Role of Capital Markets and Chartered Accountants

1. Role of Capital Marketsand Chartered Accountants Ferdous Khan, B. Sc., MBA, FCA ICAB, Dhaka, March 2011

2. Welcome • Madam President, Hon. Chairman of the session, Hon. Chief Guest, Hon. Vice Presidents, Hon. Council Members, distinguished Members, ladies and gentleman; it is my pleasure today to have this opportunity to make this presentation to you on Role of Capital Markets and Role of Chartered Accountants. We have limited time, and I will be able to present to you high lights.

3. Capital Markets • Capital markets are where companies which need long-term finance can meet investors who have finance to offer. This finance may be equity finance involving shares, or debt finance in which case companies can choose from a wide range of loans and debt securities. • Capital markets are also where investors buy and sell company and government securities. Their trading decisions reflect information on company performance provided by financial statements and financial analysis, dividend announcements by companies, market expectations - on the future levels of interest rates, inflation and investment decisions made by companies.

4. Capital Market • Why capital markets? • To allow for the efficient allocation of capital across industries, and by extension, society as a whole. • Wealth generation for Savers cum investors by directing their savings to most efficient use of Capital and Labor in companies seeking finance, on a long-term basis.

5. Functions of a capital market • First, they are where long-term funds can be raised by companies from those with funds to invest, such as financial institutions and private investors. In fulfilling this function, they are primary markets for new issues of equity and debt. • Second, capital markets allow investors to sell their shares and bonds, or buy new ones to change composition of their portfolios. Here, capital markets act as secondary markets. The secondary market plays a key role in corporate finance, because by facilitating the buying and selling, it increases their liquidity and hence their value (by reducing risks). Investors would pay less for a security that would be difficult to sell at a later date. The secondary market is also a source of pricing information for the primary market and so helps to increase the efficiency with which the primary market allocates new funds to their best use.

6. Determinants of efficiency An efficient market needs operational efficiency, allocational efficiency and pricing efficiency • Operational efficiency means that transaction costs should be low and sales executed quickly. • Pricing efficiency means that share prices fully and fairly reflect all relevant information and so are fair prices. • Allocational efficiency means that capital markets allocate funds to their most productive use by companies through cash generation requirements.

7. Investment decisions • A Company demands capital when it has projects which can generate cash flow from operations and make a return on the capital, higher than its cost of capital; • A saver offers his savings as investment when he considers he will receive a return higher than the risk free rate from the share/security; • The regulatory environment is required to ensure that market is not misled about the potential of projects of a company; and all value/price sensitive information is rapidly made available to market. • Insider dealing is prohibited; • Public announcements and regulatory submissions are required; • Sound and Proper persons test for Companies, Auditors, Regulators and market participants are enforced. Management and Directors of companies are required to pass stringent sound and proper person tests. And these processes are continuous.

8. Value creation and addition • Value is different than price; Value is intrinsic, meaning within; Value can be created by a company by enhancing surplus cash generation (reduce costs or enhance revenue), by reducing risks, by reducing pay back period and other things that are determinants of value; • Value may be added by undertaking projects which generates surplus cash at a rate higher than cost of capital employed. • Value is destroyed when an investment has an IRR below the cost of capital employed. • There are Zero sum games, like speculative betting, or Gambling.

9. Value of shares • Value of a share is discounted net present value of all cash flow from owning that share. • The discounting rate is the appropriate cost of capital. • Dividend valuation approach (DVA) - relies on the equivalence of the market price of a stock, P0,with the present value of the dividends ( or cash flows) expected from the stock.

10. Valuation model • The discount rate in finding the present value is considered to be the cost of equity capital. Cost of equity capital = risk-free rate +beta (market rate - risk- free rate) Re = Rf +  (Rm - Rf) A firm’s beta is correlationship of its price to market price movements.

