Reasons and Recommendation
Abstract
The Capital Market of Bangladesh is passing tough times since December 2010 as high volatility is eroding the capital of Thousands of Investors that might turn into social instability. This fall is caused by many factors that I tried to identify and tried to link up between causal factors of market crash and regulatory failure. Primary issue related problems was faulty listing methods and IPO overpricing, few numbers of new listings, revaluating assets before company listing, high premium in issuance of right share/Repeat IPO etc. while secondary market related problems was stock splits and stock price manipulations through block trading, circular trading and insider trading. Investor’s greed and irrational behavior played a big rule to make the stock prices sky rocking as they were crazy to buy shares without judging the company fundamentals.
Shares of the companies with closed operations and big accumulated losses were rising constantly due to investors high risk appetite that caused them to loss everything. Government had already taken many steps (including SEC reforms) to stabilize the market but failed as investors confidence is in the bottom level. Government and regulators should work together to identify the main speculators and should brought under proper trial to bring investors back to the market. Regulator should make reforms on Listing procedures and other faulty regulatory frameworks to ensure transparency and efficiency in the capital market and also should bring clear guidelines regarding Private Placements, Asset Revaluation, Insider Trading, Dealing with Omnibus Accounts etc.
Keywords: Stock Market, regulatory bodies, syndicate, investors, Stock market Bubble, Liquidity Manipulation, Omnibus Account.
Table of Content
Introduction
The indispensable part of an economy is Stock Market which acts as an intermediary for movement of funds between surplus units and deficit units. It is a place to raise capital by means of issuing share and hence transacting it on a regular basis among the participants. Thus, a share is just like a commodity sold in the stock market through stock exchange. By purchasing shares of a company an investor become the owner of that company up to the intrinsic value of his shareholding and also become entitled to the profit or loss of the company proportionate to his share.
In a market economy, the capital market plays a vital role in the efficient allocation of scarce resources. Well functioning and developed capital markets augments the process of economic development, efficiency welfare through different ways such as encourage savings, draw more savers and users into the investment process, draw more institution into the intermediation process, help mobilization of non financial resources, attract external resources, discipline sick organization and investments organizing production of goods and services and creating employment opportunities (Chowdhury, T.A., 2005). There is a saying that the stock market is the pulse of the economy. In the developed western world, how the stock market is doing is not only a matter for prime-time news bulletin but also a matter of public interest on an hourly-basis.
Keeping conspiracy theory aside, instability or extreme volatility of a capital market may suggest weaknesses in the market. Further, this is an indicator of looming economic uncertainty (Monem, R., 2011).
There is no doubt that a vibrant capital market is likely to support a robust economy but two major catastrophes in the capital market of Bangladesh within one and half decades do not indicate the existence of a vibrant market; rather these show a highly risky and unstable capital market. The recent surge in the capital market has shaken the whole country as millions of people became insolvent within a very short span of time. It was observed in 2010 that the DSE (Dhaka Stock Exchange) general index was the highest ever which made it Asia’s top performer after China (Islam, 2011), while the reverse scenario was scaring investors in the 1st quarter of 2011 as the lowest down ever in the index was observed during that period.
The present study is an endeavor to justify the present condition of the stock market identifying the reasons of the catastrophe, to measure the impact of the surge and fall on the investors simultaneously identifying their expectations from the regulatory bodies and to provide recommendations to overcome the present conditions.
Objective of the study
The main objective of the study is to analyze the reasons and impact of the recent catastrophe in the stock market in Bangladesh. To achieve the main objective, the study sets the following specific objectives:
1. To depict the present scenario of the stock market and the recent catastrophe of the stock market in Bangladesh
2. To find out the reasons of the recent catastrophe in the stock market in Bangladesh.
3. To provide some recommendations to overcome the present scenario of the stock market in Bangladesh.
Methodology of the Study
We have used only secondary sources of data and they are Secondary Source
The used secondary sources for the study are Books, investigation report, past research, newspaper, journal, electronic publications and indices data of DSE and CSE
Limitations of the Study
The present study is a self funded work and therefore it was not possible to collect opinion of all types of people relating to the stock market. It could be much more representative and comprehensive, if opinion could be collected from other parts of the country
Previous research on this topic
Many studies are done around the world to find the reasons of stock market crash and linked with regulatory issues. Recent economic crunch and stock market crash in US motivated economists to conduct in-depth research on it. In Bangladesh many analysts expressed their view
regarding the capital market crash but no comprehensive research work is still done on it.
