Mar 162014

Investing in real estate has been the traditional method of securing future financial stability by increasing one’s net worth. With the advent of share trading, investments in property have been in direct competition to attract investment rupees.

Bricks and mortar or shares was the toss up considered by many investors as they pondered the risks and benefits of each. For many though, investing in real estate, particularly commercial real estate, is financially out of scope.

But what if you could pool your resources with other investors and invest in large-scale commercial real estate as a group? Real estate investment trusts, commonly known as REITs, (pronounced like ‘treats’) allows you to do just that. They offer the benefits of real estate ownership without the headaches or expense of being a landlord.

The Securities and Exchange Commission (SEC) together with the Colombo Stock Exchange (CSE) is currently discussing the formation and structures of REITs as a new product with several market participants who have shown an interest in launching such an investment vehicle in the context of Sri Lanka’s property environment.

Types of REITsREITs are corporations/trusts that own and manage a portfolio of real estate-based assets. Typically there are two main types of REITs – Equity REITs (own and operate income-producing real estate) and Mortgage REITs (lends money directly to real estate owners and their operators or indirectly through acquisition of loans or mortgage-backed securities). REITs that engage in both of these product features are commonly known as Hybrid REITs.

Investments in REITs are generally designed to create the important advantages of ‘liquidity’ and ‘diversity’. Unlike actual real estate property, these shares can be quickly and easily sold. And because you’re investing in a portfolio of properties rather than a single building, risk elements are mitigated.

Property types such as office spaces, shopping malls, apartments, warehouses, healthcare complexes, theatres and even mixed commercial spaces are eligible to makeup the core asset base of a REIT.

A simplified example of an Equity REIT generally consists of four key components.

1.A company/trustee that owns and operates income-producing real estate:

The trustee acts on behalf of the unit holders and in return takes a trustee fee.

2.An authorized portfolio of core investments/assets that are made available to be parcelled into the REIT offering:These assets generate the all-important income stream from which investors are able to derive their returns.

3.A property management company to provide management services required by the portfolio of properties.Receives a management fee in return.

4.Lastly, but most importantly – the unit holders.3A pool of investors (minimum numbers determined to ascertain eligibility of a REIT) who invest in a REIT product and receive dividends and other distributions.

An illustration of the above is as follows:

Benefits offered  REITs came about in 1960, when the US Congress decided that smaller investors should also be able to invest in large-scale, income-producing real estate. It determined that the best way to do this was to follow the model of investing in other industries — the purchase of ‘equity’.The engagement of the SEC and CSE with proponents of this investment vehicle contends with the legal framework for operation and issues such as a proposed lobby to avoid double taxation at the corporate and individual level. In countries such as the US, Australia, Singapore and Malaysia taxes on the core asset of a REIT product is passed onto the individual investor.

As there is an increased demand for commercial office space in Sri Lanka, which is largely driven by the banking, IT and tourism sectors, astute product suppliers have realized the opportunity to extend the benefits of real estate to investors who would otherwise not have the capacity to have property on their investment portfolios.REITs offer several other benefits over actually owning properties.

They are highly liquid. In other words, while it’s difficult and time-consuming to buy, rent and sell houses on your own, this isn’t the case with REITs, which can be bought and sold as easily as stocks.
REITs enable you to own a share in non-residential properties as well, such as hotels, malls and other commercial or industrial properties.
Lastly, the minimum investment with a REIT is comparatively lower and investors can start small and increase their exposure over time by gauging the performance of the product invested into.

In most cases these types of investment vehicles have delivered higher yields than benchmark investments in most global investment platforms. In the US for example, REIT products during a 20-year span from 1990 to 2010 consistently outperformed 10-year Treasury bonds.

Risks involvedAs is the case with any investment a REIT too has inherent risks that an investor should be aware of. A drop in the price or valuations of a property will have an adverse effect on the price of the units of a REIT whilst low occupancy in the core assets will affect the distributed income stream. Other potential risks to be considered are insufficient diversification, tenancy durations and the quality of tenants.The SEC hopes to pique the interest of many target stakeholders to enter the capital market through the introduction of a REIT product.

