Project work report on NEPSE and SEBON

A PROJECT WORK REPORT ON

SECURITIES MARKETS AND REGULATION OF SECURITIES MARKETS IN NEPAL

Submitted To Prof. Dr. Rajan Bahadur Paudel Faculty, Investment Management Uniglobe College, Pokhara University

Submitted By Even Roll Numbered Group MBA (Finance) Trimester III, Uniglobe College

February 15, 2013 Baneshwor, Kathmandu

ACKNOWLEDGEMENT We would like to express our immense gratitude to Professor Dr. Rajan Bahadur Paudel for his constant support and motivation that has encouraged us to come up with such an interesting and knowledgeable report that would help us to have clear insights on securities trading and regulation in Nepal. We owe our sincere thanks to great many people who helped and supported us during the accomplishment of this project work mainly to the staffs of computer lab and library of Uniglobe College. We also extend our heartfelt thanks to our well wishers.

Even Roll Numbered Group

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TABLE OF CONTENTS ACKNOWLEDGEMENT ............................................................................................... i TABLE OF CONTENTS................................................................................................ ii LIST OF TABLES ........................................................................................................ iv LIST OF FIGURES ....................................................................................................... iv ACRONYMS ..................................................................................................................v

CHAPTER I: INTRODUCTION ..................................................................................1 1.1. History of Security Market ....................................................................................1 1.2. Introduction to Securities Board of Nepal (SEBON) ..............................................2 1.2.1. Objectives and Functions ..............................................................................2 1.2.2. Organizational Structure ...............................................................................3 1.3. Introduction to Nepal Stock Exchange (NEPSE) ...................................................5 1.3.1. Functions and Objectives ..............................................................................5 1.3.2. Organizational Structure ...............................................................................6

CHAPTER II: MAJOR ACTIVITIES OF SEBON AND NEPSE ..............................8 2.1. Activities of SEBON .............................................................................................8 2.1.1. Securities Registration and Prospectus Approval .............................................8 2.1.2. Public Issue Approval .....................................................................................8 2.1.3. Right and Bonus Share Registration ................................................................8 2.1.4. Licensing Renewal and Cancellation ...............................................................8 2.1.5. Supervision and Monitoring ............................................................................9 2.1.6. Settlement of Grievances ................................................................................9 2.1.7. Investors Education....................................................................................... 10 2.1.8. Legal Enforcement ........................................................................................ 10 2.2. Activities of NEPSE ............................................................................................ 10 2.2.1. Facilitates Trading ........................................................................................ 11 2.2.2. Admission of New Members ......................................................................... 11 ii

2.2.3. Market Operations ........................................................................................ 11 2.2.4. Investor Awareness ....................................................................................... 12

CHAPTER III: MAJOR ISSUES AND DISCUSSION ............................................. 13 3.1. Overview of Markets ........................................................................................... 13 3.2. Trading Mechanism ............................................................................................. 14 3.3. Initial Public Offering ......................................................................................... 15 3.4. List of Underwriters in Nepal .............................................................................. 16 3.5. Private placement ................................................................................................ 16 3.6. Provisions of shelf registration in Nepal .............................................................. 18 3.7. Auction Market and Dealer Market ..................................................................... 18 3.8. Types of Order in Nepal ...................................................................................... 20 3.9. Order Matching Rules ......................................................................................... 22 3.10. Settlement ......................................................................................................... 23 3.11. About OTC Market in Nepal ............................................................................. 23 3.12. Member of NEPSE ............................................................................................ 24 3.13. Listing Requirement of NEPSE ......................................................................... 24 3.14. Provision of Block Transaction.......................................................................... 25 3.15. Circuit Breakers ................................................................................................ 26 3.16. Price Range ....................................................................................................... 26 3.17. Bond Trading in Nepal ...................................................................................... 26 3.18. Trading Cost...................................................................................................... 27 3.19. Short Sale .......................................................................................................... 28 3.20. Buying on Margin ............................................................................................. 28

CHAPTER IV: CONCLUSION AND RECOMMENDATIONS .............................. 30

REFERENCES ............................................................................................................ 32 APPENDIX .................................................................................................................. 33

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LIST OF TABLES Page No. Table 3.1: Total Private Placement of Bonds from 1997 to 2009

17

Table 3.2: Brokerage Cost for Equity

27

Table 3.3: Brokerage for Government Bond

27

Table 3.4: Brokerage for all other Stocks which is not listed in 1 and 2.

28

LIST OF FIGURES Fig 3.1: Auction Market Example

19

Fig 3.2: Examples of Auction and Dealer Market

20

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ACRONYMS A/C

:

Account

BFI

:

Bank and Financial Institution

BOD

:

Board of Directors

B/S

:

Balance Sheet

CIT

:

Citizen Investment Trust

CRO

:

Company Registrar’s Office

GoN

:

Government of Nepal

HMG

:

His Majesty’s Government

IPO

:

Initial Public Offerings

NEPSE

:

Nepal Stock Exchange

NIDC

:

Nepal Industrial and Development Corporation

NIM

:

New Issue Markets

NRB

:

Nepal Rastra Bank

NYSE

:

New York Stock Exchange

OTC

:

Over the Counter

PL A/C

:

Profit and Loss Account

SEBON

:

Securities Board of Nepal

SEC

:

Security Exchange Commission

SMC

:

Security Marketing Center

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CHAPTER I: INTRODUCTION 1.1. History of Security Market The history of capital market in Nepal dates back to 1936 (1997 B.S.), the year in which the shares of Biratnagar Jute Mills Ltd. were floated. In 1937, Tejarath Adda was set up to facilitate loans to the government employees and was converted into Nepal Bank Ltd. HMG Nepal introduced the Company Act in 1964 and issued 6 percent 5 years government bonds through Nepal Rastra Bank to collect the developmental expenditures. HMG Nepal announced the Industrial Policy in 1974 and under this policy an institution named Securities Marketing Center (SMC) was established to deal in government securities-development bonds, national savings bonds, and corporate securities of few companies. At that time, the government has the virtual monopoly over the security market. Then, Securities Exchange Center (SEC) was established in 1976 with an objective of facilitating and promoting the growth of capital market. It was the only capital market institution in Nepal. Securities Exchange Act was surfaced in 1984 after which the SEC started to operate under this act. The purpose of this act was to provide systematic and favorable market environment for securities ensuring and protecting the interest of individuals and institutional investors as well as to increase the public equity participation in various firms and companies. SEC had provided facilities to trade the government securities and few of corporate securities like shares and debentures. In the initial phase, the center listed only the shares of 10 companies and operated without members i.e. brokers and dealers. So, initially SEC itself undertook the job of brokering, underwriting, managing public issue, market making for government bonds and other financial services. Apart from this, there was the absence of effective secondary market to ensure liquidity to the securities. The interim government (1990/91) initiated financial reform program and two indirect investment vehicles-Citizen's Investment Fund and NIDC Capital Markets Ltd. was established with the collective investment schemes in the corporate sector. Then, due to the rapidly growing privatization and economic liberalization, the operation of SEC was felt to change to make it compatible with the changing economic system. As a result, HMG Nepal brought about change in the 1

structure of SEC by dividing it into two distinct but integrated entities called Securities Board of Nepal (SEBON) and Nepal Stock Exchange Ltd. (NEPSE). Since then they are operating as the main bodies of securities market in Nepal. 1.2. Introduction to Securities Board of Nepal (SEBON) Securities Board of Nepal commonly known as SEBON was established on June 7, 1993 with its mission to facilitate the orderly development of a dynamic and competitive capital market and maintain its credibility, fairness, efficiency, transparency and responsiveness under the Securities Exchange Act 1983. It acts as an apex regulator of the securities market in Nepal. The major function of the SEBON is to look after registration of the securities and approval of the public issues. However, the objectives and functions of SEBON captures multi dimensional role in enhancing the efficiency of security market in Nepal. 1.2.1. Objectives and Functions As mentioned earlier, SEBON looks after the regulation of the security trading and security market in Nepal. Moreover, it frames the policies and programs required to monitor the securities market. As per the Securities related Act, 2007, the major functions of SEBON are as follows: a. Register securities of public limited companies. b. Approve prospectus for issuing securities. c. Provide license to operate stock exchanges. d. Provide license to operate securities businesses. e. Permit the operation of collective investment schemes and investment fund programme. f. Draft regulations, and issue directives and guidelines. g. Supervise and monitor stock exchanges and securities business activities. h. Take legal action against the non-compliance companies as per the legal provisions. i.