Government had formed an enquiry team headed by Mr. Ibrahim Khalid, former deputy Governor of the Central Bank to make a probe into the recent activity and to identify the culprits that submitted their report to the government. I am going to discuss the causes of recent Credit Crisis of 2007-2009 and “Ibrahim Khalid stock probe report” regarding the stock market of Bangladesh in this chapter
Stock Market and Crash What is a stock market?
Fellowes (2008, p.29) described that stock market has same features like a normal mar-ket with buyers, sellers and agreed price. He also added that there will be a middleman who guides investor to deal offers of buying and selling shares in the stock market We usually find stock exchange, regulatory organizations, investors, listed companies with securities, broker houses, merchant banks, and other intermediary organizations in a stock market with co-operation of central bank and government of the country.
What is a stock market crash?
“Stock market crash is a sharp and unexpected decline of stock market prices for a very short period of time, usually accompanied with the decline of many other assets’ prices” mentioned by stockmarketcrashes.net. It causes significant capital losses of investors and speculators. The market participants become panicked which leads to more losses.
Reasons of Stock Market crash 2010
After the recent catastrophe of share market of Bangladesh, Government of Peoples Republic of Bangladesh had formed a high powered committee in 2011 to investigate the issue and to give a report to the government within two months. The committee was headed by the ex-deputy governor of Bangladesh Bank, Mr. Khondokar Ibrahim Khaled and the committee was named
“Ibrahim Khaled share market probe committee”. The committee published a report that was initially kept undisclosed to the general people but later on it was disclosed as investors groups and civil society was creating pressure over the government for disclosing it. The committee submitted a report consisting of the reasons for the crash and recommendations with couple of case studies on 7th April, 2011. The report has identified a group of manipulators including key
officials, auditors, issuers, issue managers, brokers, individual investors and some other stakeholders
Figure 1: DSE daily DGEN index of December, 2010
Figure 2: Daily DGEN index of January, 2011
According to the Investigation report (2011) of the probe committee, reasons for the stock market crash are following:
1) Role of market regulators and their employees: The role of SEC to control & monitor capital market, working in favor of manipulators, approving unethical proposal and issuing wrong directives which lead to unexpected market conditions deteriorated the image of SEC. Investigation report mentioned some names of corrupt employees of the market regulators who were directly or indirectly responsible in the market manipulation.
There is a job overlapping between SEC and exchanges. Such as, DSE & SEC both organizations have surveillance department for the same job but there is no co-ordination.
Listing committee of DSE & CSE examines listing application of company but SEC doesn’t do it properly and approve it. Placement of Mutual fund & IPO at a price lower than the market value has become a new method of bribery for powerful employees of regulators. There is another accusation that these senior level employees received placement by using other`s name which is very difficult to identify. The report admits that SEC doesn’t have enough employees for example; qualified accountant, financial analyst and researcher to control and monitor the market. Rahman&Moazzem (2011) identified in their study that Dhaka stock exchange is becoming more volatile but the regulators are unable to defend it. They also suggested increasing manpower and quality of professionals in SEC.
2) Demutualization of Exchanges: There are both elected & nominated members in DSE and CSE. Basically, elected members run the administration due to less interest &
relation of nominated members. As a result, the players of the capital market act as controllers. Meanwhile, controllers are inactive during unethical activities due to conflict of interest. In the investigation report it was said that different stake holders of capital market and civil society support & demand for demutualization of exchanges. The meaning of Demutualization is separating controlling functions from controller’s functions, empowering controller and taking decisions without being motivated by the market players.
