SEBON as a regulatory body has the responsibility to protect the investors, but when it comes to investment choices we believe in "Let the investors decide"; Interview with Dr. Rewat Bahadur Karki, chairman of SEBON

Rewat Bahadur Karki, chairman of SEBON, had been appointed in the said position for the tenure of four years starting from 17th October, 2015. Dr Karki holds a PhD in Economics from Magadha University, Bodhgaya, India, and MA in Economics from Tribhuvan University, Nepal, and is also a law graduate from the same University. Dr Karki, had also previously served as the Chairman of the Board of Directors of Rastriya Banijya Bank and Expert Member of SEBON before being appointed as Chairman in SEBON, was working as an Economist & freelance Expert of Banking & Capital Market.

Dr Karki started a number of reforms including trading automation while assuming role of General Manager and Ex-Officio Member of Board of Directors of Nepal Stock Exchange Ltd. (NEPSE) during 2006 to 2008. He has worked for more than 25 years at Nepal Rastra Bank, the Central Bank of Nepal in different capacities including as Economic Advisor in the Research Department and Director in the Banking and Financial Institutions Regulation Dept. Internationally, Dr Karki served as an Advisor to Executive Director (2002-2005) at International Monetary Fund (IMF), Washington D.C. USA, and also as an Economist (1992-1994), Bank of Namibia, Namibia. Dr Karki has also worked as Director to different Boards. As a Board of Directors, he was involved in different financial institutions: NABIL Investment Banking Ltd., Citizen Investment Trust, Nepal Stock Exchange Ltd., and Credit Information Bureau including Mid-Western, and Far Western Grameen Bikas Banks.

SEBON being the apex regulator of securities market of Nepal plays a prime in the development and proliferation of Nepali market. On this backdrop Aakriti Thakali and Krishna Khatiwada from Sharesansar caught up with Dr. Rewat Bahadur Karki. The excerpts of the interview are:

You have completed two years and running in the third year of your chairmanship, what are the developments so far?

I believe in doing rather than just saying. We’ve been currently working on number of reform programs and awareness campaigns because of which I hadn’t been able to schedule appointment. However, to state a few, they are:

1. Improvement in our capacity as a regulator
2. Introduction of ethical and moral codes
3. Expansion of primary market to all over Nepal.
4. Improvement of secondary market
5. Improvement of broker service
6. Improvement of merchant banking service
7. International recognition through IOSCO membership.
8. Grievances of the Investors.

What are the major challenges that you’ve faced or are facing?

It’s been 25 years since the establishment of secondary market in Nepal and along the way, many challenges have come.

Problems pertinent to Merchant banks and primary market

Given the geographical diversity of our country, some parts are very difficult to access which has hindered the expansion of capital market. A few years back had you even imagined that people from Bajura, Manang and Humla could apply for IPO so soon? Now the interested investors can apply either online or manually through ASBA via banks in all 77 districts. This has facilitated the primary market access in remote districts like Manang, where about 500 Demat accounts have been opened that will further lay the foundation for secondary market access as well.

Self-Discipline

Being a regulatory body, SEBON itself should be an example of good governance. Back in 2064/65 when I was in NEPSE, I had introduced the Codes of Conduct for employees & Board members there. It should have been implemented in SEBON regulations earlier than that but the irony is, the employee codes of conduct including the codes for the board of members, is being implemented now in SEBON after 10 years, after I came here.

In order to make others honest or the market participants honest, we must be honest first. So in such situation if we also buy shares and start investing, how can we be a fair regulator? Recently we’ve penalized brokers who have committed mistakes, how was that possible? It’s because we’re ethical, honest and we do not have any personal interest in the case.

We had implemented the codes for the employees of SEBON from 2073 Magh, and then we implemented the code for Board committee from Shrawan, 2074. We have also issued good governance directives for Listed Companies which is being effective from Shrawn, 2075.

This is the age of information dissemination, so we have to make the channels for information sharing as effective and efficient as possible. If you look a while back, you can see that the entire market was influenced by a few large investors. Even in the primary sector the small investors had no chance of being allocated as the ones applying for higher units were allocated. But is that the situation now?

You might have seen it yourself the primary market has become inclusive and wide and according to the new allotment procedure, all investors, small or large, have equal chance of being allocated. In case, an issue is oversubscribed, based on lottery system each investor has equal probability of getting at least 10 units. This has attracted more investors into the system and the market is getting inclusive and wider including the remote districts.

However, this won’t last forever either as the system is always evolving. Now that we’ve become a member of IOSCO, we’ll almost match our standards at par with international standards and practices. As this is the silver jubilee year of both SEBON and NEPSE, we are slowly moving towards the open pricing system like the developed countries, which will make our market more efficient in the days to come.

