Broker Credit Drives Up Market

• Bourse Sitting On A Bubble

The bourse is growing on broker credit*, an activity frowned, or deemed illegal** in other markets, as such an activity may cause a systemic risk to the stock market in the event of default at settlement.
Such credit is generally extended to retailers, the drivers of the market these days.
The market has been on the ascent since August 27, coinciding with the period of the removal of the Securities and Exchange Commission (SEC) Thilak Karunaratne by a VIP for pursuing investigations against market manipulators.
SEC comes under President Mahinda Rajapaksa in his capacity as Finance Minister.
On Wednesday (September 5), though the benchmark ASI gained by 44.91 points (0.84%) over the previous day Tuesday’s close, the more sensitive MPI fell by 7.70 points (0.15%) due to profit taking, a market source told this newspaper, made worse by a Rs. 28.14 million net foreign outflow (NFO). Turnover was Rs. 941.4 million.
However in the following two days both these indices gained sharply, the ASI by 124.72 points (2.3%) to close the week at 5,496.85 points and the MPI by 122.63 points (2.5%) to close at 5,093.36 points. Thursday’s turnover was Rs. 1.1 billion and that of Friday, Rs. 1.8 billion.
The market is dominated by day traders out to make a quick buck, he said. Sooner or later the bubble will burst.
The bourse is driven by brokers over-extending their credit limits, which theoretically are capped at three times their net capital,* but this is being abused, he alleged. Then they should then be prosecuted, this reporter, queried?
Those who tried to prosecute such were sent home, the source in reply said, referring to the recent sackings of SEC Chairman Mrs. Indrani Sugathadasa and her successor Thilak Karunaratne in the space of eight months (with the last of those sackings taking place only last month), as well as Sujeewa Mudalige, an SEC Commissioner and a former President of the Institute of Chartered Accountants of Sri Lanka (see also the lead story in this newspaper’s last week’s business pages).
The source further said that though Friday’s turnover was Rs. 1,758.2 million, foreign purchases were a mere Rs. 229.62 million, an indication that the market was driven by locals. The bourse experienced a Rs. 155.13 million net foreign inflow (NFI) on Friday.
Among the main contributors to Friday’s turnover was blue chip Sampath Bank with Rs. 342 million, including a standalone Rs. 195 million transaction and two other blue chips, namely John Keells Holdings and Lanka Orix Finance Company, chipping in with Rs. 252 million and Rs. 100 million respectively.
The ASI gained by 107.93 points (2%) and the MPI by 98.04 points (1.96%) on Friday.
Meanwhile an official speaking on the grounds of anonymity said that the SEC checks brokers’ books once a month. There were instances where such credit rules have had been abused, but those have had been rectified under the “T+3” settlement period, he said.
The source further said that in a “bullish” market such as that which is being experienced currently, it’s easy for recalcitrant brokers to bring their books into order.
He however said that they are alarmed at the rise in value of penny stocks in the present “bull” run, which, according to their key performance indicators such as profits and earnings per share, there was no justification for the increase in their share values.
“We are seeing a repeat of what happened in the market several months or a few years ago,” he said, referring to the boom in the market, after the end of the LTTE war in May 2009.
On the other hand stocks which are of intrinsic value have hardly made any gains. When current daily market turnover levels are compared with highly capitalized stocks which lead in market capitalization in the stock market, it is penny stocks which are the present day champions in the Colombo bourse, generating the highest amount of turnover, he said
The recent removal of key persons from the SEC by the Government has paved the way for manipulative stockbrokers and investors alike to do as they please without the fear of being prosecuted, another source earlier said, referring to  “the party in the bourse” which is being continued, when the  ASI gained a further 70.84 points (1.37%) and the MPI by 92.54 points (1.92%), despite a Rs. 23.41 million NFO at Monday’s trading and continuing the same vein the following days as well last week, backed by retailer play.
