The
Fixed Income Securities Market in
Sri Lanka has no doubt achieved
considerable development in the
recent past. Are we happy and contended?
Or are we striving towards more
and more success?
To
answer these questions, it is worthwhile
understanding what this market is;
what are the ideal conditions and
objectives that we strive to achieve?
Where do we stand today? What have
been the developments in the recent
past? And where do we want to go?
etc., etc.
A
Fixed Income Securities Market is
a market place where transactions
involving Fixed Income Securities
(FISs) are carried out. They can
be:
1.
Outright buy or sell transactions
2. Repurchase or reverse repurchase
transactions involving fixed income
securities (REPOs and Reverse REPOs)
3. Transactions of derivatives such
as Forward Rate Agreements, Interest
Rate Swaps, Futures and Options
connected with FISs that provide
better price discovery, hedging
and liquidity support for the outright
and REPO markets.
What
is a Fixed Income Security? To understand
a FIS it is first important to differentiate
between three segments of the financial
market.
1.
Loan market
2. Contractual Savings Market
3. Securities Market
The
loan market represents the Banks
of various types, Finance and Leasing
Companies that carry out the intermediary
functions of accepting deposits
or funds under various forms and
lending such money thereby creating
non-transferable assets.
The
contractual savings market is the
segment where there are long term
savings contracts such as Provident
Funds and Insurance Schemes and
the funds and institutions concerned
engage in an intermediary process.
The
securities market is where the market
participants are engaged in transactions
concerning tradable securities.
These securities can be broadly
categorised into two types viz.
debt securities and equity securities.
Accordingly there are two market
sub segments i.e.
1.
Debt Market
2. Equity Market
Of
course, there are hybrid instruments
such as preference shares and convertible
debentures which will go into an
appropriate segment, may be equity
market or debt market respectively.
The
debt market is the market place
where the debt securities are traded.
The debt securities, as we know,
tend to have some specific features
:
1.
They represent borrowings by the
issuers and hence the buyers or
investors are creditors.
2. The investors are entitled to
receive of interest on these instruments.
3. These interest payments are made
at fixed rates or floating rates
where, in both cases, the basis
of interest payment is predetermined
by the issuer at the time of issue.
4. Hence, the term fixed income
securities; of course, the income
can be quite volatile depending
on the prevailing interest rate
scenario. The debt market is also
referred to as the Fixed Income
Securities Market.
5. The securities can be issued
on a secured or on an unsecured
basis.
6. They may be issued in tranches
where some are subordinated to the
rights of the others.
7. The securities may be rated or
un-rated. Ratings indicate the credit
quality.
8. The securities can be embedded
with call, put or prepayment options
that create somewhat complex cash
flow patterns for the so called
“Fixed Income” securities.
9. A variety of coupon structures,
embedded options and different credit
ratings make it possible to have
a large array of FISs that cater
to various requirements of issuers
and investors.
Who
issues Fixed Income Securities?
Anyone who wants to borrow may issue
FISs. Governments, authorities,
companies, associations and special
purpose vehicles etc issue FISs.
In
Sri Lanka, in particular, the biggest
issuer of FISs is the Government
of Sri Lanka. There are Government
securities issued in two forms viz.
Treasury Bills and Treasury Bonds.
There are two statutes that govern
the issues, viz.
1.
The Local Treasury Bills Ordinance.
2. The Registered Stocks and Securities
Ordinance.
The Government issues the securities
to bridge the fiscal deficit. The
issued and outstanding Treasury
Bills and Treasury Bonds of the
Government of Sri Lanka as at 31st
December 2003 were Rs. 219.3 Bio
and Rs. 483.1Bio respectively. The
Government in addition to these
had Rs. 248.4 Bio worth of Rupee
Loans, a non-tradable security issued
and outstanding and Rs. 8.8 Bio
worth of US Dollar denominated Sri
Lanka Development Bonds. With other
domestic borrowings the total domestic
debt was Rs. 1019.9 Bio. The foreign
borrowings were Rs. 843.9 Bio making
a total public debt of Rs. 1,863.8
Bio.
