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Creating an Enabling Environment for Broader Capital Market Development in Sri Lanka

Project Development Objective ( PDO )

This program aims to support the Government of Sri Lanka’s efforts in developing a deeper and more diversified capital market that can meet the demands of savers and investors whilst meeting the long term financing needs of the economy by:
(1) supporting Central Bank of Sri Lanka (CBSL) in designing and implementing the government bond market development activities to improve the efficiency and liquidity of the bond market and scale up the secondary market to attract more cost-effective long-term financing;
(2) supporting Securities and Exchange Commission of Sri Lanka (SEC) in improving corporate bonds issuance regulations and making improvements to the market intermediary rules in line with IOSCO principles to boost investor confidence; and
(3) expanding the investor base by (a) supporting CBSL to establish a diversified investment strategy, improved internal investment governance and expertise for the Employees Provident Fund (EPF) and (b) supporting IBSL to amend the Insurance Act and regulations in line with Insurance Core Principles (ICPs) with a view to improve consumers’ confidence and enabling further market development.

Background

Sri Lanka is focusing on long-term strategic and structural development challenges as it strives to transition to an upper middle income country. The country has experienced fast growth over the past decade but the growth has slowed down recently. During 2011-2015, Sri Lanka’s economy was one of the fastest growing among South Asian peers with an average growth of 6.1 percent. The reduction in poverty and improvements in household welfare since 2002 is noteworthy and places the country well on its way towards eradicating extreme poverty. However, with a financial market that is dominated by the banking sector, the under-developed capital market is ill equipped to support the growth momentum that the country aspires to. Inadequate diversification of Sri Lanka’s financial system impacts financial efficiency, limits options for credit intermediation needed for growth and greater stability, and impairs economic resilience. The underdevelopment of the capital, pension, and insurance markets undermines the ability of Sri Lanka to meet the long-term financing needs of the economy[1].
 
As pointed out by the 2015 FSAP (Development Module), Sri Lanka is confronted with challenges to build a sound enabling environment that could support the development of capital markets. Key challenges include (i) an inefficient and underdeveloped government bond market that fails to fulfil its potential and relevant catalytic role as reference and anchor for the development of other capital market products such as corporate bonds; (ii) a regulatory framework that needs to be strengthened and become more efficient to enhance investor confidence and facilitate the launch of a wider set of capital markets products; and (iii) a narrow investor base that needs to both expand and improve its capacity to invest in a more diverse asset class. A comprehensive and well-sequenced approach is required to unlock the path for the development of capital markets.

[1] In a report prepared for the Colombo Stock Exchange in 2012, Mckinsey & Company estimated that in order to sustain the 8.0 percent growth rate, the government needs to mobilize at least US$300 billion over the next 8 years.

 

Activities / Output

The envisaged activities of this technical assistance are as follows:

Component 1: Government Bond Market Development

(i) Enhance Institutional Framework for Government Bond Market Development

(ii) Supply Issues: Strengthen Primary Market

(iii) Strengthen Secondary Market Pre-Trade and Post-Trade Mechanisms to enhance transparency and price discovery

(iv) Debt market development workshops/trainings with key stakeholders and market participants to gain buy-in for the introduction/implementation of the proposed reforms

 

Component 2:  Improving Regulatory Framework

This component will focus on key implementing regulations following the revised SEC Act to enable further market development.

(i) Review and suggest improvements to corporate bonds issuance regulation and procedures; 

(ii) Improving Securities regulations/rules

 

Component 3:  Expanding Investor Base 

(i) Addressing investors / demand side constraints

(ii) Comprehensive mapping of the current investor base and demand side constraints focusing on government bonds by different investor segments and develop an action plan 

(iii) Implementation of measures to diversify the investor base 

(iv) Establishing a diversified Investment Strategy and Business Process Improvements for EPF

(v) Amendments to the Insurance Act and regulations

Expected Outcomes

The main expected outcomes of the project are as follows: 

1. Strengthened institutional structure, transparency, and issuance practice, helping to reduce fragmentation and build a reliable and liquid benchmark yield curve

2. New measures to improve secondary market transparency and liquidity adopted (e.g., PD and ETP)

3. Increased flexibility for corporate bonds issuance rules/procedures

4. Improved market intermediary rules in line with IOSCO standards, helping to improve confidence for investors

5. Improved investment policies, practices and efficiency for EPF

6. Improved enabling environment for insurance market to expand (Insurance Act and regulations in line with ICPs enacted)