Shedding skin?

Courier Briefing
Wednesday, May 23rd, 2018


General Manager of the Shenzhen Stock Exchange (SZSE) Wang Jianjun (R, Front), Chair of Shanghai Stock Exchange (SSE)’s Supervisory Board Pan Xuexian (L, Front) and Dhaka Stock Exchange (DSE) Managing Director KAM Majedur Rahman (C, Front) exchange documents after signing a partnership agreement in Dhaka, Bangladesh, on May 14, 2018. (Picture - collected)

 

The DSE’s strategic tie-up with the Shanghai-Shenzhen exchanges leaves it well-placed to complete what will be its third coming.

 

May 14 will be etched in Bangladesh’s financial records as a landmark date when Dhaka Stock Exchange (DSE) signed an equity acquisition agreement with a Chinese consortium, consisting of the Shenzhen Stock Exchange (SZSE) and Shanghai Stock Exchange (SSE). This news is reportedly being rejoiced by the stock market stakeholders, as they are hopeful it might help regain investors’ confidence, garner more foreign investment and boost DSE’s brand image, that has been in tatters since the crash of 2010

 

The consortium issued a statement recently, where it said: “Based on the principle of equality, mutual benefit and win-win cooperation in compliance with Chinese and Bangladeshi laws and regulations, the consortium will advance cooperation in key areas such as trading technology, market cultivation, and product development in an orderly manner to achieve higher-quality growth.”

 

A celebratory air

 

Wang Jianjun, president and CEO of SZSE, and Pan Xuexian, chair of the SSE Supervisory Board, signed the agreement on behalf of the Chinese consortium, while DSE Managing Director KAM Majedur Rahman signed the agreement on behalf of his organization.

 

Speaking at the signing ceremony as the chief guest, Finance Minister AMA Muhith said he hoped the Tk 947 crore or $120 million  agreement would be beneficial for both countries.

 

“The Chinese stock exchanges have a lot of expertise and success (so) we should try to follow their example and let them make a difference in our stock markets,” Muhith said. “The Chinese consortium could also benefit as they are partnering a country whose capital market is finally getting organized and established.”

 

The Bangladesh Securities and Exchange Commission (BSEC) chairman, M Khairul Hossain, said the development of the DSE was the result of significant efforts taken from 2011-2013 to reform the laws around the Dhaka and Chittagong stock exchanges, in order to avoid the kind of crash that it suffered in either 1996 or 2010. Rising and falling, boom-and-bust, crashing and rallying are all part of any stock exchange’s fiduciary activities. But DSE’s two crashes 14 years apart served to more or less cripple the market for months or years to come.

 

“In the last few years, we have taken a series of reforms for the betterment of the stock market (and) as a result, the stock market is now more transparent and accountable to investors and stakeholders,” said the BSEC chairman, whose organisation represented the most significant hurdle to cross in the final weeks. “We hope that the partnership with the Chinese consortium will contribute significantly to the further development of the stock market.”

 

Wang Jianjun, president and CEO of SZSE, said China and Bangladesh are both developing countries with similar national conditions and development goals. “China will stick to the national policy of opening up and the principal of development with open doors, actively promoting cooperation with the Belt and Road countries,” he said, keen to stress the close alignment between the Chinese government’s policies (such as the One Belt One Road, also called Belt-and-Road initiative envisioned by Xi Jinping and written into the Chinese constitution last year) and the strategy pursued by the exchanges.

 

As China seeks closer economic ties with other countries as part of its Belt and Road Initiative — a vast network of ports, railways, roads and infrastructure — its state-owned bourses have also been investing in foreign exchanges.

 

What’s in it for Bangladesh?

 

According to the agreement, the consortium acquired 450 million shares of the DSE, one-fourth of the total number, with a transaction amount at Tk 9.47 billion (close to $120 million).

 

The Chinese consortium will buy each share at Tk 21, or $0.25, totaling some $125 million for the one-fourth stake which values at $53 million. The premium works out to Tk 11 per share. Previously, China offered Tk 22 per share, but lowered its bidding price because the DSE paid out a 10% dividend last year.