11. Value creation strategies • Value-creating strategies can be applied in practice: • Net operating profit after tax can be increased by eliminating unnecessary costs. Undertaking projects which generate returns in excess of the company’s cost of capital can be achieved by using net present value (NPV) and internal rate of return (IRR) as investment appraisal methods. • A company’s cost of capital can be reduced by the sensible use of debt. • The amount of invested capital can be reduced by disposing of unwanted assets and by returning unwanted cash to shareholders via a share repurchase scheme.

12. Price of Finance • Price in a capital market, like any other market is determined by supply and demand. • Demand in this context in a normal capital market means demand for funds/finance from companies or issuers of securities. Secondary market demand also affect prices. • Supply in this context means supply of savings from investors in a long-term investments, mostly directed through structured savings arrangements such as Pensions and Insurance arrangements.

13. Investment Principles for Savers • First principle of investment is never loose your savings. • So, one invests in risk free capital, such as in Government bonds or securities, when seeking risk free investments like when in pension age. Depending on risk profile, investors then add risk to investment profile and seek enhanced return to match the price of risks. • Secord principle of investment advise is always get paid back. Pay back period, price/earnings ratios, interest cover, dividend cover etc. are all different ways for an investor to determine how long it would take to get paid back. Risk enhances with time, and longer the pay back period, lower is the desirability of the investment.

14. Chartered Accountants • Qualified Chartered Accounts have been playing a tremendous role in enhancement of Governance, Trust, Efficiency and Transparency in a Capital Markets. • Chartered Accountants with their ethics, integrity, and professionalism can provide the foundation of the basics of efficiency in the capital markets through assisting operational, pricing and allocational efficiency .

15. Integrity, Ethics, Independence and Skills • In a typical capital market scenario, Intermediaries, Investors, Issuers, Corporate and Regulatory Authorities rely on Ethics, Integrity, Independence, and Skills of the Chartered Accountants in discharging their respective obligations to the investors. The entire field of Financial Services rely heavily on Trust of the work of Chartered Accountants.

16. Roles • Chartered Accountants play the following roles, among others, in the capital markets. • As an auditor to the company tapping the capital markets; • Emerging practice role; • As an advisor to the company tapping the capital markets; • As a regulator working for SEC or Stock Exchanges; • As an Entrepreneurial role - intermediary; • As an Investment Banker; • In the IPO Process; • As in other emerging roles

17. Auditor role • Providing, professional opinion on completeness, accuracy, compliance, and presentation – could be independent auditor or an internal auditor; • Ethics, and Integrity of the professional is key, as also the professionalism, independence in opinion; • Provides the basis of trust in evaluation of transactions in financial markets. • Auditor’s by their independent external and internal audit provide assurance on the quality and quantity of risk in the financials of the company, thus reducing the risk premium required in investing in the company. London Stock Exchange still requires all their listed companies Financial Statements to be Audited by Chartered Accountants, whilst rest could be Audited by any Registered Auditors.

18. Advisor role • The advisory role has evolved from being an advisor on tax and related matters to positioning the company amongst the knowledgeable investors, advising the company on the value chain which they need to pursue, and continued feedback on the key acts which the Company must do to sustain its valuation, attract quality investors interest etc. • Keeping in view the complications and stiff pulls and pressures of burgeoning capital markets, the skills and expertise of trained Chartered Accountants are highly relied upon by the financial services sector, intermediaries, investors, issuers, corporate and SEC, DSE AND CSE. And now, more opportunities await the professionals in this area.

19. Emerging practice role • The whole approach towards risk management, controls have changed. • Managements are increasingly providing a better budget for risk management and Chartered Accountants plays an important role as Chief Risk Officer, or Chief Internal Control. • Knowledge of accounts, accounting, finance, financial analysis and law pertaining to issues of securities with regards to provisions of the Companies Act, Securities Exchange Commission Act etc. • In addition, knowledge of the client or the Issuers business helps in profiling and positioning of the business to the outside world at large. This is the key ingredient to any fund raising plan.

