Intermediaries asked to prepare action plan to minimise negative equity

Stockbrokers and merchant banks have been asked to prepare their action plan on how they can minimise negative equity, which did not come down in line with the recent stock market rally.

Upon instructions of Bangladesh Securities and Exchange Commission (BSEC), the two bourses wrote to their member firms that disburse margin loans and the firms' money is stuck due to the bad shape of investment portfolios.

According to regulatory filings by brokers and merchant banks, the total negative equity in the stock market portfolios was Tk12,700 crore at the end of June last year when DSEX, the key index of the Dhaka Stock Exchange (DSE), was below the 4,000-mark.

At the end of December, DSEX closed around 35% higher, but the total negative equity in the market only fell by 5% to Tk12,250 crore.

The industry, at the end of December, reported a quarter-on-quarter reduction in total negative equities in investment accounts – from Tk12,355 crore at the end of September to Tk12,250 crore at the end of December – but the progress is not satisfactory, BSEC said in a letter to the bourses and the association of merchant bankers last week.

BSEC wants the bourses to guide their member firms on how brokers would minimise their portion in handicapped assets.

According to the regulatory compilation seen by The Business Standard, 129 intermediary firms are lending to their clients to buy listed securities.

Of them, DSE member firms' December-end exposure in insolvent investment accounts is over Tk7,000 crore while clients of their peers at the Chittagong Stock Exchange (CSE) owe Tk101 crore.

On the other hand, merchant bankers' funds of more than Tk5,100 crore are stuck in investment accounts as their clients' equity in the respective portfolios is in negative territory.

Meanwhile, Bangladesh Merchant Bankers Association (BMBA) has been asked to discuss the subject with its member firms and then report to BSEC.

DSE, CSE, and BMBA are scheduled to separately give their feedback to BSEC by Tuesday on how their entities are planning to reduce toxic assets.

Upon receiving BSEC instructions, both bourses already wrote to their broker companies, according to officials concerned. 

DSE is going to arrange a Zoom conference soon with its brokers to finalise an action plan, said Abdul Matin Patwari, managing director (in-charge) at the premier bourse.

BMBA is also discussing the matter with its members that are collectively burdened by at least one-third of the total negative equity.

When asked about how to solve the decade-long problem, BMBA President Sayadur Rahman told The Business Standard the industry needs fresh concessional funds and also the authority to rescue the negative-equity portfolios.

Another alternative could be realising the losses in the accounts of the merchant banks concerned, he suggested.

Leverage: The evil

A margin loan is what investors borrow from their broker or merchant banker to buy more listed securities for maximising their gains, which technically is called leverage.

When the market had been showing an upward trend until the end of 2010, a large number of stock investors had been in love with leverage.

However, as soon as the market's decade-long downturn began in December 2010, the leverage turned to be the shark and multiplied borrowers' capital erosion rate.

As soon as the erosion surpasses investors' own capital, only lenders' assets remain in the investment portfolio.

Ideally, at such a point, the lender calls the client to deposit fresh funds into the account or face a forced liquidation of the investment portfolio so that the lender can get its money back with interest.

As part of political preference to save small investors during the market crash a decade ago, the government and the capital market regulator verbally ordered lenders not to forcefully liquidate any investment account. That was the beginning of the crisis, which still persists.

Still, nearly 42,000 investment accounts with brokers and merchant banks are in the negative equity territory, which means account holders owe money to their broker or merchant bank. At the end of 2019, the number of insolvent Beneficiary Owner accounts or investment accounts was over 46,000.

In accounts, lenders are counting the accrued interest on the sum lent, but as the accounts are virtually dormant due to negative equity, they are unable to collect the interest receivable.

However, considering the practical problem, regulators are allowing the 129 market intermediaries not to set aside portions from annual profits as provisions against the incurred unrealised losses.

With the market turnaround since mid-2020, many investors are hoping to get rid of the negative equity someday, but the dream to correct their mistake is still distant for most of them as the stunning market rally over the last two quarters of 2020 also failed to help them.