Revitalising Bangladesh's stock market: A comprehensive roadmap for sustainable growth and resilience

The stock market of Bangladesh is a crucial component of the country's economic development and financial inclusion. But despite being a beacon of economic promise, the market has been plagued by several challenges, such as low liquidity, high volatility, weak governance, lack of investor confidence, and poor market infrastructure. 

These issues have hampered the market's efficiency, stability, and attractiveness, and have prevented it from reaching its full potential. Therefore, there is an urgent need for comprehensive reforms to revitalise and make it more sustainable, competitive, and resilient.

To chart out a roadmap for reforms, it is essential to recognise the core principles of a stock market — capital raising and formation, price discovery through continuous buying and selling, liquidity, risk and return, transparency and disclosures, and risk management and investor protection.

While the bourses in Bangladesh are great at raising capital and risk management (in terms of settlement of funds vs securities), they are failing to meet certain standards for the rest of the core principles. Since there are a multitude of reforms necessary to revitalise, the roadmap can be divided into two parts: urgent action for immediate impact and building a sustainable future.

But it is crucial to consider that the effectiveness of any reform roadmap, including mine, is undeniably tied to one critical factor: the Bangladesh Securities and Exchange Commission (BSEC) must permanently abolish the Floor Price Rule. 

This unconventional rule is the antithesis of a stock market's core principals. In June 2020, I penned an article on The Business Standard outlining its detrimental effects titled "Floor Price Rule: How Good Intentions Invariably Turn into Bad Policies" when it was initially introduced. 

Its reintroduction in 2022 represents a collective failure for our industry. Even if the Floor Price Rule is removed, the overhang of this rule will constantly haunt every type of investor and market intermediary. Without the BSEC's decisive action to abolish the Floor Price Rule for future crises, achieving a sustainable market will remain elusive, perpetuating a cycle from one crisis to the next.

Urgent action for immediate impact

Reforming the IPO process: The establishment of stock markets decades ago provided an alternative means for companies to raise capital for expansion. As previously mentioned, Bangladesh's stock markets do well at fundraising for companies approved by the BSEC. 

However, post-demutualisation (2013) there is one persisting glaring flaw: the quality of IPOs. The presence of financially questionable and dubious-intentioned companies attract scrutiny, capital erosion for investors, discourages good companies, and ultimately hinders market growth. 

One key issue fueling this problem are banks. Bangladesh has an overabundance of banks for its GDP size, all competing for a limited pool of good companies. This pressure leads banks to lend aggressively, making IPOs less attractive for strong corporations. The stock market's approval process, burdened by regulations, further discourages good companies seeking faster capital access.

To resolve this, regulators and stock exchanges must collaborate to create a predictable and streamlined IPO approval process, attracting quality companies.

Another issue is that of flawed gatekeeping. Post-demutualisation, the BSEC's role as sole gatekeeper for IPOs has granted it significant power, streamlining approvals but also raising concerns about its ability to effectively vet companies. The lack of independent review mechanisms further strengthens the BSEC's unchecked authority. 

The BSEC's power to override stock exchange objections against questionable IPOs undermines the exchange's role as a front-line gatekeeper and exposes investors to risky companies. The BSEC's current penalty system for IPO misconduct is often perceived as weak and ineffective. This emboldens companies and sponsors to engage in unethical practices with minimal consequences.

Implementing international best practices such as letting bourses do their due diligence and process on proposed IPOs, and then having the BSEC grant final approval or disapproval will help resolve these.

Then there is the matter of book building. Companies seeking capital have two pricing options: fixed price offerings (simple, each share worth Tk10 as par face value) and book building (dynamic, but prone to manipulation). 

The latter is preferred by firms with strong financials, confident their shares deserve a premium. Eligible investors (comprising merchant banks, stock dealers, mutual funds, etc.) participate in the book building process by individually bidding for shares and suggesting prices. 

The offer price is then determined after the bid closing date, based on the demand and supply of the shares. This system can be fair, efficient, and transparent; but unfortunately, Bangladesh's current implementation has limitations.

The BSEC, motivated by concerns over a few high-priced issues, implemented rigid rules that restrict bidding ranges, leading to a one-size-fits-all approach. This discourages good companies seeking their expected premium, hindering their ability to access capital and potentially harming long-term market growth.

