THE CHALLENGES OF CAPITAL MARKET REGULATION

1. THE CHALLENGES OF CAPITAL MARKET REGULATION BY MRS. ABIGAIL ORITSEBEMIGHO OBHIELO SECURITIES AND EXCHANGE COMMISSION LAGOS.

2. CHALLENGES OF CAPITAL MARKET REGULATION I stand on existing PROTOCOL DISTINGUISHED PROFESSIONAL COLLEGUES, LADIES AND GENTLEMEN Good afternoon, it is an honor to be here with you today. I have been asked to speak to you on the challenges of capital market regulation. Before I begin my prepared paper, I am obligated to give you the usual disclaimer that the views I will express here today are my own and do not necessarily reflect those of the SECURITIES AND EXCHANGE COMMISSION.

3. PREAMBLE As we all very well know, capital market do not operate in isolation or is it limited to buying and selling of shares to make urge gains all the time. It encapsulates a whole range of activities, institutions, and a myriad of interested parties. The interplay of these cumulates into challenges for the regulation of the capital market. There is no gainsaying that sound regulation strengthens confidence in capital market and therefore helps its development.

4. Bank Consolidation The year 2007 was a very busy year for the Nigerian capital market. It was the year; the Banks had to comply with the central bank of Nigeria consolidation policy. It brought with it a host of challenges, for the Banks, the regulators, the existing market infrastructure, the investors and other participants. It also brought good fortune across the board, but was short-lived by the global financial crisis in 2008.

5. THE GLOBAL FINANCIAL CRISIS The global financial crisis brought financial loss indirectly to the Nigerian investors as well. The crisis also bought regulatory and corporate governance issues to the front burner. It exposed the weaknesses of the regulatory and supervisory framework of countries. When it started, it was believed that Nigeria was not going to be affected as the Nigerian financial system was not dealing with the type of financial instruments that were not performing in the global scene. We seem to forget that we were in a global market without boundaries and that what happens in one country could affect another country directly or indirectly. Nigeria of course, was affected indirectly. It was the ripple effect that caught up with the Nigerian capital market. Foreign portfolio and hedge fund managers, who had invested heavily in the offer for subscription of banks,

6. had to safeguard their client investment by exiting the Nigeria Capital Market. While they were investing in the Nigeria Capital Market, they created a seeming liquid market. There was scarcity of stock in the secondary market and almost all offers in the primary market were heavily oversubscribed. Investors could not be allocated all the shares they paid for so it became necessary to return money to subscribers. The result of the scarcity of shares and the stimulated interest in the capital market introduced its own challenges. The economic principles came to play, demand was more than supply, so Prices of all shares appreciated , even moribund companies benefited from the unexplained sudden rise in the prices of shares across the market. More people got involved, even those who had very little knowledge of the workings of the capital market sought to become shareholders, if not for anything but to sell and make huge profits.

7. As the global crisis deepened, the foreign investors decided to exit the Nigerian capital market, by off loading their large volume of shares into the market. The market got saturated with shares without corresponding buyers. On the part of the retail investors they could not catch in to take profit as share certificates were not being issued promptly and the process of certificate verification at the Registrars offices took so long to be completed. Since the retail investor could not exit and there were no willing buyers, share prices across the market started plummeting. Very many investors lost out as the good fortune which they saw passed them by. The activities above led to the investigation, of the Stock Exchange, Capital Market Operators, some Issuers of Securities and the companies whose shares started rising when there were no fundamentals to support them.

8. NIGERIA CAPITAL MARKET CRISIS Apart from the global financial crisis, Nigeria had its own peculiar internal financial crisis in the capital market. There was large scale usage of margin loan granted by Banks to stockbrokers to buy shares which later had serious negative consequences for the banks who gave the loans. There were cases of fraudulent and unethical practices by the Executive and board of some banks; none purchase of shares for client by some stockbrokers; misappropriation of client funds by receiving agents; cases of multiple applications; non return of surplus money by some issuers of securities; and non release of issue proceed by some receiving bankers. SEC and CBN promptly commenced investigation of the activities of the affected banks and capital market operators which was stimulating the capital market negatively. Those with indentified and proven cases of infractions were presented before the Administrative Proceedings Committee– APC for hearing .

9. POLICY IMPLEMENTATION AND SUBSEQUENT CHALLENGES Failure of Public Banks and There Nationalization Public banks who could not meet with the required minimum capital, and could not also get a willing acquirer rather than allow them to be liquidated, were taken over by central bank and NDIC. Having streamlined their activities were subsequently Nationalized APRIL 2011 CODE OF CORPORATE GOVERNANCE The introduction of the code of corporate governance, required mandatory undertaken by the Board of public companies to comply with its provisions and to file half yearly returns within a given timeframe. The general observation was that most companies failed to comply, as specified. Non compliance was therefore penalized by the commission. It took SEC the application of its enforcement powers before public companies could embrace the code of corporate governance and state same in their published Annual financial statements.

