Many insiders feel that the size and shape of the country’s stock market is lopsided overweighed by BFIs. Perhaps it’s high time that privately owned firms and other similar companies join the bull and the bear ride, they say.
--By Sanjeev Sharma
The Nepali stock market has been on a bull run setting new records in recent months. Led by the banks and financial institutions alongside insurance companies, the NEPSE Index has been reaching new heights nearing the 2,000-points mark. The gravity defying high speed increase in the ‘Kathmandu bourse’ overtly showcases the strong confidence of general investors.
Nevertheless, the current composition of the country’s capital market has been a long debated issue as the NEPSE Index is largely dominated by BFIs. Compared to the intermediary sector (BFIs and insurance), the real sector has only a tiny presence in the stock market, mainly represented by some hydropower, hotel and manufacturing companies. Excluding the hydropower companies and hotels, manufacturing and processing companies have just a 2.53 percent of the market capitalisation of the NEPSE Index, whereas, BFIs have the lion share of the market cap with around 70 percent.
Then and Now
Looking at the present structure of the NEPSE Index, it is an irony in that the domestic stock market started with the floatation of shares to the public by a manufacturing company and a bank. It was in 1973 BS when Biratnagar Jute Mills and Nepal Bank floated their shares to the general public. However, a century after the historic event, the stock market is solely dominated by the BFIs.
The current composition of NEPSE is a result of a heterogeneous mix of various contributing elements. When the stock exchange formally opened its trading floor in 1994, many manufacturing companies came to the market. “Tax incentives were offered in order to attract the manufacturing industries to become publicly listed during the initial years,” says Niranjan Phuyal, Acting Deputy Manager of NEPSE. “However, the incentives did not fare well as only very small scale industries entered the stock market.”
Currently, the total number of publicly listed real sector companies is 30 with the largest being the Manufacturing and Processing group (18) followed by Hydropower (8) and Hotels (4). Nonetheless, many companies under these groups, mainly Manufacturing and Processing, are absent from the regular stock trading. Looking at the last 90 day’s stock trading of these companies, Unilever Nepal is the only company with regular share trading. This clearly indicates the lack of demand for shares of real sector companies among the investors.
Meanwhile, the degrading industrial environment in the country also played a key role behind the low participation of real sector companies. Coupled with the violent insurgency, severe electricity shortages, labour problems along with lack of supportive policies, many manufacturing companies were forced to close during the 2000s causing a precarious situation for the real sector industries which is continuing today.
Starting from the late 90s the stock market saw a gradual delisting of real sector companies. After witnessing the difficulties of being a publicly listed company, many manufacturing industries slowly exited the stock market. According to Phuyal, today owners of privately held companies are likely to find complying with procedures cumbersome after becoming public. “Privately held firms can submit a simple report at the company registrar at the year-end stating that they have conducted the AGM,” he mentions. “But if the companies are about to float shares to the public, they are required to establish a separate share department,” he adds.
The ‘hassles’ do not stop here. After the IPO, the companies need to organise annual general meetings where the promoters are likely to be bombarded by various questions from public shareholders. They are also required to publish quarterly, half yearly and yearly reports on a regular basis. Likewise, they are required to stay connected with the Securities Board of Nepal (SEBON), the market regulator, and NEPSE. And both groups would require the companies to disclose essential information. This has led to experts to cite accountability and transparency as the reasons regarding the unwillingness of owners to list their firms in the stock exchange. And, since most of the Nepali real sector companies are family-owned, owners of such companies are hesitant to share the control of the firms with others at the expense of raising capital.
“The confidence of real sector companies has been low for both promoters and investors. This has been a deterrent for companies looking to enter the stock market,” opines Anuj Agrawal, Vice President of Confederation of Nepalese Industries (CNI). Agrawal, who is also the Director of Vishal Group, points to bank financing as another impediment in the way of increasing the stock market participation of real sector companies. “For real sector companies, banks look for recourse-based (personal guarantee) financing,” he says, adding, “Once a company is publicly listed, the original promoters still would need to personally guarantee all loans, even though they own a smaller percentage of shares.”
Higher IPO Cost
Higher IPO costs is also among the major deterrents in this regard.“Generally, companies enter capital markets to collect long term capital in large amounts at low cost. Nonetheless, Nepali capital market has not been able to fulfil the core objective of the globally accepted principle,” says Phuyal. Due to the higher associated cost of IPO, Nepali companies are spending significant amounts of money to issue shares to the general public. IPO expenditures of Mero Microfinance, for example, totaled Rs 7 million to issue shares worth Rs 9 million recently.