Institutional investors
Property companies that own income generating properties
Banks that have exposure to property
Portfolio and asset management companies
Property developers
Foreign investors

Regulatory frameworkCurrently there is robust engagement around the introduction of these products including the regulatory framework necessary to protect potential investors. A study of the initial entry and performance of these products in similar markets is also being carried out by the SEC with learning outcomes expected to assist the formation of relevant governing rules in context of the Sri Lankan markets.

The SEC expects to coordinate a consultative process with other key organisations and regulatory bodies to formalize such key requirements as accounting standards, taxation rules, defined responsibilities of key stakeholders, dividend policies, valuations, reporting processes and the rights of investors of these products.  

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Jan 132014
Foundation laid; time for other stakeholders to deliver: Godahewa
By Indika Sakalasooriya

Dr.Nalaka Godahewa, Chairman of the Securities and Exchange recently shared his thoughts with the Mirror Business about the year that ended and his expectations for the country’s capital market for the New Year. The following are excerpts.

Q: Let’s begin with your expectations for the capital market in the New Year?
Expectations for 2014 are extremely positive. There is a lot of positive sentiment about the market activities if you talk to any stakeholder.
One of the key reasons is, in 2013 we stabilized the market and laid a very strong foundation for us to grow from this point onwards. The regulatory leaks that were there were plugged and very clear-cut three year plan was introduced and of which at least 40 to 50 percent is completed. And also, if you look at the total capital raised in 2013, that was the perhaps the best in the recent past. It grew over 270 percent. So, I would say in 2013, the capital market has done well. Since we have now laid strong foundation, the market stakeholders should make sure to deliver on the strong platform we have created.

Q: Though you say market stakeholders are extremely positive, we hear that a number of stockbrokers are struggling?
They are struggling because of what happened in the past. They are not negative about what will happen in the market in the coming years. Last year, the equity market reported a growth of 4.8 percent. So, the people who depended on the equity market—when the business is distributed among 29 brokers—had to undergo certain hardships. In fact almost 50 percent of them are struggling. It is a fact. If you look at every other industry it is same. That’s why the Central Bank is asking finance companies to merge and consolidate.  Same thing goes for brokering companies. There are far too many. When there’s too many, some consolidation needs to come in. Either they could consolidate or become deactivate for a while, and come back when the market is ready accept a larger a number.

Q: Is there such a possibility? For those struggling to go into hibernation and come back when the times are good?
There’s proposal which has come to the Colombo Stock Exchange (CSE). They have forwarded it to us. We have not discussed it at the Commission level but at the Secretariat level we have discussed about it, and we are looking at it positively. In many other countries this has happened and it’s not a new thing.

Q: We hear that some brokers are even closing their regional branches.
Yes, we are aware of it. As I said about 50 percent of our brokers are currently losing money. When they are losing money and the market is not growing they are compelled to scale down their operations. We don’t like it. But as I said, we cannot interfere into their business and tell them what to do. My only hope is that market will pick up faster, so they can expand or at least maintain where they are. To support them, we went a little beyond our scope and talked to all these large government entities and asked why they were not active in the market. We felt that they were missing the bus. Now I can see they are coming back and this will help brokers. At the same time, we have given fair warning to brokers not to mess it up like the last time by trying to dump shares into these state agencies. The professional fund managers at these state agencies should also be mindful not to get caught. We as the regulator will also closely monitor this and expect to take proactive actions to avert any misconduct.

Q: Since you admitted that many brokers operate, is the SEC actively, like the Central Bank, encouraging the brokers to consolidate?
Unlike the Central Bank who clearly told finance companies to consolidate, we haven’t told brokers anything of that nature. We are not telling them what to do. The industry has to decide itself. If you look at the last one and a half years, every time they have come up with a constructive idea, we have accommodated it. We have these consultative meetings with them which are part of an ongoing programme. But we are not here to tell them how to do business. Our job is to develop the market and protect investor interest.

