The Quest for Trust: Capital Market Watchdog Takes on Status Quo

Sri Lanka’s capital market culture must be lifted from the depths. This means doing much more than opening up old wounds to go after the crooks; the entire system must be changed, one day at a time

By devan daniel.

Published on July 03, 2015 with No Comments

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The new Director General of the Securities and Exchange Commission (SEC) Vajira Wijegunawardane, a former investment banker and fund manager, nature enthusiast, and wildlife photographer, is taking the fight to captive officials and ratings agencies, and corrupt brokers, analysts and investors. His struggle is not against a few criminally minded individuals, but an entire system. Wijegunawardane recounts when the regulator was controlled by capital market manipulators and their political backers, and vows never to allow regulatory capture again—not on his watch. Investigations that were swept under the carpet would be taken up again. Professional conduct of market intermediaries such as brokers and fund managers will be looked into. The regulation of credit rating agencies will be tightened. The public has lost trust in the capital market and Wijegunawardane wants to change that, fast.

You are a nature enthusiast and accomplished wildlife photographer. You’ve spent much of your leisure out in the wild. Will this help in the hot seat of Director General of the capital market watchdog?
I am familiar with animal behaviour which in turn helps me to deal with ferocious animals! My family really enjoys the outdoors and exploring the natural beauty of our country and we stay away from the high life. I have not sought any favours from anyone nor do I owe any favours. I am not under obligation to anyone. I think it’s very important to be in that position especially as a regulator to carry out the responsibility one is tasked with effectively.

When the stock exchange was going berserk post-conflict, what was going through your mind and what was your role in the SEC at that time. If you were in charge, what would you have done differently?
I think the end of the conflict presented a unique opportunity for the capital market. There was a string of IPO’s and many new investors opened trading accounts. However, this post-conflict euphoria was abused by some market participants through unprofessional conduct and what I would term ‘short termism’. A focus on short term profits sends ethics out of the window. Unfair or inefficient capital markets would drive away investors in the medium term which is exactly what happened to our market.

I was spearheading the capital market development mandate of the SEC as the Director in charge and I was a member of the Surveillance and Investigations Committee, as a result I was privy to all the goings-on in terms of market misconduct and abuse at the time.

If I was in charge, in hindsight I would say some of the measures taken by the SEC such as the price band would have been introduced much earlier in a less ad hoc manner and investors made aware of the pitfalls of trading on credit. As a regulator, one needs to know where to draw the line and as such I would not have had any informal interactions with the people being investigated for violations of securities laws, powerful politically connected persons and market participants. I would have fully probed the violations irrespective of the persons or entities involved and if that meant having to go home for doing the right thing I would have gladly done it.

What was your experience after the regulator was tamed and two SEC heads Ms Indrani Sugathadasa and Tilak Karunaratne resigned within a year of each other?
There was this term used ‘regulatory capture’ where the regulator is disabled to carry out its mandate by an organized set of market participants by distorting facts and misleading the highest decision makers. Their arrogance was such that some boasted they set the rules that suited them and would even be in control of the SEC once some identified people at the SEC were taken out, and of course one of them was me. This is why the SEC as the regulator of the capital market needs to be made as independent as possible by the policy makers to carry out its responsibility effectively. As the regulator, if one is not given a free hand to do the job properly, there is no point hanging around to carry out orders and you have to respect the two heads who resigned with their self-respect intact.

With them gone, I was also eased off from the Surveillance and Investigations Committee; I presume it was a reward for doing my job properly. In hindsight, that was the best thing that could have happened given the circumstances. I joined the SEC in 2007 as the Director responsible for implementing the SEC- Capital Market Development Master Plan 2006-2015 where much has been achieved at policy level, albeit not making too much noise about it. The many changes at the helm of SEC during the recent past resulted in bits and pieces of the same plan been picked up to make a separate plan before the lapse of the original plan.