For the IPO, listing and clearance, companies are required to pay 0.2 percent of their paid-up capital to SEBON and 0.075 percent to NEPSE, 0.075-0.008 percent to CDS and Clearing and, lately, 0.10 percent of the total amount of primary shares to credit rating agencies. They also have to pay fees to issue managers depending upon the size of IPOs. Meanwhile, expenses related to refunding the applicants who did not receive primary shares also add to their financial woes. “The costs are high also due to the lengthy IPO process. It takes around six months for companies to complete the process of listing at present,” says Dr Rewat Bahadur Karki, Chairman of SEBON.
According to him, the regulator is trying to shorten the process which will thus reduce the overall costs. “We have already started the automation process so that the listing procedure can be completed within two months,” he informs. SEBON is implementing ASBA (Application Supported by Blocked Amount) System from August, which will shorten the distribution of shares over a two-week period from the earlier 90 days.
Outdated IPO Pricing
The obsolete IPO pricing mechanism is among the main bottlenecks for increasing the listing of real sector companies. Companies can only issue shares at par value or Rs 100 per share in their IPOs at present. This has held back many prospective companies from joining the stock exchange except for those such as BFIs and insurance firms that are legally obliged to list. The country’s private sector has long been demanding a replacement for the IPO pricing system which no other stock market except ours is currently practicing in the world.
“Why would anyone sell their shares at a value lower than their net worth?” questions CNI Vice President Agrawal. According to him, allowing companies to issue shares at ‘premium’ or ‘fair value’ will resolve one of the major barriers for real sector companies to list. NEPSE Acting Manager Phuyal also expressed similar views. “It is ridiculous that we demand companies and brands like Ncell, Wai-Wai and Surya Nepal to get listed. Why would such big companies with huge net worths anyway want to issue IPOs at just Rs 100 per share?” he question. Despite good opportunities to raise capital in IPO, large companies are reluctant to dilute their huge net worth and distribute dividends to public shareholders at such low prices.
Benefits from Increased Listing
There are several benefits to be gained if the number of real sector companies can be increased in the stock market. With more companies participating in the stock market, the capital market can become more mature. The rising presence of the companies from the sector is likely to kick-start the stalled industrial growth of the country. “It can be a base for the country’s industrialisation,” says Phuyal. In the meantime, the stock market can become a true mirror of the country’s economy with the listing of more real sector companies. Many say that due to the high level of influence of BFIs and insurance companies, the Nepali stock market has not been able to reflect the country’s economy as major parts such as agriculture, manufacturing and tourism and hospitality are either absent or present only in tiny sizes in the stock exchange. SEBON Chairman Karki hopes that the BFI sector is likely to become more trustworthy as it starts to provide loans to productive businesses if the stock exchange has a significant presence of real sector companies.
Other benefits would include the ability for companies to unlock shareholder values for original promoters, provide ease of entry and exit, and allow access to more equity based capital, thereby reducing the debt risk, according to CNI Vice Chairman Agrawal. “The benefits to the economy are such that they will help spread the wealth amongst a broader group of shareholders and give access to the general public and other institutions in sectoral diversification of their investments,” he says. “In countries like ours, publicly listed companies are seen to be more transparent and generally viewed as following a higher level of corporate good governance.”
Ways to Increase Listing
Bringing the family-run privately held companies into the stock exchange will not be an easy job. Nevertheless, with proper and effective policies, real sector companies can be attracted to join the stock market. Discussions are on the rise to find an appropriate IPO modality to encourage real sector companies to list. Though a consensus has yet to be established in this regard, a full free pricing of IPO and Book Building Process are seen as two options.
NEPSE Acting Manager Phuyal proposes the Book Building Process as a better alternative to the free pricing of IPO. “It is being practiced in India and many other emerging markets,” he informs. According to him, the book building process can particularly benefit public investors as the shares are subscribed downwards towards the cut-off price point from the highest bidding price. “The investors who participated in the bidding process and bid equal or above the cut-off price will get the shares at the rate of the cut-off price meaning that fair value of stocks can be established and small investors can also have some discounts while buying the primary shares,” he adds.
SEBON Chairman Karki, meanwhile, floats the idea of an IPO pricing mechanism where companies are allowed to float shares at five times higher than their net worth. “We can opt for this system. After the market is fully developed, we can practice free floatation of shares,” he mentions. Looking at the practices of IPO mechanisms across the world at present, developing and emerging markets are practicing Book Building Process along with Dutch Auction and French Auction, whereas, developed markets follow the free pricing of IPO.