Q: What is the current position of the SEC Act amendment?
SEC Act amendment as you know was handed over the Finance Ministry after the Commission approval in July last year. Then the Treasury took a decision to review it once again with an independent group, which I think is a good move. There were several bills that came into the parliament last year which were challenged.  Therefore it is important to get an independent view. They are regularly meeting and SEC representatives are also there.

From what I hear, 50 percent of the draft bill has been looked at. If you ask me I would like them to finish fast as possible. But I don’t know how long that’ll take. But as soon as that process is over, it should go the Cabinet and then to the parliament.  We need it very badly.

Q: What are the salient points in the amended Act?
The new Act will give SEC civil sanctions. Everything we currently have is criminal sanctions. When it comes to criminal sanctions, everything you have to prove beyond reasonable doubt which takes a longer period and sometimes you might not be able to prove at the end. That’s why regulators all over the world have moved towards civil sanctions where you can make a call on probability. When the market is growing, to strengthen the regulation we need those powers. At the same time the Act will facilitate product development, CCP and demutualization of the CSE.

Q: When you assumed duties as SEC Chairman in 2012, the market was in turmoil. It was referred a “casino” run by a certain “mafia”. Three were stories of manipulation, front-running and all kinds of market malpractices. Some alleged that your appointment to the SEC was also engineered by a section of powerful investors who wanted manipulate the market the way they wanted. But in 2013, the market sort of stabilized and as far as we know there were no major incidents of market misconduct. And top of that you are bringing new regulations. What was the formula you adapted?
First of all I thank you for asking that. When I assumed duties there was a crisis. I was in fact asked to come by the President because there was a crisis.
In a crisis, people always tend to find scapegoats. So there was a lot of suspicion and allegations. Even when I came, there were allegations that my motives are different. But my approach was to be patient and focus on what we need to do.

Firstly, we sat down, analyzed the situation and developed a long term plan. We got all the market stakeholders involved and got their views and put in an action plan to recognize what we needed to do to develop the market in the long term.

Secondly, we focused on the issues. There were a lot of investigations going on and we went into each and every one and completed them. One position I took was you can’t go by what people say. You have to go by the book and follow procedures. Rather than making statements to the media about what I feel about investigations, I kept my mouth shut. I declined to comment and allowed the Secretariat to do their job. They went to the Commission with their recommendations and now everything is completed.

During the initial period, our focus was stabilizing the market because I felt that was what we were lacking at that moment.  Having stabilized the market, now our focus is shifting more towards the regulatory areas.

If you look at the last 3 to 4 months, we have focused heavily on the gaps that were there in the regulatory mechanism. Sometimes it’s easy to find fault with people and the system when there are gaps in the regulation. There is no point in crying over spilt milk. You must find out why these things are happening. I believe we have identified the issues and addressed them so that they cannot happen any longer. And even the surveillance system was much focused last year. They were very proactive and when we feel that there was something funny going on, we called them and took proactive measures to prevent any market misconduct. That is why if you take 2013, it was more of an eventless year. If you ask me from 2014 onwards, our focus will be more on regulation and protecting investor interest.

Q: As you said during last few months, you have been bringing in a number of new regulations. Don’t you think that’s far too many at a short span of time?
Actually someone else also asked me the same questions whether it’s far too many. I don’t think so, because if someone wants to get ready for the future, we should have done those things long time before. The series of regulations that came into play were not new ideas. They were in the system.
The SEC had been discussing those with the CSE and the industry for many years. If you take minimum free float, there were three previous consultations but nothing really happened. What’s the point of talking about them and doing nothing? Somebody has to act. Then when you act there is fear that there would be resistance. But I was confident there wouldn’t be resistance because everything we did was brought in after a lot of discussion. We have discussed with every concerned party before implementing. Although you saw a number of regulations coming in together, none of them were ad-hoc. The media also gave us a lot of support and looked at the new regulation at a very positive manner.

