Salient features of proposed Securities Exchange Act

February 6, 2018 Azhar Razak

By Rajeev Amarasuriya

In the early part of this year, the legislature will consider the promulgation of the new Securities Exchange Act, which will provide the legal framework for the regulation and supervision of the capital market.

Original Securities Council Act

It was 30 years ago, in 1987, when the first piece of legislation was introduced in the form of the ‘Securities Council’ Act No. 36 of 1987, which established the Securities Council and identified its objects as being (a) creation and maintenance of a market in which securities can be issued and traded in an orderly and fair manner, (b) protection of the financial interest of investors, (c) operation of a compensation fund to protect investors and (d) regulation of the securities market and to ensure that professional standards are maintained in such market.

The powers, duties and functions of the Securities Council included to issue licences to operate as stock exchanges and stockbrokers; to give directions to a licensed stock exchange; to grant compensation to any investor who suffers pecuniary loss resulting from the failure of a licensed stockbroker or a licensed stock dealer to meet his contractual obligations; to advise the government on the development of the securities market; to suspend or cancel the listing of any securities or the trading of any given securities, for the protection of investors; to inquire into the business affairs of a licensed stock exchange, stockbroker or stock dealer and public companies listed with a licensed stock exchange; to publish findings of malfeasance by any licensed stockbroker or stock dealer or any public company listed with the licensed stock exchange and to implement the policies and programmes of the government with respect to the market in securities.

The Securities Council Act also included provisions to deal with insider dealing/prohibitions pertaining to transactions made on the basis of unpublished price-sensitive information.

Amendment in 1991

Several amendments were incorporated to the Securities Council Act in 1991, which included the change of name of the council to the ‘Securities and Exchange Commission of Sri Lanka’, introduction and regulation of unit trusts, enabling provisions for the regulation of takeovers and mergers and several other provisions to strengthen the powers of the commission in respect of supervision and enforcement. This included a widening of the supervisory jurisdiction of the commission and also included new provisions for compounding of offences.

Amendment in 2003

In 2003, amendments were incorporated to the act, which included widening the jurisdiction to market intermediaries, creating the cess fund and levy of cess and further strengthening the regulatory framework in line with the experiential requirements and international best practice.

Amendment in 2009

A few further amendments were incorporated to the act in 2009, which included a new power vested in the commission to issue general or specific directives to listed public companies from time to time.

Need for a new act

From about 2007, the Securities and Exchange Commission (SEC) had made a policy decision that a new consolidated Securities Act was a requirement to provide a better and more efficacious framework in line with international best practice towards effectively regulating the capital market. During the first term of the present SEC Chairman Thilak Karunaratne, considerable work had gone into drafting a new act, addressing the needs of the market but since his resignation in August 2012, the promulgation of the new act did not see light.

It was after the appointment of the present commission in the early part of 2015, which was once again chaired by Karunaratne, that this process was revived.

The commission appointed a special advisory committee, under the Chairmanship of K. Kanag-Isvaran, PC to guide the process of drafting a new consolidated piece of legislation and the formulation of the new Securities Exchange Act recommenced under the guidance of the commission and special advisory committee, the culmination of which was the submission in November of the present Securities Exchange Bill to parliament by the prime minister, who is also the Minister of National Policies and Economic Affairs, under which ministry the SEC comes.

During the process of drafting, the SEC requested the International Organisation of Securities Commissions (IOSCO) to conduct a country review in Sri Lanka, in order to independently identify the gaps in the regulatory sphere and this new piece of legislation, expected to be considered by parliament shortly, addresses these gaps and seeks to bring the legal framework on par with many areas of international best practice.

In fact, IOSCO Secretary General Paul Andrews was quoted as saying, “The Sri Lankan SEC showed courage, which many other regulators would not show, by allowing the IOSCO to review the Sri Lankan regulatory standards and to advise on the areas which need improvement.”

He also went on to state, “It shows commitment and shows strength of character. It’s good for business in Sri Lanka to have good regulations.”
The following is a brief analysis pertaining to several important provisions of this new bill.

Constitution of commission, objects and powers

The long title of the proposed new Securities Exchange Act provides that it is “An act to establish the securities and exchange commission of Sri Lanka; to regulate market institutions, public offers of securities, market intermediaries; to deal with market misconduct and to meet the challenges encountered by securities markets in an effective and efficient manner…” and seeks to seamlessly consolidate the several aspects which must come within a law that would regulate a capital market.

The objects of the proposed act are (a) to establish the Securities and Exchange Commission of Sri Lanka for the creation and maintenance of a fair, efficient and transparent securities market, (b) to protect the interests of investors both local and foreign, (c) to ensure the maintenance of high professional standards in the provision of services under this act and (d) to mitigate systemic risks in the financial system.

The objects have not been substantially revised, except for the inclusion of the object of the mitigation of systemic risk in the financial system, which is vital and was implicit under the old act as well. Protection of investors is still a paramount consideration over other competing interests such as competition and capital formation, which have been given parallel importance in jurisdictions such as the US.