Nonetheless, changing the IPO mechanism alone might not bring substantial changes in the current structure if other supportive sides are ignored. “Any one factor by itself may have limited impact,” says Agrawal.“Several areas such as banking, regulations, is to exit are needed to ensure we see the desired result.”
Will Mandatory Listing Help?
In recent years, there have been arguments raging for and against mandatory listing of real sector companies. The government has been urged to introduce policies so that real sector companies are forced to join the stock exchange. Proponents of the provision see it as a necessary policy initiative. “Policies can be implemented for mandatory listing of companies with Rs 500 million in capital or above,” suggests Dr Karki. “It should also be mandatory for existing companies to disclose their source of income. By disclosing the source of income, they should be entitled to some incentives which can lead to the enlistment of companies in the stock exchange.”
However, Agrawal disagrees. “Mandatory listing is seldom seen around the world. Companies need to have a clear need and value added from the listings,” he says. NEPSE Acting Manager Phuyal, meanwhile, holds a different view. “It should be made mandatory for companies enjoying government subsidies,” he suggests. He cites the example of hospitals and research centres which are registered under the public limited company category. “Such institutions get tax waivers from the government. If we can bring them into the stock exchange, their level of transparency will also increase,” he adds.
After years of dillydallying, the government has stepped up efforts to list manufacturing companies in the stock exchange. It is said to be preparing a policy for the phase wise listing of manufacturing companies which includes tax concessions and other subsidies along with a mandatory provision. Though the policy has not been finalised as yet, a 15 percent tax rebate for publicly listed manufacturing companies was announced in the budget for FY 2016/17 from the earlier 10 percent. After the implementation of the new tax system, listed companies are required to pay around 21 percent in corporate income tax. Meanwhile, if the announcement fails to achieve the desired effect, the Ministry of Finance is also said to be planning to enforce the policy for mandatory listing of companies.
To Go or Not to Go Public?
--By Hom Nath Gaire
Increasing the participation of real sector companies in the Nepali capital market has been a topic of debate for a long time. Whenever a new leadership takes over the Securities Board of Nepal (SEBON)- the market regulator- talks surface about how to remove the impediments to get the private sector (real) companies listed in the Nepal Stock Exchange (NEPSE) or how to motivate the companies to go public with attractive packages.
Similarly, every year when policy makers, including representatives from SEBON and private sectors, meet to prepare the new budget and fiscal policy, they talk about creating a favourable environment and providing tax incentives to attract real sector companies into the capital market.
After years of discussing and debating on the issue, the government announced a package to provide a 10 percent rebate on income tax if the real sector companies are listed in NEPSE. Nevertheless, the government initiative was received with a cold response from companies as they did not even express their interest to go public. The government again in the budget for FY 2073/74 increased the rebate on income tax to 15 percent. The concession can be an encouraging factor for the domestic stock market as it matters much for businesses, if properly utilised.
However, private sector representatives are not openly talking on the issue which indicates that to become publicly listed companies is not their primary concern. Therefore, it is necessary to realise that only providing tax incentives is not sufficient to bring privately held companies into the capital market. It is important for the government, policy makers and regulators to remove the impediments in order to create a sound business environment to bring the real sector companies into the market.
Despite the very low number of real sector companies listed in the stock exchange at present, it is surprising that the domestic stock market was started with the public offering of a manufacturing company. It was in 1937 when Biratnagar Jute mill Ltd was established and became the first company to float shares to the public.
Over the years, many manufacturing companies came and floated shares to the public. Nonetheless, the number of companies raising money from the public has dramatically declined as the country’s business environment has degraded due to continuing political uncertainty and bureaucratic hurdles, lack of proper policies among other impediments. Now the stock market is facing such a situation where neither the manufacturing (excluding hydro companies) nor trading and services companies are interested in going public or to collect capital from the capital market. Banks, financial institutions and insurance companies are exceptions since they are bound by laws to issues shares of at least 30 percent of their paid-up capital to the general public.
Why Companies are Unwilling to go Public
The capital market is considered to be the effective mechanism for channeling funds from surplus units to deficit units. However, it is necessary to understand that the term 'deficit units' is self-explanatory meaning whenever there is a deficit of investable funds, the economic units seek capital flow from outside. Here now comes the role of the capital market as a platform for the companies to raise money at low costs.
Looking at the present context, it seems that Nepali private companies have abundant capital or they are not getting capital intensive viable projects to get into. Therefore they are not willing to raise capital from the capital (primary) market.