Q: With regard to the minimum 20 percent free float rule, I was told that about 100 companies will have to comply. Has any concerned party contacted the SEC and asked for any kind of leeway of exception?
About 100 companies listed are below 20 percent and about 70 are main board companies. And if you look at some of the companies, they have only about 3 to 4 percent public free float and some even don’t have that. Formerly nobody has spoken to use but informally a few people have checked about the process. We in fact ran a few advertisements clearly putting down the formula and we got the CSE to write to all the companies. It was more or less a clarity issue rather than a concern.
At the same time, there was fear among the people that the multi-nationals won’t like this. The little bit of informal feedback I’ve received suggest that it is not the case going to be.

Q: Since you came in, we see the SEC and CSE working together and doing a lot market development activities on a joint-basis. Don’t you think in doing that the SEC has gone beyond its scope?
First of all, we cannot say we have gone beyond our scope because our scope has two aspects; market development and investor protection.
When I say market development, people think the SEC is talking about marketing. Market development is creating a market where people can raise funds and trade in a transparent and fair manner. World over capital markets have become very sophisticated and offer a number of new products and instruments. We need to create those things in our market so that there are opportunities to raise funds. That is one of the primary objectives of the SEC.
At the same time, because people are raising money from the public, the SEC has the primary job of protecting investor interest. That becomes a more important aspect in a developed and established market. In our case the market was not there. We were at least 20 years behind when you compare with our closest neighbour, India.

I would like you to look at SEBI (Securities and Exchange Board of India) which was set up in 1987, the same year where our SEC was set up. At the time our market was far ahead of India in terms of technology and sophistication. But if you look at India today, their markets are as sophisticated as any other market in the world. And who was driving that? It was SEBI. They played a very active role in developing the market and are still doing it. But in Sri Lanka, we got this mindset that we are regulators and didn’t do much to develop the market. Now what we are trying to do is to do both; market development and investor protection. That’s why we work closely with the CSE and we would continue to do so.

Q: There were indications that Sri Lanka was seriously looking at in setting up a commodities exchange. What is the current status of it?
Commodities exchange I understand had been an assignment at one point given to the SEC. But it is not necessarily SEC’s mandate to establish a commodities exchange as it involves a number of other stakeholders and ministries. The SEC has come to a particular level with regard to this about two-three years ago and got stuck. To me, a commodities exchange was not a priority last year. We need Treasury advice in this if we are to pursue a commodities exchange.

Q: There was strong speculation that you will either step down or asked to leave. What do you have to say about these speculations?
Question is for what? And if those speculations were correct, I wouldn’t be here now. I have a term and if the term is to end early there has to be a valid reason. So far I have not been communicated anything in this regard by those who appointed me to this position.

Jan 012014
SEC mulls ‘independent opinion’ on offer price for future IPOs
The Securities and Exchange Commission (SEC) has carried out a study to assess the possibility of mandating the justification of the ‘fairness of the Initial Public Offering (IPO) offer price’ by an independent and competent party, an year-end review by the SEC noted.

Overpricing was identified as one of the key reasons for some of the post-war IPOs to fail by a section of the country’s analyst community.

Meanwhile, the SEC and the Colombo Stock Exchange (CSE) is currently engaged in discussions with information technology (IT) and business process outsourcing (BPO) companies in the country to identify the possibility of getting them listed.

“IT/BPO industry initial discussions were held in November 2013 to identify the possibility of listing to raise capital. A follow-up awareness session with representatives of the Sri Lanka Association of Software and Service Companies (SLASSCOM) is scheduled for January 2014,” the review noted.

Both the SEC and CSE have been trying to get more privately held companies to go public to develop the country’s capital market. A separate initiative is currently underway to see the possibility of getting the state-owned enterprises.

With the intention of attracting further foreign direct investment into the country, a concept paper has been finalized to list the Board of Investment (BoI) companies.

“The inputs from the CSE and BoI were also considered during the process. A presentation in this regard was made to BoI representatives,” the SEC said.