An
interesting addition to the Government
Securities Market was the issue
of US Dollar denominated Sri Lanka
Development Bonds commencing from
2001. These Bonds are issued with
floating rate of interest linked
to the six months’ LIBOR rate.
Issues are made through competitive
bidding amongst selected authorized
dealers and Primary Dealers. Up
to August 2004, during this year,
the government issued Development
Bonds of USD 194 Mio in two stages
of USD 144 Mio and USD 50 Mio. The
government plans to issue as much
as USD.400 Mio during the year.
The Development Bonds appear to
reduce the burden on Rupee interest
rates to some extent and also can
be considered a matching source
of funds where the utilization is
for foreign currency denominated
expenditure or debt servicing.
The
public debt being more than the
GDP of the country ( Rs 1,760 Bio
for year 2003 at current prices
) there is no doubt the Government
is the biggest issuer of FISs. Accordingly,
the Government Securities Market
has seen substantial developments
over the years.
The
other significant debt issuers at
present are the special purpose
vehicles in the form of trusts to
issue securitised paper against
lease receivables and similar cash
flows. The size of this market is
approximately estimated to be around
Rs.15 Billion.
The
corporate debt is issued mainly
by Banks for their capital requirements
and other large corporates to meet
their long term funding. The listed
market capitalization of corporate
debt outstanding as at 31st December
2003 was Rs.10 Billion.
As
stated above, more than 95% of all
the tradable FI securities are those
issued by the Government. Do the
“others” not need money?
Why do corporate bodies not issue
debt securities to meet their funding
requirements? How about local authorities,
corporations, housing Banks? There
seems to be some severe dislike
to go to the FIS market to raise
funds. Or is it lack of awareness?
Lack of confidence that the market
can, in fact, raise the funds required
through FISs? Or is it having too
many restrictions and regulations
that make issuers shy away from
this market? Where do they in fact
get the funds?
The
sources of debt funding that keep
the potential issuers happy for
the moment can be identified as
follows:
1.
Companies seem to rely on the Banking
system i.e. the loan market instead
of the debt securities market. This
is probably a matter of habit. Banks
are there to lend so why issue bonds?
After all, it is a lot of a hassle.
2. Companies, apart from Bank finance,
do also raise a part of their funding
from share issues and retained profits
thereby relying on equity finance.
3. Government corporations and semi
Governmental institutions too seem
to be relying on Banks. Or they
may have restricted borrowings.
4. Government corporations and semi
Governmental institutions rely also
on foreign project loans that are
directly identified and earmarked
for projects.
5. Similarly, Government departments
and authorities such as Mahaweli
rely on directly identified foreign
borrowings of the Government apart
from the budgetary allocations.
6. Housing and development Banks
too tend to enjoy various credit
lines that enable availability of
debt finance, in addition to certain
amount of debt instruments issued.
7. Apart from direct project type
foreign borrowings, the Government
and semi Government entities tend
to have budgetary allocations for
their capital expenditure.
8. The local authorities apart from
their revenue from taxes, rates,
duties etc. rely on the Central
Government budgetary allocations.
Very little or no borrowings are
observed. The current legal framework
may not permit direct borrowings.
In
analyzing the different potential
issuers, the competitors to raising
debt by Government sponsored projects
and entities can be identified as:
1.
Direct Budgetary allocations by
the Government. Of course the Government
may borrow for these purposes.
2. Foreign borrowings and
3. Bank borrowings
The
competitors to companies in raising
debt finance appear to be the Commercial
Banks, Development & Specialized
Banks, Finance Companies and Leasing
Companies.
The
important issue in hand is that
the traditional means of finance
of most of the potential issuers
of debt have created a status of
complacency that they do not seem
to think of going to debt securities
market to raise funds.
We
know that US is the largest bond
market in the world. The US bond
market comprises of four types of
securities:
| 1.
Government Securities |
|
| |
|
|
| 2.
Federal Agency Securities |
|
| |
-
Federally Related Institutions
(Government Owned Agencies) |
|
| |
-
Government Sponsored Enterprises
(GSEs) |
|
| |
|
|
| 3.
Municipality Securities |
|
| |
-
State and Local Governments |
|
| |
|
|
| 4.
Corporate Debt |
|
We
do not wish to go into a deep analysis
of the US Government Securities
Market. There are three types of
securities viz. :
| 1.