20. Certifying • Accountants play a key role in advising on/certifying the following: 1. Compliance with the corporate governance. 2. Promoter contribution in a project. 3. Amount deployed/spent on project. • Requirements to capitalize with the expansion in the role, approach and accountability there is a tremendous responsibility cast on the Chartered Accountants to play their role effectively and stay ahead in the competition. • Again, Chartered Accountants by their Ethics, Integrity and independent Professional position provides assurance on quality and quantity of risks in those opinions and financials.

21. As a regulator • Chartered Accountants can work as a regulator either for Stock Exchanges or for SEC. They also work for Bangladesh Bank, and Government. As a regulator, chartered accountants can be skillfully employed in policymaking, monitoring review, surveillance and investigation. • ICAB members have been acting for the SEC and are also on the boards of DSE and CSE; • ICAB members have been co-opted in the investigation committee set up by the Government recently to investigate the affairs of the capital markets; • There is increased realization in market participants that having a chartered accountant on Board pays – It pays to pay a Chartered Accountant. Or keep his company as such.

22. As an Entrepreneurial role - intermediary • New Investment banking firms, broking entities and the improving regulatory environment has encouraged Chartered Accountants to become entrepreneur by themselves. With the better understanding of the financial products, Chartered Accountants have become an effective entrepreneurs in distribution, wealth management etc.

23. Investment Banker • As an Investment Banker, a Chartered Accountant also helps in formulating financial strategy to successfully tap the capital markets and ensure success for the fund raising plan of companies. • Putting together an efficient capital structure, creating financial model, profiling business promoters and management and advising on valuation are the other key ingredients for successful capital market entry.

24. Contribution to Efficiency of Capital Markets • No stock market anywhere in the world is a perfect market. However, companies and investors rather need capital markets to be efficient and to offer fair prices and good regulatory environment so they can make reasoned investment and financing decisions and executions. • Chartered Accountants with their Integrity first and their professionalism in the second, provides the basis building blocks for the Trust that is required for the efficiency in the Capital Markets.

25. IPO Process roles • Initial public offerings (IPO) are often considered to be the ultimate goal for any entrepreneurial venture. An IPO is offering stock to the public on an open market for the first time. Once a company decides to go public, it needs to pick its IPO team, consisting of the lead investment bank, an accountant and a law firm. • The prospectus is an offer document that is used to describe all aspects of the company - its financial data for the past five years, the management team, the target market, competitors and growth strategy. • Chartered Accountants here also play a key assurance role.

26. IPO Process roles • The independent accountant’s role in the IPO process includes auditing the financial statements, restating them in compliance with SEC requirements, and resolving accounting issues. Increasing emphasis is being placed on the scope of “comfort letters” which a company’s auditor provides to the underwriters and the company’s board as part of their due diligence. • Commentary on accounting policies and problems, improper revenue recognition, avoiding changes merely for the purpose of inflating profits are few of the areas, the accountants insight are sought. • Accountants can also leverage their experience during the planning phase to help ensure that the RJSC records are in order before the IPO process.

27. Other emerging roles • Financial analyst, media expert covering the capital markets, investment advisor, financial services marketing are some of the emerging roles for the young Chartered Accountants to deploy their skills effectively.

28. Self Assessment • There are room for improvement in what we do. • We are all products of our environment and the environment affects us. We need to do critical self examination as to how well we do what we do. • Are we united, have a proper voice, and delivering our potential. • All our work alone could not have prevented the Stock Market going up and then coming down, that’s what markets do. • Audit is the principle monopoly activity of this body.

29. Thanks • Thank you for allowing me to make this presentation. Thank you for listening. You are all experts in the same field that others say I claim also to be an expert. • I welcome any clarification that you may seek on the presentation. • If it is not in the presentation, I shall try to answer the question to my best of abilities.