Dec 262013
SEC to amend disclosure rules on director dealings
The Securities and Exchange Commission is expected to amend the listing rules pertaining to disclosures on director dealings, to chuck out some ambiguities that have fuelled late disclosures by some parties.

According to SEC Deputy Director General/Officer in Charge, Dhammika Perera, a specific time period will be indicated in the new rules for directors to disclose their dealings.

The Colombo Stock Exchange’s present listing rules direct listed entities to make an immediate announcement of disclosures made by a director in terms of Section 200 of the Companies Act.

The Section 200 of the Companies Act requires directors to make disclosures of an acquisition or disposal of shares of their companies to the board of directors.

Those familiar with the regulatory aspects in connection to director dealings said, most of the directors tend to use the infrequency of board meetings as an excuse to make delayed disclosures.

Dec 262013
SEC educates Criminal Investigation Department
The Securities and Exchange Commission of Sri Lanka (SEC) as the regulator of the capital market of Sri Lanka is committed towards promoting, developing and maintaining a capital market that is fair, efficient, orderly and transparent.

Increasing financial literacy to attain the above mentioned is of utmost importance and is among the top priorities of the SEC. Accordingly, the SEC conducts seminars and workshops locally as well as internationally.

In keeping with the aforesaid commitment a seminar was conducted by the SEC for the officials of the Criminal Investigation Department (CID) to enhance their knowledge on the capital market and its developments. It covered operations of the capital market, securities law and market irregularities with emphasis on money laundering.

The seminar was conducted by Dhammika Perera, Officer – in-Charge/ Deputy Director General of the SEC. A seminar of this calibre is considered as vital in an era when the world is collectively looking at combating organized forms of crime which are not only financially strengthened but also propagated through global financial markets.

The SEC will continue to work with law enforcement institutions to increase financial literacy among professionals and to curb various market irregularities with the aim maintaining fair, efficient, orderly and transparent markets.

Dec 162013
CSE to implement minimum free float from January
The capital market watchdog Securities and Exchange Commission (SEC) is likely to issue a directive in early part of next year, setting out rules on the ‘minimum mandatory continuous free floating limits’ for Colombo Stock Exchange (CSE) listed companies, according to a top official.

SEC’s Officer in Charge (OIC) and Director Investigations Dhammika Perera said the directive would come as a blanket rule which must be applied by all listed entities— big or small, domestic or multinational.

The new rules will require a Main board listed company to maintain a minimum of 20 percent stake in the hands of the public while the requirement for a Diri Savi board listed company is 10 percent.

“Having said that, we do not expect all these companies to have their 20 percent or 10 percent stake in the hands of the public on the following day of the directive. We will give them some time to increase their existing public stakes to the stipulated levels over time. But eventually all will have to up their public free float to these levels,” he insisted.

The draft rules in the public consultation paper issued by SEC in September 2013 said they would allow two years from the effective date of the rules for all the listed entities to increase their public shareholding to the stipulated levels, but the increase must happen at least by 5 percent per annum.

Furthermore, SEC will have the discretion to reject or grant extensions for companies that fail to maintain the minimum public float. In the event of no further extension time is granted, those companies will be penalized by transferring them to the Default board.

However, the yet to be issued directive will have some leniency on Main board listed companies while some exemptions might be granted for them if the circumstances warrant.

“We might consider some of the requests on a case-by-case basis and they might be allowed some kind of leniency on the rule if the circumstances warrant. But no exemptions will be granted for Diri Savi board listed companies,” he added.

Mirror Business learns that exemption might be granted for entities whose market capitalization of the public float is maintained at minimum Rs.5 billion. But this will also depend on the number of shares and the percentage stake held by the public is in agreeable terms to the SEC.

The absence of a sizable free float is often cited as a deterrent to a more transparent and a liquid stock market. Hence the Colombo bourse is becoming less attractive for foreigners and foreign funds who seek easy exit whenever they want.

