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Why can’t we be like this forever CSE?

The Prince of Kandy

Thanks to COVID-19 a lot of things that should have happened in Sri Lanka a long time ago have happened. The Amended Electronic Transactions Act was recognised[i], and a lot of things went into the digital space. The stock exchange has also revamped their website and through guidance has made it easy for firms to migrate, hopefully eternally, to hybrid AGMs. The yesteryear AGMs full of retirees with one share scrounging on complimentary bites and wasting everyone’s time with planted questions is most likely now completely over.

The CSE has also fast-tracked demutualisation, put in place the framework for a delivery vs payment mechanism system, and started pro-active communication at levels that matter. The Securities and Exchange Commission has grown a pair[ii] and looked to pose the question on the central bank’s constructed primary dealer monopoly on the debt markets.

To quote the article;

The SEC Chairman explained to the Governor that there had been an initiative under the Financial Sector Modernisation Project (FSMP) funded by the World Bank to set up an integrated Central Counter Party system (CCP) with regard to settlement of securities. However, later the Central Bank had decided to limit the CCP to only Government Securities and domestic foreign currency transactions in the initial phase.

On Corporate Debt

Debt issuances remain in the confines of a select elite, but the cracks are beginning to show. People are being duped by the current negative real returns at banks and the potential negative real return at the Employees Provident Fund. They will lobby for open markets in the foreseeable future.

Trading of corporate debt on the exchange remains closed. Atrad the system used by most brokerages has not been allowed by regulation to interface with the debt boards. Even Capital Alliance the self-proclaimed leader in debt and a primary dealer does not allow the regular Joe to interface with the system. Only Jafferjee Brothers Stockbrokers allow their clientele to trade on the corporate debt market without interfacing with an advisor.

The Qualified Investor rule, where issuances remain closed to those under Rs 5 million in corporate debt holding, remains a huge deterrent and an unnecessary protective measure to the success of the market. Small-time investors provide liquidity, price discovery, and a higher margin business to the brokerages.

So long as the investor is willing to accept the risks, they should be allowed entry. After all young people working in the industry have been deemed by the regulator to be qualified to do so but would not be able to do so with such a high entry barrier.

Concentration of Issuance

The debt and share issuances through public offerings remain monopolistic. Those acquainted with dynamic models (considering time) would realise how the starting concentrations of holdings would impact the subsequent trading of an instrument. Current practices allow companies considerable power in the instance of over-subscription on how to allocate the shares.

Put simply if a company has an IPO which is oversubscribed 5 times over and then decides to issue shares to the largest bidders then there would be subsequently less day to day trading of the share. If the company decides to allocate shares to the smaller bidders, then there would be more trading of the share. With equity, this form of allocation is understandable as there is an element of control but with debt, it is hard to see the regulators rationale.

We live in a nation of obscene concentrations of wealth. It is the tendency that companies roll over debt. They always have a liabilities side to their balance sheet. In the case of trouble with high concentrations of issuances, powerful people can influence the banking system to pump credit into a company to allow their debt to be paid off and socialise the eventual losses through the banking system.

The paternalism of the exchange

Most people would quite rightly dismiss the endorsement of the exchange. The imbalance in net worth between the regulator/exchange and those being regulated is too vast to be bridged. The SEC with its enforcement track record has dissuaded many from entering the market.

This, however, is beyond the capital markets. We live in a country wherein even the notion of vehicular homicide is not discussed over prolonged periods.

In this vein, the regulator takes on the same thinking as Lankan parents to a daughter and her social life. The same daughter would be allowed every freedom in the West but not so at home because it is not safe. This all results in us not having the same products that they do in the West.

The difference with capital markets

Capital, however, is different from a human being. In the grander scheme of things (life/death) it will not matter. The beauty of the American system is its ability to foster incredible wealth. This success cannot come without concurrent freedom to house spectacular failure.

The US housing market is one of the most volatile. It has crashed multiple times and most recently even took out the pension savings of its allies in Europe. Capitalism on such a scale may not be agreeable to Leftist Lanka but one cannot disagree with the immense wealth stored in the property in New York and California. The powerful in Sri Lanka is currently attempting this in the property developments in Colombo.

American optimism is undeniably one of the greatest forces in the global economy. A recent paper[iii] from the Bank of England finds that the global faith in American credit underpins a major chunk of global trade.

