Dealing with Market Intermediaries and Market Information

1. Dealing with Market Intermediaries and Market Information By Md. Ashraful Islam Executive Director, SEC

2. Contents Part-A: Dealing with Market Intermediaries • Market & intermediary fundamentals • How investors should deal with intermediaries • How regulators deal with intermediaries Part-B: Dealing with Market Information • Efficient market hypothesis • Access to information • Various market information • Mandatory disclosure of some information • Restriction on disclosure of some information • Prohibition of trading on insider information • Others

3. Market & Intermediary Fundamentals

4. Market Fundamentals • Market: A market is the means through which buyers and sellers are brought together to aid in the transfer of goods and/or services. So a market need not have a physical location but the only necessity is that buyers and sellers are facilitated to communicate regarding the relevant aspects of transaction. Both buyers and sellers benefit from existence of the market • A financial market deals with variety of financial assets but those who establish and administer the market do not usually own the assets, they simply provide a physical location or electronic system that allows potential buyers and sellers to interact. They help the market function by providing information and facilities to aid in transfer of ownership. There are mainly two types of financial assets: -Money market financial assets, maturity< or = 1 year -Capital market financial assets, maturity > 1 year There are many financial markets but they are not all equal – some are more active and liquid, others are relatively illiquid and inefficient in their operations.

5. Various Types of Financial Assets • Types of financial assets: • Money market financial assets: • Treasury bills • Certificate of deposits • Commercial paper etc • Capital market financial assets: • Common shares • Preferred shares • Bonds • Debentures • Mutual funds • Options • Futures etc Different types of financial assets have different characteristics and involve different levels of risk-return combinations. At present we live in a world of rapid pace of financial innovation because of two significant events- advent of telecommunication, internet and computer technology, and the globalization of business, especially finance.

6. Features of a Good Capital Market • Access to timely and accurate information on prevailing buy and sell offers (demand and supply) including price and volume of past transaction for justifying price of current transaction by the buyer and seller, which is one important attribute of a good market • Liquidity,the ability to buy or sell an asset quickly at a price not substantially different form the prices of prior transactions, assuming no new information is available. Marketability( likelihood of being sold quickly) and price continuity (prices do not change much from one transaction to the next unless substantial new information becomes available). But a market to have price continuity requires depth (existence of potential buyers and sellers at any time willing to trade at prices above or below the current market price)

7. Features of a Good Capital Market… • Low transaction cost. A perfect market should be free of transaction cost- cost of reaching the market, brokerage cost and cost of transferring the asset. If buyers and sellers could do transactions skillfully, brokerage cost would not be involved. But in reality, buyers/sellers do not have that skill and raises need for intermediaries and involve cost bit it should be low. • Prices should adjust quickly to all new informationin the marketregarding the asset reflecting fairness of prevailing market price of the asset. • A perfect market should be free from regulation, but in reality to handle the prevailingimperfections, market regulation is required but it should be at minimum level. But in real market, all these features are hardly existing, which raise the need for intermediaries and regulation of the market in order to develop a fair, transparent, efficient and reliable market.

9. Roles of Market Intermediaries • Transform financial assets in more preferred form: Intermediaries transform less preferred financial assets into more preferred financial assets for the general public assuming the risk involved in the transformation process. Various intermediaries are involved in various parts of transformation and value addition/retention services for the assets. • Work as Conduit between buyers and sellers: Market intermediaries work as conduit between buyers and sellers.

10. Market Intermediary Economic Functions • They perform at least any one of the following economic functions: • Maturity intermediation, • Denomination intermediation • Liquidity intermediation • Risk reduction through diversification and credit enhancement, • Cost reduction through large number of contract signing and information processing, • providing payment mechanism etc

11. Various Types of Capital Market Intermediaries • Merchant bankers (Investment bankers)- Issue manager, portfolio manager, underwriter • Mutual fund (Investment companies)- Asset management companies, trustees, custodians • Brokers, dealers, authorized representatives, market makers, depository participants • Credit rating agencies etc.

12. Financial Innovation • Financial innovation: At the edge of more competition, increased volatility, and existing tax regulation and laws, market participants need more efficient ways of risk sharing or more efficient ways of merely doing things by the use of modern communication and computer technologies which resulted in many innovative products and services. A key financial innovation in the 1980s is asset backed securitization that dramatically influences the role of financial intermediaries. • Asset securitization converts illiquid pool of loans into securities with greater liquidity and reduced credit risk. It provides direct financing between the borrowers and investors, short-circuiting the traditional intermediaries. In securitization, more than one institution may be involve in lending capital. This technique has major implications for financial market as well as the structure of financial intermediaries. This may be a wave of the future, as it appears to be more efficient mechanism for brining borrowers and investors together than traditional financing through financial intermediaries. Securitization benefits issuers, investors, borrowers and financial system.