However the lack of liquidity in the Colombo bourse was also proved helpful to avert sudden massive capital outflows during the heightened Fed tapering fears this year. On the contrary, emerging markets like Indonesia, India and Brazil which have liquid capital markets saw massive outflows during the same period.

Setting up of minimum continuous free float limits has been on SEC’s agenda for the last three years and it never took off having twice called for the public comments back in September 2010 and July 2011.

“This time we received many representations for our consultation paper and we took all the measures to incorporate their concerns as much as possible in drafting the directive,” Perera said. (DK)

Dec 132013
SEC tightens related party transaction rules
The Securities and Exchange Commission yesterday tightened the rules on related party transactions by introducing a detailed best practices code with effect from January 1, 2014, aiming to safeguard minority shareholders and put in place an internal control mechanism in listed firms.

However, the adoption of the best practices code would be on voluntary basis during the first two years of the introduction. But from 2016, the adoption of the best practices code becomes mandatory for all listed firms.

The companies which will adopt the best practices code from January 2014 on a voluntary basis for an initial period of two years will be exempted from complying with the disclosure requirements stipulated in Listing Rule 7.6 (XVI) and item 29 of Appendix 8A, which will be repealed in 2016.

However, the provisions in the best practices code appear to be more detailed and demanding compared to disclosure provisions in the Listing Rule 7.6 (XVI).

For instance, the best practices code proposes to set up a Related Party Transaction Review Committee within the firm to confirm that a related party transaction is not against the company’s interest and mention whether the review committee obtained an opinion from an independent expert before forming its view.

Further shareholder approval by a way of a special resolution is required under the new best practices code if a listed entity or its subsidiary buys or disposes 1/3 of the total assets of either of them to a related party.

Oct 292013
SEC mulls minimum credit rating for debt issuances
The Sri Lanka’s capital market watchdog Securities and Exchange Commission (SEC) is currently considering the restriction corporate debt issuances which are coming with below investment grade, according to a top SEC official.

Director Capital Market Development at the SEC, Vajira Wijegunawardane yesterday told a forum that the market should not allow issuances with low ratings to be listed even in the second board as failures could damage investor confidence which sometimes could never be regained.

“This is something we are currently looking at to see whether we can restrict them,” he said, speaking at a round table discussion on the Corporate Bond Market (CBM) outlook.

According to the Colombo Stock Exchange’s (CSE) listing rules, a company can list its debt instruments in the Second Board irrespective of their credit rating. However listing in the Main Board requires the debt instrument to have the investmentgraderatingof BBB.

Be it the Main Board or the Second Board, the risk associated with the instrument is the same and thus the investors become vulnerable by investing on such low rated bonds, some analysts point out.

Another section of analysts argue that there should be debt instruments with different risk and return profiles as investors assume different risk appetites. They also said that the regulator should not regulate issuer’s rating, but the investment bankers who manage these issues.

Meanwhile, the CSE Director Vajira Kulatilaka said that unsophisticated investors could sometimes be driven more by a higher interest rate than the credit rating of the debt instrument. “In fact we insisted the minimum should be at least BBB+ and not anything below,” he remarked.

Kulatilaka who is also the CEO of NDB Investment Banking Cluster is one of the members in a committee that decides on the minimum issuer ratings.

Sri Lankan companies are currently in a debenture rush, getting the maximum benefit of the withholding tax exemption allowed on such interest income. Year-to-date, 18 Lankan companies have raised as much as Rs. 40 billion through debentures, breaking the previous highest of Rs. 15 billion recorded in 2010.

“People simply cannot bear a single debenture issue failure at this pace market growth. We have to be very careful in getting credit ratings. So, we are very careful in deciding who should come to the market,” Kulatilaka stressed. In 1996, Bangladesh suffered a debenture issue failure and the corporate debt market never recovered since then.

These comments were expressed at the International Organization of Securities Commissions (IOSCO) Asia-Pacific regional committee, CBM outreach program in Sri Lanka hosted by SEC at Colombo Hilton.

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