Conduct research, study and awareness programmes regarding securities markets.

j.

Advise the Government of Nepal to formulate policies and programmes relating to securities market as and when required.

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k. To supervise and monitor the functions and activities of securities-dealers. l.

To grant permission to operate collective investment schemes and investment fund programs, and to supervise and monitor them.

1.2.2. Organizational Structure The organizational structure of SEBON has seven departments and sixteen sections. Presently, there are 37 staffs (including chairman) in SEBON. Out of 37 staff, 20 staffs are at officer level and remaining in assistant level and support the staff. The current staff remain inadequate to perform various functions and to tackle with many issues and challenges of the Board including the current size of the market, challenges of market supervision and legal enforcement and need of increasing use of information technology for human resource management and market supervision, conducting and encouraging research on the area of capital markets, conducting investors' education and awareness building programmes continuously, and formulate and implement capital market master plan in order to improve regulation and supervision of capital market. Recently conducted research in SEBON revealed the need of staff especially human resource manager, researcher and statistician, computer programmer, and librarian to be inadequate. a. The Board The Governing Board of SEBON comprises seven members representing from various government and non-government sectors. The seven-member board includes a full-time Chairman appointed by the Government of Nepal for the tenure of four years. Other members of the Board are joint secretary from Ministry of Finance, joint secretary from Ministry of Law, Justice and Constitutional Assembly Affairs, a representative from the Nepal Rastra Bank, a representative from Institute of Chartered Accountants of Nepal, a representative from Federation of Nepalese Chambers of Commerce and Industries, and an expert member appointed by the Government of Nepal.

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b. The Committee SEBON has six different committees performing varieties of functions. The governance committee provide information, advice and feedback for the formulation and improvement of policy and procedure relating to the functions of Board, making its activities more transparent, efficient and public oriented by monitoring the service delivery and governance, SEBON has formed a 'Governance Committee' under the convener of Chairman comprising two directors and deputy directors from the Management Department and Legal Department as members. In order to make prospectus of issuing companies more informative and credible 'Securities Registration and Issue Approval Committee' with representatives from SEBON and Company Registrar Office (CRO) is in operation. Provision has also been made for the representation from the Nepal Rastra Bank and Insurance Board in the committee as and when required. SEBON has formed 'Financial Administration and Financial Information Analysis Committee' under the convener of Board member representing from the Institute of Chartered Accountants of Nepal comprising Heads of the Management Department, Financial Information Analysis Department and Finance Section as members with the objectives of developing the recording and reporting formats of financial information by stock exchange, securities businesspersons and listed companies which to be kept in their offices, submitted to Securities Board of Nepal and stock exchange along with the objectives of finalising the annual budget and programme of the Board, updating and reviewing the annual budget and expenditure, reviewing the audited report from the auditor and drafting the response to the audit report. In order to provide recommendations on organization structure of Board, need of manpower, management information system, delegation of authority, returns and privilege to members and staff of the Board, a 'Institutional Reform Committee' was formed under the convener of the expert member of the Board comprising Head of the Management Department as member and Head of the Corporate Finance Department as member secretary. In order to improve in the compliances of the securities related legislations and to provide suggestions by reviewing the drafted securities legislations and directives, Legal Enforcement Committee has been made. Likewise, investigation committee was formed under the 4

convener of director in order to perform the initial work relating to legal enforcement and to provide necessary assistance for the activities relating to legal enforcement committee. The committee investigated the case against the NICM performing share registrar activities without license and submitted the report to Board. 1.3. Introduction to Nepal Stock Exchange (NEPSE) NEPSE Ltd. is a non-profit organization, operating under Securities Exchange Act, 1983. NEPSE opened its trading floor on January 13, 1994 through its newly appointed licensed members with an "Open Out-Cry" system for the transaction of securities with 25 brokers and 3 market makers. NEPSE, the successor to the Securities Exchange Centre (which was in existence since 1976), was intended to assume a lead role in the activities more confined to the operation of the securities market, while the Securities Board was created to function as the body responsible for the oversight regulation of the securities market. Nepal Government, under a program initiated to reform capital markets converted Securities Exchange Center into Nepal Stock Exchange in 1993. The trading floor is restricted to listed corporate securities and government bonds with the market intermediaries in buying and selling of such securities. The initial improvement of the transparency of operations at the Exchange with its restructuring generated an interest among the investing public in Nepal, and NEPSE experienced a substantial increase of activity both in the primary as well as the secondary markets. A number of companies had successful initial public offerings, with the share issues oversubscribed on many occasions. NEPSE is a secondary market where already issued shares are traded. Government of Nepal, Nepal Rastra Bank, Nepal Industrial Development Corporation and members are the shareholders of NEPSE. 1.3.1. Functions and Objectives The basic objective of NEPSE is to impart free marketability and liquidity to the government and corporate securities by facilitating transactions in its trading floor through market intermediaries such as brokers and market makers, etc. Some of other functions and objectives of NEPSE which also come in purview of SEBON are listed below: a. To systematize the task of clearing accounts related to transactions in securities. 5

b. To supervise whether or not security dealers are behaving in the manner prescribed in this Act, or the rules and the bye-rules framed under this Act, while conducting business of dealing in securities, and suspend the license to conduct the business of dealing in securities in case any securities dealer is not found to be behaving accordingly. c. To make or ensure necessary arrangements to regulate the volume of securities transacted and the procedure of conducting such transactions in order to ensure the promotion, development and clean operation of stock exchanges. d. To make necessary arrangements to prevent insider trading or any other offenses relating to transactions in securities in order to protect the interest of investors in securities. e. To systematize and make transparent the act of acquiring the ownership of a company or gaining control over its management by purchasing its shares in a single lot or in different lots. f. To establish coordination and exchange cooperation with the appropriate agencies in order to supervise and regulate matters concerning securities or companies. g. To discharge or make arrangements for discharging such other functions as are necessary for the development of securities and the capital market. 1.3.2. Organizational Structure The Board of Directors (BOD), which governs NEPSE, constitutes of members representing different sectors as per Securities Act 2006. At Present, the BOD constitutes 2 Members including a chairman from Nepal Government, 2 Members from Nepal Rastra Bank, 1 from NIDC. Moreover, one member will be nominated by BOD as an expert in capital market. General Manager of NEPSE will serve as a director on the BOD. The board is the apex body of NEPSE which takes on day to day activity of the stock exchange including various staffs of different departments. Currently, the NEPSE has a board of 5 members including a chairman and other 4 members from different sectors appointed by SEBON and GoN. NEPSE operates with 59 broker members and 2 market makers. Besides this, NEPSE has also granted membership to issue and sales manager securities trader (Dealer). Issue and sales manager works as manager to the issue and

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underwriter for public issue of securities whereas securities trader (Dealer) works as individual portfolio manager. At present there are 11 sales and issue manager and 2 dealers (Secondary market).