US households do not finance current account deficits with foreigners’ physical saving, but with digital purchasing power, created by banks that are more likely to be domestic than foreign. –

How does international capital flow? Michael Kumhof, Phurichai Rungcharoenkitkul and Andrej Sokol

Forcing the Issue

Take the proposed REIT framework and Empower board. The uptake has been slow. Small companies are not going to have the same level of box-ticking capacity as their larger rivals. If they want to list and someone wants to invest in them why not let them?

Large companies are riddled with fraud it is just that we are unable to see it. The 634,557 that can trade on the CSE like money and want more of it. We are capable of making a risk to reward judgement and don’t want some communist telling us otherwise.

Take the rule that REITs have to pay out 95% of their earnings. In the current market most would want a REIT instrument to reinvest those earnings in more property. If managers don’t act in the interest of shareholders, we get rid of them. Don’t confine companies to what you think is right.

Ombudsman

Shareholders can only get rid of management when there are systems of democracy. The capacity to vote and the obligations of the company to every shareholder here are important.

The proposed ombudsman[iv] should be set up to interface digitally by default. The online stock forums were ranting on how Nations Trust Bank decided to pay their recent dividends by cheque and due to COVID-19 a dividend due on March 19 only got credited in July.

Setting up an easy interface where people can select which company they are complaining on and the common issue they are facing makes everything easy. Daraz.lk and Uber Eats have such systems that require minimal initial interfacing with the complainant. This saves time and resources to deal with the actual meat of the issue. 

Actual digitisation

Making information free

The CSE currently charges a fee of Rs 1000 for access to some information on its site. This information is readily available through other sources (notably any online trading system) and is sometimes even in the Annual Reports uploaded on the site.

Jafferjee Brothers provide a lot of information through their trading portal that is concise, easy to read, and helps in making decisions to trade. This means that people are more likely to make a decision to trade on the stockbroker’s website. Access to the trading portal is free and the broker makes money when people trade.

The CSE could go one step further and upload all available annual reports from even before the early 2000s to the website. This should not cost much and also is useful to long term investors like Warren Buffett. Making sure that accurate financial information is available on Bloomberg and FT.com is also important.

RSS

Enable Really Simple Syndication (RSS) on the CSE site. The information that is already published for free on the exchange requires a market participant to visit the platform to access it. Enabling RSS would mean that without investing in expensive systems the more tech-savvy could enable systems that provide alerts whenever a company a person is interested in makes a disclosure.

The Sri Lankan parliament and Foreign Central Banks have enabled RSS on all updates to their site. This allows the information on their site to be accessed more widely and without people needing to check regularly on a particular page.

People at the CSE and their mindset would think this would reduce the value of your site in terms of advertising and analytics. For instance, TopJobs.lk would never allow an RSS feed to be implemented as that would stop people having to visit their site. Through RSS TopJobs.lk would also be giving it’s rivals access to information in a manner that they can easily republish as their own.

Here it should be clearly reiterated that the CSE IS NOT IN THE BUSINESS OF RUNNING A WEBSITE. Widespread propagation of information from your site is good for the functioning of an exchange. This would increase the potential market participants.

European Single Electronic Format[v]

The European Single Electronic Format is a standard that sets out how financial information should be published. Foreign assistance and domestic implementation are possible for this initiative.

The EU aims to be the superpower of standards. The EU has lots of pension money that could greatly increase the value of our undervalued exchange.

Sri Lankan Accountants should look to convince their listed companies to adopt this standard and at the very least become familiar with something that can get them a job in a foreign company.

Email and voting systems

Everything from the CSE comes through the post. My postman is not happy especially when some incompetent company decides to send a printed annual report. With the amended Electronics Transaction Act this does not seem necessary.

The CSE should set up their own mail servers capable of reaching the 11,741 of us that hold shares in John Keells Holdings. These servers should be trustworthy and not end up sending mail to the spam folder. This would save considerably in postage and improve the quality of communication.

Voting on AGMs can be done digitally. Develop forms and systems at the CDS allowing people to interface easily with their companies.

Make space on the site to upload video

AGMS are now recorded and that makes it possible for them to be uploaded to the site. This allows people not able to access the livestream to see the proceedings of the event. It also helps future investors see the history of the company.

We have a large and proficient English-speaking population which is most apparent in our capital markets. We should look to communicate this internationally and get valuations more in line with a country that has had Test status for decades.

Conclusion

The President is a hands-on leader who likes to see things improving. People will have to show results in a timely fashion. The proposed reforms in this article are easy and in the public interest.