Currently, our bourse is heavily dominated by the BFIs’ scrips and we can constantly hear people saying we should increase more real sector companies and that is true too. Real sector companies contribute to the real growth of the economy, whereas BFIs are financial intermediary whose prime function is to collect dispersed funds and redirect it to productive sectors.

Human Resource challenges

To regulate such large sector of more than 400 institutions, SEBON was heavily understaffed, so now we’re in the process of hiring more competent and qualified employees. We had a total of 23 employees previously and now the employee’s number has reached around 56. This is also not enough, so we are hiring more qualified people and have given priority to the capacity enhancement of the employees.

Double regulation for NEPSE

One other challenge we’re facing is the dual supervision that NEPSE has to comply to. On one side, NEPSE has to be accountable to us as a part of capital market and on the other, they have to be accountable to the government of Nepal as a government entity. So I think for this reason NEPSE should be fully corporatized like in other countries.

Taking all these into consideration, we’ve worked on all these challenges from different angles. About a decade ago or so the trading was automated in NEPSE when I was the CEO there, but clearing automation and ownership transfer automation hadn’t been established for long. So when I came here as the Chairman of SEBON on Kartik 1, 2072, we started full automation from Magh, 2072. It was a great achievement in the history of Nepalese capital market.

Similarly, the second thing is market depth. For around 8/9 years, the investors were investing without knowing anything about the market-depth. But now they have full access to market depth and we’ve also introduced trading of dematerialized scrips only.

Then we’ve worked towards capacity enhancement of merchant banks and brokers through their paid-up capital increment and introduced margin trading through brokers thereby expanding their scope. Similarly, we’ve also expanded the scope of merchant bankers, as now they can provide advisory services too.

Similarly, we’ve have addressed the problems faced by the investors too. For example, in the past, the investors had to stay in long lines even to get their own cash dividend, bonus and right shares, which would have taken a long time but now it all comes right to their own bank account and demat account. There are still a few issues regarding proper information dissemination but other than that it has become very easy for the investors now.

Similarly, there was a trend of applying from multiple accounts commonly known as “borey”, to increase the chances of being allotted but that doesn’t exist now.

The greatest challenge now is to expand the secondary market throughout the nation and the greatest hindrance we’re currently facing is the organizational structure of NEPSE which is still Government owned. When it first started NEPSE was like a NGO, working as a not-for-profit organization. So in 2064/65 when I was there we changed  it to a profit-making organization, replaced the representation of two brokers by experts in the NEPSE Board directors, but still no significant changes have come in its other aspect’s reform. Since our stock exchange is still government owned, it has structural issues and this doesn’t give good message in the international market.

Just reaching 77 districts isn’t enough; the software’s capacity of NEPSE along with CDSC and other market participants must also be enhanced to cope with the increased market. That time, when I was in NEPSE, we conducted ADB (Asian Development Bank) funded project for trading automation. Accordingly, NEPSE had committed to change the software within five years but that didn’t happen. Recently, after SEBON direction, NEPSE and CDSC have conducted system audit and submitted their report and in that report a lot of their shortcomings and weaknesses have come into surface. So being a developing country, we have a lot to catch up in regards to IT not just from NEPSE and CDSC but from all the market participants as well.

What are the recent updates on online trading? Risk mechanism and preparation wise.

When we in NEPSE automated the system back in 2064/65, our focus was on internationally compatible and tested system, which was completed by an investment of about Rs 2 crore 11 lakh (USD 3 lakh) under ADB’s assisted project. Under the project, the trading was automated through LAN (Local Area Network) and we managed to increase the no of brokers from 23 to 50. After three months of automated operation, I as a chief of NEPSE managed to move to WAN (Wide Area Network) to provide internet based trading from brokers’ offices to NEPSE in order to give facility to both broker and investor. And hence now the current system’s focus is to take that online directly to customers’ reach. I don’t know the technical details but as a regulator we are focusing on the new system’s international compatibility.

We’ve already become the member of international regulatory organization (IOSCO). So it is crucial that our software matches the international standard in terms of user experience and safety. Not just for that, we also need our software to be internationally compatible as we have now allowed international financial organizations like ADB, IFC (World Bank) etc. in our market. So for these reasons our infrastructure must be healthy, strong, reliable and independent.

