THERE is a growing feeling in the financial services sector that its investment banking wing is too quiet for comfort. There are valid reasons for it, not all of them attributable to the slackness of this sub-sector.
While we have bustling stock markets, the fact is that due to many structural and attitudinal weaknesses, Pakistan has not been able to create an active debt paper market – a weakness also pinpointed by SBP’ last Monetary Policy statement.
In essence, investment bankers promote investment on behalf of the venture sponsors. The level of investment banking activity therefore depends on the pace of fresh investment and sponsor preparedness to look at options other than bank borrowing.
Besides, not every investment proposition is of a size that forms a marketable lot for issuance of equity or debt paper, and results in a definite and worthwhile cost advantage to the sponsors.
For the sponsors to be able to successfully issue equity or debt paper, they must have a track record that inspires confidence among prospective investors about the investment’s projected earnings and capacity of the sponsors to fulfill their obligations to the investors.
Many sponsors don’t like disclosing details about their own past or that of their businesses, and therefore opt for bank borrowing even though it is expensive, and must be collateralised.
To float equity or debt paper, sponsors must have the investment venture credit-rated. Textile, with the largest number of listed companies on Pakistan’s stock markets, seems least willing to avail the services of investment banks because of its lacklustre track record.
There is visible reluctance to inter-acting with intrusive credit rating agencies and sharing sensitive details that must be disclosed for any debt or equity paper to qualify for public offering. Sponsor deficiency thus remains a major stumbling block in promoting corporate debt or equity paper.
In recent years, this unhealthy trend received a boost. Even reputable sponsors didn’t opt in favour of issuing fresh equity or debt paper since they could borrow from the banking sector at a cost as low as 1.5 per cent per annum , courtesy the inspired distortions in interest rates. It was thus no surprise that we witnessed virtually no issues of debt or equity papers in the past two years.
Big banks (either singly or in syndicates) took care of sponsors’ funding needs thus saving them the hassle of floating equity or debt paper. What is questionable, though, is whether such sponsors and their bankers acted wisely because loans, especially medium-term borrowings obtained on floating rates will now be eating into the sponsors’ profits.
A bigger danger is that ridiculously low borrowing rates may have engendered a false sense of profit security, and prompted such borrowers into investing in ventures with low returns.
The short-sighted attitude of both sponsors and bankers towards strengthening equity and corporate debt paper markets could eventually weaken the financial services sector by limiting investor choices.
As a matter of fact, it is already showing signs thereof. Huge negative returns that savers have been forced to accept, are eroding the all important saving and return-conscious culture.
With little investment choices available to them, almost all savers and investors are turning into speculators, which is simply bad. Economies bloom on a mix of security-minded investors and speculators; in isolation, neither group can nourish a healthy economy.
As it is, even until late 2003, when corporations were actively focusing on floating fresh equity and debt paper, a noticeable trend was that large chunks of debt paper were usually grabbed by big banks, insurance companies and pension funds, leaving small sums to be subscribed to by the common investors.
While insurance companies and pension funds had a valid reason to buy the debt paper in large chunks, purchases by banks effectively prevented the deepening of an active debt paper trading market buoyed by small and medium-sized investors.
That it is so, is proved by the fact that hardly any sell/buy prices are quoted for corporate debt papers. In such a market (that denies ready liquidity to investors by not quoting sell/buy prices) an active debt paper market can hardly develop.
It also raises a dicey issue: how do institutions periodically value their debt paper holdings, and determine capital gains or losses accruing thereon, and how do their external auditors verify the correctness of debt security valuation? Surely, they know how to credibly value such securities and certify valid profits or losses.
This trend has eroded investor interest in buying corporate debt paper. Not surprisingly therefore, today, only 40 debt securities are being quoted on the country’ stock exchanges. This number includes 12 government debt securities ( Dollar Bonds, Federal Investment Bonds, Foreign Exchange Bearer Certificates), 14 Term Finance Certificates issued by financial institutions, and 14 corporate debt securities (including three issued by state-owned corporations). Compared to an equities market whose capitalisation runs into tens of billions of dollars, the proportion of corporate debt paper is mere pittance.
Given the changed scenario of funding choices being exercised by venture sponsors and the role banks have adopted in this affair, it is no surprise that investment banks had little to show in terms of investment promotion activity.
Besides, the SECP regulatory framework that (quite correctly) specifies various levels of minimum equity requirements for a host of non-bank financing activities, encouraged investment banks to focus their energies into a variety of directions.
Investment banks are focusing on advisory services, facilitating strategic partnerships and balance sheet re-structuring, much less on facilitating the floatation of debt and equity papers. But the changing interest rate scenario holds out the promise of revival of their main activity i.e. investment promotion through initial public offerings (IPOs), underwriting debt and equity floatation and placement of these securities with prospective investors – an activity that had take the back seat in recent years.
The likely revival of investment banking, however, does not imply the widening or deepening of the debt paper market because investment banks would revert to their old practices i.e. pre-flotation placement of huge chunks of debt securities with powerful investors. Should this happen, it will again prevent the expansion of the debt paper market. It is this weakness that must be addressed by SECP. It is time regulators initiated the practice of closely monitoring the development of market profile along desired lines.
SECP should monitor the pace of expansion of the debt paper market so that small and medium-sized investors partake in this vital market to make it truly active in terms of readily available buy/sell quotations.
As an additional support mechanism, the procedure for opening of CDC accounts of investors in debt paper should be simplified so that the common investors are assured of smooth purchase and sale of debt securities. This is vitally important for balanced development of the country’s capital markets.
This objective, however, cannot be achieved unless commercial banks are discouraged from exercising the influence they seem to be having on the capital markets. It has caused counter-productive trends to surface. SBP has realised the importance of limiting the role of commercial banks in the capital markets; it may, perhaps, be proper to limit their investment in corporate debt securities as well.