3) Investment of bank in the capital market: In 2009 & 10 banks and financial institutions invested huge amount of deposit money in the stock market. As a result share prices sky rocketed until December 2010. When Bangladesh Bank restricted more than
10 percent investment of deposited money, increased CRR and SLR ratio, created liquidity crisis and market crashed.
4) Pre-IPO & IPO process: Investigation committee considered that due to Pre-IPO & IPO manipulation share prices sky rocketed and that is the main reason for the share market crash. Manipulators illegally & unethically created a Kerb market in Pre-IPO stage.
Without recommendation by the listing committee application for IPO was accepted.
SEC did not examine abnormal asset revaluation and indicative price. As a result in Pre- IPO or IPO stage placement process and placement trade Kerb market overvalued share prices. This eventually generated liquidity crisis in the capital market.
5) Uniform face value of share: During the meeting between investigation committee and different stake holders of share market, a most important reason for abnormal climbing of index was indicated to uniform face value of share at Taka 10. Splitting share does not change revenue or asset of a company and should not affect the share price. But Small investors showed their utmost inter-est to buy split share with their small investment and consequently pushed the price up. Up to 62 listed companies split their shares in 2009 &
2010. So, it ab-normally increased liquidity of the market and brought notable change in market capitalization. Investigation report shows that MC increased 655% of companies those adopted share uniform and MC increased only 46% of those that did not adopt.
From July 2009 to December 2010 the role of total MC were 81.5% of companies which adopted share uniform and only18.5% those that did not adopt.
6) Placement trade / Kerb market: Before issuing IPO, Issue manager or Issuer Company sell shares to their nominated person and that is called Private placement or pre-IPO placement. Private placement is risky because it doesn’t have accounting discloser. In the developed countries there are some fixed rules but in Bangladesh SEC didn’t have proper rules for it. As a result some manipulators used it as a tool of price manipulation.
Investigation committee found that in most of the cases placement was offered at less than the IPO price. Though aim of public offering is participation of public but placement doesn’t make sure it. Eight companies issued convertible preference share in 2009 & 10 in which average 69% went for placement. So, participation of the public was hindered and that created placement trade or Kerb market. Some companies distributed 50-90 percent of their paid up capital in private placement. However, when a company raises too much paid up capital through private placement, the number of free-floating shares decreased. That’s why the difference between demand & supply push share prices up.
Moreover, non-listed companies created liquidity crisis as huge investment was stuck up with these companies. Placement created new process of trading outside of the share market and that is illegal. By taking chance of placement many small companies raised capital from illiterate and un-informed investors with their artificial financial reports.
7) Omnibus account: Investigation report found Omnibus accounts of ICB and merchant banks as another major reason behind the stock market debacle. Every branch of merchant bank operates only one omnibus account. There could be 3-10 thousands BO Accounts under the omnibus account which are not under the surveillance of SEC. So, information of individual accounts and its transaction are kept only with merchant banks.
As investigation reports shows that this kind of account made a lot of illegal transactions.
It publishes name of 30 big players including ICB for a lot of suspicious transactions and says most manipulators traded from the omnibus accounts. It was also reported at least Taka 2.5 billion has been traded from hidden or omnibus accounts.
8) Asset revaluation & Rumor: By taking chance of weak asset revaluation method companies have overvalued their asset. In this process dishonest auditors generated artificial audit reports. So, calculating of NAV on overvalued asset indicates wrong signal. Some companies issued Bonus shares against unrealized gain of revalued asset price which is a faulty accounting practice. There is rule to maintain provision against
“deferred tax” during asset revaluation to pay tax in future, but companies are not following it. Investigation reports pointed some companies which got NAV more than 100% to 3,472% after asset revaluation.
9) Book building method: It’s a procedure of determining price of IPO at which it is offered. The fair price is determined by the demand of a security from institutional investors and their indicative price. The main aim of introducing this method in Bangladesh stock market was to attract more firms for enlisting in the stock exchanges through fair share pricing. However, it was found as an instrument of manipulating market prices. Investigation report reveals that during the price discovery/bidding stage investors manipulated share prices for placement with too high price. High price was maintained only for the lock-in period and then investors offloaded their shares. As a result they pulled out a lot of profit within a short period and after that the share price did not increase. In this pro-cess corrupted Issuer and issue manager manipulated the price.
