How much has the Dhaka Stock Exchange reformed?

For the last nine months, we have all been, directly or indirectly, a part of rebuilding the nation, attempting to assemble the pieces over where bribery, corruption and treason were considered to be the finishing touches to the 'jigsaw puzzle'. Even though some sectors have seen stoic reforms, one sector that is still neglected is the country's capital market. 

Even until last week, investors and regular netizens took to the streets, demanding the resignation of the current BSEC commissioner for failing to protect the investors' hard-earned capital. In hindsight, it is not a key part of a regulator's job description to control prices but rather to facilitate operations and ensure no illegal trading activity is taking place. 

Stocks represent ownership in a business. However, stock prices are controlled by market forces and do not always reciprocate with the company's performance. Whenever there is built-up demand and capital flowing into the market, be it locally or via foreign portfolio investments (FPI), the market index, along with a majority of the market, is bound to go up and vice versa. 

No amount of added government incentives or the introduction of additional securities (be it government or otherwise) can boost the capital market unless the market capitalisation is optimised to a level of the "developed markets", like the US or the UK, or until the corporate governance issues surrounding the company listings and operations are dealt with strictly. 

It has been almost two decades since the 2010 stock market crash and the Dhaka Stock Exchange (DSE) is yet to recover to its baseline levels. 

On 24 May, the DSE stands at 4746.42555, whereas considering the number of new IPOs that have been issued in the last 15 years, the market index should have been at least near the 12000-15000 mark, if it were to be representative of the DSE back in 2010. By incorporating all the new IPOs, right shares, and bonus shares that have been issued subsequently. 

In retrospect, the Karachi Stock Exchange (KSE) has gone from 9411.75 to 116673 in the same timeframe, as per investing.com. Given the rising India-Pakistan tensions across the border, the KSE lost around 3.03% of its value on the first day following the dispute, but the DSE lost 149.31 points, which translates to a 3.01% loss! 

It begs the question, as to which countries are potentially at crossroads with each other, and if Bangladesh has indeed grown into one of Southeast Asia's largest economies, why are the country's FPI and FDI inflows on a downward spiral? 

Since the inception of DSE, the main component of making money has been centred around IPOs. Companies that got listed had either no future and wanted to encash the last bit of funding by draining the resources of investment banks and retail investors via listing their shares and offloading them at a significantly higher price, or they wished to avail themselves of the tax breaks and rights share issue privileges once funding from merchant banks dried out. 

There have been many instances whereby a company enlisted itself at face value and, within days, reached share prices in excess of TK100, only to revert to Tk3-5 levels in the following couple of years. Allegations had been raised whereby the sponsors of the companies themselves were usually behind the price hike, whereby they offloaded the shares and used the funds to open another company, only to keep the vicious cycle repeating on loop. 

This brings us to a key component: if there was a way for investors to make money in the market while share prices are coming down, perhaps the market manipulators would not be interested in bringing the prices down so abruptly?

One such initiative is short selling, whereby investors can borrow shares of a stock from another broker, sell it off at the current market price and wait to rebuy the shares once the price plummets to a certain level. The difference in price will be the borrower's profit. Another initiative could be to introduce derivatives, primarily put options on stocks themselves. 

Derivatives pose an inherent risk that the size of the contract can be manyfold the instrument on which they are based; hence, it's important to develop a central counterparty (CCP) that would be in charge of handling the operations, similar to how CDBL keeps track of the way shares are traded and settled on a day-to-day basis. Because a stock is pre-verified, it is not possible to sell short. Until recently this was prohibited by rule, but recent amendments now permit short selling, but, in practice, the settlement system does not allow it to happen. 

All the regulatory functions within BSEC, with the exception of market surveillance (installed in 2012), are entirely paper-based; thus, an implementation of an updated regulatory information system that will deal with accounting, company records, procurement, payroll, registration, licensing and enforcement should be implemented. 

There should be separate bodies that deal with the mutual funds and special purpose vehicles (SPV) and asset backed securities (ABS), which will help pool in more investments in these sectors, since they are specialised fields and require further due diligence and technical prowess separate from the daily operations at the DSE. 

Gazettes regarding derivatives and short selling, which do not contradict the current capacity and encourage new technology, should be worked upon and published by the designated authorities if they want more foreign capital to flow into the markets. 

By introducing daily settlement cycles and eliminating the T+1, T+2, and T+3 ideologies, short selling can be facilitated and the prospect of intra-day trading, which is widely practised around all the major exchanges around the world, can finally be introduced. Financial literacy programmes which will teach retail investors about technical analysis and portfolio management should be made available at various brokerages in order to ensure that the next group of future investors do not repeat the same mistakes that their predecessors did. 

The lack of BSEC's capacity to register, assess and regulate the CCP (and infrastructure generally) is a substantial risk. The current registration department lacks the capacity to evaluate CCP rules, operating procedures and IT systems. There is no clear structure for ongoing regulation of the CCP, which is likely to fall under the Supervision and Regulation of Intermediaries Department (SRI), which is under-resourced and lacks the knowledge and capacity to fulfil its obligations. 

Once these "reforms" and instruments are implemented, risk-based capital adequacy (RBCA) rules can be introduced such that regulatory decisions are reviewed and compliance with regards to every sector is ensured along with the data. 

The list above is not exhaustive and can only be considered a small window to peek into the opportunity that the Bangladesh capital market has in line with its current state of affairs. No amount of roadshows will bring in adequate FPI if irrational policies like the imposition of floor prices, which were in place earlier, continue to be implemented for abrupt and prolonged periods in the future. 

Will the ordinary retail investors continue to suffer like Sisyphus did in Tartarus? Or will the regulatory Greek gods finally bestow their mercy on the masses by introducing critical market reforms in Bangladesh 2.0? This is a question that continues to haunt the 32 lakh retail and institutional investors of Bangladesh to this day.

A former investment analyst, Sayeed Ibrahim Ahmed is currently an Assistant Professor of Finance at American International University Bangladesh (AIUB), pursuing research along the lines of capital markets and economic policy.

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.