Bangladesh 2.0: How capital markets reform may benefit from banking crisis

There has been a huge amount of rightful focus, since the successful July uprising, on the crisis in the banking sector. As a result of 15 years of bad governance and corruption under the previous regime, the sector is in tatters. 
Now we'll discuss the reform roadmap for the capital markets and argue that such necessary effort may counterintuitively benefit from the banking crisis.
The last Bangladesh Securities and Exchange Commission (BSEC) neglected its primary role as the regulator, which is to ensure the smooth functioning of the marketplace. Instead, it operated as the market's chief cheerleader with 17 ineffective global roadshows while foreign investment in the market was at its lowest level in history.
In addition to its failure, BSEC took it upon itself to stop the market falling by imposing artificial floor prices, as well as preventing market participants from selling.
Worse, there is now growing evidence that a number of BSEC officials, led by the previous two chairmen, actually facilitated and benefitted from illegal market activities.
With a new Commission in place, now is the ideal time for all the stakeholders in the capital markets to work together to help the capital markets achieve their potential.
The new Commission, under Chairman Khondoker Rashed Maqsood, should be praised for very rapid and proactive action in investigating the widespread illegal activities conducted in the past decade.
While holding past crimes accountable is critical, we must also focus on the reformations. We believe the government should set up a Capital Markets Task Force to work together with key stakeholders to develop the reform roadmap. 
This can be supported by the ADB in the form of a fourth Capital Markets Development Programme (CMDP). The last one was more than six years ago and now is the perfect time to develop a new roadmap.
In Bangladesh, the capital markets are seen as a place of speculation, with many even terming it a "casino." In fact, the capital markets add value to economic prosperity. It connects investors with surplus savings with companies or issuers that need access to growth capital. 
It also pools contractual savings into instruments such as pension funds and mutual funds. Furthermore, it improves the efficiency of companies by rewarding efficient companies with higher valuations and punishing poorly performing companies with lower valuations. 
Additionally, it provides liquidity that would allow early-stage investors to unwind their investments. It provides alternative and potentially more rewarding alternatives than bonds for investors while providing sufficient liquidity for quick exits
Of course, the efficiency factor depends on whether stocks are driven by sound value investment metrics or illegal market manipulation.
So, how might the banking crisis actually benefit capital markets development?
The benefit is likely to be the outcome of two supply-side factors.
Firstly, in order to deal with the NPL crisis, the authorities will need to seize the assets of the loan defaulters such as companies they control and pool these into an "Asset Management Company" or "Bad Bank."
These companies need to be managed much like in a Private Equity (PE) fund, with potentially new management, balance sheet restructuring, and then an exit or asset sale either to other international or local corporate buyers or potentially through a listing on the capital markets.  
For example, on 19 September, the High Court ordered Bangladesh Bank to take over all the assets of the Beximco Group to pay off all of the debts of Salman F Rahman and family members who are reported to have taken out loans as much as Tk45,000 crore.
Some of these companies are already listed, but some are not. When we consider the number of defaulter-owned non-listed companies that need to be transferred into the National Asset Management Agency, the potential additional supply of good quality companies to our capital markets may be significant.
Secondly, the banking crisis and reform agenda may benefit the capital markets by reducing the incentives to take bank loans by companies. Historically, some Bangladeshi companies preferred bank financing to capital markets issuance for growth capital because they believed bank loans could be "managed" by perennially renegotiating the loan duration and getting extensions. 
One might call them willful defaulters. With the transparency and governance reforms underway in the banking sector, this may be much less of an option making equity issuance more attractive.  
In Bangladesh, there have been mixed signals on the commitment to privatisation but we believe that there would be benefits for our capital markets development in terms of new listings of large, liquid companies, as well as freeing up of capital to the government's balance sheets.
Moreover, as we highlighted in the last article on banking reforms, privatisations and asset securitisation of key infrastructure assets such as Padma Bridge will raise much-needed funds.
We believe Saudi Arabia, UAE and Qatar would have an interest in buying privatised energy assets from the government. 
There may be additional benefits beyond getting valuable foreign currency, in terms of locking in longer-term energy contracts with key Middle Eastern energy suppliers who invest in the divested energy assets.
The state-owned banks are likely immediate candidates for listing, but the authorities need to be careful that the companies they wish to privatise have been restructured and are financially viable before coming to market.
An important role for stock market regulators is to ensure that there is transparency and a level playing field in the market and that neither companies nor large investors trade on inside information.
This requires substantial investment in market monitoring or surveillance technology. Additional resources should be allocated to analyse CDBL records more thoroughly to provide more confirmation and evidence of price manipulation.
BSEC also needs to ensure that companies that raise capital in the market for the first time in an Initial Public Offering (IPO) do so based on honest and accurate information about the state of the company's balance sheet, as well as the current and future prospects for the basis.
The ongoing concern preventing a number of companies from listing has been what they have perceived as an inequitable IPO pricing mechanism. Substantial premium new issues are traded on the listing, reflecting a low valuation assigned by the regulator.
Simply put, healthy companies do not have an incentive beyond the tax we highlight below to sell shares "cheaply" in the capital markets. The adoption of book building has only helped to a limited extent and this IPO issuance process needs to be reevaluated.
Also keeping the asset protection component of investors in mind, the delisting of unhealthy companies that feed the speculation engine must also be made more efficient.
A more challenging and controversial issue is that some companies that understate their earnings and assets to minimise their tax liability, might be dissuaded from listing given that the valuation they would receive for their company would be significantly less than a "fair" value based on a true representation of their company accounts.
While one might argue there should be no exemptions that would cause moral hazard on misreporting of accounts, it might be worth considering a tax amnesty where those companies that chose to restate their accounts as part of a listing process would avoid fines to restate their accounts. 
If the tax incentives for listing were significant enough then perhaps more companies would choose to restate