There is also new provision, which enables the listing of securities of an exchange, on such exchange, which would become immediately relevant when the demutualization of the Colombo Stock Exchange takes effect

The commission largely comprises of the same, except for the replacement of the president of the Institute of Chartered Accountants of Sri Lanka, with a Fellow Member of the Institute of Chartered Accountants of Sri Lanka, who is not engaged in auditing as nominated by its council. This was to eliminate any conflicts of interest that could arise from an auditor, who provides professional services to listed market regulatees becoming part of the commission and also in view of the fact that under this proposed act, auditors have certain obligations.

The term of office of every appointed or nominated commission member is for three years and is limited to a maximum period of two successive terms of office, which is an important provision from a governance standpoint.

Conflicts of interest

A further safeguard to ensure the independence of the commission has been included whereby the minister, when appointing commissioners, must have regard not only to that person’s integrity and standing but also the likelihood of any conflict between the interests of the commission and any interest that person has or represents.

Powers of commission

The powers of the commission include (a) to advise the government on the development of the securities market and to assist in the effective implementation of the policies, (b) to encourage and promote the development of securities markets in Sri Lanka, (c) to give general or specific directives to any person or persons including market institutions, market intermediaries, registered persons, clearing members, trading participants, depository participants, issuers, investors or recognized market operators, (d) to give general or specific directives to supplementary services providers of market institutions, market intermediaries or listed pubic companies from time to time, (e) to grant a licence to a body corporate to operate as a market institution and ensure its proper conduct, (f) to grant a licence to any person to operate as a market intermediary and ensure its proper conduct, (g) to register a person advising clients on sale or purchase of securities for and on behalf of a market intermediary as a registered person and to regulate their conduct in the discharge of their duties, (h) to issue general or specific directives to listed public companies or listed foreign entities from time to time, (i) to issue specific directives to any person to prevent the imminent infringement of this act, regulations or rules and to restrain infringement, (j) to regulate the listing and trading of securities in an exchange, (k) to regulate the issuance of securities, (l) to prohibit or suspend the listing of any securities or to delist the listed securities or to take such steps as the commission considers necessary for the protection of investors, (m) to regulate a takeover or merger of a listed public company or any matter connected therewith, (n) to inquire and conduct investigations into any activity of a market institution, market intermediary, a registered person, a listed public company or a listed foreign entity and (o) to conduct investigations into any alleged violation or contravention of the provisions of this act or any regulation, rule or directive.

Director general and staff

The director general under the new act will come under the direct purview of the commission and will be appointed and also removed by the commission.

The staff of the commission will also be appointed by the commission and their terms of service and remuneration will be determined by the commission. These are further provisions that strengthen the independence of the commission.

Markets and market institutions

Part II of the act under the heading ‘Markets and Market Institutions’ contains the provisions pertaining to exchanges, clearing houses and central depositories.

Exchanges

Chapter 1 of Part II, which deals with exchanges (which is defined to mean a stock exchange or a derivatives exchange licensed under this act) among other things, sets out the threshold requirements to become an exchange, which gives paramount importance to governance and investor protection, the duties of an exchange including to ensure an orderly and fair market in securities that are traded through its facilities, to act in the public interest having particular regard to the need for the protection of investors and other administrative and operational requirements.
In fact, there is specific provision which imposes a duty on a director of an exchange to act at all times in the public interest having particular regard to the need to protect investors.

There is also new provision, which enables the listing of securities of an exchange, on such exchange, which would become immediately relevant when the demutualization of the Colombo Stock Exchange takes effect.

Clearing houses

Chapter 2 deals with the regulation of clearing houses for the purposes of clearing and settlement and among other things, sets out the threshold requirements to be licensed as a clearing facility, provisions pertaining to regulation and supervision of the clearing house and its members, establishment and administration of a settlement guarantee fund, etc.

Further provisions include prioritization of default proceedings of a clearing house in the distribution of assets and other ancillary powers to facilitate clearing operations.

With the promulgation of the act, the legal provisions will be in place for the setting up of a central counterparty, which would engage in the clearing and settlement of trades, thereby minimizing/spreading the risk of non-settlement.

Central depository

Under the proposed act, there is also a separate Chapter for the regulation of central depositories. Under the present operative act, Central Depository Systems (Pvt.) Limited (CDS) has been registered under generic provisions.

General provisions pertaining to markets and market institutions

There are also general provisions applicable to market institutions, including requirement for rules to be approved by the commission, need for approval to hold more than 5 percent of the voting rights and other governance measures including the power vested in the commission to make preliminary orders, fit and proper rules/criteria for directors, etc.

(Rajeev Amarasuriya is an Attorney-at-Law with a wide practice in the areas of public law and corporate consultancy. He is a Fellow Member of the Chartered Institute of Management Accountants (CIMA – UK) and an alumnus of both the Faculty of Law of the University of Colombo and Harvard Kennedy School of Government, Executive Education. He is a Commissioner of the Securities and Exchange Commission of Sri Lanka. The views expressed herein do not necessarily reflect the views of the SEC)