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CHAPTER II: MAJOR ACTIVITIES OF SEBON AND NEPSE 2.1. Activities of SEBON As we know that the SEBON looks after the regulation of the security trading and security market in Nepal and frames the policies and programs required for monitoring the securities market. In achieving its objectives of doing so, it performs various activities which can be summarized in following points. 2.1.1. Securities Registration and Prospectus Approval The Securities Act, 2007, has incorporated a provision that requires the public companies to register all the securities to be issued with the SEBON. According to this provision, SEBON registers the ordinary share, rights share, and debenture of companies comprising like commercial banks, development banks, finance companies, insurance companies, hotels and companies from other sector as well. 2.1.2. Public Issue Approval SEBON registers securities of various companies as mentioned earlier and approves their prospectus for public issue if deemed satisfactory and complied with existing regulations. 2.1.3. Right and Bonus Share Registration It registers the right and bonus shares to be issued by the company. Approval to float right and bonus shares is to be taken prior from the SEBON. 2.1.4. Licensing Renewal and Cancellation Under the provisions of Securities Act, 2007 and Securities Businesspersons (Broker, Dealer and Market maker) Regulation, 2007, SEBON looks after the renewal of securities businesspersons fulfilling the criteria as required. Under the provisions of Securities Act, 2007, and Securities Businesspersons (Broker, Dealer and Market Maker) Regulation, 2007, companies willing to obtain licenses of stockbroker should submit an application to the Board along with the recommendation of the stock exchange. Under the provisions of Securities Act, 2007 and Securities Market Operation Regulation, 2007, SEBON also is authorized to renew the license of NEPSE as it receives the license renewal application from NEPSE. In pursuant to sub-section (2) of section (61) of Securities Act, 2007 securities businesspersons are required to renew their licenses by submitting the annual 8

fee as prescribed within three months of the expiry of the fiscal year. And in the case of not being able to renew within the stipulated time by submitting the annual fee according to subsection (2) of subsection (3), it is required to renew by paying twenty five percent of the amount of annual fee additional as fine until three months of the expiry of time frame. SEBON, under this provision, has published information to public about the cancellation of license can be made. 2.1.5. Supervision and Monitoring As per the prevailing Securities Act, SEBON carries out on-site inspection of public issues of companies. Similarly, SEBON issues various directives to the issue managers and monitors the compliance of the directives for the improvement on non compliances seen in the process of inspection. Merchant Bankers are required to submit their annual reports including profit and loss account, balance sheet, cash flow statements and securities trading report to SEBON within three months of the expiry of the fiscal year. As per the prevailing securities legislation, stock exchange should submit various types of information regarding the securities trading to SEBON. Among the information to be submitted to SEBON, NEPSE have to submit audited reports, quarterly reports, daily trading reports, reports related to actions taken to SEBON. SEBON develops Real Time Surveillance system with establishing electronic link to NEPSE for the supervision of daily securities trading. With this, SEBON has made stockbrokers to clarify their trading statements if needed after noting doubtful transactions through real time monitoring and surveillance. Through this system, SEBON has been monitoring floor activities accordingly or through this system, SEBON has been insistently monitoring the traded persons and institutions including traded companies, traded value and number shares traded. In the process of monitoring the secondary market, SEBON has been preparing the brief reports of daily trading companies, reports of weekly traded companies, block transactions related reports, reports of total traded amount of stockbrokers on weekly basis, statement of securities not traded more than three months, records of promoters share transaction and transaction records of Merchant Banker on regular basis as needed. 2.1.6. Settlement of Grievances Grievances relating to the request for suspending the transaction, company merger, irregularities in allotment, employee share, closure of shareholders register, shares not 9

being listed, submission of different financial statements, distribution of bonus share and dividend less than declared, orders not being executed, fine against share certificate, share application being cancelled and not refunding the amount on cancelled transaction etc is received by the Board and addresses such grievances with the concerned corporates. 2.1.7. Investors Education Considering for the empowerment of general investors' awareness relating to securities market, SEBON conducts training programme, educational programme relating to securities market and the role of SEBON, publishes various tips in different newspapers and televisions in order to increase awareness of the investors regarding investment in securities. In addition, SEBON conducts a study with the objectives of recommending on the improvement of organizational structure and managing human resources, utility of information technology and its possibility considering its contribution on the development of the capital market etc. 2.1.8. Legal Enforcement As the section 116 of Securities Act, 2007 has authorized the Board for framing Regulations on different subjects; the Board has authority to amend, frame and enforce different regulations and directives. In order to improve internal governance and financial discipline of the Board pursuant to the rules of Government of Nepal, SEBON has enacted some regulations like Securities Board of Nepal Procurement Regulation, 2009 and Securities Board of Nepal Financial Administration Regulation, 2009 since September 17, 2009. In addition, the board has recently amended Securities Registration and Issue Regulation, 2008 3, Stock Exchange Operation Regulation, 2008, has issued Bonus Share Issue Directives, 2010 Mutual Fund Regulation, 2010 Central Securities Depository Services Regulation, 2010, has Drafted Portfolio Management Directives.

2.2. Activities of NEPSE In order to impart free marketability and liquidity to the government and corporate securities by facilitating transactions in its trading floor through market intermediaries such as brokers and market makers, NEPSE carries out following major activities.

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2.2.1. Facilitates Trading NEPSE provides the trading floor or interface between the buyers and sellers of the securities. Equity shares, preference shares, debentures, government bonds and mutual funds are traded in this market. NEPSE the only Stock Exchange in Nepal introduced fully automated screen based trading since 24th August, 2007. The NEPSE trading system is called ‘NEPSE Automated Trading System ‘(NATS) is a fully automated screen based trading system, which adopts the principle of an order driven market. 2.2.2. Admission of New Members The membership of NEPSE has increased significantly in recent days. In recruiting members NEPSE makes effort to levy an entry fee from the new members. The entrance fee is one among many sources of revenue available to a Stock Exchange. New members approach the Exchange for membership since they believe that the Exchange membership would provide them with an opportunity to make profits. Such opportunities have been made possible due to the investments made by the Exchange in the past in developing its systems and procedures. In view of the rather subjective nature of the determination of such fees, NEPSE should obtain the approval of the Securities Board prior to the implementation of the entry fee. 2.2.3. Market Operations A noticeable improvement in the operation of the Stock Exchange has been made. The computerized record-keeping of the trading, clearing and settlement information of the Exchange is maintained. Mainly based on formats designed in January 1994, with necessary amendments to suit subsequent changes in operational aspects, the switch to computerize record-keeping has provided the Exchange management with a better handle on monitoring the activities of the members. As a result, there has been a commendable improvement in curbing the initiation of sale transactions without possessing valid sale documents, and in reducing the accumulation of liabilities over and above the permissible limits and the collection of settlement dues from member firms. In addition to maintaining the information required to supervise the activities of the member firms in a more efficient manner, the success in the better regulation of selected aspects of member post-trade activities is also due to the willingness displayed by certain managers of the Exchange to initiate action against errant brokers in a timely manner. 11

2.2.4. Investor Awareness It conducts various investor awareness programs and interactions in order to help the investors to understand the regulations and the issues involved in the trading of the securities. Such act of NEPSE helps in preparing the aware pool of the investors that could be the building blocks towards developing a efficient investment environment in Nepal.

