SEC relaxes controls, credit to increase by Rs. 5bn

* System will fall more into debt, illiquidity will re-surface, need to look for other sources for capital, says broker


The much awaited announcement which kept the stock exchange jittery for weeks was finally made yesterday, with the market closed for a special bank holiday. The country’s capital markets watchdog the Securities and Exchange Commission (SEC) announced that limits imposed on brokers to extend credit would be relaxed which would increase the amount of credit available in the market by Rs. 5 billion.

However, a leading broker firm has warned that the market would have to look for other sources for capital because the fresh infusion of credit would soon wear-out.

The Colombo Stock Exchange has seen lacklustre trading in recent weeks and investors eagerly anticipated this relaxation of broker credit. The SEC was not able to make a swift decision on the matter as the market would have liked to and took its time to deliberate.

"At the Commission meeting held yesterday (Jan. 16), the Securities and Exchange Commission of Sri Lanka (SEC) decided to permit stock broking firms to leverage 3 times adjusted net capital with immediate effect. Adjusted net capital is the net capital computed as per the Colombo Stock Exchange (CSE) Member Regulations less 50 percent of fixed assets. In line with other regional markets, 50 percent was deducted to take into account the concerns of realizing illiquid assets into cash," the SEC announced in a statement yesterday evening.

 "By permitting the stock broking firms to leverage 3 times adjusted net capital, the additional credit available in the market will increase by Rs. 5 billion resulting in the total credit available among stock broking firms to Rs 8.7 billion," it said.

 "Having considered the dimensions of credit extension and to establish a balance between the two principals of lending norms and risk management, the SEC reviewed the Credit Extension by Stock Broker Firms Rule.

 "As a capital market regulator, it is a core function of the SEC to ensure that capital and other prudential requirements are sufficient to address the level of risk taking by the stock broking firms in extending credit with adequacy in the financial strength, disclosures, systems and governance processes which should be monitored on a regular basis in order to prevent any systemic risk to the capital market. At present the stock broking companies are permitted to extend credit based on the liquid assets of the company less obligations," the SEC said.

The once-best performing stock exchange in the world, which grew 125 percent in 2009 and 96 percent in 2010, registered an 8.5 percent dip last year as controversy rocked an already overvalued market, analysts said.

The CSE has fallen 2.39 percent year-to-date as at January 13.

Last week, a leading broker firm urged stakeholders in the market to search for other sources of funding rather than depending on credit.

"The credit extension is ultimately one of the final bullets the regulators have to infuse the market with capital. If speculators and investors are unable to unwind positions and return to cash it could spell trouble for the markets. It is time for the brokers, regulators and investors to work together and look for other sources of capital for the markets. Every broker wants to attract the larger funds that are currently pulling out of the market. It is equally important to tap the global independent trader community that is always after a good trade. This will support and provide the much needed liquidity to the market. After all, this is a traders market and the year 2012 will be no different," Bartleet Religare Securities (BRS) said last Friday.

It said the relaxation of broker credit restrictions could temporarily give the marker some lift.

"If credit was extended…there will be a few billion worth of rupees coming into the market. This may provide temporary retail support for the index and may push the speculative counters higher. We forecast that the Bartleet Speculator Index (BSI) could run up another 10 percent to 15 percent in the next few weeks, while the ASPI will only gain 1/3 of that in value. As we have witnessed on the last few occasions, rally’s last at maximum 1 to 1.5 days. This is due to the fact that all the money that is used to pump up the system is borrowed.

"Eventually the new capital will also get stuck and the system will fall more into debt and illiquidity will return to the market. Again this is history repeating itself as markets very rarely learn their lessons of the past. Technically the ASPI is held down by its long term 100 day weekly moving average at 6,125 and it will be interesting to see if the Index can break pass this level and sustain itself. The MPI on the other hand is stuck in the range between 4,800 and 5,500 and does not seem to be going anywhere anytime soon," the BRS said.

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