10)Serial and artificial trading: Some manipulators created artificial active trading environment among themselves through bulk transaction and increased share prices.
Moreover serial trading and price manipulation by many buy-sell orders through different accounts and broker houses which overheated the market.
11)Issue of Right and preference share: Right Share is issued at a discount price to existing shareholders. SEC took 4/5 months to take the decision of right issue proposal which is mysterious. Meanwhile companies inform the market about Right issuance and increased the share price. Moreover, issuance of Right share increase number of share which should decrease share price but it did not happen. Investing in Preference share is safe to get a fixed percentage of profit. To make the share attractive companies keep an opportunity to convert it and in that case it is called Convertible Preference Share.
Companies issued preference share for only 2-3 months even for 1 month which is not common in other countries. The faults with convertible preference share were its time period (short), convertible process and private placement. Investigation committee found that SEC did not have proper guidelines for Right and Preference Share issuance.
12)Suspicious transaction of top players: Investigation report reveals some names of individual and institutional investors as top buyers and sellers during abnormal increase and decrease of index in different time periods. The transactions of these investors were suspicious and affected the market heavily and liable for abnormal rise and fall.
13)Block placement: There was a lot of suspicious block trading of mutual funds. Some investors got enormous amount of placement time to time.
14)Direct listing: With the approval of SEC few companies have been directly listed in the stock exchange. These companies come to the market with inflated share prices.
Investigation report mentioned that indicative prices of these companies were determined even 58 times more than EPS and 9 times of NAV. Though share prices of these types of directly listed companies have been artificially determined, but SEC or exchanges did not investigate the reason of abnormal price.
Recommendation
We suggest following recommendations for stronger capital market in Bangladesh in line of our analysis.
1. Demutualization of Stock Exchanges
Stock Exchanges of Bangladesh are controlled by its members under the supervision of SEC. But such control creates conflicts of interests in the market. In India, Bombay Stock Exchange was demutualized under the pressure of Government. Bangladesh should follow the same. Peoples heading the DSE are highly debated for his rule in market manipulation (Ibrahim Khalid Report).
According to the report “conflict of Interest” made the body almost inactive on its rule.
Government should force Exchanges to be demutualized. In this regard, government can take the help of any donor agency (World Bank or Asian Development Bank) to develop necessary infrastructure.
2. Strengthening the Market Surveillance Systems
To strengthen the SEC’s operations and governance, (i) a real-time market surveillance system should be installed, and (ii) capacity building will be provided to improve monitoring, supervision, and enforcement capacity of the SEC. The SEC surveillance system should complement the stock exchanges’ own market surveillance activities and ensure that the exchanges are performing their regulatory functions well. The stock exchanges should establish a regulatory review committee to support the implementation of surveillance systems and to prevent vested interests of the exchanges’ members from encroaching on the exchanges’
regulatory functions. The committee will be composed of representatives from the legal and accounting professions, who will be independent of members of the exchanges, and an SEC representative who will participate as an observer. The committee will be responsible for establishing policy and direction in applying the regulations of the exchanges; reviewing existing regulations, regulatory practices, and procedures of the exchanges; and providing views on new regulations and recommending appropriate regulations. The two stock exchanges can form an inter-market surveillance unit, to share and discuss matters of mutual concern and to share information.
3. Ensuring Integrity and Efficiency of SEC Members and Staffs
Staff of SEC, CSE, and DSE will be trained in modern market surveillance and enforcement techniques to enable them to be more effective at detecting trading irregularities and market abuses. The training will include examination of evidence and analysis of trading accounts of
brokerage firms. In addition, staff will be trained not to contaminate evidence obtained from the surveillance system that could later be used in prosecuting a matter in the courts.
4. Co-ordination between SEC and Stock Exchanges
From the analysis and Investigation report we found lack of coordination and inconsistencies between the functions of SEC and Stock Exchanges. Esp. in case of Company listing and surveillance, Coordination is highly important. To combat future debacle both SEC and stock exchanges should work closely.