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CHAPTER III: MAJOR ISSUES AND DISCUSSION Buying and selling i.e. trading of securities of listed securities are normally placed with broker. A first step for initial investor to invest in any securities is usually the selection of the best security. An investor has to consider the various factors before selecting securities for investment. In short, the securities transaction rely on the mechanics or procedures of exchange to guide investors in making wise investment decision by diverting funds in securities of worthwhile investment merits. In order to have clear insights on how securities are traded and how the entire processes, right from registration of security to trade in the secondary market and transfer of the security from one to another investor is very important and crucial to understand. Thus, it seems essential to know and understand about following issues of securities and its regulations in case of Nepal. 3.1. Overview of Markets Markets is a place where buyers and sellers gather together to negotiate their products in return of monetary value. It is traditional approach to the definition of the market. However, today’s market has gone through fundamental changes where physical distance between the buyers and sellers seems to have reduced by the brokers in case of the security market. Securities markets are classified in various ways but there are no any hard and fast rules to classify the market. On the basis of securities issue and trading activities we can classify securities market as primary market and secondary market. Similarly, on the basis of maturity period of security, it can be classified as money market and capital market. Physical location is another criterion to classify security market into organized stock exchanges and over- the counter market. On the basis of trading time, the security market may be classified into continuous and call market. But for the purpose of simplicity markets may be broadly divided into primary market and the secondary market for trading of the shares. a. Primary Market The market where first hand securities are traded is known as the primary market. Initial Public Offerings (IPO) is an example of the trading in the primary market. In 13

context of Nepal, various banks and companies float their shares in the market through merchant or investment bankers which is a concrete example of the primary market. The market is concerned with the new securities which are offered to investors for the first time. This market is used by the companies, and the government to raise funds for different purposes. The primary markets are also called the New Issue Market (NIM), Initial Public Offerings, right offerings; private placement, etc. are primary market activities. b. Secondary Market The secondary markets facilitate the trading of securities which has already been in the market or the second hand securities. NEPSE is the secondary market in Nepal which facilitates the trading of the securities from prospective buyers and sellers through the brokerage mechanism of trading using NATS. 3.2. Trading Mechanism NEPSE is the secondary market in Nepal. The NEPSE has adopted an auction system of trading securities. It means transactions of securities are conducted on the open auction principal on the trading floor. In Nepal, in order to buying and selling securities in secondary market buyer or seller should give order to certified broker filling the order slip as per rules and regulation of NEPSE. The buyer or seller should mention the necessary details information such as: name of the organization, type of stock, number of stocks and price and time period i.e. applicable for both parties. After that placement of order, buyer or seller collects ordering slip with registration number. Then the buy or sell orders are taken to the floor of NEPSE by the broker or his\her representative. In the floor of stock exchange, the buying broker with highest bid will post the price and his code number on the buying column, while the selling broker with the lowest offer will post the price and the code number on the selling column on the quotation board. The orders to buy and sell get executed when the prices for buy and sell match. Once the orders are executed in the floor, it is recorded in the exchange and is committed to buyer and sellers of the security through brokers.

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3.3. Initial Public Offering An initial public offering (IPO) or stock market launch is a type of public offering where shares of stock in a company are sold to the general public, on a securities exchange, for the first time. Through this process, a private company transforms into a public company. Initial public offerings are used by companies to raise expansion capital, to possibly monetize the investments of early private investors, and to become publicly traded enterprises. A company selling shares is never required to repay the capital to its public investors. After the IPO, when shares trade freely in the open market, money passes between public investors. Generally it is the first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded. In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), the best offering price and the time to bring it to market. IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock will do on its initial day of trading and in the near future because there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, which are subject to additional uncertainty regarding their future values. Thus IPOs commonly are underpriced compared to the price at which they be marketed. Such under pricing is reflected in price jumps that occurs on the date when the shares are first traded in security market. Details of the proposed offering are disclosed to potential purchasers in the form of a lengthy document known as a prospectus. Most companies undertaking an IPO do so with the assistance of an investment banking firm acting in the capacity of an underwriter. Underwriters provide a valuable service, which includes help with correctly assessing the value of shares (share price), and establishing a public market for shares (initial sale). An IPO is also referred to as a "public offering." Civil Bank has floated its shares to the public for the first time to raise Rs 800 million which is the biggest initial public offering (IPO) launched by the private sector till date. The bank has been successful in raising the said amount from the primary market; the paid-up capital of the category 'A' financial institution will top Rs 2 billion. In addition, 15

Commerz and Trust Bank Nepal Limited is in the process of issuing IPO of 6 million shares at the face value of Rs. 100 from February 17, 2013. Their issue managers are Growmore Investment, Civil Capital, Nabil Investment and CIT (Citizen Investment Trust). 3.4. List of Underwriters in Nepal Underwriting refers to the process that a large financial service provider (bank, insurer, investment house) uses to assess the eligibility of a customer to receive their products (equity capital, insurance, mortgage, or credit). The process by which investment bankers raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt) may be defined as Underwritings. A company or other entity that administers the public issuance and distribution of securities from a corporation or other issuing body is known as the underwriter. An underwriter works closely with the issuing body to determine the offering price of the securities buys them from the issuer and sells them to investors via the underwriter's distribution network. Underwriters generally receive underwriting fees from their issuing clients, but they also usually earn profits when selling the underwritten shares to investors. There are total 14 underwriters registered in SEBON (Shown in Appendix). These underwriters are further classified on the basis of Issue management, Share Registration, Underwriter and Portfolio Management. 3.5. Private placement A Company can sell the entire issue to single purchaser (generally, a financial institution or wealthy individual) of a group of such purchasers. This type of sale is known as a private placement. Private placement also known as direct placement, because the company negotiates directly with the investors over the terms of the offering, eliminating the underwriting function of the investment banker, debt securities may be issued either publicly or privately. A consideration in determining whether to issue securities privately is depends on the type of securities, amount of funds and position of capital market. In context of Nepal private placement of ordinary shares is rare; however, the bonds are often floated by private placement approach. Some of the private placement made in Nepal can be shown in the table below.

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Year

Table 3.1: Total Private Placement of Bonds from 1997 to 2009 Total Issue Amount (in millions) Public Issue Private Placement

1997

93

93

-

2002

360

100

260

2003

300

100

200

100

400

2005 2006

900

330

570

2008

2950

440

2510

2009

900

750

150

Total

6003

1913

4090

100

31.87

68.13

Percent Source: Securities Board of Nepal.

Investors involved in private placements are usually large banks, mutual funds, insurance companies and pension funds. Private placement is the opposite of a public issue, in which securities are made available for sale on the open market. Since a private placement is offered to a few, select individuals, the placement does not have to be registered with the Securities and Exchange Commission. In many cases, detailed financial information is not disclosed and need for a prospectus is waived. Finally, since the placements are private rather than public, the average investor is only made aware of the placement after it has occurred. In context of Nepal, securities act 2063 has provision for private placement. Firm can raise fund through private placement in following circumstances: a. If the firm has to sell or distribute securities to less than 50 investors at a time. b. Securities issued to own employee or staffs. As long as shareholders are comfortable with the dilution of ownership, a private placement can be a cost-effective method for a company to raise small but significant amounts of capital in a relatively short time while maintaining the company's ability to incur additional debt.

