New legislation redefines regulatory oversight of Sri Lanka's capital markets

Sri Lanka’s stock market has grown by leaps and bounds since the end of the civil war in 2009. But while major upgrades to trading infrastructure are well under way, legislation governing the sector – particularly regarding the regulatory body, the Securities and Exchange Commission of Sri Lanka (SEC) – has at times failed to keep pace. However, in 2016 major changes are expected to laws dictating the SEC’s management of the trading of securities.

The SEC Act, enacted in 1987, has been amended three times, in 1991, 2003 and 2009. At its core it laid the groundwork for the current SEC to regulate the securities market in Sri Lanka, including the granting of licences to stock exchanges, registering and managing market intermediaries and setting up a compensation fund. While attempts have been made since 2009 to amend the act further, no resolution has been finalised as of early 2016.

Civil Vs Criminal

A consultation paper in 2012, funded by the World Bank, proposed new administrative and civil enforcement powers to deal with capital markets offences, most of which remain part of the discussion today. Importantly, the SEC’s current mandate to enforce regulation is based solely upon criminal prosecution and the compounding of offences, with action limited to suspension or cancellation of licences. While criminal prosecution is an important component of any regulatory framework, the consultation paper notes it is often cumbersome and costly when taking into account the nature of trading and cross-border offences. For this reason, most major markets, such as Australia and Malaysia, allow their regulators to pursue civil cases independent from criminal investigations. This, in turn, allows a regulator to differentiate between types of conduct and implement a graduated regulation methodology, applying administrative sanctions before civil and criminal, building mutual cooperation between the regulator and stakeholders, and encouraging self-regulation.

Civil and administrative sanctions would allow the SEC to employ a number of useful tools. Civil sanctions allow for civil proceedings in court to recover ill-gotten gains, injunction orders to combat unethical business practices, the ability to recover legal costs and banning directors of public companies. Administrative sanctions include fines and the issuance of public reprimands. Proposed amendments will also allow the regulator to take civil action to disgorge profits made through insider trading, as well as take action against market manipulation. While the current act does have specific provisions against insider trading, amendments will provide greater clarity. The same goes for issues around market manipulation, moving an offence from a stated SEC rule to something covered explicitly under the SEC Act, along with the introduction of statutory presumptions to help in prosecution, and the introduction of statutory defences.

Overall, an amended act is expected to put Sri Lankan capital markets at the level of international standards recommended by the International Organisation of Securities Commissions, namely its set of principles that require comprehensive enforcement powers. Such amendments were handed over to the Ministry of Finance in 2013, with a special committee to review them. Following the general elections and throughout 2015, both the regulator and the Colombo Stock Exchange (CSE) remained confident the act would come online in 2016.

Demutualise

An updated SEC Act is expected to bring other improvements in 2016, including regulation for a demutualised exchange. Currently, the CSE operates as a self-regulatory organisation, formed as a mutually owned company limited by guarantee. The process of demutualisation – converting membership into shares and running as a public, for-profit institution – would follow trends set by some more developed markets and would potentially help expansion efforts through more competition and innovation.