Does Nepal Need A New Stock Exchange?

 To modernise the economy, the government established the Nepal Stock Exchange (NEPSE) in January 1994 to facilitate the organised buying and selling of securities. The establishment of a trading floor has provided a platform for mobilising diverse resources, including those of small investors nationwide.

Experts have consistently emphasised the urgent need for capital market reforms to effectively mobilise resources for the country's development.

Regarding ownership, NEPSE - the nation's sole stock exchange - is primarily owned by the government with a 58.66% stake. The remaining shares are held by Nepal Rastra Bank (9.5%), Employees Provident Fund (10%), and Rastriya Banijya Bank (11.23%). Nepal Rastra Bank has reportedly been seeking to divest its shares while the government maintains a dominant stake despite the central bank's intention to exit as a promoter.

Over time, the number of companies listed on NEPSE has increased significantly. The financial sector has historically dominated Nepal's stock market, with hydropower companies gaining prominence in recent years. Alongside the securities market, the development of a robust bond market is equally crucial to enable the capital market to contribute to national development by addressing resource gaps.

Against this backdrop, new players are applying for stock exchange licences, a development expected to enhance competition in the securities and bond markets. However, despite applications from private sector players, the regulator - Securities Board of Nepal (SEBON) - remains indecisive. The issue has been brought before a parliamentary panel and challenged in court.

A strong anti-lobby has created uncertainty and even the government has failed to provide clear instructions to SEBON. There are divided opinions regarding the licensing of new stock exchanges. Reportedly, influential corporate houses are divided into two powerful groups, both vying for licences.

According to high-level government sources, the government may grant a licence for another stock exchange, anticipating the potential expansion of the securities and bond markets in the coming decades. Furthermore, the appointment of the SEBON Chairperson was delayed significantly, despite mounting criticism of the government's indecisiveness. Reportedly, aspiring candidates for the SEBON chairperson were backed by different lobby groups.

Former Finance Minister, Barsha Man Pun, has accused former Prime Minister, Pushpa Kamal Dahal-led government of being ousted due to the influence of new stock exchange lobbyists who allegedly brought leaders from the two largest parties together to form the government.

However, Pun has not been able to provide concrete evidence to substantiate the claim that the licensing of new stock exchanges was the primary reason for the downfall of the Dahal-led government.

Nevertheless, in a move that is better late than never, the government has appointed a chairperson for SEBON. Santosh Narayan Shrestha was appointed as SEBON chairperson on November 25 after the position remained vacant for 11 months.

Further, the government has also formed a study panel, led by former Nepal Rastra Bank Deputy Governor, Chinta Mani Siwakoti, to investigate the potential advantages and disadvantages of licensing new stock exchanges and to determine the necessary standards.

Recommendation of study panel on licensing new stock exchanges

The study panel led by Siwakoti has recommended that new stock exchanges can be licensed as per the provisions of the Securities Act, 2007. The Act stipulates a minimum paid-up capital of Rs three billion for obtaining a stock exchange licence. However, the study panel has suggested that the regulator may increase this minimum paid-up capital as deemed necessary.

Furthermore, the study panel emphasised that entities with established strategic partnerships with organisations or companies specialising in securities market institutional governance should be considered strong candidates for obtaining a licence. The panel recommended diversifying the ownership structure of new stock exchanges and prioritising those with experience and professional expertise in the securities exchange market.

The panel has also emphasised the importance of strong internal control mechanisms by defining eligibility criteria and experience requirements for Board of Directors (BoD) members and establishing a code of conduct for the BoD.

The panel recommends that the BoD comprise at least five members, including at least one female member, with a majority of independent directors. Additionally, 30% of the paid-up capital of the new stock exchange must be issued as an Initial Public Offering (IPO) within a specified timeframe after commencing operations.

Simultaneously, the panel has recommended restructuring NEPSE and SEBON. Noting that SEBON has been seeking guidance from the Ministry of Finance regarding the licensing of new stock exchange players for the past decade and a half, the panel has urged the government to grant greater autonomy to the regulator in this matter.

Is a new stock market necessary

Most importantly, the study panel led by former Deputy Governor of NRB, Siwakoti, highlighted the extremely slow pace of reform and restructuring within NEPSE over the past decade and a half. The panel asserted that market competition is the only reliable catalyst for accelerating these reform initiatives.