An initial public offering (IPO) is the first sale of a stock by a company. Small companies looking for further growth often use IPOs as ways to generate the capital needed to expand their businesses. There are many advantages for a company to go public. As said earlier, the financial benefit in the form of raising capital is the most distinct advantage. Capital can be used to fund research and development, fund capital expenditure or even used to pay off existing debts. Another advantage is the increased public awareness of the company because IPOs often generate publicity by making their products known to a new group of potential customers.
Even with the benefits of IPOs, public companies often face many challenges as well. One of the most important changes a publicly listed company has to undertake is the need for added disclosure for investors. Public companies are regulated by SEBON in regard to periodic financial reporting, which may be difficult for newer public companies. They must also meet various other rules and regulations. Especially for smaller companies, the cost of complying with regulatory requirements can be burdensome. Some of the additional costs include the generation of financial reporting documents, audit fees, creation of investor relation departments and accounting oversight committees.
Companies listed in the stock exchange also face the added pressure of the market which may cause them to focus more on short-term results rather than long-term growth. The actions of the company's management also become increasingly scrutinised as investors constantly look for rising profits. This may lead management to perform somewhat questionable practices in order to boost earnings. Thus, before deciding whether or not to go public, companies must evaluate all of the potential advantages and disadvantages that will arise.
In Nepal, most of the corporate houses have been involved in diverse forms of businesses ranging from trading, export-import, alongside manufacturing, hydropower, service industries like hotels, tourism and financial services. The well-diversified business portfolio also may be the reason for preventing real sector companies to go public since the balanced portfolio is giving them attractive returns on combined investments.
Another way of going public is selling the stakes of already established companies through the primary market. But the million dollar question in this regard is why well-established companies need to sell their stakes to the public. In this case going public is nothing but the distribution of sole profits to the masses unless the capital collected from the market is not being reinvested on the projects which will generate relatively attractive returns.
Although further expansion is a benefit to the company, there are both advantages and disadvantages that arise when a company goes public. Thus no rational company owner would be ready to sell the stakes of their profits without having alternative investment plans either the expansion of the existing business or starting a new venture. However, for this kind of public offering, companies need some premium (incentive) on top of the book value of their stocks. In this regard, the policy that the government and the regulator of the Nepali capital market have adopted seems to be too conservative which does not allow companies to go public through a book building process. Some of the key factors stopping the companies from going public are:
Publicly held companies are required to file quarterly financial reports at SEBON. They must also disclose the salaries and stock holdings of key executives. There is also dissatisfaction from investors who think the managers are not worth the paycheck.
Loss of control
Generally, as profits go up, so does the stock prices with attractive earnings per share at a slow and steady rate. However, earnings don’t always grow slowly and steadily which creates fluctuation in stock prices. A flagging stock price can crush the morale of investors, especially the promoters. If the shares fall too low, someone else may just buy enough shares and kick the promoters out.
Given all the disclosures, competitors will know a lot about the pricing, margins, profitability and financial structure. As the publicly listed companies are required to publish their data, competitors can extrapolate weaknesses and exploit them. If the competitors are privately held, that imbalance of information could be a severe handicap.
Evaluating the data and other information, investors and analysts predict how companies will perform in the coming quarters. If the analysts do not follow the positions of the companies well enough, penny-stock scammers might find a field for manipulating the shares. Similarly, pleasing analysts may lead to decisions that may result in achieving good short-term results at the expense of better long-term performances.
Going public is neither cheap nor easy. There are too many accountants, lawyers, bankers and insiders who want to have a piece of the pie from the market position of the companies. Before going public promoters generally focus on making the company the best it could be. But for publicly traded entities it appears to be costly as associated costs are higher.
The writer is Director at CNI.
"Free Pricing of IPO is Required"
Why is there such a low level of participation by real sector companies in the stock market?
Lack of strong mandatory provisions and incentive packages are holding back the real sector companies from getting listed in the stock exchange. We have made various recommendations to the government in this regard.
What mandatory provisions are you seeking?
To start with, policies can be implemented for mandatory listing of companies with Rs 500 million in capital or above.
It should also be mandatory for existing companies to disclose their source of income. By disclosing the source of income, they should be made entitled for some incentives. This can lead to the enlistment of companies in the stock exchange as they will be cleared from the issues regarding income sources. This will thus encourage them to mobilise large amounts of capital through the country’s capital market.
What provisions need to be incorporated in the incentive package?
The incentive package should comprise of monetary, fiscal and other policies. The government has taken a positive step by announcing in the budget for FY 2016/17 a tax rebate of 15 percent for companies listed in the stock exchange. This initiative aims to encourage more companies to enter the stock market.
The government has incorporated our recommendation in the new budget. While this is certainly a positive step forward, it is not enough. As I said earlier, a complete incentive package along with some mandatory provisions are required to bring the real sector companies into the market.