If you are doing things on pen and paper, at physical meetings, and/or slowly you are doing it wrong. The CSE must not be allowed to go back to its old ways and we the market participants should not allow it.

The trading system can now go back to a 9:30 am to 2:30 pm schedule. Not doing so would be an insult to the effectiveness of the COVID-19 taskforce.


[i] http://www.dailynews.lk/2020/05/27/finance/219417/%E2%80%98no-legal-taboo-holding-agms-digitally%E2%80%99

[ii] http://www.ft.lk/front-page/SEC-Chairman-calls-on-Central-Bank-Governor/44-701656

[iii] https://www.bankofengland.co.uk/working-paper/2020/how-does-international-capital-flow

[iv] https://ceylontoday.lk/news/cse-ombudsman-to-be-introduced-soon

[v] https://www.esma.europa.eu/policy-activities/corporate-disclosure/european-single-electronic-format

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Integrity in Credit Rating

At the end of the book titled ‘The Interpretation of Financial Statements’[1] by Benjamin Graham, in a chapter titled ‘Conclusion’ he writes the following;

“There are other factors outside of the company that are perhaps equally important in their influence of the value of its securities. The outlook for the industry, general business and security market conditions, periods of inflation or depression, artificial market influences, the popular favour of the type of security- these factors cannot be measured in terms of exact ratios and margins of safety. They can only be judged by a general knowledge gained by constant contact with financial and business news.”

This paragraph follows many chapters of text deconstructing financial statements in a methodical manner, which in the words of the paragraph preceding the one quoted above, suggesting that “By an examination of the statements it is possible to form an opinion as to the present position and potentialities of the company”

The book concludes on the note that;

The investor who buys securities when the market price looks cheap on the basis of the company’s statements, and sells them when they look high on this same basis, probably will not make spectacular profits. But on the other hand, he will probably avoid equally spectacular and more frequent losses. He should have a better than average chance of obtaining satisfactory results. And this is the chief objective of intelligent investing.

Efficient Market Hypothesis

To quote Wikipedia[2];

“The efficient-market hypothesis (EMH) is a theory in financial economics that states that asset prices fully reflect all available information. A direct implication is that it is impossible to “beat the market” consistently on a risk-adjusted basis since market prices should only react to new information.”

Benjamin Graham’s work and Eugene Fama’s theory represent a broad consensus amongst financial professionals. Benjamin Graham’s work is considered the Bible to value investors. Eugene Fama’s work is widely taught at universities.

Taking both to be true it is fair in my opinion to suggest that the share price and its movements suggest a trend in underlying credit worthiness of an institution. The logic is that the aim of an investor is to price a share according to its current asset holding and future earnings. Future earnings make possible the repayment of credit. This when combined with EMH suggests that the market price reflects all available information. This thinking is present in the academic literature[3].

To quote from the latter referenced paper’s abstract;

“an approach of estimating failure probabilities based solely on stock market prices…

We find a close correspondence between changes in the estimated probabilities of failure and the actual credit events occurring. Credit ratings from major credit rating agencies, on the other hand, are shown to react much less and much slower to credit quality changes”

A declining share price relative to the market (a decline greater than the market) would suggest a decline in credit worthiness. This is why most people in fair markets see a decline in share price highly correlated with a decline in credit rating. 

Put more simply the decline in the price of Melstacorp is due to its recent acquiring of shares in JKH. The acquisition is not perceived as beneficial to future earnings. The company obtained significant credit over the last year and should have been downgraded.

Laughable Ratings

To quote from the Fitch Ratings press report[4] on Melstacorp

“The group had a comfortable liquidity position at end-March 2018, with LKR19 billion of unutilised but committed credit lines and LKR15 billion of unrestricted cash available to meet LKR19 billion of debt maturing in the next 12 months. We expect Melstacorp to generate around LKR5 billion of negative FCF in FY19 amid higher capex at ASP. The group has strong access to local banks due to its position as one of Sri Lanka’s largest corporates and its solid credit profile.”

Melstacorp has the highest possible rating for an LKA institution of AAA. This rating is in spite of forecasted net cash outflows and a currently negative cash position. The company has been in a negative cash position for many years.

Taking the Interim Statements

The recent interim statements uploaded to the CSE were noticeably missing the cash flow statement. This is an issue that I raised with the company. Though a forgivable oversight I do not see why it was not picked up earlier by analysts. This is further made worse by the fact that the CSE uploaded a corrected version as if though no error had been committed.