 

In addition, the Chinese offer also includes around $37 million worth of technical assistance to bring the bourse up to speed. Their proposal includes developing an SME (small and medium enterprises) market in Bangladesh. In association with its Chinese partners, the DSE aims to diversify its product offerings. In addition, both stakeholders plan to launch the ELITE V-Next alliance program in Bangladesh. Reports suggest that the Chinese have also offered to forgo profit on their investment in the first 10 years.

 

The consortium will also assist the DSE in mapping information disclosure and investor service automation framework. The Chinese consortium also offers assistance in developing human resources, which is needed to raise DSE’s overall portfolio.

 

When implemented, the DSE hopes to boost its brand image and attract more foreign investment (as long as the taka stops depreciating though). The Bangladeshi finance minister expressed optimism that Bangladesh would greatly benefit in developing its capital market by following in Chinese footsteps. At the agreement signing ceremony, the chairman of Bangladesh Security Exchange Commission (BSEC) said, “we expect that the strategic partner will contribute significantly to the Bangladesh capital market development as the Chinese bourses developed significantly despite their opening in 1990.”

 

Recapping the bid

 

The National Stock Exchange (NSE) of India, competing with the Chinese consortium, had offered to buy each share for Tk 15, or $0.18. When aggregated, this amounted to 47% lower than the Chinese offer. Like the Chinese, the NSE also made a promise to invest in DSE’s overall modernization process. However, it did not disclose either the nature or the size of its technical assistance. In addition, the NSE asked for two DSE board seats, which they would leave after five years.

 

Realising the DSE board tallied in favour of the Chinese bid, India resorted to diplomacy. In February, Vikram Limaye, CEO of the NSE, visited Dhaka to make his case. He spoke with officials from both the DSE and BSEC and emphasized NSE’s experience with stock exchange development.

 

Initially, Limaye’s negotiations seemed to work as the commission instructed the DSE to revisit the tender process. But the commission’s decision triggered strong reactions among the DSE board members and market observers.

 

Yet Beijing was also careful to not upset Delhi, which is wary of Chinese activities in its neighborhood. In his speech, Wang Jianjun said the new partnership with Bangladesh would “add new dimensions for cooperation to the Bangladesh-China-India-Myanmar (BCIM) Economic Corridor.” Clearly reflecting that there was no intention to bypass India to materialize its development agenda in South Asia. The purchase is being seen more as a strategic move to help raise funds for its Silk Route projects in the South Asian region. This is China’s second stock market buy in South Asia.

 

A year earlier, the same two Chinese bourses along with a third Chinese company forming a different consortium bought a 40 percent stake in Karachi-based Pakistan Stock Exchange in an $85-million deal. The BSEC had ordered the DSE to ensure that any deal did not include terms that contradicted the laws of the country, or those that harmed the interest of other shareholders.

 

Nuts and bolts

 

The signing of the deal took place with the DSEX, the key index tracking the DSE, in the middle of a dreadful run. It would take till May 20th for the bourse to end a session (day’s trading) with the index up on where it closed the previous day – the first of the month.  It represented perhaps not the most august beginning to the relationship, but in frankness the two are completely unrelated. For the time being at least, it is best not to tie the movement of the index to the strategic partnership that is yet to be implemented.

 

But naturally people are eager to see the partnership take effect, and will be keenly observing what changes – positive or otherwise – occur or are set in motion as a result of the Chinese involvement. The players directly involved were pretty coy about this, and offered few details in public as to what would be the visible activities accruing from the deal. But this very detailed response over email by Lu Xusheng, press secretary of the Shenzhen Stock Exchange, to a question on the specific operational plan to be pursued by the consortium once the partnership is fully functional, can be very helpful:

 

“Based on the actual situation of Bangladesh and the strategic planning and development needs of DSE, in accordance with local laws and regulations, we will actively participate in the corporate governance of DSE, assist DSE in improving its strategic planning, impel DSE to build and improve product and service modules, help Bangladesh develop multi-tiered capital markets, and promote the economic integration and development of China and Bangladesh.