In terms of foreign investors on the demand side, there is a lot to do. Foreign investors are less than 1% of the Bangladesh market compared to 10% in Pakistan and Vietnam, and more than 30% in India and Sri Lanka.
Their primary complaint is the lack of high-quality companies with liquidity and strong corporate governance in which to invest. So a stronger supply side will increase demand. If there are international roadshows, it should be driven by the brokers themselves with BIDA and BSEC playing a supportive role. Not the other way around.
Another important area for development focus should be expanding the domestic institutional investor base. Bangladesh's mutual fund sector is less than 3% of the market whereas India's is ten times as large.
It was notable in the last T20 World Cup that the Indian National Cricket team was promoting mutual fund investments on behalf of the Indian Mutual Fund Association. The Bangladesh AMC associations need to mount a similar campaign to promote the benefits of professional fund management based on fundamental research to retail investors.
We also need to review the regulation to allow more insurance companies and pension/provident funds to invest in stocks. The latter sector is still in its infancy in Bangladesh but as pension funds expand, they will be an important source of new demand for stocks and bonds.
Bangladesh has a largely untapped opportunity to leverage technology to transform its capital markets. The adoption of online trading platforms can rapidly expand the investor base. By offering faster, more efficient trade execution, along with higher quality company research and analytics, brokers can offer better customer service and engagement to increase profitability.

We believe that technology can help make investing in stocks become a more mainstream activity for a broader range of people from all sorts of income groups. 

Once micro-investing is integrated with digital payments and wallet systems such as bKash, one can envisage in the near future, that farmers, fishermen, factory workers and rickshaw drivers could be investing a few thousand takas per month into stock mutual funds or stocks directly. They could be connected to savings products, and even medical insurance through their digital wallets.

Bangladesh can realistically target 50 lakh new online investors within the next five years if all the capital markets stakeholders collaborate and engage in collective intelligence in order to engineer the best possible outcome for all within a stipulated time frame. 

Part of a reform agenda is the need to formulate a digital transformation roadmap for Bangladesh's capital markets. This includes factors to stimulate the demand side, most critically the move to adopt online trading and also RegTech – or the potential for technology to improve the regulatory framework and governance, which is critical to restoring and sustaining investor confidence.

In the meantime, it is important to form a new task force and bring all the key stakeholders together, so that we do not miss the opportunity to bring a "Monsoon Revolution" to Bangladesh's capital markets.

Ifty Islam. Sketch: TBS

Ifty Islam is the Chairman of Asian Tiger Capital Partners. Email: [email protected] 

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.