10. ADOPTION OF THE INTERNATIONAL FINANCIAL REPORTING STANDARD (IFRS) Adoption of IFRS was approved by the Federal Executive council during this period. There were quantifiable benefits to be derived. The capital market participants were not ready at the time approval was given for adoption. The timeframe given for the adoption was short and this posed a very serious challenge. The processes to be followed were very tasking. Knowledge of IFRS across the market was limited. There was urgent need for capacity building. Several changes in procedure , processes , infrastructure and huge investment was therefore needed to address the demands adoption of IFRS brought. Both the regulators and the public companies were engrossed with strategies to overcome these challenges. All of these posed serious challenges for the regulators, the public companies, and External Auditors and Professional bodies.

11. PROVISION OF FINANCIAL INFORMATION TO THE MARKET Compliance with Sections 60 to 65 of the Investment and Securities Act (ISA) 2007 on corporate responsibilities of public companies posed some challenges. To give effect, the commission designed a reporting format for public companies to render periodic and annual audited financial statements to the investing public. This was aimed at ensuring that investment decisions were based on timely and reliable financial information. A time period within which these statements should be released to the market and the commission was also stated. Companies generally failed to comply with this regulatory requirement. Enforcing this rule was necessary at this time because of some of the identified causes of the global financial crisis. Information off course is key to capital market activities. All efforts to make public companies comply failed. Series of reminders were sent and names of companies whose periodic reports were due for filing and release to the market were published in the National daily Newspapers as a reminder. As a last resort, the commission applied the sanction rules, companies who defaulted were penalized. It was after the punitive action that public companies started to comply. All of these presented challenges to the Regulator as the relevant regulated entities failed to comply regulatory requirement as and when due.

12. CONSEQUENCES OF THE FINANCIAL CRISIS • The global and domestic financial crisis revealed some regulatory challenges which needed to be addressed, for example • The crisis brought regulatory and corporate governance issues to the front burner as it exposed the weaknesses of the regulatory and supervisory framework of countries. • It showed that Lack of collaboration among regulators prevented a comprehensive and a consolidated view of the activities in their respective domain. • It revealed that regulators were not proactive enough in identifying and addressing possible threats to the capital market . • It became evident that financial institutions which were poorly governed posed a risk to themselves and to others which could lead to the collapse of financial markets.

13. THE PERSPECTIVE OF THE PAPER Having dwelt a little on some key happenings in the financial market and the Nigeria capital market, it is considered important to put the topic for discussion in perspective by defining the key words which are Challenge, capital market and regulation. Definitions Challenges (1a) A challenge is something new and difficult which requires great effort and determination. For example a new government's first challenge could be the economy.( Collins English dictionary ) (1b) A challenge is a difficulty that bears within it an opportunity for development, Once we triumph over a challenge we rise up to a higher level than before.

14. CAPITAL MARKET (2a) Capital market according to the (Webster’s New World Finance and Investment Dictionary), is defined as the markets in which debt and equity are raised and then traded in the secondary market. (2b) the capital market can also be defined as the segment of the financial system for the sourcing of medium to long-term funds. The maturity or tenor of the instruments issued and traded, by this definition, is the major distinguishing factor between the money and the capital markets. While the maximum tenor or maturity date of instruments traded in the money market is usually less than one year that of capital market could range from one year to perpetuity.

15. REGULATION (3) Regulation on the other hand is defined as a rule of order having the force of law, prescribed by a superior or competent authority, relating to the actions of those under the authority's control. A summary of the definitions gives a clue that the challenges in the capital market bears with it an opportunity for development. The regulator can therefore come up with enforceable rules, so that the benefits within the opportunities can be realised.

16. HOW DOES REGULATION IMPACT ON CAPITAL MARKET Regulation of capital markets covers the participants, institutions, and the instruments that are traded in the market. Regulation enables capital market to function more efficiently, transparent and impartial. Capital market is of great interest to the global community that is why the International organization of securities organization (IOSCO), the umbrella body for securities commissions from time to time comes up with best practices in securities regulation. As at June 2010, it came up with 38 principles of securities regulation, which are premised on three core objectives namely: • Protecting investors • Ensuring that markets are fair, efficient, and transparent; • Reducing systemic risks

17. Members of the organization are implored to practically implement the principles under their respective legal framework. The principles provide a good basis to analyze the activities of the capital market and its participant’s .It also facilitate assessment of the steps taken to ensure that the challenges of capital market regulation are stemmed. The entire 38 principles are included as an appendix simply for your information and to give you a basis to assess the performance of the capital market from the perspective of the regulator and the other participants. They are neatly put in groups for the ease of appreciation. Whenever the concerns about challenges of capital market is being discussed our attention should focus on what ought to have been done by each of these groups that was not done. Fixing them should therefore be a collective effort of all concern . See Appendix A for the principles.