13. Measuring Market Performance • Index • Operational efficiency • Price efficiency

14. How Investors Should Deal with Market Intermediaries

15. How Investors Should Deal with Market Intermediaries • Investors should know the services and obligations of the stock brokers/ARs and portfolio managers to them • Investors should know their own responsibilities to brokers/ARs and portfolio managers • Investors should know their own obligations to the market • What investors should do if feel deceived

16. Obligations of stock broker to their clients • Accepting customer to open customer account for trading • Executing customer’s orders for buy/sell as per their written or telephonic order • Providing trade confirmation report on the executed order with details within 24 hours of trading • Making payment against sell of security, or delivery of security bought, to the customer on end of T+3(for A,B,G,N scripts) or on end of T+79doe Z category script). In case of default, interest @1.5 per month on the value of transaction is also payable to the customer.

17. Obligations of stock broker to their clients… • Replacing defective script or refund the money to the customer with interest @ 2.5% per month from the date of settlement of transaction to the date of refund, along with the benefit accrued, if any, provided complaint is lodged within 10 days of book closure or 6 months of settlement date, whichever is earlier, for defective script as per the settlement of transaction regulation • Settling customers complaint, if any, against the stock broker concerned. • Keeping separately customer’s securities from others securities • Keeping separately customers money through consolidated customers bank account from brokers money

18. Responsibilities of investors to stock-brokers • Signature of investor/client in the customer account information form to create contractual agreement • Knowing the client code number for trading • Introducers information • Following margin facilities terms & conditions • Negotiating a rate for broker commission for trade • Taking acknowledgement receipt for share deposit with signature of concerned AR of broker • Taking money receipt for fund deposit with signature of concerned AR of broker • Declaration in respect of share trading by director or sponsor, 10% or above holder etc.

19. Obligations of investors for the market • Investors should not involve in creating artificial price through syndication and manipulation • Should not influence issuer to inflate financial report and to declare artificial dividend • Should not influence/misguide other investors for trading • Should not involve in spreading rumor or phony information in the market

20. How Regulators Deal with Market Intermediaries

21. How Regulators Deal with Market Intermediaries • Although market intermediaries provide their services to the capital market, their activities are not free from supervision and beyond securities laws • Intermediaries must have to comply with the securities laws in conducting their activities • Regulators supervise and monitor their activities and ensure their compliance with securities laws to uphold a fair, efficient and transparent market through conducting inspection, ensuring maintenance of their books of accounts and records, ensuring submission of compliance report, quarterly and annual reports etc.

22. 1. Dealing with stock brokers/dealers/ authorized representatives • Inspection to check compliance: To ensure whether stock brokers/dealers/authorized representatives are discharging their duties and performing their activities as per securities laws and rules, the Commission by its own initiative or based on any complaint if it deems, may conduct inspection of books of accounts, registers, other documents within 3 days of prior notice or without notice in case of emergency. Inspection is to be carried out and result of the inspection is to be furnished in a report to the Commission within 30 days of inspection notice from the Commission. The Commission can extend the time if it deems so. • Measures on inspection report: The Commission takes necessary measures based on the report or it may instruct for more detailed inspection. The Commission informs all concerned including the complainants about the measures it has taken. • Opportunity for appeal: If any stock broker/dealer/AR become affected by any order under the Stock Broker, Stock Dealer and Authorized Representative Rules, 2000, it can appeal to the Commission within 15 days of receiving the order in Appeal Form, supplementing additional information and papers in favor of the appeal.

23. Dealing with stock brokers/dealers/authorized representatives… • Hearing on appeal: To consider the appeal, the Commission conduct hearing in presence of the appealer or its representative and can call necessary papers. • Commission’s decision: The Commission will decide on the appeal within 30 days of its submission and inform the decision to the appealer. If the decision on the appeal cancels the registration or suspend the registration, a copy of the decision will be send to the Stock exchanges. If suspension of the registration occurs under section 12(1) or 12(7), the suspension order shall prevail until the appeal resolved. • Review of decision: The Commission can review its decision given under section 17 by its own initiative or appeal petition from the concerned and in this case the Commission’s decision will be the final decision.

24. Dealing with stock brokers/dealers/authorized representatives… • Status of the authorized representatives in case of suspension/ cancellation of employer’s registration - In such case, AR can work with other operational broker/dealer after taking release from the existing broker/dealer • Issue of notice etc: Notice or any other order/information under this rules can be sent to the person or authorized person of the organization. Otherwise it can be sent to last known address of that person or its authorized person through registered post or special messenger or corrier service or if required through newspaper. • Compliance with code of conduct: Brokers/dealers/AR’s have to maintain code of conduct as per their concerned rules.