Treasury Bills |
| |
- with maturities
up to one year
- issued on a discounted basis |
| |
|
| 2.
Treasury Notes |
| |
- with maturities ranging
from 2 years to 10 years
- issued with interest coupons |
| |
|
| 3.
Treasury Bonds |
| |
- with maturities ranging
from 10 years to 30 years
- issued with interest coupons |
An
interesting variety of Treasury
Securities is the TIPS (Treasury
Inflation Protected Securities),
which are also called the TIIS (Treasury
Inflation Indexed Securities). These
securities ensure a fixed real return
adjusted for changes in the rate
of inflation. Higher the inflation,
higher the nominal return and vice
versa.
Another
interesting development is the coupon
stripping of Treasury Securities.
By stripping the coupons, one can
make a separate series of zero coupon
bonds which can trade separately.
This process will identify and eliminate
arbitrage opportunities where one
can buy a bond, strip it and sell
the strips at a higher price than
the bond. This opportunity particularly
arises when the yield curve is steep
upward sloping.
A
special arrangement for stripping
of coupons is in place in the US
FIS market. This is called Separate
Trading of Registered Interest and
Principal Securities (STRIPS).
As
stated above, either Government
Owned Agencies or Government Sponsored
Agencies issue these securities.
Some of the issuers are:
1.
Government National Mortgage Association
(Ginnie Mae)
2. Export Funding Corporation
3. Federal Farm Credit System
4. Federal National Mortgage Association
(Fannie Mae)
5. Federal Home Loan Bank Corporation
(Freddie Mac)
6. Student Loan Marketing Association
(Sallie Mae)
7. Federal Farm Credit Assistance
Corporation
The
extent to which the above issuers
have the credit risk vary. Some
like the Federal Farm Credit Assistance
Corporation are backed by full faith
and credit of the Government.
These
agencies issue securities in two
forms:
| 1.
Debentures which are not backed
by specific cash flows |
| |
|
| 2.
Mortgage backed/Asset backed
securities. These are of two
types |
| |
• Mortgage pass through
securities
• Collateralized
Mortgage Obligations (CMOs) |
Essentially
these are securitisations of the
cash flows of the mortgage loans.
The
name here is misleading. These are
not securities essentially issued
by municipalities. They are issued
by state and local Governments.
There are a variety of securities
issued:
| •
General Obligation Debt |
| |
- Unlimited Tax
backed
- Limited Tax backed |
| •
Appropriation backed obligations |
| •
Revenue bonds where the source
of repayment is the revenue
generated by the projects |
Some
examples of revenue bonds are:
1) Utility Revenue Bonds
2) Transportation Revenue Bonds
3) Housing Revenue Bonds
4) Higher Education Revenue Bonds
5) Healthcare Revenue Bonds
6) Sports Complex and Convention
Centre Revenue Bonds
7) Seaport Revenue Bonds
8) Industrial Revenue Bonds
As
stated earlier, these are issued
by companies to meet their capital
requirements and these instruments
rank ahead of the equity, in the
event of winding up of the business.
Observing
the variety of instruments in the
US Bond market, it is worthwhile
looking at the feasibility of issue
of other forms of Fixed Income Securities
apart from the Government Securities
that are widely spread and corporate
debt that already exist to some
extent.
May
I suggest some crazy ideas for consideration
one day or the other? Can we issue
bonds such as:
1.
Hospital Bonds backed by part of
the excise duty on tobacco and liquor
to develop the hospitals.
2. Student Loan Bonds backed by
Student Loans on the basis that
our University students will repay
the loans after University Education.
3. Highway bonds backed by the tariff/toll
to be collected to develop highways
4. Energy Bonds to fund the generation
of energy.
5. Mortgage Backed Securities (MBSs)
issued by separate entities that
will be in the business of pooling
mortgages and raising funds against
the same.
6. Lease Backed Securities; Our
market already has a kind of lease
receivables securitisation which
is not tested in accounting, taxation
and legal aspects.
7. Airport Bonds that can raise
funds to develop the airports, backed
by the future airport taxes.