This can be fixed by reintroducing wider bid ranges for book building (beyond the current restrictions) allowing for a more accurate discovery of fair share prices, while maintaining the 10% minimum share float requirement for market liquidity. The BSEC should actively monitor bidding activity for potential manipulation. 

Finally, while Bangladesh's stock markets do well at raising capital, a crucial piece is missing: the presence of high-growth startups. It's time we bridge this gap and create a dedicated listing process for these promising ventures. 

Many Bangladeshi startups are already showcasing remarkable potential, even amidst challenging fundraising environments. With capital from the stock market, these companies can achieve significant growth, providing investors with the opportunity to be part of their success stories. 

Noteworthy traditional examples like Square Pharmaceuticals and Grameenphone have flourished after joining the stock market, and the same potential awaits startups such as Pathao or Chaldal. Investors very much prefer the opportunity to invest in companies that are familiar and useful to them, rather than companies that are unknown to them.

Deceptive categories, confused investors: Our current stock categories (A, B, N, Z) seem straightforward (based on certain compliance standards and dividend payouts), but they can be misleading, especially for retail investors. 

While the intention is to differentiate good vs. bad stocks, the reality is that many A-category companies (including large, mid, and small caps) exhibit high volatility and illiquidity, making them far from ideal for long-term wealth creation.

We can fix this by taking inspiration from the Indian market — a more nuanced system based on market capitalisation, liquidity, and trading volume. This approach categorises stocks into groups like: Group A - large-cap, highly stable companies with low volatility (think Reliance Industries, HDFC Bank, Infosys); Group B - mid-cap companies with moderate market capitalization and potential for higher growth, but increased volatility; Group C - small-cap companies with lower market capitalization and high volatility, offering high potential returns but significant risks; and Group Z - newly listed or limited history companies, typically the most volatile.

This system would provide retail investors with a clearer picture of risk and stability, helping them avoid panic-buying or selling during market fluctuations. By focusing on capital safety and consistent returns, investors can make more informed decisions aligned with their long-term goals.

Even better, consider abolishing the current system altogether and replacing it with a risk-based rating system. This system would assess listed companies based on their financial performance, governance quality, and disclosure standards. By providing a holistic view of a company's health and risks, such a system would empower investors to choose stocks best suited for wealth generation with relative safety.

Margin Loan Reform: The current 1:1 margin loan system, granting clients equal loans for all A and B category stocks with Price to Earnings (P/E) lower than 40, poses a hidden danger. This seemingly balanced approach can fuel excessive market volatility, especially when considering the flaws in the current stock categorization. 

Many volatile and underperforming stocks can technically fall under category A or B and have low P/E ratios, attracting margin funds despite their inherent risks. This helps fuel irrational rallies and boom-bust cycles.

The solution is to adopt a more nuanced system based on factors like market capitalisation, liquidity, and trading volume, as seen in the Indian market model. This ensures margin loans prioritise stable, large-cap stocks, minimising exposure to risky small-cap companies. 

We should also implement a tiered system where clients can invest a higher proportion of their own funds in Category A stocks compared to B stocks. For example, a 60:40 split would encourage responsible investing and mitigate margin call risks for both clients and brokers. By directing funds toward stable stocks and discouraging speculation in risky ones, we can create a more resilient and predictable market environment.

Revising circuit breaker rules: The current circuit breaker rules, meant to protect investors, have ironically become tools for manipulators to stir up market turmoil and trigger irrational price swings. The current one-size-fits-all approach, with a 10% up or down limit for all stocks (with some exceptions), fails to address the varying risks and needs of different categories.

For example: It has become common practice for manipulators to use wash trading techniques to create artificial volume of low-priced, and/or low-liquid stocks by buying and selling the same stock between themselves or affiliated accounts, creating the illusion of high demand and driving the price up. This eventually hits the circuit breakers, signalling a false rally on the stock. 

Unsuspecting investors jump in, pushing prices up even higher on subsequent days. Manipulators then quickly sell their inflated shares once their target price and volume are met for exit, making profits at the expense of unsuspecting investors who bought at the artificially high price.

The solution could be to embrace the Indian model by implementing a tiered system based on stock categories like A (large-cap, stable), B (moderate volatility), C (high risk), and Z (new/illiquid).