18. REGULATION OF THE NIGERIAN CAPITAL MARKET The Securities and Exchange Commission is the apex regulatory body of the Nigerian Capital Market. It is responsible for the regulation and development of the market .It’s core function is to protect the rights and benefits of investors. Market Regulation In regulating the capital market, the Commission undertakes the following activities in order to protect investors, market operators and also ensure market integrity.

19. Registration of securities and market intermediaries ensures that only fit and proper persons / institutions are allowed to operate in the market.  Instruments and persons registered in the market are: • Securities/Commodity Exchanges/Capital Trade Points • Futures, Options and Derivatives Exchanges • Depository, Clearing and Settlement agencies • Capital Market Operators:

20. Issuing Houses • Securities dealers/Stock brokers/Sub- brokers • Registrars/Transfer agents • Trustees • Reporting Accountants • Solicitors • Investment Advisers etc. • Securities: • Equities • Debentures • Debt instruments • Collective investment schemes

21. Inspection is either done “on-site” or “off-site”.  The Commission, at regular intervals, calls for information from capital market operators. It also undertakes and conducts inquiries and investigation of any participant in the market whenever necessary. • Surveillance is carried out on exchanges and trading systems to forestall breaches of market rules as well as deter and detect manipulations and trading practices which are capable of causing market disruption. • Investigation of alleged breaches of the laws and regulations governing the capital market and enforcement of sanctions where appropriate.

22. Enforcement actions are taken against market operators who are found wanting after investigation is carried out. In minor cases, an all parties meeting is convened by the Commission where it mediates between parties involved in a dispute.  However, if the case is serious or where no resolution is reached or a party fails to comply with a directive given at the all parties meeting, the defaulting party will be called before the Administrative Proceedings Committee (APC), which is a quasi judicial court, with only civil jurisdiction.    Appeals against decisions of the APC are usually made at the Investment and Securities Tribunal (IST).  Enforcement action may be in the form of payment of fine, ban, suspension or even forwarding the case to the Nigeria Police Force (NPF), Economic and Financial Crimes Commission (EFCC) or the Attorney - General of the Federation (AGF) where allegations are found to be criminal in nature. • Rules are made by the Commission as developments occur.  This is to ensure that the Commission meets up with international best practices.

23. CAPITAL MARKET AND THE INSTRUMENT TRADED Capital market exists to provide a public forum for the raising and investing of money and as an exit mechanism for those who have participated in the raising of this capital. This function permits investors to enter into a transaction to acquire a financial instrument, secure in the belief that, should the need occur, they have an exit route and they can turn financial instruments into cash. Today market – based economies evolved from the modern economies whose health is premised on orderly capital markets. Financial markets play a major role in fulfilling society‘s key economic needs.

24. These include: • Funding governments, local production, and international trade; • Facilitating investment for those with excess funds above their immediate needs; • Expediting development of large infrastructure projects; • Permitting the conversion of investment in financial instruments into cash; • Providing mechanisms to exchange one currency for another; • Offering mechanism to offset the risks that underlie economic activities.

25. Without healthy financial markets, economic transactions would be very expensive to transact; they could even be conducted by barter or else settled in some type of local currency. Acquiring goods and services from outside a local area would be difficult and costly because there would be no readily accessible, cost effective place to exchange one local currency for another. Companies, financial institutions, sovereign states, local authorities, quasi- governmental entities, not – for profit and supra- state entities such as the World Bank use the capital market to acquire funds to pay for the economic activities in which they engage.

26. The capital market also provides financial instruments, known as derivatives. The technical term of a derivative is a financial instrument the value of which is derived from the value of another asset (e.g. a bond, share, currency, or commodity). They are mechanisms for managing financial risk and they have been used for a long time. Derivative as a financial instrument is yet to be fully embraced in the Nigerian financial system. They have important risk properties; this means that they can be used as tools for managing the risk exposures that every financial transaction carries- the risk that the basic element supporting the transaction may change. For example, interest rates, currency exchange rates, commodity prices and share value all fluctuate over time. Derivative provides a method for offsetting the risks of these fluctuations.

27. However, derivatives have underlying risks of their own that can cause problems. Lax oversight and failure to control derivative risk led to the collapse of barring, the merchant bank in 1995, and the write- off of $835 million in losses accumulated over many years at a subsidiary of Allied Irish Bank in 2001. A number of markets have developed infrastructure for trading derivative and the management of risk. They include several commodity and financial futures market; the largest is the Chicago mercantile Exchange. Such markets are used by those who wish to ‘hedge ‘or lay off a risk, or take on a risk with the hope of earning a return from doing so.

