1. Sri Lankas controversial bond issue: ethics, judgement and governance in financial services Fresh look at bond saga in Sri Lanka - Strategist 27/07/2015
2. The purpose This presentation is an attempt to shed light on the potential dark side of a recent bond issue in Sri Lanka. While relying on secondary information we also review some unusual events that have taken place. Like in many other countries regulators in Sri Lanka cannot make an absolutely safe environment for financial services. Financial services sector in general and central banking in particular depend on, to a large extent, on ethics, judgement and morals of participants. Here we look at whether it is the system or the responsible persons have failed.
3. Background A recent government bond issue by the Central Bank of Sri Lanka has become a key discussion topic in Sri Lanka and overseas. The issue appears to have the hallmarks of mismanagement at best and fraud at worst. Many academics and professionals have participated in the discussion. The estimated accounting loss is estimated at Rs 6 billion. However, most of the analysts have not taken into account the resultant reputational damage and likely negative impact on future bond issues and economy in general.
4. Sri Lankas controversial bond issue in perspective SLs controversial bond issue is almost unprecedented When a central banker had come under scrutiny governments have acted swiftly to remove or suspend them Sri Lanka was slow to act Nigerias Central Bank governor was suspended by the president for financial irregularities. Stern action was taken. http://www.bbc.com/news/world-africa- 26270561
5. Governance and compliance There seems to be governance issues at high level Communication of facts has failed and/or facts were communicated but ignored by the policymakers and lawmakers Processes and procedures may not have been the best but they were sufficient Real issue appears to be the failure to comply with existing processes and procedures Lawmakers were at best slow to react and at worst covering up
6. Wrong start - political appointee not a central banker Appointment of a foreign citizen unusual move Candidate with commercial experience but very little central banking experience at senior level Candidate was not aware of the procedures of the Central Bank Knowledge and skill of monetary policy setting was also questionable. Consideration was not given to internal candidates Politics was a hindrance to rational thinking and decision making Recruitment and appointment process was flawed
7. Triple mistakes Volume, Price, Duration Importance of metrics ignored - one cannot manage what one cannot measure Volume: before purchase one needs to know how much to purchase. This should have been documented. It is the policy of any treasury operation. Transparency was lacking. Communication of the volume is paramount to market efficiency foundation of financial markets. It appears reasonable effort was not made to communicate the volume needed in an impartial manner
8. Triple mistakes Volume, Price, Duration It appears that some of the participants were aware of the volume. This disadvantaged the other participants Bank staff have raised this issue Once again market efficiency was compromised
9. Determining price - know thy price Trading price or price range should be realistic It should be meaningful relative to the prevailing market conditions Efficient markets should deliver efficient prices Extreme price volatility is a sign of market distortions Up to 300 b.p. (basis points) above the market is an unacceptable variation Price does not reflect the prevailing interest rate structure. Global interest rates are stable.
10. Determining price market efficiency Market distortion created by unlimited information to limited number of participants created a privileged position for some Arms length rule was not followed Prudent person rule was violated Relationship between the governor and a participant was not disclosed Related party transaction gives rise to insider trading claims which in turn is a serious offence Punishment for insider trading is a prison sentence in many countries
11. Determining price use of available information Price is relative to the prevailing environment Prevailing environment should have been analysed using available information Dealing and research teams had the required information Did decision makers intentionally ignore the information and recommendations? In a well-developed central banking system why was the communication so poor between the governor and his advisors? Was advice ignored?
12. Duration transparent information Duration is basic information that any treasury manager should know Duration of the portfolio should have been analysed and discussed in debt management strategy meetings Yield curve relationship between interest rates and time to maturity of the bonds should have been available in documents and on computer screens (or even mobile phones) Given the published information available better decisions on duration could have been made.
13. Duration internal strategy ignored? Required information was available Duration was clear Current interest structure and expectations were reasonably clear global interest rates were unlikely to increase sharply Shorter duration bonds would have been more appropriate to the requirements Available information has not been taken into account
14. Unusual Trinity Was interest of CBSL compromised by Governor/Son-in-law relationship? Central Bank of Sri Lanka (CBSL) Perpetual Treasuries (PT)Bank of Ceylon
15. Triple failures Failure 1: Related party was not disclosed Failure 2: Unusual related party transaction was not disclosed giving rise to an insider trading claim Failure 3: Expert advice ignored
16. Dealer (PT) using another dealer (BOC) One cannot help but question this relationship Perpetual Trustees used another dealer An unusual move Why did a state-owned bank (BOC) act as a dealer to a dealer(PT)?
17. Slow response from regulators Regulators response has been slow Only after extreme pressure from the lawmakers the Prime Minister agreed to a parliamentary enquiry It is reasonable to assume that political obstacles forced regulators go slow.
18. President the Whistleblower President identified the problem Some may argue that the President of Sri Lanka does not possess the required knowledge without giving credit to his senior advisors Common procedure is for the CB Governor to step down. Failure to do so created further interest on this controversial bond issue
19. Did the President stop short of his duty by the country? Nigerias President Goodluck Jonathan suspended the Central Bank governor for financial recklessness and far-reaching irregularities http://www.ft.com/cms/s/0/9c09b882-9a18-11e3-a407- 00144feab7de.html#axzz3hK7ZGemd http://www.economist.com/blogs/baobab/2014/02/trouble- nigerias-central-bank Should Sri Lanka also follow Nigerian example? Presidents inaction is unexplained to the market
20. Unprecedented damage is underestimated There are estimates of Rs. 6000 millions of damage These estimates do not take into account the reputational damage and resultant increase in interest rates for future issues Also they do not take into account cost of high interest to the wider economy and resultant drag on the economy as a whole