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October 10, 2004

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Regulating institutional investments for capital market development

Barrister Tureen Afroz

1996 Share Market Crash still remains as a bad memory for today's capital market regulators as well as the investors of Bangladesh. Over the last 8 years, the Government of Bangladesh has taken a number of regulatory measures to boost the capital market of the country. The Government even sought assistance from various international agencies to suggest necessary capital market reforms for Bangladesh. The main international agencies that have been working in the capital market reforms projects in Bangladesh today are : Asian Development Bank (ADB), the International Monetary Fund (IMF), The World Bank, the United States Agency for International Development (USAID) and the United Nations Development Program (UNDP). However, the capital market of Bangladesh is yet to make a steady growth. The investors are still very scared to return to the market as they have lost their confidence in the market and specially, the regulatory body after the 1996 incidence.

The Government recently realised that increasing the base for institutional investors would help the steady growth of capital market in Bangladesh. It is now believed that developing the institutional sources of capital in Bangladesh would in turn increase the demand for securities in the market. As a result, the capital market would revive with more active investor participation. Therefore, the Government has amended a number of relevant laws to facilitate increasing investments in capital market instruments by institutional investors.

For example, Section 27, Insurance (Amendment) Act 2000 restricted the mandatory investments limits of investment companies in government securities and government approved securities to only 30% of their total investable funds. Earlier the insurance companies in Bangladesh could invest their insurance funds only in Government and Government approved securities. In particular, the insurance companies used to invest their funds in National Savings Certificates (NSCs). However, since the reduction of interest rate on the NSCs, the insurance companies have been looking for alternative channel to make profitable investment. Therefore, after the enactment of Insurance (Amendment) Act 2000, the insurance companies are permitted to invest up to 70% of their funds into any other investments, including securities market products.

Similarly, earlier the private pensions and the provident funds were required to fully invest their funds into government securities only. However, the Section 20B Trusts (Amendment) Act 2000 permits private pensions and provident funds to invest up to 25% of their total investable funds into listed securities.

Having realised that the mutual funds are one of the major sources of capital that can be invested in securities market, the Government decided to promote floating of private mutual funds in the capital market. By formulating the Securities and Exchange Commission (Mutual Fund) Regulation 1997 and later replacing it by the Securities and Exchange Commission (Mutual Fund) Rule 2001, the Securities and Exchange Commission (SEC) encouraged private sector-sponsored mutual funds to operate in the securities market. As a result, the first private mutual fund (AIMS First Guaranteed Mutual Fund) was licensed in January 2000 and listed on the stock exchanges in May 2000. The second private mutual fund (Grameen Mutual Fund) was registered with SEC in August 2001.

All these recent regulatory measures were undertaken with a view to increasing the institutional investment in capital market. However, it is stated that even after making all of the above regulatory moves, securities market in Bangladesh still suffers from various setbacks. The market is yet to recover from the 1996 shock. Domestic investors continue to exhibit lack of confidence in the market, especially in the secondary securities market. Only a limited number of foreign investors is showing interest to venture the capital market of Bangladesh. It is estimated that from 1997 to July 2003 the total foreign investment in the initial public offerings in Bangladesh stood at very poor level - on an average less than $ 1 million a year. Currently, shares of a large number of listed companies are being traded far below face values at the two stock exchanges. According to market sources, as of July 2004, shares of 42.33% listed companies in Dhaka Stock Exchange and shares of 50% listed companies in Chittagong Stock Exchange are priced below par for long. It has also been reported that almost 50% of the brokerage houses at Dhaka Stock Exchange are currently remaining dormant.