25. A. Regular and sudden inspections Supervision & Monitoring Broker/dealer/ AR Activities: • SEC conducts regular monthly inspection on 2 brokers/dealers of DSE and 2 brokers/dealers of CSE at random basis to check whether they are operating in compliance with securities laws and to enforce its implementation • DSE conducts regular monthly inspection on its 5 brokers/dealers at random basis to check whether they are operating in compliance with securities laws and to enforce its compliance • CSE conducts regular monthly inspection on its 5 brokers/dealers at random basis to check whether they are operating in compliance with securities laws and to enforce its compliance • SEC and exchanges may initiate any inspection on any intermediary any time if it deems to do so.

26. B. Report submission • Monthly compliance report: All the stock brokers/dealers /authorized representatives have to furnish compliance report on their activities in prescribed format to the Commission on monthly basis • Quarterly report: • Audited financial statements: Each stock broker/dealer shall submit audited financial statements to the Commission through stock exchange within 4 months after completion of their respective financial year.

27. C. Maintenance of books of accounts etc : 1) Maintenance of books of accounts: • Journal, cash books or any other original entries that form the basis for the ledgers • books of record of all order for purchase or sale of securities, • all purchase and sale of securities, • all receipts and deliveries of securities, • all other debts and credits • Ledgers reflecting asset, liability, reserve capital, income and expense accounts • Ledgers reflecting securities in transfers, securities borrowed and securities loaned and securities bought or sold of which the delivery is delayed - Chronological and customer wise record of money received and paid - Chronological and customer wise record of securities received and delivered including name, quantity, ref no. of security - Chronological record of transactions made in a consolidated customer’s account • Trial balance of all ledger accounts to be prepared at least once at the end of six months of every year of account

28. Maintenance of books of accounts etc…: • Record of transactions with the banks • Book of contracts with other members • Duplicates/counterfoils of memos of confirmation issued to customers • The books of accounts and other documents are to be preserved for a period of not less than five years. 2) Maintenance of consolidated customers account with scheduled bank for the deposit of money received from or paid to customer • Separation of customers’ securities from the securities of its own account • Additional documents: • Register for the list of customers with name, address , code number • Registers relating securities buy/sell of securities: • Howla or contract wise register • Security wise register • Customer wise register • Preservation of hard copy of the documents signed by authorized officer if computer-based system is used • List of AR with name, address • Agreement incorporating AR’s responsibly and limit of activity

29. Maintenance of books of accounts etc…..: • Company law matters: • Holding board meeting at least once in every three months and four in a year • Holding of AGM once in every calendar year as per section 81 of Company Act • Reporting change in directorship to RJSC and SE within 14 days of change • Reporting any change in company status to SEC 15 days of change

30. Maintenance of books of accounts etc…: • General: • Margin arrangement through agreement • No. of trade workstations • No. of ARs • Paid-up capital • Net worth (min half of paid-up capital) • Appointment of compliance officer • Reporting net capital balance as per rule 3(2) to SE within 3 working days of next month • Margin maintenance status • Single security exposure • Single client exposure • Reporting short sale if any • Reporting financial netting if any for non-permitted securities

31. 2. Dealing with Merchant Bankers • Inspection to check compliance: To be sure whether merchant bankers and portfolio managers are discharging their duties, performing their activities and keeping its books of accounts, records and other documents as per securities laws and Merchant Banker and Portfolio Manager Rules, 1996, the Commission can appoint any person as inspector to conduct inspection within 3 days of prior notice including the subject or less than that time as approved by the Commission. Inspection is to be carried out and result of the inspection is to be furnished in a report to the Commission within 60 days of starting inspection. • Measures on inspection report: The Commission will consider the matter within 30 days of receiving the report and if any merchant banker or portfolio manager is found guilty, the Commission can suspend or cancel the registration or can issue directive to comply with the laws and rules. But it will not cancel or suspend registration without giving a reasonable opportunity of 15 days to defend in writing and without conducting a special inspection about the allegation. • Opportunity to defend: On having written defense in time and in consideration of special inspection report, the Commission will conduct hearing and take decision and inform it in writing.

32. 2. Dealing with Merchant Bankers…. • Opportunity to appeal: Being aggrieved by the Commission decision, the merchant banker and portfolio manager can appeal to the commission for its review within 15 days of receiving the copy. • Review of decision: The Commission can review upon receiving appeal petition from the concerned, and the Commission will take final decision in this connection. • Compliance with code of conduct: Merchant banker and portfolio managers have to maintain code of conduct as per their concerned rules.