8. Provincial Bonds that can help
development of the provinces, subject
to strict fiscal discipline, backed
by the future revenues of such Provincial
Councils.
9. Foreign Employment Bonds backed
by levies on those engaged in Foreign
Employment to uplift the infrastructure
facilities for the benefit of those
employed abroad.
What
is the feasibility of issuing such
bonds? How will it help the market?
How will it assist in the fiscal
policy and monetary policy?
It
is possible to complement some of
the funding directly done by the
Government under different types
of Bonds. For example, a Highway
Bond will replace the Government’s
need to raise borrowings under the
central budget but give the responsibility
to a separate entity which is not
part of the Central Government Funding.
In instances such as Hospital Bonds
or Healthcare Bonds backed by future
excise duties, the Government may
enjoy the benefit of not having
to set aside immediate funds while
sacrificing part of the future revenues.
To
develop this process into a workable
solution, let us identify and propose
few models that may evolve through
a process.
 |
| |
Diagram
1 - Direct Government Borrowings |
This
is the model that is followed at
present. It is a very basic stage
of pooling all the revenues centrally
and then distribution by the General
Treasury.
 |
| |
Diagram
2 - Indirect Government Borrowings |
In
this model the Government yet increases
its commitment by way of contingent
liabilities instead of direct borrowings.
However an advantage is that the
interest cost of borrowing and loan
repayment will not be a direct burden
on the budget except in an instance
of default.
 |
| |
Diagram
3 - Securitised Revenue Bonds |
In
this model the Government does not
create any direct or contingent
liability. Hence the Government
can reduce the fiscal deficit in
a systematic manner over a period
of time.
 |
| |
Diagram
4 - Independent Government Agency
Borrowings |
In
this model, the Government does
not have any involvement in raising
funds except that the project may
be initiated by the Government.
Raising of funds will be done by
the projects on their own merits.
The
models can evolve in stages from
Model 1 to Model 4. Initially the
benefit on the Government's fiscal
policy may not be visible or significant.
But as time goes on there will be
enormous advantages leaving some
of the non-core activities outside
the Government.
This
is a serious limitation that will
arise. Most of the external borrowings
are specific loans for identified
purposes. Converting such loan obligations
into debt securities may be a tedious
or impossible task. Skills &
wide spread use of securitisation
will definitely help. This matter
needs further study but a tentative
model can be given below:
 |
| |
Diagram
5 - Securitising Foreign Debt |
The
non-tradable foreign debt can theoretically
be converted into tradable foreign
debt. Questions of the borrowing
costs will arise as most of the
foreign debt has been raised at
concessionary rates. Further, the
conditionalties of the lending agencies
would not permit such early repayment
and fresh issues. In any case such
resources of creating tradable securities
may better be spent in creating
such securities for the future projects
rather than for the projects already
undertaken and/or completed. Further,
the relevance will be seen only
at a time when borrowings at concessionary
rates would no longer be available.
Having
talked about creating Semi-Government
or Non-Government Agency and Project
securities, there are yet many barriers
that need to be defeated.
In
particular, it is necessary to seriously
study all the legal implications,
regulations, tax implications and
accounting issues that affect the
securitisation process. The market
is not mature enough and the legal
outcomes not tested. Particularly,
removal of assets through securitisation
is not yet properly established
in our system.
A
task force to study securitisation
and to come out with a draft Bill
to make the necessary changes to
the Statutes concerned is a matter
of priority.
For
the development of the FIS market,
there are a numbers of factors that
need to be addressed. The essential
pre-requisites for the development
of the market can be summarized
in an acronym BIIPGRILL ©.
This stands for:
a.
A good variety of Buyers
b. A good variety of Issuers
c. A range of Instruments
including Derivatives
d. Active and Sufficient number
of Players
e. A good Play
Ground
f. Rules
of the Game
g. Information
at no cost
h. Liquidity
of the instruments through large
volumes
i. Low
Transaction Cost
Let
us analyse each of the pre-requisites
in detail.
The
development of any Fixed Income
Securities market requires that
there should be a variety of buyers
with diverse requirements with regard
to the risk appetite, investments
horizon, liquidity requirements,
investment volumes, the level of
sophistication etc.