5. Bank Finance in Capital Market
Commercial Banks relies heavily on capital market by investing directly and indirectly (Margin Loans) that creates high risk on depositor’s money. So Regulators should impose restriction on investment on Capital market by Banks. In India, Banks can invest a certain portion of their owner’s equity/capital (not deposit) to capital market but in Bangladesh Banks can invest 10% of their total liability that is not rational at all. Such huge investment by banks pushes only the demand side and creates bubble to the market as supply side response is very low in Bangladesh.
SO, regulators should set new limit on the basis of Shareholders equity and should monitor this very strictly.
6. Introduction of Asset Revaluations Policy
In my analysis, I showed how companies revalued their fixed assets to manipulate stock price that caused distortion in the market and ultimately caused huge sufferings for Investors. In Bangladesh there is no certified surveyors in Bangladesh and also don’t have any Chartered surveyor Institute. So, their jobs could not be reliable and that’s why regulators should establish clear guideline for Asset revaluation. Chartered Accountant (CA) firms can play a rule to revalue asset until Chartered surveyor Institute. But CA firm that conduct asset revaluation should not audit the company account. Also companies should take SEC nod before disclosing the asset revaluation result and SEC should check the result with due diligence.
7. Consistency in Regulation
From the analysis made in this report, I found various inconsistencies in the SEC regulations.
SEC notification came only when the market rises continuously for many days that do not reflect good regulation. The Bangladeshi stock market needs to move towards a market based system of regulation for capital market activities and SEC should act proactively instead of its reactive response. SEC does not measure the costs and benefits of its rapidly changing guidelines/regulations. SEC and GOB should have long term visions regarding market and should make cost-benefit analysis before making any rule/law as it affect investor’s return.
Regulatory parity and consistency between all institutions and participants conducting related capital market activities has to be ensured at all times.
8. Supply of adequate securities
Supply side response during last two years was very poor relative to sky rocking demand of securities that helped to inflate the price of almost every share traded in Dhaka and Chittagong stock exchanges. Government initiated to offload more securities of government owned enterprises several times to meet unanticipated demands of the market but finally it has failed to offload these securities. Government should take measures to bring good companies (both local and MNCs) by allowing easy access and good IPO price to promote the market. Other regulators like (Bangladesh Bank, Bangladesh Telecom Regulatory Authority, Registrar of Joint Stock companies and Ministries) can also take measures to enlist new companies to the market to enhance the depth of it.
9. Transparency in listing procedure
As listing methods (Book Building methods and direct listing) played a vicious rule to damage the stability of the market; major change should be brought to make it acceptable and transparent. In this regard, SEC should promote only Fixed Price method as it lack less opportunity to manipulate the offer price. SEC can also use due diligence to fix the offer price under this method.
For Book Building Method, price bidder Eligible Institutional Investors (EIIs) should deposit at least 10% of the value of the securities that they are interested to buy. Such deposit will make them more careful and help them to make better analysis to quote any price. Lock-in period should be fixed to at least 180 days at short lock-in (21 days) help them to speculate them more to get higher returns. Institutes and persons behind the book building scam should be under trial and steps should be taken to the confiscate their ill-gotten wealth. Peoples of Regulatory bodies who allowed such offences also should be brought under proper trial. Direct listing method should not be allowed as it is very to manipulate under this method.
10. Serial Trading and Manipulation
As there are many evidences that some investors and institutions were involved in the serial trading and insider trading to manipulate the price of individual stocks under regulatory supports.
Manipulative trading under Omnibus accounts should be fully investigated and peoples and institutions under the hidden accounts should be identified and also should bring under trial if any irregularity is found.
Conclusion
As an important part of the economy of the country, well-functioning of the capital market is a must for the industrialization process of a un-industrialized country like Bangladesh but un- stability in the same may negatively affect the total financial system. Therefore, all related corners including Government, Regulatory bodies, Listed Companies, Brokerage houses, institutional investors, and retail investors should act rationally to maintain the stability in the capital market for the greater interest of the country.
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