33. Supervision & Monitoring of Merchant Banker and Portfolio Manager Activities: A. Inspection • SEC conducts sudden inspection on merchant bankers and portfolio managers to check whether they are operating in compliance with securities laws and keeping records of their activities properly

34. B. Report submission • Monthly compliance report: All the merchant bankers and portfolio managers have to furnish compliance report on their activities in prescribed format to the Commission on monthly basis • Unaudited quarterly financial statement: Each merchant banker shall submit unaudited quarterly financial statement to the Commission to check capital adequacy • Financial statements: Each merchant banker or portfolio manager shall submit financial statements to the Commission.

35. C. Maintenance of books of accounts and records: • Books of accounts & records: • Balance sheet • Profit-loss statement • Cash flow statement • Auditor’s opinion on accounts • Books of accounts as prescribed by the Commission • Shall maintain records for min 12 years

36. 3. Mutual fund • Four participants of MF are: • Sponsor • Trustee • Asset management company (AMC) • Custodian • MF is a trust fund and trustee bears responsibility to ensure activities of MF, AMC, custodian in accordance with trust deeds, securities laws, Mutual Fund Rules.

37. Supervision and monitoring of MF activities: Inspection: • Inspection objectives: • Ensuring proper maintenance of books of accounts to reflect their activities • Ensuring compliance of securities laws and rules • Examination of the role of MF, trustee, asset management company in case of takeover • Enquiring complaints against MF participants in the interest of investors • Any other reason if the Commission deems

38. Inspection and action procedure: • Inspection notice to be issued at lest 3 days prior to inspection, to all MF participants • All directors, officers, staffs of the inspecting participant will produce their respective books of accounts, other documents, document on activities of MF to the inspection officer • Based on inspection result, the inspection officer will submit report to the Commission as soon as possible • The Commission will consider the report within 30 days of receipt and give the defaulter an opportunity to express its personal opinion before taking any decision • The Commission may appoint auditor to investigate in to books of accounts or other matters based on inspection report

39. Inspection and action procedure…..: • Without investigation by appointing investigation officers, the Commission shall not suspend or cancel registration of any participant. • On receipt of report from investigation officer, the Commission will issue show cause notice to the defaulter as to why punishment will not be imposed on him • On receipt of answer, the Commission will issue order and shall send copy to all participants • If the fund is suspended, all its operation will remain suspended during the period • If the fund registration is cancelled, all activities and transaction will be stopped. • Suspension/cancellation news will have to be published in national news papers(2) • The aggrieved person may appeal to the Commission

40. Dealing with Market Information

41. Efficient Market Hypothesis • Everyday, at any point of time, the price of a security is thought to be built as a consequence of various market information as interpreted by the investors, which is known as Efficient Market Hypothesis(EMH) • A good market provides access to timely and accurate information • Flow of unauthorized information and misleading information can cause disruption of the market • Disclosure of some information is mandatory and restriction of misleading information is also mandatory

42. Access to Market Information Network Electronic media (Website, TV, Radio, Email, Message Group, SMS) News paper/magazines • Various stakeholders • in capital market • Issuers • Investors • Intermediaries • Regulators • Others SEC/DSE/ CSE Review/ Publications Trade data in CD Capital Market SEC/DSE/ CSE/CDBL/ Company websites Company annual/half-yearly/quarterly reports 3rd party data service providers

43. Various Market Related Information • Past Trade data • Current trade data • Price sensitive information • AGM, EGM & record date/book closure • Technical information • Fundamental information • Economic information • Securities laws related information • Prospectus • Lottery result & refund information etc.

44. Mandatory disclosure of some information • Price sensitive information: • Price sensitive information that may affect the price of a security must be disclosed in public by the issuer through daily newspaper advertisement(within 2 days). • SEC and the stock exchanges are to be informed within 30 minutes • Price sensitive information is stored in stock exchange news server that can be viewed through website. • Issuer companies are directed to hold their meetings that may decide on price sensitive information after trade hours or in holidays

45. Restriction on disclosure of some information • Company must not publish undecided information sensitive to price • Nobody can publish or spread misleading information about capital market

46. Prohibition of Insider Trading • Insiders of a company like sponsors, directors, officers or staff involving in price sensitive issues are restricted from buy/sell of their securities of that company under the Prohibition of Insider Trading Rules, 1995.

47. Others • Quarterly, annual FS: • Issuer companies are directed to submit their quarterly FS and annual FS in their website • Company statistics: DSE/CSE website provide trade data and also other company financial data in their website, which is easily accessible. • Company websites etc

48. Thank You