When regulatory intervention does more harm than good | The Daily Star
12:00 AM, July 01, 2020 / LAST MODIFIED: 01:47 AM, July 01, 2020

When regulatory intervention does more harm than good

A decade ago, a verbal directive from the regulator to stop the practice of forced-sale hit the stock market hard and the impacts are still being felt these days.

Similarly, the floor price setting put in place in the wake of the coronavirus pandemic has almost been doing the same, analysts say.

"Regulatory intervention to save the stock market index is quite unexpected. If they try to do it, the market gets hurt. It was proved in case of stopping the forced-sale," said a top official of an asset management company.

The Bangladesh Securities and Exchange Commission (BSEC) intervened in 2011 in a bid to prevent the forced-sale by stock brokers and merchant banks.

It came after most of the stock brokers and merchant bankers provided margin loans to general investors to buy stocks during the bullish market in 2010.

When the market started to plunge, the brokers and merchant bankers started to sell the stocks from the investors' account to adjust the credit as the borrowers failed to repay loans. The practice is called forced-sale.

Almost all the general investors along with the regulator stopped the lenders from doing so, assuming the action would hasten slump and investors would incur losses.

"The consequences of deterring the forced-sale were so devastating that we were scared to execute forced-sales," said a merchant banker, adding that the regulator could not refrain the index from falling.

As the shares bought through the margin loans were not sold and the prices collapsed, most investors did not receive any penny back from their investment, he said.

Brokers and merchant bankers have still been suffering from the losses stemming from the margin loans although a decade has passed since then.

The loss from the margin loans was more than Tk 11,100 crore. Some brokers and merchant bankers booked their loss and some others are yet to follow suit.

The institutional investors still can't invest in the market because of the losses, said the merchant banker.

Curbing the forced-sale was an example of breaches of laws and general norms of the world stock market and it was deadly for the market though it looked good initially, said a stock broker.

In the same way, the floor price would be another cause for a big blow for the market in the upcoming days, he added.

The BSEC set the floor price on March 19 with a view to stopping the index from plummeting further amid the pandemic, bypassing the forces of the market.

On the day, the commission put in place the floor price of all stocks taking into account the last five-days average price. This would be the lowest price until the provision is scrapped.

"When you obstruct the free movement of the stock price determined by the market forces, the market would definitely go down. We witnessed it in case of margin loans," said the stock broker.

The newly appointed commission is convinced that the floor price should be scrapped but it fears that there might be protests from investors as they don't realise the outcomes of the floor price.

The floor price would affect the small investors most. Big investors can trade stocks on the block market but small cannot, said a top official of an asset management company.

"It is seriously eroding the confidence of foreign investors as well because they always prefer a liquid market. But the floor price has made the market illiquid."

The average turnover at the Dhaka Stock Exchange fell to Tk 60 crore after the floor price was introduced, way down from Tk 450 crore before the policy intervention.

"The image of the market has been tarnished globally and international investors would not want to invest in the market in the future."

A similar initiative was taken by the Karachi Stock Exchange (KSE) in Pakistan during the global financial crisis of 2007-08 in order to halt a sharp fall in its market index. After the floor price system was scrapped, securities declined significantly.

"It is proven that the floor price is not effective the way the government thinks of it," an asset manager said.

If the floor price lingers, most of the brokers and merchant banks will be compelled to cut salaries and jobs of their staff and shut branches amid thin trading activities, said another stock broker.

"You can't keep a stock price at a certain level artificially. If you try to do so, it would spook investors' confidence and sow the seed for a market crash," he said.

The market has been falling around the world due to the pandemic and this is normal as the profits of listed companies are set to decline in the current year in the most sectors because of the collapse in demand.

"However, the index would rebound on its own when the pandemic peters out. So, the regulator's intervention in price mechanism is totally unexpected." 

 

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