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Mon, 24 November 2014 16:44:27
Sri Lanka in push towards equity, commodity futures
13 Sep, 2008 07:50:09
Sept 13, 2008 (LBO) - Sri Lanka could introduce derivatives not only for equities but also commodities and services for which the island has natural advantages, officials said.
Ajay Shah, an Indian-based consultant who conducted a study for the Securities and Exchange Commission (SEC) says Sri Lanka could start an equity index futures contract and futures in about half a dozen very liquid stocks, and also in tea and perhaps even freight.

Commodity Futures

"Sri Lanka is a global auction centre for tea, and Colombo is also in a major shipping route," says Shah.

"But to promote such a product globally, specialist intermediaries in the Singapore and Middle East will have to be attracted."

At the moment there is no chosen 'benchmark' tea, and trading is conducted in a multitude of grades, with even one trading lot from the same garden in the same factory differing in quality from day to day with the change in climate.

SEC director general Channa de Silva says the his institution and the Colombo Stock Exchange, which already trades equity and some debt, has to prepare the ground work.

One task is to improve liquidity, by encouraging trading.

"We have to encourage more day trading," says de Silva. "But to do that we need to cut fees and for that agreement must be reached with all parties."

Shah says India suffered the same fate as Sri Lanka after independence. But from 1991 the country has had monetary reform, with the Reserve Bank of India gaining independence from the Treasury interference.

India is moving towards a free floating exchange rate; from flawed 'soft-pegged' or 'dirty float' that is prone to high inflation and currency collapse.

Shah says India's monetary framework is now a serious impediment to the forward march of its financial markets, which are moving forward rapidly.

Clearing House

"But to start equity derivatives in Sri Lanka, the current exchange controls are not an issue," he told LBO.

"Having a proper monetary policy framework would become important in later stages of financial market development."

A reform that is needed for derivatives to take off is a central clearing house to insulate counterparties from the risk of default. A single defaulting futures contract could have a domino effect which will bring down the entire market.

De Silva says CDS could be developed to handle the functions of a central clearing house. Shah says the intermediary cost in Sri Lanka is among the highest in the region, which includes broker commission, and fees charged by the Colombo Stock Exchange and the Securities and Exchange Commission.

The country's Central Depository System (CDS), which is a registry of scripless securities, charges fees based on the volumes transacted.

Shah says in India it is already a transaction based fee.

India has seen spectacular growth in derivatives, with notional trading volumes in derivatives already exceeding equities. Its financial markets are rapidly attracting foreign capital.

Capital Controls

Sri Lanka was a regional centre for finance before gaining independence, where companies as far as Malaysia issued stock and raised money in a market that was dominated by plantations stocks.

Its stock exchange, known as the Colombo Brokers Association was one of the oldest in Asia after Tokyo.

But after independence Sri Lanka converted its colonial currency board which allowed the free flow of capital and kept the exchange fixed into a central bank with money printing powers.

The balance of payments problems created by money printed to finance budget deficits then led to the closure of the capital accounts and further restrictions.

Meanwhile countries that kept their currency boards such as Singapore and Hong Kong easily became financial centres.

Though Sri Lankan policymakers often talk of being a 'financial hub' without monetary reform to either a currency board or a floating rate, such ideals are a distant dream.

Shah says clearing houses operate with risk management software rather than simply relying on capital, by managing the margin deposits of market participants and ensuring that each contract is enforced and settled.

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