From the year 2017 to 2018 total assets of the company increased from 121 billion to 232 billion. Though this may be due to the way in which they now consolidate their accounts it is unlikely to suggest that the underlying assets are at the disposal of the holding company.

Conclusion

Why is the share price movement at such odds with the credit rating? Who is giving finance to Melstacorp and why?


[1] The Interpretation of Financial Statements, Book by Benjamin Graham and Charles McGolrick

[2] https://en.wikipedia.org/wiki/Efficient-market_hypothesis

[3] Measuring the risk of financial institutions’ portfolios: some suggestions for alternative techniques using stock prices, S. G. HALL AND D. K. MILES; Estimating Default Probabilities Using Stock Prices: The Swedish Banking Sector During the 1990s Banking Crisis by Hans NE Byström

[4] http://www.lankabusinessonline.com/fitch-assigns-melstacorp-first-time-aaalka-rating-outlook-stable/

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Bakamoono.lk at it again

The self-appointed moral police of the world is out and about again. Bakamoono.lk in a recent post has spread the normalization of censorship accompanied by ill-informed activism. They have shamelessly spread clickbait published by the BBC.

It is titled Japanese Magazine Apologises Over University ‘Sex Listing’. The title is purposely vague and misleading. I believe the said ‘Sex Listing’ refers to the ranking of the university by how sexually promiscuous their student body tends to be.

To rehash, following a campaign led by an offended individual, a magazine decided to pull back a story. So, what exactly is so offensive about the article?

The most damning indictment in the BBC article goes;

The article mentioned five colleges where students were “easily available” at drinking parties and described how to “coax” women and judge whether a woman was sexually available based on her clothing and appearance, reports say.

https://www.bbc.com/news/world-asia-46794476

Note; coax though similar in sound is very different from the word coerce.

Is it Called For?

The words “reports say” would show that even the BBC article is going by second-hand information. The underlying campaign has also failed to reach its signature goal.

Sadly, the magazine is only in Japanese and I can’t find the original article. However, another article also deemed offensive by the original campaigner from the same site and referred to in her YouTube description (on the campaign video) is available. Though I agree this is subjective, a google translate of this article also makes it difficult to spot anything calling for censorship. The magazine is similar to the Guys Only publication found in Sri Lanka.

Going by the description I believe the original poster is mostly concerned with the original article as “This sexualizing of women is not funny.” She should then choose not to read it. People calling for censorship must realize the gravity of their request and explain articulately as to why it is called for.

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Vehicles for the Rich

This piece serves as a gambit to a relatively unpopular budgetary reform that should be pushed through. In Sri Lanka as in the rest of the world the vehicle is a status symbol. It’s role as a status symbol is however more pronounced in Sri Lanka. High duty, petrol costs, and realizable value in the secondary market make the vehicle a reliable indicator of wealth. The significant costs in owning a vehicle combined with the considerable ease with which it can be offered as collateral make it popular as an asset class amongst businessmen. Businessmen also use the transferability of the asset class to cover taxable income or unexplained wealth. Vehicles are the preferred form of collateral outstation (any region outside the Western Province) indicating problems with financial deepening and distribution.

True on so many levels

One must consider vehicle drivers, owners, service providers, financiers, and then agents from a social lens. Revisiting the list, one sees that they are ordered in ascending order in terms of wealth. Ishara Chinthaka Nanayakkara, Indra Silva, the Yaseen family, David Pieris, and Arthur Senanayake come to mind. It is my sense that vehicle dealing has overtaken tea as a creator of disproportionate wealth. This is odd as it doesn’t take much in the way of intelligence to import and then sell a vehicle. People notice vehicles. The school run of the British School of Colombo is a significant eye sore to those averse to gaudy displays of wealth by the newly rich. One would imagine that there is a daily gala occurring at the WTC by observing the way in which people roll up to work. There is considerable social angst against this.

False on the most significant one

Vehicles are a signifier of individual wealth. They are not however a signifier of societal wealth. A vehicle is only as important as it is in Sri Lanka when your infrastructure is poor. Wealthy nations have efficient public transport used by a considerable portion of their population. Rich Sri Lankans will still have to feel poor amongst their foreign counterparts who have more equitable taxation and better mobility. We must start to think of vehicle taxation as part of wealth distribution and more importantly as part of a wider transport policy.

Please share your ideas by commenting to help formulate this idea into a budget suggestion.