 

“Firstly, to further carry out bilateral basic research. The Chinese Consortium plans to dispatch its staff to DSE for in-depth research, and welcomes DSE to send its staff to SZSE for the same. Exchanges between the research institutions of two parties are expected to provide research support for further future cooperation. And exchanges between both parties’ staff are expected to clarify the key demands of each other and lay a foundation for implementing the specific cooperation requirements.

 

“Secondly, to further strengthen the DSE market construction capabilities. DSE attaches great importance to the offering and listing of SMEs. Our achievements in China on the construction of a multi-tiered capital market system have been widely recognized. The Chinese Consortium will provide DSE with experience and technical support in aspects like the construction of the SME board and the cultivation of a market service system. The Chinese Consortium will also actively assist DSE in improving construction of bond market, fund market and derivatives market to enrich DSE’s diversified product system. Based on the upgrade requirements of DSE’s technical system and our advantages, the Chinese Consortium also proposes a series of technical cooperation solutions. In the future, the Chinese Consortium will strengthen cooperation in key areas, and promote and achieve technical win-win based on the development direction of Bangladesh.

 

“Thirdly, to further promote connectivity between the capital markets of both parties. We’ll take an active role in utilizing the functions of the SZSE’s V-next platform, improve the China-Bangladesh cross-border capital service mechanism, and promote the China-Bangladesh cross-border capital formation. We encourage Chinese enterprises that do business in Bangladesh to use diversified methods (such as stocks, bonds, and asset securitization) for financing in DSE. We’ll explore the panda bond issue by Bangladesh government and enterprises and promote infrastructure construction in Bangladesh. In addition, we encourage market institutions to develop cross-border financial products and promote the cross-board asset allocation in the two markets.”

 

Stakeholders’ opinion

 

Former advisor to the Caretaker Government and economist AB Mirza Azizul Islam said that “The Shanghai Stock Exchange and the Shenzhen Stock Exchange have a good reputation for their well-regulated operations. As a partner, they will have much to offer the DSE to improve its own operations. It is assumed the DSE governance will also improve as the consortium involvement increases.”

 

Mirza Azizul also noted that the partnership will attract investors, both foreign and domestic, while boosting confidence among existing investors. He hoped it would develop new products to draw investors.

 

Ahmed Rashid Lali, a former vice president of the DSE, said: “The partnership will introduce radical professional change in the administration and management of the DSE. The market will be more transparent and accountable to stakeholders. In terms of operation, the DSE would reach international standard as our technology will be significantly improved.”

 

“This was part of a process which began 5 years back, as part of the demutualization of DSE,” said Toufique Hossain, author and stock market analyst. It was decided back then to appoint a strategic investor.

 

He said that the reason the Chinese won the bid was because of the technical support which they had promised, which itself almost worth Tk 300 crore and will help modernise the bourse. “We hope that within this range of support, elements such as market infrastructure & compliance, strategy and incentives for small and medium investors will also be included. DSE’s primary objective now should be to look into what is included within the sphere of that support.”

 

“It is a positive move, considering that a Chinese board member in DSE will ensure third-party monitoring. Even in terms of knowledge sharing, we all know how well the Chinese stock market runs, so their input will be valuable for us. We could also look into how they had similarly claimed a stake in the Pakistani stock market and how it benefited them (regarding regulatory and compliance issues, for example.)”

 

But Toufique also suggested to give the market some time in order to expect positive results, at least a year. After the stock market crash in 2010, restoring investors’ confidence and ensuring monitoring to stop manipulation and bringing transparency were key demands from the stakeholders.  Experts and stakeholders believe the DSE expects a well-regulated and technically sound stock market for the betterment of the investors as well as the shareholders with the help of the consortium.

 

Mahbub H Mazumdar, CEO of AFC Capital, a merchant bank, told Dhaka Courier that the consortium and the DSE will participate in and support the Belt and Road Initiative.