Did you expect to be appointed Director General of the SEC?
Not that I expected it, but this time around I knew there would be a fair system in place, and as a result I was confident I had a good chance. This is a position many people have lobbied for because of the authority it wields but I have not done any of that despite having links to the right people. I am guided by the moral principle of not being under obligation to anyone. Of course the position of DG was not my ultimate objective of sticking around at the SEC despite many pressures and attractive offers from the industry. I felt a responsibility towards like-minded co-workers and the market as a whole. My biggest motivation to hold forth was that some internal parties in collusion with some errant market participants wanted to see the backs of some of us. I was always hopeful that one day, given the opportunity I would be able to positively contribute to turn things around for the better with the support of like-minded people. Now that the Commission has placed its trust and confidence in me, I will do my best, slowly but surely, and strive to place our capital market in a different footing and create a level playing field for everyone.

What can you tell us about the investigations?
When Mr Karunaratne left there were 17 cases still open which were soon closed for the lack of evidence by his successor. We will review all investigations and complaints to ascertain if every possible angle has been covered and some are of course ongoing. I know everyone is in a hurry to see the outcome of these investigations but I can confidently say that we will fully probe all cases but to give a timeline at this stage will be difficult. It is unfortunate that in the past there have been certain deliberate miscommunications to the effect that some of us at the SEC are after individuals, which is not the case at all. For us individuals or entities involved are immaterial and we only focus on whether any violations of the provisions of the SEC Act or any rule has taken place and take appropriate enforcement action. If any activity triggers an alert or referral we will investigate it. We are not on a witch hunt. When you are in a regulated business, if violations have indeed taken place, then those responsible have to face the consequences or otherwise there is a breakdown in confidence. I am a firm believer that the compliant should never be penalized.

The Financial Corruption Investigation Division (FCID) is already investigating several alleged capital market offences of the post-conflict era. What’s SEC’s role in this?
Some of the facts relating to certain cases have been submitted to the FCID by people in the market who have details of some of these questionable transactions. This may be due to the perception that regulatory enforcement is lax, a situation which needs to be addressed without delay. We do collaborate with the FCID whenever they make a request. The SEC needs to enable an effective system to receive tips on wrongdoing and even compensate informants for doing so.

What were the roadblocks placed before the regulator then and what are your challenges now?
Earlier we did not have a free hand but now things are different. Going forward, ideally the SEC needs to be made independent by statute where the secretariat will be empowered to carry out its mandate in a fair impartial manner without any outside influence. We are not unique, quite a few other jurisdictions have been through this phase and now it’s time to put systems and procedures in place to ensure what happened will never occur again.

The securities law in Sri Lanka was enacted 28 years ago, amended in 1991, 2003 and 2009, and is not equipped to deal with future needs and emerging challenges facing modern capital markets. Some of the challenges that need to be overcome include: Lack of professionalism among some market participants; Short termism; Perception of lax enforcement; Low level of Financial Literacy; Strengthening the technical capacity and expertise; Lack of a cohesive approach among local regulators; Corporate Governance.

700_7308-wIn their race for short term gains, ethics were thrown out the window and many brokers and fund managers forgot their fiduciary duty to their clients. Now there is a loss of confidence in the entire system. How can the SEC change this?
When the best interests of investors are ignored in pursuance of short-term profits, obviously it leads to a loss of confidence. A lot of people have got used to a system of doing things in a certain way, where ethics and good governance were absent. So change will be gradual and will not happen overnight. The SEC will aggressively promote a culture of compliance and at the same time strengthen its oversight and monitoring capabilities to keep a constant eye to detect wrongdoing early. If violations are detected we will take prompt action because failure to act fast, as in the past, only encourages unethical behaviour.

Capital market participants need to realise that a strong culture of professionalism and ethics is central to its growth and stability. Regulators must be in a position to ensure the existence of fair, efficient and transparent markets, which should be at the core of any effort to protect investors.

I believe regaining public trust and confidence requires a stronger ethical dimension to individual participants’ actions. Good behaviour cannot simply be legislated and regulated, it must be encouraged and internalised by companies.The significance of our capital market can only be ensured if our regulatory and governance framework is underpinned by a culture of accountability and propriety across all stakeholders.