17

3.6. Provisions of shelf registration in Nepal In context of the USA, a regulation that a corporation can evoke to comply with U.S. Securities and Exchange Commission (SEC) registration requirements for a new stock offering up to three years before doing the actual public offering. However, the corporation must still file the required annual and quarterly reports with the SEC. In terms of SEC regulations, it is formally known as SEC Rule 415. A procedure that allows firms to file one registration statement covering several issues of the same security is called shelf registration. Large, well known public companies that issue securities frequently might file a master registration statement with the Security Exchange Commission and then update it with a short form statement just prior to each individual offering, in such a case, a company could decide at particular time to sell registered securities and have the sale completed before noon. This procedure is known as shelf registration because in effect the company puts in new securities “on the shelf” and then sells them to investors when it thinks the market is right. With the registration "on the shelf," the corporation, by simply updating regularly filed annual, quarterly, and related reports to the SEC, can go to the market as conditions become favorable with a minimum of administrative preparation and expense. A system of shelf registration is mostly used by large corporations to shortcut the registration process. The benefit of the system is that a company is able to issue securities in a matter of days as opposed to weeks or months. Under this the flotation costs are much lower. In Nepal there is no any provision regarding shelf registration until 2012 but internationally it exists. 3.7. Auction Market and Dealer Market Auction Market is a market in which buyers enter competitive bids and sellers enter competitive offers at the same time. The price a stock is traded represents the highest price that a buyer is willing to pay and the lowest price that a seller is willing to sell at. Matching bids and offers are then paired together and the orders are executed. The New York Stock Exchange (NYSE) is an example of an auction market. Auction markets differ from over the counter where trades are negotiated. Important auction markets for common stocks are the NYSE, the Paris Bourse, the Tokyo Stock Exchange, NEPSE etc. Auction markets also exist for new issues such as those of government bonds. Proponents 18

of auction markets maintain that allowing investors to trade directly with each other reduces execution costs. Operationally, this direct trading is achieved by exposing public limit orders to incoming market orders. For example, 4 buyers want to buy a share of XYZ and make the following bids: $10.00, 10.02, 10.03 and $10.06. Conversely, there are 4 sellers that desire to sell XYZ and they submitted offers to sell their shares at the following prices: $10.06, 10.09, 10.12 and $10.13. In this scenario, the individuals that made bids/offers for XYZ at $10.06 will have their orders executed. All remaining orders will not immediately be executed and the current price of XYZ will then be $10.06. Fig 3.1: Auction Market Example

Sources: the journal of finance,oct. 2000 Dealer Market is a market where dealers are assigned for specific securities. The dealers create liquid markets by purchasing and selling against personal inventory. Dealer markets are differ from the general investment markets, in that traders who focus on particular commodities engage in buying and selling activity using their own accounts rather than being represented by a third party. Securities dealers who make use of a dealer market are often referred to as Market Makers. In this type of trading environment, the buyers and sellers make use of their own resources in order to conduct trading. NYSE, NASDAQ, and the EuroNext markets are primarily order book markets. 19

A dealer market is different from an auction market. With auction markets, there is usually one specialist who functions as the gatekeeper for incoming orders to buy and sell. Essentially, the specialist works out of one location and matches the buying and selling orders as they come in. Their sole function is to process the orders. By contrast, a dealer market allows the traders or dealers to make use of their own resources to conduct trading activity, do research, and provide support to their investor customers. In addition, the Market Makers are not limited in the same manner as a specialist in an auction market. Multiple dealers in a dealer market situation may be risking and investing their capital in a given stock. One of the key advantages of a dealer market; the ability to move quickly in buying and selling securities means a greater opportunity to earn a higher return or minimize loss on any given investment. A dealer market may be focused on any type of commodity, including stocks and treasuries. Fig 3.2: Examples of Auction and Dealer Market

Source: Broker Dealer Market Incorporation 3.8. Types of Order in Nepal The secondary market is the market in which securities are traded on the stock market. In the secondary market, companies are not in search of capital; instead, you as an investor deal with other buyers and sellers of securities. This is where actual stock-exchange trading takes place. All traded securities are public and available to everyone. This is the market where different types of order are placed. All trades are made up of separate orders, that are used together to make a complete trade. All trades consist of at least two orders (one buy and one sell order). If a trade is entered with a buy order, then it will be exited with a sell order, and vice versa. For example, if a trader expected the market's price to go up, the simplest trade would consist 20

of one buy order to enter the trade, and one sell order to exit the trade. Conversely, if a trader expected the market's price to go down, the simplest trade would consist of one sell order to enter the trade, and one buy order to exit the trade. The following explanations will explain each of the order types, and how these orders are used in trading: a. Market Orders A market order is an order which does not specify a price limit; rather market orders are matched to the best available contra-side bid or offer. These are buy or sell orders that are to be executed immediately at current market prices (buy or sell “at market”). When a trade is executed, the specialist’s clerk will fill out an order card that reports the time, price, and quantity of shares traded, and the transaction will be reported on the exchange’s ticker tape. This simple scenario, however, is subject to a few potential complications. First, the posted price quotes (bid and ask orders) actually represent commitment to trade up to a specified number of shares. If the market order is for more than this number of shares, the order may be filled at multiple prices. Second, another trader may beat out investor to the quote, meaning that her order would then be executed at a worse price. Finally, the best price quote may change before her order arrives, again causing execution at a price different from the one at the moment of order. b. Stop Orders Stop orders are orders that create market orders when the specified trigger price is reached. As market orders, stop orders are not visible in the order book for any market participant. A buy stop order is an order placed at a price above the market that will trigger the creation of a market buy order when the market trades at the stop price or higher. A sell stop order is placed below the market and creates a market order if the market trades at or below the stop price. There is no guarantee that an order triggered by a stop will be filled at the stop price. Instead, it is treated the same as any other market order. A stop is only activated when an actual trade takes place that is at or through the stop. Even if both the bid and offer are through the stop price (for example, when both the bid and the offer are higher than the buy stop price, if the market price is 1.5, a trader 21

might place a buy stop order with a price of 1.6). Stop orders are often referred to as stop-loss orders in that they are often used to protect a trader's position from deteriorating beyond a certain point and stopping further loss. Positions can be initiated or closed out using stop orders. Stops are available on most futures. c. Limit Orders Investors may also place orders, specifying prices at which they are willing to buy or sell a security. A buy limit order indicates that the security may be purchased only at the designated price or lower. A sell limit order indicates that the security may be sold at the designated price or higher. The danger of limit order is that it comes with no guarantee it will be executed at all.The designated price may not be obtainable. For example, if a trader placed a limit order with a price of Rs2, the order would only get filled at Rs2 or better, if it got filled at all. Limit orders are used when you want to make sure that you get a suitable price, and are willing to risk not being filled at all. d. Discretionary Orders Discretionary order gives the broker the power to buy and sell for securities at the broker's discretion. Broker sells the securities as per market demand of purchaser by considering other various factors. A discretionary order is an order that allows the broker to delay the execution at its discretion to try to get a better price. These are sometimes called not-held orders. In context of Nepal, the market orders are executed; the prospective seller go to the brokerage firm and fills up the slip in order to sell the securities in the market price at particular time during the trading in the stock exchange. Stop orders and Limit orders are not place in the exchange market in Nepal. 3.9. Order Matching Rules The system adopts principle of order driven market. The best buy order is matched with the best sell order. An order may match partially with another order producing multiple trades. For order matching the best buy order is the one with the highest price and the best sell order is the one with the lowest price. This is because the system views all buy orders available from the point of view of the sellers and all sell orders from the point of view of the buyers in the market. So, of all buy orders available in the market at any point 22