28. THE PRIMARY AND SECONDARY MARKETS A primary market is one where new debt or equity issues are arranged. Irrespective of the complexity or sophistication of the instrument used in a primary market transaction, an equity or debt issue is simply raising new cash in exchange for a new financial claim which is evidenced by a legal instrument. Holders of equity and debt instruments issued in the primary market often want to sell them. Such sales are a secondary market transaction. Stock exchange trading information reported in financial papers is about secondary trading, the exit route for someone who no longer wants to hold a financial instrument.

29. THE INSTITUTIONS THAT INTERRACT IN THE CAPITAL MARKET The financial system consists of the money and capital market. The institutions that interact within the capital market are: Insurance companies, Pension fund Administrators, Central Bank of Nigeria, Nigerian Stock Exchange, Professional bodies, Corporate Affairs commission, Financial Reporting council, Ministry of Finance, Investment and securities Tribunal, market intermediaries, Investors, media, etc. From the list above it is clear that the capital market is inundated with many other key players, whose activities greatly impact on the overall outcome of the market. Some may be counter-productive in terms of primary loyalty when related to the performance of the overall regulation of the capital market

30. Actions taken to date by Securities and Exchange Commission (SEC) • The Global Financial Crisis and the domestic crisis presented several challenges. From the investigations carried out it was observed that participants were engaged in practices that were either not regulated or the rules in place were no longer adequate. To bring the market back to sanity, a host of new Rules/amendment were put in place. See attachment B • A new Code of Corporate Governance was introduced in April 2011. • The Commission also took steps to put a number of structure, in place e.g.

31. Demutualization of the Nigerian Stock Exchange (NSE) • Bond Market Development. • Introduction of Book Building and Shelf Registration. • Approval-in-principle granted to National Association of Securities Dealers (NASD) Ltd to operate Over the Counter market (OTC). • Introduction of New Products. • Adoption of International Financial Reporting Standards (IFRS). • Migration to Risk-Based Supervision (RBS). • Market Automation. • Investor Education Programme. • Drafting of Securitization Law.

32. Gazette of Anti-money Laundering (AML)/Counter Terrorism Financing (CFT) manual for capital market operators. • Robust synergy with the Law Enforcement Agencies. • Improvement of Complaint Management System. • National Investor Protection Fund (NIFF) • International Collaborations. • Media Partnership. • Forbearance for Stockbrokers.

33. RECOMMENDATIONS • The crisis has made clear that the financial system is a global system with linkage across countries. Thus, there is need to expand the local regulatory structure to a global level to effectively check systemic risk. Monitoring systemic risk at the global level is therefore imperative. • The Commission will need to continue to forge closer relationships with other regulators, both locally through the Financial Services Regulatory Coordinating Committee (FSRCC) which is said to have been reviewed and re-invigorated and internationally, through the aegis of the International Organization of Securities Commissions (IOSCO). • The Nigerian Stock Exchange should continuously be encouraged to more effectively assume and perform the oversight functions associated with its Self Regulatory Organization (SRO) status. Other trade groups which are expected to evolve into SROs should also be encouraged to meet the conditions for assuming such status.

34. SEC needs to lay more emphasis on its oversight of capital market institutions and participant that are subject to regulation. • SEC needs to continue to maintain a zero tolerance policy on infractions. Enforcement actions should be taken against defaulting operators. • Capital Market Operators and their employees should be encouraged to abide by the code of conduct with a view to promoting professionalism and accountability. • Compliance with the code of corporate governance should be more vigorously monitored.

35. Having ensured the implementation of IFRS for the capital market, monitoring compliance should be addressed. More capacity building across the market is relevant to meet the daunting disclosure requirement. • More effort should be made to ensure that timely periodic and annual returns to the market and the commission are aggressively pursued. Information is key and it should not be compromised. The commission should maintain its enforcement actions. • Having ensured the implementation of IFRS for the capital market, monitoring compliance should be addressed. More capacity building across the market is relevant to meet the daunting disclosure requirement.

36. All gaps and overlap in regulatory oversight need to be bridged to avoid regulatory arbitrage. Policy statements, rules or circulars issued by the different primary regulators in the capital market should take cognizance of market rules put in place by SEC. • The commission need to be more adequately funded, so that her staff strength can be increased for more effective oversight activities. The US SEC is an example • Any market participants found to abuse the integrity of the market need to be sanctioned, and made to face the law.

37. CONCLUSION Challenges of capital market regulation can be approached from different perspectives, based of course from the view point of the person dealing with the subject. On my part I have approached the topic from the perspective of an insider but with some personal views added. Capital markets need a collective and positive effort to meet the intended purpose. Behavioral and band wagon effects has serious negative impact on markets. Markets fall and rise, people are meant to learn from history, but this is never the case. People rather choose to learn from their own mistakes. Thank you for listening and God bless you all.