Rating shopping is another serious issue. The SEC has already issued a ruling on debt issuer ratings where the lower of two ratings must be applied, but what more can the SEC do to ensure the credit rating industry maintains its credibility?
The rating agencies come within the regulatory purview of the SEC and the current rules are inadequate. There is a problem when a company goes to another rating agency for a higher credit rating when it gets a downgrade. We need to have internationally accepted ratings methodologies and we are keen to establish this. We will also improve the rating rationale in the prospectus for investors to get a better understanding. You may have a one-notch difference when two ratings agencies rate one single company, but anything more than this is too big a disparity and cannot be possible because the fundamentals of a company to determine its credit risk is the same no matter which rating agency looks at it. The SEC has spearheaded efforts to get our corporate debt market moving. If any debt issue fails it will spell disaster for our capital market prospects. We cannot take any chances. We are exploring ways and means of regularizing the credit ratings agencies and will be guided by the recommendations of IOSCO (International Organisation of Securities Commissions) in this regard.

What does the SEC hope to achieve in the near term?
There are three key initiatives we will be focusing on for implementation by the end of 2016.The SEC Act amendment will give us powers to introduce civil and administrative sanctions, issue reprimands, disgorge ill-gotten gains and compensate investors. We would be enabled to regulate the business conduct of individual participants, hitherto unregulated capital market intermediaries such as Investment banks and the unlisted corporate bond market in order to strengthen investor protection. During this time we also hope to rollout the Central Counter Party system implementation in partnership with the CSE to address the settlement and asset commitment risk prevailing in the market and as a prerequisite for enabling products such as derivatives. Demutualisation of the Colombo Stock Exchange is the other key for the strategic interests of the Exchange to be pursued in an efficient and aggressive manner.

Where do you see the capital market in two years and ten years from now?
In Sri Lanka fund raising and investment activity is currently dominated by the banking sector. The capital market size is around 30% of GDP and this presents a unique opportunity for all stakeholders. The capital market should be able to facilitate growth to complement the banking sector and support aspirational growth targets of the country. The deepening of capital markets have been critical for sustaining rapid economic expansion in many countries and to achieve this end, investor and public confidence are premised on the integrity of markets and their participants.

So rather than two years we will focus on the next one and half years to place the capital market on a solid footing by striving to implement what I mentioned earlier plus efforts targeted at maintaining a fair, efficient, transparent and competitive market. We will strive to do what is necessary to make the SEC an employer of choice and attract the best talent to be a step ahead of the market. Going forward, the regulator will carry out its mandate to the letter and when that happens confidence will automatically return.

Ten years from now I expect the capital market to be the preferred mode for long term capital raising and investment, a range of products will be on offer across the entire risk spectrum, the sophistication levels of investors will be high to select the right products, many profitable opportunities will be on offer for professional intermediary services; what’s more, it will be a key sector for generation of high skilled employment, it will be known as a well regulated market offering a level playing field and will become an important emerging market that is a preferred destination for foreign institutional investments among others.

US and EU capital market rules are strict; can they be adopted here and how?
The deficit of trust has affected many markets around the world. Often, underlying these crises are some incidences associated with poor governance, misconduct and lack of ethics and professionalism, which has severe ramifications on the trust and confidence that is integral to markets and the financial system. Hence, the regulators, wherever they may be, are faced with similar issues.

We only have the basic products and our rules need to be fully revamped and have minimum standards to achieve our objectives. Certain stricter rules may be a bit premature for a market like ours at the moment which is at an evolving stage. When violations do occur, prompt enforcement action should be taken. This is an area in the past where fingers were pointed towards the SEC and has led to a perception of lax enforcement by the regulator. We need to promote a culture of compliance and at the same time utilize technology to the fullest for market monitoring and have strong oversight over conduct of market participants to detect wrongdoing early and take preventive measures. Going forward, the SEC would like to be in the business of prevention rather than in the business of cleaning up.

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