We can’t say exactly if it will decline as there are many other factors too. We were informed that, online trading will begin from Shrawan 2075 on a trial basis. NEPSE and the brokers started their operation from 2050 BS, and till 2064 i.e. for 14 years straight no one decreased the broker commission charge. In FY 2064/65, 50 percent broker commission was reduced and now after eight years in 2073, the commission again was reduced by 40 percent. In course of time, it goes on declining by making competitive and internationally compatible. Reform has to be made in the broker service along with the branch networking. Recently the brokers have established their branches outside the Kathmandu Valley but for now they are performing like an independent body not as a branch of the main broker. So we have introduced some procedures and standards through regulations to address this issue.

What are the developments for creating trade settlement guarantee funds?

NEPSE has already prepared the working modality for the trade settlement guarantee fund. However, given the importance of such funds, only work model isn’t sufficient. We need to put them under the legal system. So we have given approval of setting up of such fund through “Trading Byelaws” to be effective from Shrawn 1, 2075. Previously we only had “Trading Regulations, 2053”, but now “Trading and Listing Regulations, 2075” is being introduced from FY 2075/76, with the approval of the government by replacing the earlier one.

What are your thoughts on giving broker license to Banks and adding more brokers?  Will expansion of current brokers outside valley will give positive result?

Rather than what is right, i think we should focus on which alternative is best for the current market situation.  Although the brokers are opening up branches outside the Kathmandu valley, it is not the best alternative; their branch expansion has been allowed due to limited other alternatives. So given the wide access of the bank, it is one of the best alternatives as mandated by broker’s regulation, 2064 B.S. However, banks themselves can’t function as the brokers rather they can establish a broker subsidiary like Merchant Bank or Laghubitta and then that subsidiary can be licensed. This provision is already available but approval from NRB (Nepal Rastra Bank) is a must and NRB has announced this opening through Monetary Policy of 2075/76. SEBON has also declared a policy through “SEBON Policy and Programs of 2075/76” to manage local broker in Provinces and Districts.

So we’re looking into all possible alternatives that can work and within a year, I think we will have some definite results.

Similarly, when we say of expanding the secondary market throughout the country, we must be aware that the basic requirement for it is the availability of primary market followed by economically active districts and areas. Previously, only 21 districts of Terai were considered economically active but that has changed now. Today many districts are coming to that level and primary market is available throughout the country and that too have created a better fundamental for the expansion of secondary market in competitive as well as qualitative manner.

What is the procedure of grievance handling in SEBON?

We have a separate division for grievance handling. Every complaint that comes is dealt in systematic manner with proper investigation and jurisdiction. From one point of view I think SEBON is the most empowered regulatory body as it is also a quasi-judicial institution. Unlike other regulatory bodies, we have the authority to investigate the case and give decisions including financial fines. Similarly, under the Money Laundering Act we have rights as a regulator, to charge financial penalty from Rs 10 lakhs to Rs 5 crore. And if you see, we have penalized two brokers by the amount of Rs.10 lakhs each recently. Similarly, such fines have been charged under the Securities Act too.

The various acts and laws regarding the securities are in the process of revision which has been in effect since 2063/64. At that time the penalty fees ranged from Rs 50 thousands to Rs 3 lakhs, which in today's’ date has lower value due to inflation. Under the recently passed Commodity Act such fees range up to Rs 50 lakhs. In this way we ensure that the complaints registered get proper attention and justice.

There are many instance of insider trading seen on market and layman investors are ruined by this type of trading. How is Insider trading being handled?

We have some provisions for Insider Trading in the Securities Act, 2063. However, the difficulty lies in finding the person responsible and proving the guilt. Insider trading is much like poverty and corruption, which we can’t bring down to zero but we can minimize it. Insider trading is very vague and we’ll have to tactfully work on minimizing it. Plus the thing is it can’t be done by SEBON alone. A large part of it depends on self-discipline and organizational codes of conduct. The code of conduct for listed companies has been introduced by SEBON recently which will be implemented from the next fiscal year. Similarly, SEBON is also currently drafting an “insider trading” regulation, which will incorporate the detail provisions on Insider trading.

There are a lot of Hydropower scrips in pipeline and it has taken so long to approve. Is it because of the lack of regulating body and the Rating?

The prime reason for such delay is the delay in submission of all the necessary documents by the respective company. If you see in our pipeline status, we are very prompt in our response. Upon submission of first request we immediately review and pass our comments along with the list of documents to be presented within eight working days. So, the ball is in their court, so whatever delay is happening is happening from their side. The approval will be faster when they submit the required documents faster. So whatever issues are being held is not because of us, it’s because of their inability to present all the required information on time.