The
Sri Lankan FIS market however is
concentrated in the hands of few
institutional investors. Having
observed that more than 95% of the
FIS market is represented by the
Government securities, it is adequate
to analyze the holdings of Government
securities to understand if we have
a variety of buyers.
As at December 2003 total Domestic
Debt outstanding was Rs 1,019 Bio.
The Employees Provident Fund, (EPF)
being the largest single investor
in Government securities held Rs
323 Bio worth of Government securities.
This was 31.7% of the total. Similarly
the National Savings Bank (NSB)
held Rs 138.9 Bio (13.6%). Commercial
Banks in total held Rs 183.8 Bio
(18%) and the Central Bank held
Rs 44.5 Bio (4.4%). Others including
Primary Dealers held Rs 329 Bio
(32.3%).
Primary
Dealers are those licensed by the
Central Bank to bid at the primary
auctions of Government securities.
There are twelve Primary Dealers
appointed at present. Primary Dealers
buy Government securities in the
primary auctions and sell/ hold
and sell them in the secondary market.
There is a minimum bid requirement
(10% of each auction) to each of
the Primary Dealers. Primary Dealers
are also subjected to capital adequacy
requirements, a comprehensive code
of conduct, requirements to publish
financial statements on a semi annual
basis, and a range of such regulations.
They are also supervised by the
Public Debt Department of the Central
Bank of Sri Lanka.
Primary
Dealers are exclusively engaged
in the trading of Government securities.
They are either fully owned subsidiaries
of Commercial Banks, companies sponsored
by other financial market promoters
or units of Commercial Banks.
Primary
Dealers also maintain accounts for
the end investors in the Central
Depository of the Central Bank of
Sri Lanka. This function is performed
by Commercial Banks too.
Apart
from the existing institutional
structure, there need to be a wider
framework of institutions that generate
the demand for Fixed Income Securities.
The current limited institutions
do not necessarily form an active
market.
 |
| |
Diagram
6 - The FIS market dominated
by the Government Securities
and few Institutions |
There
is a role to be played by the various
types of unit trusts and investment
trusts that can create investment
instruments backed by FISs. Such
instruments as Treasury Bill Backed
securities (TBBSs) when offered
by such portfolio and fund managers
will collect funds from the retail
and high net worth investors. The
unit trusts/ mutual funds can also
offer funds that incorporate investments
in a range of fixed income securities
that will enable taking credit risk
while at the same time pooling the
credit risk. Sri Lankan investors
in corporate debt did invest directly
by themselves and learned the lessons
when one merchant-Banking firm failed
to honour the commitments. It is
risky for individuals to hold corporate
debt directly without holding diversified
portfolios. The unsystematic risk
would not be diversified. On the
other hand a mutual fund investing
in a large number of securities
will not only diversify the risk
but also pool the risk getting the
benefit of the large numbers. Hence
it is far safer for the investors
in FISs to invest through mutual
funds except in the case of Government
securities where there is no credit
risk to pool or business risk to
diversify. An active role by the
Unit Trust industry will definitely
add value to the FIS market.
EPF
being a dominant player and the
resultant tendency to use the EPF
on a non-market basis has both good
and bad outcomes. In a rising rate
scenario, the dominant players can
come forward to stabilize the market.
However it is a well-recognized
principle that under normal conditions,
dominance by few players is a symptom
of a less efficient market.
If
the market is confined to such few
dominant players then, there is
no doubt, there is very little width
the market may have.
Even
out of the dominant investor group,
there is no firm demand at all times
for securities in the long end of
the term structure. This is a statement
that sounds completely baseless
given the large provident funds
and insurance funds that exist in
the system. Both these categories
are long-term funds that invariably
should have a high appetite for
long-term investments. However,
the reality is otherwise.
Though
these entities have "long term
funds" they do not have long
term return commitments towards
their suppliers of funds. For example,
EPF does not guarantee a specified
minimum return in the long run.
Should we not encourage competing
pension funds who would offer such
value addition?
Similarly,
the insurance companies who have
long-term life funds do not guarantee
a decent return over a long period.
Instead they tend to assume a very
low guaranteed rate and any surplus
is passed on to the policyholders
by way of bonuses. This essentially
is a way of playing in the short
end of the market.
