facilitated the implementation of an integrated Broker Back Office and Order Management System (OMS) for stockbroking firms, which is jointly financed by the SEC and CSE. Majority of the stockbroking firms installed the system and underwent a compliance audit for the purpose of fund disbursement. The OMS will not only be a pre-requisite for the market to move to a Central Counterparty (CCP) - DvP system but also enable seamless trading, clearing and settlement of securities.

We believe that achieving good regulatory outcomes require a collective effort. Therefore, we took steps to regularly engage with our stakeholders, particularly with investors, stockbrokers and the unit trust industry in order to discuss key issues and improve the manner in which we regulate our market. We are committed to not only remain responsive and effective but also work together with all the stakeholders to develop the market.

In order to keep up with the modern trends of capital markets it is imperative that we have highly educated, well trained and motivated staff. The SEC continued to spend its resources to train our staff, the most valuable asset of our organisation. Towards achieving this end, most members of our staff have participated in many seminars, training programmes and similar knowledge enhancement initiatives abroad during the year.

I strongly feel that we have now laid the foundation to meet the opportunities and challenges that lie ahead and support economic growth and look forward to working with our stakeholders to achieve these objectives. In conclusion, I wish to thank Ranil Wickremesinghe MP, our line minister as well as the Prime Minister, Niroshan Perera, MP, our State Minister, R. Paskaralingam, Senior Advisor to the Ministry of National Policies and Economic Affairs, M.I.M. Rafeek, Secretary to the ministry and all other officials at the ministry for their support and cooperation extended for the smooth functioning of the commission.

My thanks also go to the members of the commission for their invaluable contribution. I also wish to thank the Director General and the staff of the Secretariat for their excellent commitment and hard work.