of time, a seller would obviously like to sell at the highest possible buy price that is offered. Hence, the best buy order is the order with the highest price and the best sell order is the order with the lowest price. 3.10. Settlement NEPSE has adopted a T+3 settlement system. Settlement will be carried out on the basis of paper versus payment. The trading is done at "T" and at T+1; the buying brokers have to submit bank vouchers for settlement with covering letter. At T+2, the selling brokers must submit share certificate with covering letter. At T+3, NEPSE prepares billing for payment and this will be forwarded to the bank. Once the settlement is done the buying brokers with the consultation of the clients must decide and present the purchased shares if they want to record it as blank transfer. This must be completed within T+5. 3.11. About OTC Market in Nepal Over-the-counter (OTC) or off-exchange trading is done directly between two parties, without any supervision of an exchange. An over-the-counter (OTC) securities market is a secondary market through which buyers and sellers of securities (or their agents or brokers) consummate transactions. The shares of companies that have been de-listed by NEPSE, the share of small companies which are unable to meet NEPSE’s and its regulator SEBON’s requirements, and the shares of banks and financial institutions (BFIs) which have issued their initial public offering (IPO) but not yet listed at the NEPSE, can be traded over the counter. With a view to providing further access to investors, NEPSE made OTC Bylaws, 2065 with the approval of the Securities Board of Nepal. It also started the over-the-counter (OTC) market from 4 June 2008 to give shareholders a chance to sell or buy the shares of companies that are either de-listed or yet to be listed on NEPSE for failing to meet the listing criteria. This has added a new dimension to the Nepali capital market. In the OTC Market one does not have to go to brokers to trade shares; one can come to NEPSE and trade, paying a commission of 2 per cent for transactions of up to Rs 25,000, 1. 5 per cent for transactions of above Rs 25,000 but under Rs 5,00,000 and 1 per cent for transactions of over Rs 5,00,000. OTC being an unorganized secondary market, it does not require

23

the involvement of brokers. Thus in Nepal, NEPSE facilitates the transfer of the rights of such OTC shares. Nepal Stock Exchange has de-listed 43 companies so far for their failure to comply with the regulations. These companies are supposed to have raised funds worth about Rs two billion from the public. Companies such as Bansbari Leather Factory, Necon Air and Nepal Bank were de-listed from NEPSE. Though the OTC Regulation 2065 came into existence four years back, so far no shares had been traded under OTC market. The shares of companies that have been de-listed by NEPSE, shares of small companies that are unable to meet NEPSE’s and Securities Board of Nepal's requirements, and shares of banks and financial institutions that have conducted its initial public offering but have not yet listed at NEPSE can be traded over the counter. For the first time in its history, the Nepali stock market has witnessed OverThe-Counter (OTC) trading with de-listed Nepal Bank Ltd (NBL)'s shares. In October 2012, the bank's 71,928 unit shares belonging to the government were transferred to NBL's 2,664 employees. The OTC trading, being an unorganized secondary market, does not require the involvement of brokers and NEPSE only facilitates the transfer. 3.12. Member of NEPSE Members of NEPSE are permitted to act as intermediaries in buying and selling of government bonds and listed corporate securities. At present, there are 59 member brokers and 2 market makers, who operate on the trading floor as per the Securities Exchange Act, 1983, rules and bye-laws. Besides this, NEPSE has also granted membership to issue and sales manager securities trader (Dealer). Issue and sales manager works as manager to the issue and underwriter for public issue of securities whereas securities trader (Dealer) works as individual portfolio manager. The tenure of the membership is one year. The license should be renewed within 3 months after the closure of the fiscal year. If not, it can be done within another three months by paying 25% penalty. 3.13. Listing Requirement of NEPSE As we know that, the objective of NEPSE is to impart free marketability and liquidity to the government and corporate securities by facilitating transactions in its trading floor through member, market intermediaries, such as broker, market makers etc. Trading 24

on the floor of the NEPSE is restricted to listed corporate securities and government bonds. At present, 210 companies have listed their securities to make them eligible for trading. So, the listing requirements of NEPSE is that the Corporate bodies wishing to be member shall have to submit application in prescribed format within specified time along with certificate of incorporation, tax certificate, Memorandum of Association , Articles of Association and concerned Act, rules and regulations in the case of corporate body other than company after the incorporation and the projected B/S and PL A/C for the next three years, last three years audited financial statement, if the year of incorporation is less than three years, the B/S and A/C of investment in shares of subsidiary company or investment made in its parent company's share capital, details of share investment in any other company other than subsidiary, the name, address, number of shares subscribed and the amount invested by shareholders having more than 5% of the share capital need to be submitted. NEPSE has aside the following pre-requisites for listing. The companies, which do not attain the set criteria, are not eligible for listing. The criteria aside to enlist the shares are: a. The minimum paid up capital must be RS. 25 Million. b. The minimum number of shareholders should be 500 but if the company has not floated the share at the time of submitting the application from for listing, then in this case listing can be done with the condition that the given number of shareholders will be attained within two years. c. The face value of the share should is either RS.10 or RS. 100 3.14. Provision of Block Transaction Block Sales institutional investor frequently trade block of ten thousands of shares of stock. The block transaction of over 10000 shares account for a good deal of all trading. The larger block transactions are often too large for specialists to handle as they do not wish to hold such large blocks of stock in their inventory. Block houses have evolved to aid in the placement of larger block trades. Block houses are brokerage firm that specialize in matching block buyer and sellers. Once a buyer and seller have been matches the block is sent to the exchange floor where specialist executes the trade. All brokers maintain an account with the stock exchange, amounting to Rs 50 million. When a broker places a buy order, NEPSE deducts the amount required to buy the shares 25

from the broker’s account. And the amount is later restored to the broker’s account when the broker submits the voucher presented by the buyer. Thus, block transaction is provisioned in Nepal. Block transaction of shares are made by the institutional investors who trade greater amount of shares at a time. 3.15. Circuit Breakers NEPSE has implemented index-based circuit breakers with effect from 2064/6/4 (21 September 2007). In addition to the circuit breakers, price range is also applicable on individual securities. The index-based circuit breaker system applies at 3 stages of the NEPSE index movement of 3%, 4% and 5%. These circuit breakers when triggered bring about a trading halt in all equity. a. In case of 3% movement either way, there would be a market halt for 15 minutes if the movement takes place during first hour of trading i.e. 13:00 hours. In case this movement takes after 13:00 hours there will be no trading halt at this level and market shall continue trading. b. In case of 4% movement either way, there would be a market halt for half an hour if the movement takes place before 14:00 hours. In case this movement takes after 14:00 hours there will be no trading halt at this level and market shall continue trading. c. In case of 5% movement in either way, trading shall be halted for the remainder of the day. 3.16. Price Range Price Range is applicable on individual securities. The trading of the individual securities are not halted but allowed to trade within the price range. The price band is 10% of previous close on either way. During the ATO session the range is 5% on either way of Previous Close Price. After the band is 2% on either way of the Last traded price till it reaches to 10% of the previous close. 3.17. Bond Trading in Nepal Trading of government bond started since 1964. The bond was listed in NEPSE in mid July 2005 for secondary market transaction. The government bond is issued for the purpose of expenditure in development projects like hydropower, transportation etc. 26

Generally bonds are issued by government through central bank to fund budget deficit whereas gives a tool to central bank to enhance effectiveness of monetary policy. Likewise, the corporate bodies issue bonds to fulfill their long term financing needs. Nepal’s bond market is underdeveloped and dominated by government securities. To meet short term financing needs government issues short-term treasury bills and national savings certificates. Government also issues longer tenor instruments, the Development Bonds, and are admitted for trading through NEPSE. However, development bonds are rarely traded and the size of the bond is quite small to satisfy demand for investment of institutional investors (including insurance companies, the Employees’ Provident Fund, and Citizen Investment Trust). As such, commercial banks are the largest investors in government securities holding approximately 54% of outstanding government securities, which they use for meeting statutory liquidity requirements. 3.18. Trading Cost Trading cost is the commissions and other expenses related to the trade of a security. Following are the trading cost associated with various securities. Table 3.2: Brokerage Cost for Equity S.No.

Trading Amount

Brokerage %

A

Up to 50,000

1

B

> 50,000 & < 5,00,000

0.9

C

> 5,00,000 & < 10,00,000

0.8

D

> 10,00,000

0.7

3.3: Brokerage for Government Bond S.No.