BFIs maintain a single book of accounts while real sector companies generally maintain 2-3 types book of accounts. The budget has addressed the issue. The budget has announced that the companies’ accounts presented to banks, tax authorities and others will be cross checked while assessing tax liabilities.
Similarly, the monetary policy needs to priorities real sector companies like hydropower and agriculture. This will make it easier for the companies to get loans at cheaper rates from BFIs which will enhance the capital market.
The outdated IPO model of our stock market is considered as the major hurdle. How can we adopt a more efficient system?
We need to examine international practices regarding IPO models. The IPO issuance at par value is an obsolete model which our market has been using for a long time. Free pricing of IPO is necessary. Looking at international practice, the par value modality is practiced only at the initial few years of starting the stock exchange.
Companies can be encouraged to enter the market if they are allowed free pricing in primary issues. Nevertheless, considering the present scenario of the Nepali stock market, we can implement other IPO models rather than the 100 percent free pricing. We can practice a system where companies can float shares at a price higher than their net worth. The goodwill of the big companies needs to be recognized- which they have earned over the years. Though the automation has been developing gradually, our stock market has not yet become mature enough.
What other modalities can be applicable in our context apart from the free pricing mechanism?
Since our market has not been developed yet, we can adopt such modalities as allowing companies to float shares five times higher than their net worth. When the market becomes fully developed, we can implement the free pricing mechanism.
The unwillingness of the company owners to join the stock market is often associated with transparency and accountability related issues. How can this mindset be changed?
Policy initiatives are needed to change this mentality. The situation is such that privately held firms can access loans from banks more easily compared to public companies and this has persisted over a long time. If we can form a system where they can easily mobilise capital through the capital market, the mentality will change automatically. Creating this environment will take time, but can be done nevertheless.
Higher IPO costs are also seen as discouraging factors for companies to enter the market. How can we harmonise existing rules and regulations to facilitate the entry of real sector companies?
It is true that the associated costs in the IPOs are an impediment. We have been trying to lower the IPO costs so that more companies can participate in the market. The costs are high also due to the lengthy IPO process. It takes around six months for companies to complete the process of listing at present. We have already started the automation process so that the listing procedure can be completed within two months. With the implementation of ASBA (Application Supported by Blocked Amount) System from August, companies can complete the distribution of shares over a two-week period from the earlier 90 days. Similarly, we are also working for the quick listing of companies. As per our recommendation, work to amend the Stock Market Listing Bylaws, 2053 is going on in order to remove problems in the listing process.
What benefits do you see coming from the increased participation of real sector companies in the stock market?
It can spur on the industrialisation of the country. The banking and financial sector is likely to become more trustworthy as it starts to provide loans to productive businesses. Likewise, the NEPSE index will become more credible and will start to reflect the actual status of the country’s economy. The current structure of NEPSE index is defective.
In what way?
As per accepted global stock market practice, the actual index needs to be based on the floated shares in the market. To say that the market capitalisation is currently at 65 percent of the GDP is misleading. The amount in the Float Index is the actual market capitalisation. For example, only three percent shares of Nepal Telecom has been floated in the market. The remaining is held by the government and CIT and these shares are not traded in the market. Nevertheless, all the shares of that company are calculated in the market capitalisation. In actuality, the Float Index represents the market. If we look at it on this basis, the market capitalisation of NEPSE is currently between 25-30 percent of the country’s GDP. At present the market is comprised of 65 percent promoter shares and 35 percent, or one-third,of general or floated shares.
The exit process of promoters from the publicly listed companies is also said to be one of the reasons for the real sector companies to enter the market. What can be done in this regard?
As our market is not yet fully developed, the exit process cannot be relaxed. If the exit of the promoters is relaxed, it is likely to create anomalies in the market. A certain lock-in period needs to be maintained to ensure the healthy growth of publicly listed companies which is important for the overall development of the stock market. We can formulate policies that will evaluate the exit proposals of promoters based on ‘fit and proper tests.’
As the stock market regulator how do you assess SEBON’s weaknesses regarding the low level of real sector companies in the market?
I acknowledge that there have been weaknesses from our side to spur institutional investments. Proper policies need to be in place to attract institutional investors in the market to facilitate real sector companies. We should concentrate our efforts on creating a conducive environment for the real sector companies where smooth mobilisation of money is possible through the capital market.
What are SEBON’s plans to modernise the stock market?