 

Mohammad Alauddin, a stock trader, said: “As a small investor, I would like to forget the memories of 2010. What happened was due to manipulation and careless monitoring. We only expect the consortium to develop a mechanism to ensure fair play in trading.”

 

Shaolin Stocks

 

On the face of it, the tie-up between the Dhaka Stock Exchange and a Chinese consortium comprising two of the country’s three stock exchanges follows a trend of cross-border mergers or acquisitions between exchanges as capital markets become more integrated globally. In this increasingly globalised world, investors can move money around easily so cross-border mergers between exchanges are said to “make sense” to facilitate the flow of funds. The latest bout of merger bids has focused very much on derivatives trading, which is much more profitable for exchanges than equities trading.

 

At its root though, the partnership is the result of the far more specific and difficult experience endured by Bangladeshi investors who went through the debacle that hit the DSE in December 2010, when from an all-time high, the main index nearly halved, representing a loss of 22 percent of GDP and wiping out $27 billion in market capitalisation by October 2012.

 

Following the market debacle, a high-level probe was established by the Government of Bangladesh in 2011 to examine the deficiencies that led to the crash. The probe also highlighted limited enforcement of regulation by the Bangladesh Securities and Exchange Commission (BSEC) and commercial banks’ excessive investment in stock markets.

 

The way back from those boondocks was set out in the development of a capital market master plan (2012–2022). Through a strong partnership between the Government of Bangladesh and the Asia trhe n Development Bank (ADB), which has been involved with capital market development in Bangladesh for over 25 years, reforms have been rolled out, and the market is building confidence as the new policies and regulatory incentives under the Second Capital Market Development Program (CMDP 2) and ongoing Third Capital Market Development Program (CMDP 3) “gain traction”, according to the Manila-based lender’s own assessment.

 

Edging out the challenger

 

The decision by the Chinese consortium to purchase, and also to scrap for it to the extent necessary once the rival bid from India’s biggest stock exchange leading a consortium that also included the US-based NASDAQ materialised, to assume the role of DSE’s strategic partner should encourage capital market enthusiasts, even if the newly installed index for the bourse has not ended a single trading day in May higher than it started it. The clarity and steadfastness also displayed by the Shanghai and Shenzhen stock exchanges through their consortium in completing the purchase of their strategic stake in DSE can be seen as a vote of confidence in the reforms undertaken by DSE since 2013.

 

And indeed they have paid a premium for it. For comparison, we can look at the deal struck by the same consortium members for a 40 percent stake in Pakistan’s National Stock Exchange just last year, in January.

 

Goodbye Home Boys Club

 

One of the agreed reforms the Bangladesh government undertook was to correct the governance structure through demutualization of the Dhaka and Chittagong stock exchanges. This served to align the broader incentives of market development with those of what might be termed the “members of the club,” mainly the brokers and dealers. By strengthening market governance in capital markets, the CMDP 2 enhanced market efficiency and transparency, as well as improved investor protection. The timely and effective completion of the demutualization process at the stock exchanges represented another key milestone of the program in countering strong vested interest and challenging the status quo. The brokers and dealers have historically resisted any reforms that could reduce their control over the stock exchanges.

 

The demutualization of the stock exchanges is meant to segregate ownership, management, and trading rights of members and convert the two exchanges into commercial and more professionally run organizations while enabling them to pursue their strategic interests, including market development, with more vigor. The exchanges are now less susceptible to members’ vested interests, according to the ADB. Numerous steps have been taken to effectively implement and conclude the demutualization process, such as the enactment of the Demutualization Act in April 2013, followed by the submission of the demutualization schemes by both stock exchanges (i.e., operational plans), and the approval of these schemes by BSEC in September 2013.

 

As part of completing the demutualization process, it was decided to facilitate the development of crucial new technology infrastructure through alternative methods of raising capital, such as the entry of a strategic investor into both stock exchanges by June 2017.

 

Leaving CSE aside for the time -being, the fact that it is happening just a year behind schedule for DSE can be no reason to gripe, given the long road back to viability that it has endured.

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