Turnover on Monday was Rs. 981.66 million, while on the following day Tuesday it was Rs. 1.2 billion, with the only noteworthy contribution coming from Sampath Bank, which was the second highest provider to Tuesday’s turnover with Rs. 77 million, a source said.
Almost all the rest that went up were speculative stocks, with foreigners for the second consecutive day last week staying in the sidelines, with the same story true as far as high networth individuals and institutions were concerned, with play mainly dominated by retailers, he said.
On Tuesday the ASI and the MPI went up by 76.23 (1.45%) and 73.93 points (1.51%) respectively over the previous day Monday’s close.  The market experienced a Rs. 69.39 million (US$ 526,000***) NFI on that day.
It were virtual junk stocks that pushed the market up on both Monday and Tuesday, he added.
“Though it may not have had been the manipulators under investigation per se who gave the bourse more than a thrust, Government’s recent acts of omission and commission vis-à-vis the SEC has given confidence to others as well to pursue in illegal share trading activity, due to the sense of security they have that they won’t be prosecuted for such misdeeds because of the recent happenings in the SEC,” he said.
Such sense of security, despite wittingly indulging in illegal and unethical trades by such investors, aided and abetted by certain stockbrokers,  cannot be construed as misplaced or identified as a “false sense of security,” considering what has taken place in the SEC itself in under one year,” he added.
What is sauce for the goose is sauce for the gander.
Those happenings included the removal of SEC’s  former Chairperson Ms. Indrani Sugathadasa in December and her predecessor Karunaratne and Sujeewa Mudalige- a commissioner last month for their role in pursuing after market manipulators, followed by the appointments of controversial persons to fill in those vacancies, where such persons whose names are under a cloud, served and/or are serving as directors of companies, the movement of which shares are currently being the subject of such investigations by the SEC, coupled with certain dubious transactions also involving such firms, which are also the basis of other investigations by the authorities.
However the danger in the stock market making such spurious gains is that it can also rapidly fall as fast as it has risen.
This will result in the gullible investor left with junk stocks in his hand in such a turn of events, after having had paid premium prices to buy the same, by falling prey to the herd instinct that prevailed in the bourse in “good” times, as is the case today, when the prices of such stocks are being artificially propped up, giving a false sense of confidence that these “good” times are going to last for ever.
Meanwhile on Thursday the ASI and the MPI gained by 16.79 (0.31%) and 24.59 points (0.49%) respectively, on a Rs. 1.1 billion turnover, with the major contribution coming from Asiri Medical controlled by business magnate Ashok Pathirage.
Pathirage is believed to have had bought 41.7 million shares of Asiri at the market price of Rs. 8.10 a share, contributing Rs. 338 million to Thursday’s turnover. Among some of the other major contributors were Expo Lanka (Rs. 46.9 million), Seylan Bank (Rs. 30 million) and People’s Leasing Company which was subjected to foreign buying, Rs. 26 million. The bourse experienced a Rs. 66.50 million NFI on Thursday.
* Due to the possibility of a systemic risk that may overtake the bourse, the SEC deemed illegal the extension of broker credit over and above the “T+3” settlement date a few years ago (around 2010 or thereabouts). Additionally, brokers were given timeframes to clear their books in order to fall in line with SEC’s new requirement. Brokers during this period asked for extensions from SEC periodically to come to terms with the new law, which was acceded to by the regulator on several occasions. While this process was on, heads rolled in the SEC as described in the article, coinciding with a section of the broker community meeting a VIP, which resulted in at least that SEC law being rescinded, with brokers now being allowed to lend up to three times their net capital to investors. However a number of stockbrokers think that due to heads being rolled in the SEC for doing that which is right, that even the new concession is being violated, with SEC afraid to take action against the miscreant stockbrokers.
** In other jurisdictions, what is generally permitted is for stockbroking firms to float separate and independent companies to provide for investor credit. Such an operation ensures that broking firms themselves do not indulge in giving credit to investors, thereby preventing the possibility of a systemic risk in the event of debtor default.
***On the basis that 1US$= Rs. 132