We have taken several steps to modernise the stock market. The recent automation drive of the market is one such example. Similarly, we are also looking to resolve various problems being faced by investors as well as listed companies in primary and secondary markets. Likewise, we have also increased our engagement with the share brokers. We have organised visits to the stock exchanges of Dhaka and Mumbai so that brokers can experience firsthand the South Asian stock market. We are also trying to address the challenges SEBON is facing regarding its role as a regulator and supervisor. I think that SEBON needs to be more autonomous to make its activities more effective. It will be easier for us to regulate the market more efficiently if NEPSE and CDS are transformed into class ‘A’ listed institutions.
Similarly, there is also a need to internationalise the Nepali capital market. Recently, we have become a member of the Association of National Numbering Agencies (ANNA). Similarly, we are in the process of becoming a member of the International Association of Securities Commission (IOSCO). Our engagement across such international forums will be helpful in modernising our market and will also play an important role in attracting foreign investors and non-resident Nepalis to the market.
"Real sector can help in the country’s industrialization"
What are your observations on the very low levels of real sector companies in the stock market?
During the starting years of NEPSE, there were many manufacturing companies listed in the stock exchange. Tax incentives were offered in order to attract the manufacturing industries to become publicly listed. However, the incentive did not fare well as very small scale industries entered the stock market.
As the number of manufacturing companies in the country has declined due to the prolonged political uncertainty, severe electricity shortage and policy hassles, the participation rate has also sharply decreased over the years.
What factors are holding back the listing of big companies from the real sector?
The unwillingness of privately owned businesses to get listed in the stock exchange is primarily due to transparency issues. Nepali businesses are mainly family-owned. The owners of such companies generally feel that going public will mean various hassles. Companies after getting listed need to hold annual general meetings and face the general public shareholders. Similarly, they are required to disclose their financial positions by publishing balance sheets and other reports. Similarly, the companies need to make public the decisions of the board of directors. The companies also need to stay connected to securities market regulator SEBON along with NEPSE, Office of the Company Registrar and CDS and Clearing Limited.
It is the traditional thinking of company owners that is stopping real sector companies from entering the stock market.
This was what led to the delisting of manufacturing companies from the stock exchange in the past which further discouraged other companies from entering the market. Similarly, they also find the procedural parts as lengthy which is keeping real sector companies away from the stock market.
What procedural parts?
Privately held firms can submit a simple report at the company registrar at the year-end stating that they have conducted the AGM. But if the companies are about float shares to the public, they are required to establish a separate share department. After the IPO, the companies need to deal with public shareholders by organising AGMs. As there is a large participation of public shareholders in the AGMs, the promoters are likely to face various questions regarding the performance of the company and the decisions of board of directors. Then they need to publish quarterly, half yearly and yearly reports on a regular basis. Similarly, they are required to disclose information to SEBON and NEPSE.
What other factors are to blame?
The main objective of the capital market is to make capital available to entrepreneurs at low costs. Companies come to the stock market to raise capital easily for the long-term. The market has not developed as per such objectives in our context. Companies are required to follow various processes which automatically raise the associated cost of IPO. A high associated cost to get listed in the stock exchange is stopping the companies from entering the market. A company, for example, has spent Rs 7 million to issue shares worth Rs 9 million in an IPO recently.
To start the listing process, companies are first required to hire an issue manager followed by registrationat SEBON by paying certain charges, fees to the issue manager, registration feesat CDS, listing fees to NEPSE and lastly fees to the credit rating agency.
Similarly, our market has not become efficient. We are still facing various problems in the automation process. It has been seen that a company’s FPO can fetch Rs 50 billion in total. If we can increase the market’s efficiency and provide proper channeling, the collected capital is likely to be invested into the real sector. Availability of capital to start a business would not be an issue, if there are proper rules and regulations in place.
As you said earlier, the mind set of owners is also hindering the real sector companies from entering the market. How can they be encouraged to change their thinking?
It is not that the companies should be allowed to operate in whatever way they like in order to get them listed. As they raise capital from public, they need to be accountable and transparent by practicing good levels of corporate governance. Entrepreneurs should understand that maintaining a good level of corporate governance will benefit them in the long run. The thinking and attitude of businessmen should change. Unwillingness to transform into a public unit is the nature of family-owned businesses globally. The regulators should also step up to encourage them to enter the stock market.
What benefits are there for the country’s economy with the increased stock market participation of real sector companies?
Increased participation of such companies in the stock market can be a basis for the country’s industrialization. As companies can raise huge capital for long-term easily, they can increase industrial and business activities. The stock market participation can also make the companies more accountable and transparent. Similarly, the stock market can also become a true mirror of the country’s economy. At present, the actual growth data of many economic sectors is difficult to find because most industries from these sectors are not present in the country’s stock exchange.