They
may be justified in resorting to
such short-term investment horizon
due to the following reasons:
1)
Their investment objectives do not
require the assurance of a decent
long-term rate. Hence fixing the
rates over long periods may not
be necessary.
2) Particularly, given high volatility
of interest rates, they may be concerned
that fixing of returns for long
tenors may coincide with low interest
rate scenarios followed by rising
rates. In such cases the decisions
may be found to be wrong with hindsight.
3) There is no long term inflation
rate view taken by the monetary
authorities in the absence of the
trendy policies such as inflation
targeting that are pursued by certain
other countries, of course, under
different economic conditions and
financial systems. This is substituted
to some extent by the provisions
of the Fiscal Responsibility Management
Act and the medium term plans highlighted
with regard to the fiscal policy
in the Government Budgets.
4) When all the players concentrate
on the short term investment horizons,
the benchmarks are recognized based
on such short term instruments.
Those who commit into long term
instruments may appear to be performing
poorly at times of high interest
rates. Of course it will be the
opposite under low interest rate
scenario that may follow a high
interest rate scenario.
5) The blame may be put back on
the non-existence of active trading
of long term securities (say over
six years) as a result of which
the long term rate discovery and
price transparency will be difficult.
This is a "Chicken and Egg"
situation. One complements the other.
Despite
the above constraints and concerns,
it is necessary that the economy
at large is blessed with long term
funds that seek long term fixed
returns.
There
are several benefits that not only
the FIS market but also the economy
at large will enjoy:
1) When funds are compelled to
guarantee target long term returns,
then they will be "asset
hungry" for long term assets.
The result is that a range of
new long-term investment instruments
will be sought after. This will
lead to the development of the
FIS market.
2) When there is demand for long-term
assets, then the market will not
over-react and shy away from long-term
instruments even when there is
upwards pressure on interest rates.
Their need to match the long-term
funds with long-term investments
will result in a fairly stable
demand for long-term instruments.
3) The members of the funds will
enjoy stable returns with less
volatility.
4) In case the economy shifts
from a high interest rate scenario
to a low interest rate scenario
that may be sustained for several
years, then the members of the
funds will still be benefited
by long term rates fixed earlier.
As per the current practice it
is most likely that in the event
the economy settles for sustainable
low interest rates, the members
of the funds will face the low
rates unprepared and continuously
receive low interest rates. They
would realize the mistake of not
investing at fixed rates for long
periods only when it is too late
We
have already discussed the fact
that the Sri Lankan Fixed Income
Securities Market is highly concentrated
on the issue of Government securities.
We also discussed some "crazy"
ideas as to how we can widen the
range of instruments that are available
in the market. Five models were
discussed as means of gradually
eliminating the Government's role
in intermediating the raising of
funds and using of funds particularly
in development activities. Such
package of actions will invariably
result in creation of a large number
of issuers and also a variety of
instruments.
We
discussed the range of FISs issued
in the United States and also discussed
the potential instruments that can
be issued.
The
range of instruments will invariably
increase when the range of issuers
increase. The differences in credit
quality of such instruments will
make the FIS market even more interesting
to analyze. Such range of instruments
will be made use of for different
risk return profiles. There is also
the potential to incorporate call
and put options on such securities
and issue them with such embedded
options. The mortgage backed securities
market is bound to give the taste
of specific risks attached to amortizing
bonds and prepayment options in
the underlying mortgages.
A
range of derivative products will
be the natural reaction to deal
with the complexities arising from
a variety of instruments. Of immediate
necessity are the wider use of two
derivatives viz. Forward Rate Agreements
(FRAs) and Interest Rate Swaps (IRSs).
There had been occasional use of
these instruments but the market
has not developed to a stage of
being able to quote for these instruments
on an "over the counter"
basis. Fear of derivatives seems
to suppress the potential benefits.
The
Primary Dealers exchanged a series
of FRAs and IRSs in December 2002
with a view to identifying several
issues including documentation,
accounting and taxation. Although
this gave insight as to the procedural
aspects, the market appetite yet
remains very low.
At
a latter stage, of course, the market
needs to be supported by futures
and options. An alternative will
be the use of foreign currency denominated
futures and options for cross hedging
provided the capital account transactions
are permitted under the exchange
control regulations.