Tiered limits guide trading toward stable, liquid stocks, diminishing overall market volatility and fostering a safer environment. This approach enhances price discovery by encouraging continuous buying and selling for less volatile stocks, ensuring more accurate price reflection. 

Moreover, the reduced activity in risky stocks provides regulators with ample time to investigate potential manipulation. Looking ahead, while the Indian model serves as a strong foundation, there is a future consideration for adopting the US model, incorporating additional market functions to further fortify market protection.

Building a sustainable future

Moving beyond immediate fixes, this section focuses on long term strategic reforms. Detailed elaboration is not required due to the self-evident nature of the content, as our emphasis is on crucial measures. 

The subsequent points delineate strategic initiatives encompassing efforts to augment market transparency, stimulate foreign investment, and foster financial inclusion. These reforms, inherently clear in their purpose, play a pivotal role in moulding a dynamic, transparent, and unified financial ecosystem.

Promoting market research and analysis: Encouraging independent research and analysis by financial institutions and analysts can provide valuable insights for investors and contribute to informed decision-making.

Enhance market transparency and disclosure: Increase the frequency and quality of financial reporting: Require listed companies to publish more detailed and timely financial reports such as segment-level profitability, etc. 

Strengthen the role of independent auditors: Implement stricter auditor independence standards and enhance the oversight of audit firms. Enhancing the role and responsibility of the stock exchanges and the credit rating agencies, in monitoring and rating the listed companies, and ensuring timely and accurate information dissemination

Deepen and broaden the capital market: Develop a wider range of financial instruments by encouraging the issuance of new asset classes such as derivatives, exchange-traded funds (ETFs), options, futures and adding quality corporate bonds, sukuk, etc. Consider introducing well-regulated short-selling mechanisms to increase market efficiency, liquidity, and price discovery.

Facilitate cross-border investments: Relax regulations and implement policies that promote foreign investment in the Bangladeshi capital market.

Improve investor education and protection: Increase awareness of investment risks and opportunities by targeted investor education programs and campaigns to educate the public about the benefits and risks of investing in the capital market. BSEC should force all brokers to maintain easy to understand informative materials about the stock market (written in Bangla) on their websites.

Promote financial inclusion: Develop policies and initiatives that encourage broader participation in the capital market, particularly among women and rural populations.

Review and update existing securities laws and regulations: Ensure that the legal framework is consistent with international best practices and adequately addresses emerging market trends.

Strengthen corporate governance: Implement stricter corporate governance codes and regulations to promote transparency, accountability, and ethical conduct by listed companies.

Harmonise regulations with other financial sectors: Ensure that the regulations governing the capital market are coordinated with those of other financial sectors, such as banking and insurance, to promote a more integrated and stable financial system.

Enhance technological infrastructure: Modernise the trading platform of the DSE: Upgrade the trading system to improve its efficiency, reliability, and security.

Develop a robust electronic clearing and settlement system: Implement a central counterparty (CCP) system to reduce settlement risks and improve the efficiency of the settlement process.

Review taxation policies: Evaluate and, if necessary, revise tax policies related to capital gains, dividends, and other financial transactions to encourage investment and trading activities. Ensure that tax policies are predictable and supportive of long-term investment goals.

Mutual Fund Agents: Let Mutual Fund managers employ regulated Agents to sell Mutual Fund units, in a similar fashion as how Insurance companies use Insurance Agents. This will help expand the base of unitholders. 

A dynamic and transparent stock market

This roadmap is not merely a collection of scattered remedies; it is a cohesive strategy that scrutinises critical facets such as the Initial Public Offering (IPO) process, circuit breaker rules, stock categorization, and regulatory oversight. 

Through this comprehensive lens, the aforementioned discussion outlines a vision for the future, one that envisions a dynamic and transparent stock market playing a central role in Bangladesh's economic narrative once again. 

As we embark on this journey, the spotlight is on the necessary reforms that will propel the stock market of Bangladesh towards sustained growth and resilience in the face of challenges. 

To be implemented successfully and sustainably, these reforms also require political will, regulatory coordination, market cooperation, and investor awareness.

The author is the managing director of Midway Securities Ltd and Adot Curve Ventures Ltd.