The primary share issuance mechanism is largely considered discouraging. How has this affected the participation of real sector companies?
Our stock market has been pursuing an obsolete model of IPO pricing. The IPO on par value of shares is a very old system which almost all stock markets across the world stopped practicing many decades ago. It is ridiculous that we demand companies and brands like Ncell and Wai-Wai to get listed. Why would such big companies with huge net worths anyway want to issue IPOs at just Rs 100 per share? Why would they ever want to dilute their net worth and distribute dividends to public shareholders at such low prices?
Can free floatation of shares address the issue?
I do not recommend a full free pricing modality. In the 20th century, the concept of free pricing of IPOs came into practice across many advanced markets across the world. The free floatation of shares or the Dutch Auction was practiced in Nepal by government when it sold some shares in Nepal Telecom to the general public. As the Nepali stock market is yet to develop, there are better alternatives like the Book Building Process which is being practiced in India and many other emerging markets. Advanced markets are mainly practicing free pricing whereas emerging markets practice the Book Building IPO system.
How is the Book Building IPO system beneficial?
In this particular system, segmentation system is followed. The segments comprise of large, mid-sized and small scale investors. After setting the prices for each segment through a bidding process, a certain portion of shares is opened for public shareholders. The book building process can be particularly beneficial for the public investors as the shares are subscribed downwards towards the cut-off price point from the highest bidding price. The investors who participated in the bidding process and bid equal or above the cut-off price will get the shares at the rate of the cut-off price.
This IPO option is beneficial to both investors and companies. The process offers some discount to small shareholders while the companies can increase their net worth by issuing shares at a premium.
What are the other benefits of adopting a new IPO system in the Nepali stock market?
By changing the largely outdated current IPO mechanism, institutional investments will be fostered in the domestic capital market. Today a trend called the ‘borey pravitti’ has become prevalent in the market where an individual investor can collect shares by presenting citizenship certificates and application forms from hundreds of other people. Such individuals are the beneficiaries of demand created by an IPO. If the current mechanism is changed, such malpractices will be discouraged.
Lack of institutional investments in the stock market is also taken as a factor discouraging the real sector companies. How can we spur institutional investments?
Over the past 2-3 years, there has been a gradual increase in the number of institutional investors. Merchant banks, mutual funds, insurance companies along with some other companies have come forward. This is positive for a market like ours which is 99 percent occupied by individual investors. Nevertheless, much is to be done to spur institutional investments in the stock market. We need the participation of companies that are formed specifically to invest in the stock market. For that a sort of diversification is needed which is also particularly important to attract foreign institutional investors (FIIs). Broad Market is required for that purpose. Ours is an equity market dominated by banks and financial institutions. FIIs seek a diversified market comprising of the real sector along with other sectors of the economy.
Policies regarding the exit of promoters and delisting of companies are also said to hinder the real sector companies. What is your say on this?
It is undisputed that the promoters of companies need to be rewarded for taking risks and starting businesses. However, nowhere in the world is the exit process easy for the promoters after raising money from public. The promoters of the listed companies need to fully back the firms for a certain period. They can exit when the companies are fully established in the market and can operate without the backing of the promoters. A lock-in period is required for this after which the promoters can off load their shares. It can be pivotal to spur the culture of entrepreneurship in the country.
Delisting is not a good option. It is a backward process. Entrepreneurs need to know that listing of companies from the stock market is beneficial for all. Most of the world’s billionaires have earned their positions due to the increased value of their companies’ shares.
The government has increased the tax rebate in the budget for FY 2016/17 to encourage real sector companies into the stock market? How do you view this initiative?
Since the increment is nominal, I don’t think the incentive can bring significant changes in the market’s structure. Earlier the tax waiver was 10 percent which has now been raised to 15 percent. Those companies who are paying 25 percent in income taxes are now required to pay around 21 percent after the waiver. Had there been big corporate institutions in large numbers in the country, the waiver could have been helpful. Nevertheless, it could be particularly beneficial to companies like Surya Nepal that have maintained a fair level of transparency. But the question remains the same as to why such a big company would like to dilute its networth by issuing primary shares at par value.
What are NEPSE’s initiatives to bring the real sector companies into the stock market?
NEPSE is continuously encouraging the real sector companies to enter the market. We will continue to interact and engage with real sector companies and experts to find ways to facilitate their entry into the stock market. We have announced such initiations in our policies and programmes for this year.
"Floating shares at ‘fair value’ will resolve a major barrier for real sector"
What reasons are there behind the very low level of participation by real sector companies in the stock market?