Trading Amount

Brokerage %

A

Up to 5,00,000

0.20

B

> 5,00,000 & < 50,00,000

0.10

C

> 50,00,000

0.05

27

3.4: Brokerage for all other Stocks which is not listed in 1 and 2. S.No.

Trading Amount

Brokerage %

A

Up to 50,000

0.75

B

> 50,000 & < 50,00,000

0.60

C

> 50,00,000

0.40

3.19. Short Sale A short sale allows the investor to make profit from a decline in the security price. An investor borrows a share of stock from a broker and sells it. Later, the short seller must purchase a share of the same stock in order to replace the share that was borrowed. The short seller anticipates the stock price will fall, so that the share can be purchased later at a lower price that it initially sold for, if so the short seller will reap a profit. The short seller must not replace the shared but also pay the lender of the security any dividends paid during the short sale. Since there is no trend and regulations that allows the investors to open account with their brokerage firm, short sale is not practiced in Nepal. It should be permitted in Nepal but at the mean time sufficient regulations has to be made. If allowed, it can gear up the trading of securities in the market which will make the vibrant capital market. It can be considered as the factor that will help the capital market to develop. 3.20. Buying on Margin As mentioned earlier, there is no regulation which allows the investors to open margin account with their broker. Thus, buying in margin is not in practice in Nepal. However, the banks provide the funds by taking the shares or securities under collateral. It looks like buying on margin but is known as margin lending. The purpose of buying on margin and margin lending may vary significantly. Both, brokers and investors, have strongly urged for easy access to margin finance to boost the current market scenario. If investors had easy access to margin loans either through brokers or financial institutions, then they would have been able to buy more shares, sustainably fuelling the current surge in the stock market. The capital market regulator Securities Board of Nepal (SEBON) has commissioned a study by an expert to 28

design the procedure for margin lending through brokers. “SEBON” has recognized the importance of allowing margin lending by brokers to boost the market so we are going to prepare a proper legal infrastructure once the report is out,” informed an officer at SEBON. Under margin lending, brokers give partial loans to clients in order to cover a larger investment than one’s capital could directly cover for a fee. The margin account with brokers acts as leverage for investors, allowing them to purchase shares despite being short of cash, thus promoting transactions. However, in Nepal, margin lending is loosely referred to as loans floated by banks and financial institutions against the collateral of shares. Though financial institutions are not prohibited to float loans against shares to the public, investors feel that in the current scenario, obtaining loans through financial institutions by pledging shares has become difficult. Five years back, during the heyday of the capital market, easy availability of margin type loans had fuelled the bullish trend of the stock market pushing it to a peak. “If the opening up of margin finance through brokers is going to take a long time, it will be prudent to revert to the earlier system of banks giving a portion of stock price as loans on the recommendation of the brokers,” he said. The broker should give permission for lending.

29

CHAPTER IV: CONCLUSION AND RECOMMENDATIONS History has shown that the price of shares and other assets is an important part of the dynamics of economic activity, and can influence or be an indicator of social mood. An economy where the stock market is on the rise is considered to be an up-and-coming economy. In fact, the stock market is often considered the primary indicator of a country's economic strength and development. Rising share prices, for instance, tend to be associated with increased business investment and vice versa. Share prices also affect the wealth of households and their consumption. The smooth functioning of all these activities facilitates economic growth in that lower costs and enterprise risks promote the production of goods and services as well as possibly employment. In this way stock market and trading of the securities are deemed to be crucial for the financial system and prosperity. However, for all these to happen in the economy, the stock market should be efficient and developed one. It is evident from the case of various countries that usually the stock markets of the underdeveloped countries do have shortfalls in many aspects. Same is the case for Nepal. The possible reasons for the market inefficiency in the emerging stock market like Nepal may be the poor institutional infrastructure, weak legal framework, lack of supervision, slow development of the market infrastructure, poor corporate governance and accountability, low level of capacity of major market players and lack of transparency of market transaction. The absence of qualified analysts, institutional investors and investment-friendly environment is a well-known constraint in the emerging market like Nepal. The main challenges of the Nepalese stock market include frequently changing government policies, policy-level interventions, tussles of regulatory authorities, lack of commitments on economic agenda from political parties, and slow economic growth. Other challenges are to widen the use of automation, strengthen regulations and supervision, and educate investors. Similarly,

functional

autonomy

of

SEBON

(regulatory

body),

and

NEPSE

(implementation body) are also the need of the day. Moreover, it has been seen that the various aspects of securities trading like buying on margin, short sale, shelf registration etc has not been provisioned in Nepal. It may have greater implications for the security market in Nepal since such trading may boost up the trade and eventually gear up the 30

economy as a whole. Thus, it seems necessary to develop such provisions by regulatory bodies and even more should enact the concrete regulatory and legal framework that will help to enhance the efficiency of the stock market and trading of securities in Nepal.

31

REFERENCES Dangol, J. (2012). Stock Market Efficiency in Nepal. International Journal of Multidisciplinary Research. Exchange, N. S. (2010). Information Book on Share Registration. Kathmandu: NEPSE. Gurung, J. B. (2004). Growth and Performance of Securities Market in Nepal. The Journal of Nepalese Business Studies. Nepal Rastra Bank. (2013, February 6). Retrieved from NRB Website: www.nrb.org.np Nepal Stock Exchange. (2013, February 5). Retrieved from NEPSE Website: www.nepalstock.com.np Nepal, S. B. (2010). Effortful in Building Fair, Credible, Transparent, Responsive, Dynamic, and Efficient Securities Markets. Kathmandu: SEBON. Peiris, R. (1996). The Nepal Stock Exchange: A Review. Morrin Hill: University of Maryland. SEBON. (2013, February 5). Retrieved from SEBON website: www.sebon.gov.np

32

APPENDIX

33

APPENDIX – 1 PROJECT WORK CONTRIBUTION BY GROUP MEMBERS

Roll No. 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30

Name of Student Ankur Shrestha Bindi Bade Shrestha Dipika Shrestha Grisha Yadav Krishna Chalise Manisha Baral Pawan Kawan Prajwal Regmi Ritu Joshi Sajana Shrestha Sarita Maharjan Shishir KC Sona Shrestha Sushmita Amatya Bibek Khadgi

Topics Dealt Initial Public Offerings List of Underwriters in Nepal Provisions of Shelf Registration in Nepal Provision of Private Placement Auction Market and Dealer Market Types of Order Placed in Nepal OTC Markets Different Types of Member of NEPSE Listing Requirement of NEPSE Provision of Block Transaction Provision of Short Sale Bond Trading in Nepal Trading Costs Buying Margin Evolution, Functions, Acts and By-Laws

34

APPENDIX-2 LIST OF UNDERWRITERS

Underwritings on the basis of Issue Management a. NSM Merchant Banking & Investment Ltd., Putalisadak, Kathmandu b. NCM Merchant Banking Ltd., Kamalpokhari, Kathmandu c. Ace Capital Ltd., Lal Durbar, Kathmandu d. Nepal Merchant Bank Capital Ltd., Babar Mahal, Kathmandu e. Citizen Investment Trust, New Baneswor, Kathmandu f. Elite Capital Ltd., Jamal, Kathmandu g. Vibor Capital Ltd., Krishna Galli, Lalitpur h. Civil Capital Market Ltd., Kamaladi, Kathmandu i.

Investment Management Merchant Banker Ltd., Putalisadak, Kathmandu

j.