"Players"
are the market makers who create
and maintain an active market of
securities. The main players in
the Government Securities Market
are the Primary Dealers and the
Commercial Banks. Apart from them
the money brokers play a vital role.
Large institutions and funds such
as NSB, EPF and ETF also help in
creation of an active market in
addition to their role as end investors.
How
about swap dealers and option writers?
People engaged in creating securitisation
structures and issuing securitised
paper? (Happening to some extent
now). Rating Agencies competing
for business instead of a single
agency? Analysts who have got something
to analyse beyond the "plain
vanilla" Government securities?
A
market place for trading in FISs
is an essential element of a good
securities Market. At the moment
there are few routes of carrying
out trades in the Government Securities
Market.
Several
infrastructural developments took
place in the Government Securities
Market in the year 2003 and in early
2004. On 8th September 2003, the
Central Bank of Sri Lanka commissioned
the Real Time Gross Settlement System
(RTGS). On 3rd February 2004, the
Central Bank commissioned its Central
Depository for Government Securities
and the Scripless Securities Settlement
System.
The
Real Time Gross Settlement System
(RTGS) is a system that enables
settlement of transactions between
different parties participating
in the system on a real time basis
as against the previously used end
of day net settlement. Further,
transactions are settled one by
one on a gross basis without netting
off one another. This is also supported
by settlement of securities in the
Scripless Securities Settlement
System (SSSS) where the securities
trades between the parties can be
effected within the same system.
The result is a long awaited delivery
vs payment where the movement of
securities and funds happen simultaneously
between the buyer and the seller.
This has eliminated the settlement
risk thereby creating a good market
place where transactions related
risks are minimized. Further, to
enable settlement of securities
in scripless form and also to be
able to store the securities ready
to trade at any time without the
hassle of physical delivery etc.
the Central Bank also set up the
Central Depository for Government
Securities.
In
October 2003, the Association of
Primary Dealers (APD) concluded
agreements between the APD, the
individual Primary Dealers and Bloomberg
SA to set up the Lanka Primary Dealer
Bloomberg Bond Trader platform (LPBT).
This commenced operations in November
2003. The LPBT is a trading platform
for on line trading, trade recording
and trade confirmation of inter
dealer transactions open for all
the Primary Dealers and Commercial
Banks.
On
21st January 2004, the Colombo Stock
Exchange launched ‘DEX’
a debt trading system that enables
trade matching of transactions involving
beneficial interest of Government
Securities.
The
series of developments in the market
infrastructure has no doubt set
the foundation for a better-developed
FIS market.
Apart
from the technological and infrastructure
support, the market requires liquidity
both in the instruments and the
cash resources for smooth exchange
of securities.
The
market liquidity with regard to
instrument development will be dealt
with under a separate heading.
With
regard to the cash liquidity, the
market has a new development i.e.
the Intra Day Liquidity (ILF) facility
provided by the Central Bank against
Government Securities. This helps
reduction of any friction in settling
large transactions while also awaiting
other receipts of funds. In addition,
the overnight liquidity requirements
continue to be addressed by the
Overnight Repo and Reverse Repo
windows. The Repo window absorbs
the excess liquidity at a minimum
of the Repo Rate (presently 7% p.a.)
while the Reverse Repo window enables
meeting of shortages in the market
at the Reverse Repo Rate (Presently
8.5% p.a.).
In
addition, the Open Market Operations
of the Central Bank introduced a
system of auctioning the Repos for
absorbing the excess liquidity.
This enables those who have excess
cash to pass it on to the Central
Bank possibly at a rate above the
Repo rate and below the Reverse
Repo rate.
One
weakness of the current arrangement
for moving the liquidity out of
or into the system to/from the Central
Bank is the potential wide fluctuations
of the Inter-Dealer, Inter-Bank
overnight Repo rate. When the market
is very liquid the rate tends to
be above but closer to 7% p.a. (Repo
Rate) and when the market is less
liquid or when it is short of liquidity,
same overnight rate tends to be
around 8.5% p.a. (Reverse Repo rate).
Such fluctuations of the wholesale
market overnight risk free | 