The report states, "Restructuring and reform of NEPSE are crucial, however, the presence of new market players is the sole factor that can significantly expedite these reforms." Fundamentally, the panel concludes that, adhering to the principles of a liberal economy, the country cannot restrict market competition.

Opponents of new stock exchanges argue that the stock market lacks substantial representation from real-sector companies, hindering its ability to accurately reflect the state of the economy, despite its intended role as an economic barometer.

Moreover, reform initiatives aimed at increasing the participation of Non-Resident Nepalis (NRNs) in the stock market have been stalled for a considerable period due to the inability to implement capital account convertibility.

The assertion that the capital market is dominated by the financial sector and lacks representation from real sectors like manufacturing, construction and agriculture may be overly speculative, according to experts.

"Capital markets play a crucial role in enabling all types of investors to participate in economic development. However, Nepal has lagged behind in developing a robust capital market with a sound financial infrastructure, despite the establishment of NEPSE three decades ago," said Prof Pushkar Bajracharya.

A joint study of Nepal's capital market conducted by Prof Bajracharya and Prof Parashar Koirala found that while regulatory measures are gradually being updated to address contemporary issues, these efforts have not proven effective due to governance challenges within the corporate sector.

"Corporate transparency remains a significant concern. The practice of maintaining secretive accounting records persists. Minority shareholders lack access to these crucial financial records," the report emphasised.

"Further, Nepal's capital market is currently limited to the equity market. And, NEPSE remains largely isolated from global markets."

In its current state, the capital market primarily benefits investors who can navigate its complexities. It has yet to demonstrate rationality for the discerning investor.

According to Prof Bajracharya, unless significant improvements are made, the capital market will not effectively contribute to economic growth. He emphasised the need for substantial upgrades in accounting and auditing standards, disclosure practices and corporate governance. Concurrently, SEBON's monitoring and policy response capabilities must be enhanced.

Nepal's capital market exhibits high levels of speculation. The absence of market makers, such as non-banking financial institutions that mobilise long-term funds like the Employees Provident Fund, Citizen Investment Trust and Social Security Fund, coupled with inconsistent policies from Nepal Rastra Bank regarding margin lending, has resulted in significant market volatility. This instability has eroded investor confidence, leading to permanent market exits.

During the previous bull market in August 2021, it was reported that banks and financial institutions (BFIs) had substantial loan exposure to the stock market. In one instance, an entity was found to have availed loans exceeding one billion rupees. In response, Nepal Rastra Bank imposed caps on both institutional and individual investors.

The previous bull market witnessed significant trading volume and market capitalisation, which exceeded the country's GDP, reaching 103.46% in August 2021.

SEBON awaiting green signal from Ministry of Finance

SEBON is currently at the centre of intense debate regarding the licensing of new stock exchanges in Nepal. Newly appointed Chairperson, Santosh Narayan Shrestha, has clarified that SEBON will adhere to the government's directives on this matter.

It is evident that SEBON is awaiting a green signal from the Ministry of Finance (MoF) to proceed with issuing licences for new stock exchanges. The government has already decided to license new exchanges, and SEBON has initiated preparations accordingly. However, these efforts were temporarily halted by an instruction from the Parliamentary Finance Committee.

A writ petition was filed in the Supreme Court to prevent the licensing of new stock exchanges, commodity exchanges and stockbrokers. The court has since rejected this petition.

The SEBON Chairperson, Shrestha, has expressed his support for allowing real-sector companies to issue Initial Public Offerings (IPOs) at premium prices determined through the book-building process. "To encourage greater participation from real-sector companies, we will permit them to issue public offerings at premium prices. We cannot mandate a face value of Rs 100," Shrestha said. "As the regulator, we will diligently address any loopholes or weaknesses observed in premium pricing or book-building processes. Maintaining investor trust is paramount. We will ensure that companies receive appropriate valuations for their assets and that the public has ownership in the country's leading companies," he added.

Shrestha further informed that SEBON is currently investigating appropriate lock-in periods for promoters in specific companies. It is believed that revising these lock-in periods could free up resources for investors to explore new investment avenues.

However, considering the potential for overvaluation in certain sectors, particularly hydropower projects, and the possibility of low returns, shortening lock-in periods could provide an easy escape route for initial promoters. Buyers of shares from these promoters may face significant risks.