However there are some issues with regards to weak performance and governance of the company which can be seen in the credit rating’s grading too. In such case, SEBON should be alert. However, now the scenario has come to “let the investors decide” stage. So the investors themselves must be aware and conscious about their investments and the risks associated. The investors must understand that any investment they make is inherent to risk, no investment is risk free. But many times investors don’t realize that. When the return is good they’re happy and when things start to roll down, they blame the Board for approving share issues in IPO and FPO haphazardly.

Regarding the recent issue of FPO too the same thing happened. In the past, there was no standard for determining the FPO price, when Nepal Life issued FPO they had proposed to issue it at around Rs 2,912. If you see its net worth at that time it was around Rs 144, so we halted it for around 6 months and  in that duration we devised a framework/modality to determine the FPO price. This modality depends on four factors:

1. Net profit of the company for the recent three years (Capitalized Earnings)
2. Net worth per share
3. Average market price of the company for 180 days prior to submission of the request
4. Discounted cash flow

So by taking the average of these four factors, the FPO was allowed to fix its price at Rs 1425. At that time we saved around Rs. 6 billion of the investors, but have they noticed it? No they blame how the current FPO prices are so close to the market price? In the current modality we’ve also added a new point where the FPO price cannot be more than 4 times higher than the net worth of the company.

The recent FPOs of Butwal Power, NMB Bank and Nepal Bank were also determined by the same modality but despite that SEBON had to take a lot of fire saying we had approved the prices without proper study. We have followed the procedure and that is the price that came out. What happened is that the market is bearish now and the market price started falling down, however, the other factors like the cash flow, net worth and the capitalized earning are still good and same. Even then looking at the market condition, the determined price was further lowered by SEBON to make it accessible to the investors.

In addition, we made 100 percent underwriting mandatory for FPO issues and even the underwriters do their study before signing the underwriting agreement so are they fool? The thing is the FPO price might seem unattractive given the declining market trend but that isn’t the only factor that determines the FPO price. So the people, who’re saying that we’ve done the pricing without proper study and modality, please come and see the transparency in determining the FPO price.

According to the recent budget speech, companies with capital above Rs 1 billion will have to go IPO. So on that ground, how many companies will have to issue IPO?

So far we’ve noticed about 13/14 companies but it’s a start at least. Here the companies have incentive package on one hand and government requirement on the other. The companies to go public first of all will get up to 25% tax discount and they have the provision to issue at a premium. So as the companies from various sectors start to come in, our securities market will be more diverse making it more attractive for the investors.

In the fiscal year 2073/74 alone approximately 450 crore worth of right shares has been approved, which is equivalent to the total supply for last 15 years. What are the positive and negative implications of such huge supply?

All such implications can be seen in the market. Market is the platform where the forces of demand and supply work together to determine an equilibrium. After the increment of the minimum paid-up capital requirement of various levels of BFIs, almost all of them resorted to issuing either right or bonus shares rather than merger or acquisition. So because of this, the supply increased in such huge volume. This is actually one of the reasons for the bearish market now and the other important reason is the attractive interest rates in deposits.

Given the current context of our secondary market, do you think a second stock exchange is required or will privatization of NEPSE be enough?

We have tried to privatize or corporatize NEPSE for a long time i.e. more than a decade, along with some structural changes but nothing significant changes have come out of it yet. It was mentioned in NRB Act, 2058 that the NRB can’t have more than 10 percent stake but it still has 34 percent stake, government’s stake is still the same (around 58 percent). To maintain the growth and development of capital market along with the economy and to make the market more efficient and competitive, we need another stock exchange. But if we do not need change or reform and want to stay in same the status-quo, there is no need of another stock exchange.

In India too previously they had Bombay stock exchange (BSE) only, but after the setup of National Stock Exchange (NSE) the entire market became more efficient and competitive, leading to reform in BSE too. Having a second exchange doesn’t mean that it’s going to replace NEPSE rather NEPSE will also become more competitive and efficient. The man power will be more qualified and hard working. For example see Rastriya Banijya bank and Nepal Bank limited, they have made a drastic reform after the foreign commercial banks were allowed in Nepal. So if there comes a second exchange it will benefit all the market participants, the capital market and the overall economy. The brokers will be able to work with both. The companies will have choice in listing their shares at one or both. The investors will have more choices and service facilities.

Similarly, the CDS and Clearing should also be two as the subsidiary companies of both exchanges. In developed countries, yes a single large exchange can be better than many as they have proper corporate governance, efficient IT and other infrastructural & institutional system but in developing countries like Nepal the corporate governance is poor along with weak IT, infrastructural and institutional system. If there is only one exchange, the monopoly with weak efficiency will prevail prominently and it further leads to inefficient and unfair market.