In this background, it is stated that the growth of institutional investments in capital market of Bangladesh has been far below the expectation. The market is still dominated by unsophisticated retail investors. Even after enactment of Insurance (Amendment) Act 2000 and Trusts (Amendment) Act 2000, the participation of insurance companies and pension and provident funds in the capital market remained very limited. (Asian Development Bank 2003)

It is stated that the Government is yet to reform, develop and strengthen the relevant sectors under an appropriate legal and regulatory framework. International organisations, like Asian Development Bank (ADB), have made quite a few recommendations to update the current regulatory regime of insurance industry and the pension and provident fund sector in Bangladesh. However, the Government is very slow to adopt such recommendations in their full capacity. Government also at times lacks regulatory prudence to properly encourage institutional investments in capital market. For example, according to a recent statutory order of the Department of Insurance, the insurance companies in Bangladesh are allowed to invest in the state-owned Investment Corporation of Bangladesh (ICB) funds and those floated by its subsidiaries. However, it is not understood why the insurance companies are still not allowed to invest in private mutual funds.

Since 2001, The World Bank has been providing necessary expert assistance to the Government to update the age-old Insurance Act of 1938 and finally prepared a draft Insurance Act 2004 for Bangladesh. However, the Government has recently abandoned the draft act for the reasons it not being compatible with local needs of reform.

It is further stated that until the state-owned Investment Corporation of Bangladesh (ICB) is brought down to the level playing field with other private asset management companies in Bangladesh, there would remain an unfair competition in the market between public and private mutual funds and that would impede the growth of private mutual fund market in Bangladesh. ICB had been acting as the sole asset management firm in Bangladesh until November 1999. In order to develop an institutional base of the ICB and to bring it to a level playing field with private asset management companies the ICB (Amendment) Act 2000 was enacted.

Following the said act, ICB was restructured to create three new subsidiaries to carry out merchant banking, mutual fund operations and stock brokerage functions separately. The ICB subsidiaries are : (a) ICB Capital Management Ltd. (merchant bank); (b) ICB Asset Management Ltd. (manager of trusts and funds, including mutual funds); and (c) ICB Securities Trading Ltd. (Stock Broker and Securities Ltd.). Though these subsidiaries were formed, no asset was transferred to the ICB Asset Management Company. Besides, the parent ICB, which does not come under the regulatory framework of the SEC, continued to manage the existing mutual funds. Therefore, these funds can borrow unlimitedly without any quantitative restriction on their investments in a particular company, group or sector like the private funds. Also, in violation of the mutual fund rule, the ICB or the ICB Asset Management Ltd. does not publish net asset value or submit any report or pay any fees to the SEC. This, therefore, creates an unfair competition between public sector and private sector mutual funds.

It may also be stated that the SEC at times lacks regulatory insights in regulating financial products. For example, in August 2004, the SEC approved the prospectus for public float of an Islamic Mutual Fund by the stated-owned ICB Asset Management Company. It is appreciated that approval to such Islamic mutual fund would encourage the institutional investment component in capital market. However, it is doubted that in a capital market where about 40% capitalisation is held by banks and financial institutions that are shariah non-compliant, how risk-freely the portfolio of Islamic Mutual Fund would be constructed?

It is stated that to revive the dormant capital market of Bangladesh, the Government needs to channel in domestic large funds from their currently less-earning investment portfolios to better-earning financial products of capital market. Also, more private mutual funds should be generated to increase the institutional base for capital market. To have a prudent regulatory framework for encouraging institutional investment in the capital market, the Government and the capital market regulatory body, SEC should take the following regulatory measures immediately:

removing regulatory barriers to enable contractual savings funds (such as, insurance company funds, pension and provident funds etc.) to invest substantial amount of their collections into capital market instruments with better earning capacity;
enforcing a level playing regulatory measure for public and private mutual funds;
proper restructuring of ICB and making it more answerable and transparent; and
reforming current regulatory regime into one where more co-ordination is guaranteed among various regulators (SEC, the Bangladesh Bank, the Department of Insurance, Ministry of Finance, Ministry of Commerce, other concerned ministries etc.) who directly or indirectly influence capital market mechanism for institutional investments.

The author is currently doing her PhD at Monash University, Australia.

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