The Stock Exchange. A structural weakness and a path to correction

There are some 250+ companies that are quoted on the CSE, which now (October 2009) has a market capitalization of Rs1000Billion or one Trillion! However this hides some important facts. The cross ownership of many companies in the exchange gives rise to an incredible amount of double counting. The true capitalization is nearer Rs400B a considerable drop. This when added to the fact that a further chunk of shares are closely held by founders or major shareholders, both local and foreign that are hardly traded (change hands once every 5 to 10 years as strategic investments where in this market they are known as crossings) the shares usually referred to as free float amount to less than Rs100B. This is only a tenth of the market capitalization. This makes the Sri Lanka market tiny with the government not having anything to crow about.Increase of this free float by more tradeable shares should be the goal.

I am afraid the SEC which is the capital market regulator, and CSE which should promote both a larger number of companies to list and even a larger number of investors to invest do not appear to take their respective tasks seriously. In short they are derelict in their duties, which are both a disservice to the investing public and to expanding the equity market in Sri Lanka. An increased participation indirectly results in more investment, which results in greater economic growth.

Now that the war is over and sense has prevailed, a concerted effort should be made to encourage more companies to list their shares. If need be they can begin in a secondary market and migrate to a full listing as is often done in foreign countries. The junior market will usually have closely held shares and only a small proportion in public hands, with a greater proportion being listed once the company graduates to the main market. The main market should have at least 25% of its shares in public hands to gain any sort of credibility. Existing companies should be encouraged to sell more shares to get to this level. It should also be a way of encouraging subsidiaries of overseas listed companies such as Nestle, Chevron and Tobacco to have more shares in the hands of other shareholders.

None of these objectives can be achieved overnight, but unless it is done without delay according to a plan with targets, the credibility and volatility of this market is called into question. Just look at the fact that 80% of the current trades in value take place amongst no more than 50 companies of the exchange. That means that the balance companies account for very little share movement, adding to the volatility of those shares. Such volatility is open to market manipulation that cannot be proved, as anyone with a few million rupees can manipulate shares in the CSE for their personal gain at the expense of the unwary investor.