There are several reasons for the low level of participation. Historically many real sector companies listed on the stock exchange did not perform well. Hence the confidence of real sector companies has been low for both promoters and investors. This has been a deterrent for companies looking to enter the stock market.
For real sector companies, banks look for recourse-based (personal guarantee) financing. Once a company is publicly listed, the original promoters will need to personally guarantee all loans, even though they own a smaller percentage of shares. Similarly, real sector companies traditionally have not achieved the scale needed to truly benefit from being listed. The paid-up equity, for example, has by and large been low. This is now changing, of course, particularly in the last 3-4 years.
There are several challenges in listing at a ‘premium’. While BFIs and insurance companies are forced by regulations to do the IPO at par value, this is a deterrent for successful companies. Why would anyone sell their shares at a value lower than their net worth?
How can the free flotation of shares encourage real sector companies to enter the stock market?
It can certainly be a key motivator. Allowing companies to issue shares at ‘premium’ or ‘fair value’ will resolve one of the major barriers for real sector companies to become listed. This can be done via the Book Building Process or direct issuance of shares at a minimum floor price. However, any one factor by itself may have limited impact. Several areas such as banking, regulations, ease of exit are needed to ensure that we see the desired result.
Also, some experts are proposing mandatory provisions to list companies having capital above Rs 500 million in the stock exchange. How do you find the proposition?
Mandatory listing is seldom seen around the world. Companies need to have a clear need and value from the listings. Furthermore, companies may decide their own timing of being listed in the stock market particularly if they are at the growth stage. Once listed, the character of operations usually changes to a more sustainable lower risk approach which is not always the best course forward. I would therefore always suggest that we build an overall environment which attracts companies to list and makes it ‘in their interest’ to list rather than force them to list.
What benefits do you see from the stock market listing of companies?
One needs to understand the role of the capital markets and why we need companies to list so as to build the right atmosphere. We must also be equally careful to ensure that the stock market listings are properly monitored or we could cause an eventual loss of confidence if too many listed companies underperform.
Capital market listings allow companies to unlock shareholder values for original promoters, provide ease of entry and exit, and allow access to more equity based capital, thereby reducing the debt risk etc. The benefits to the economy are that they help spread the wealth amongst a broader group of shareholders and give access to the general public and other institutions in sectoral diversification of their investments. In countries like ours, publicly listed companies are seen to be more transparent and generally viewed as following a higher level of corporate good governance.
How can the government, policy makers and regulators facilitate the entry of real sector companies in the stock exchange?
Companies should be allowed to float primary shares at a premium price based on evaluation by a well rated audit firm and approval of SEBON. The government should create more tax incentives to encourage companies to enter the stock market. There is also a need to reduce some of the complexities of managing a listed company. Similarly, it is important to encourage banks to consider non-recourse based lending for listed companies.
How do you view the recent government initiative to increase tax rebate for public companies to 15 percent in the budget for FY 2016/17?
This is a welcome initiative. However, whether it is enough or not enough is a question that will be answered in the coming months. In my opinion the incentive may not be enough by itself. Moreover, as I mentioned earlier, to encourage listing we need a holistic approach. It is not just one factor alone. Rather the policy makers need to improve the overall ecosystem which includes banking and regulatory frameworks and so forth.
The unwillingness of Nepali real sector companies to get listed in the stock exchange is often related to accountability and transparency issues as most of them are family owned businesses. Hasn’t the time come for the company owners to change this mindset?
All economies and companies around the world go through an evolution. The same is happening in Nepal. We should not forget that not too long ago (25-30 years) we had license-based import regimes with fixed taxation. We also practiced a turnover tax concept. Over the past two decades, Nepali companies have evolved to a large degree. VAT and income tax are now higher sources of revenue for the government at present compared to just a few years ago when customs duty always occupied the top spot. This is a positive sign of a growing economy and a burgeoning private sector which is fast evolving into a modern, progressive, transparent, and forward looking approach.
However we need to be also aware of the limitations that are being addressed - from various laws, many of which are 40-50 years old and irrelevant, to an overall economy which is just about starting to move forward. To expect miracles overnight is unrealistic.
We need to have patience and see the glass as half full. In my opinion most of the large tax payers are now fully transparent and comply with all laws. When we go into the SME space, perhaps there is still progress happening which is partially also because of a lack of awareness.
We are also just about entering the era where private companies now have the size and the right strategy to list. I have seen several companies at least discussing the idea of becoming publicly listed. So I would urge everyone not to try and push this through. Privately owned real sector businesses can be brought into the stock market by building a supportive environment which would naturally encourage more companies to start listing.