NABIL Investment Banking Ltd., Chabahil, Kathmandu

k. Laxmi Capital Market Ltd., Pulchowk, Lalitpur Underwritings on the basis of Share Registration: a. NSM Merchant Banking & Investment Ltd., Putalisadak, Kathmandu b. NCM Merchant Banking Ltd., Kamalpokhari, Kathmandu c. Ace Capital Ltd., Lal Durbar, Kathmandu d. Nepal Merchant Bank Capital Ltd., Babar Mahal, Kathmandu e. Citizen Investment Trust, New Baneswor, Kathmandu f. Elite Capital Ltd., Jamal, Kathmandu g. Vibor Capital Ltd., Krishna Galli, Lalitpur h. Investment Management Merchant Banker Ltd., Putalisadak, Kathmandu i.

NABIL Investment Banking Ltd., Chabahil, Kathmandu

j.

Laxmi Capital Market Ltd., Pulchowk, Lalitpur

35

Underwritings on the basis of Underwriter: a. NCM Merchant Banking Ltd., Kamalpokhari, Kathmandu b. Ace Capital Ltd., Lal Durbar, Kathmandu c. Vibor Capital Ltd., Krishna Galli, Lalitpur d. Investment Management Merchant Banker Ltd., Putalisadak, Kathmandu e. NABIL Investment Banking Ltd., Chabahil, Kathmandu Underwritings on the basis of Portfolio Management: 1) Vibor Capital Ltd., Krishna Galli, Lalitpur 2) Beed Invest Ltd., Krishna galli, Lalitpur 3) Araniko Capital Management Company Ltd., Mahaboudha, Kathmandu

36

APPENDIX-3 CORPORATE BONDS ISSUED IN NEPAL

SN 1 2 3 4 5 6 7 8 9 10 11 12 13

Company Nepal Investment Bank Limited Bond 2067 Everest Bank Limited Rinpatra 2061 Bank of Kathmandu Rinpatra 2069 Nepal Investment Bank Limited Bond 2070 Nepal Industrial and Commercial Bank Limited Bond 2070 Nepal SBI Bank Rinpatra 2070 Nepal Investment Bank Bond 2071 Nepal Bidhut Pradhikaran Rinpatra 2069 Himalayan Bank Limited Rinpatra 2072 Nabil Bank Limited Bond 2075 Laxmi Bank Limited Debenture 2072 Nepal Investment Bank Limited Bond 2072 Kumari Bank Limited BOND 2070 Total

37

Number of Bond

Par Value

Amount

300,000 300,000 200,000

1,000 1,000 1,000

300,000,000 300,000,000 200,000,000

250,000

1,000

250,000,000

200,000 200,000 225,000

1,000 1,000 1,000

200,000,000 200,000,000 225,000,000

1,500,000

1,000

1,500,000,000

500,000 300,000

1,000 1,000

500,000,000 300,000,000

350,000

1,000

350,000,000

250,000 400,000

1,000 1,000

250,000,000 400,000,000 4,975,000,000

APPENDIX-4 GOVERNMENT BONDS ISSUED IN NEPAL S.N.

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Name of Bond

Listed Listed Bond Amount In Rs. In '000' million Rinpatra 7,500 750

Bikas 2072 Bikas Rinpatra 2075 Bikas Rinpatra 2075 'Ka' Bikas Rinpatra 2076 Bikas Rinpatra 2076 'Ka' Bikas Rinpatra 2076 'Ga' Bikas Rinpatra 2076 'Kha' Bikas Rinpatra 2072 'Ka' Bikas Rinpatra 2071 'Ka' Bikas Rinpatra 2071 'Kha' Bikas Rinpatra 2073 'Ka' Bikas Rinpatra 2069 Bikas Rinpatra 2072 'Kha' Bikas Rinpatra 2072 'Ga' Bikas Rinpatra 2072 'Gha' Bikas Rinpatra 2071 'Ga' Total

Interest Rate

Maturity Date

Listing Date

6

11/9/2072

3/12/2063

12,00 0 21,00 0 22,00 0 9,000

1,200

6.5

8/12/2075

8/22/2063

2,100

6.5

12/25/2063

2,200

6.5

11/29/207 5 3/21/2076

900

6.5

7/29/2076

8/13/2064

4,600

460

6.5

9/23/2076

10/29/2064

10,40 0 15,00 0 20,00 0 30,00 0 27,50 0 15,00 0 25,50 0 49,90 9 30,00 0 50,00 0 349,4 09

1,040

6.5

9/3/2076

11/8/2064

1,500

7.5

1/24/2065

2,000

8

12/19/207 2 9/20/2071

3,000

9

3/16/2071

7/6/2066

2,750

9

7/28/2073

7/6/2066

1,500

9

12/4/2066

2,550

9

10/28/206 9 2/27/2072

4,991

9

3/17/2072

4/20/2067

3,000

9.5

9/16/2072

1/21/2068

5,000

9.5

2/19/2071

5/22/2068

34,941

38

4/21/2064

11/6/2065

3/15/2067

APPENDIX-5 LIST OF ACTS AND BY-LAWS I.

Securities Regulations as per SEBON 

Securities Board Regulation, 2064



Stock Exchange Operation Regulation, 2064



Securities Businessperson (Stock Broker, Dealer & Market Maker) Regulation, 2064



Securities Businessperson (Merchant Banker) Regulation, 2064



Securities Registration and Issue Regulation, 2065 Securities Registration and Issue Regulation, 2065 (First Amendment)



SEBON Procurement Regulation, 2066



Mutual Fund Regulation, 2067



Central Depository Service Regulation, 2067 (2010)



Credit Rating Regulation, 2068

II.

Acts Securities Act, 2063

III.

Guidelines and Bylaws 

Compliance Guidelines for Securities Broker, 2058



Securities Issue Guidelines, 2065



Bonus Share Guidelines, 2067



Portfolio Management Guidelines, 2067 (2010)



Government Securities Bylaws of SEBON, 2062

 Government Securities Transaction Bylaws of NEPSE, 2062  Securities Allotment Guidelines, 2068  CDS Byelaws, 2068

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APPENDIX-6 ORGANIZATIONAL CHART OF SEBON

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APPENDIX-7 METHOD OF INDEX CALCULATION After purchasing the shares in primary market, it can be purchase or sale again in another market, which is known as secondary market. This secondary market is Nepal Stock Exchange (NEPSE). This is only one market in Nepal. The companies who issue Initial Public Offering (IPO) to make transaction in secondary market have to list its stocks to Nepal Stock Exchange accompanied with certain fees. After 7 days of listing the shares/ stocks, it can be transacted (purchase or sale) in secondary market (NEPSE) through the brokers. For example: Suppose Bank of Kathmandu Limited issued the ordinary shares in (IPO) of 20 lakh kitta. To create environment of purchasing or selling of shares in secondary market (NEPSE) by ordinary shareholders, the Bank has to list 20 lakh kitta shares in Nepal Stock Exchange. After 7 days of listing such shares, the transaction of 20 lakh kitta of BOK start to be transacted through brokers. 214 companies are listed in Nepal Stock Exchange till Poush 2068. These companies' shares may or may not be transacted in Nepal Stock Exchange every day. In purchasing or selling of shares of particular company, it may be transacted in various price levels in single day. Among the various price levels in single day, closing price of particular company is considered to calculate the market capitalization by multiplying closing price with number of shares listed in NEPSE. If there is no any transaction occurred during the day for any company the closing price of prior day is considered to calculate market capitalization. For example: Suppose in NEPSE Chilime Hydropower Company Limited has made following transaction in Poush.

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14, 15........18 To calculate market capitalization of CHCL in Poush 18, closing price of Poush 17 is not given because in Poush 16 and 17 CHCL shares transaction does not occur in NEPSE. Therefore to calculate market capitalization of CHCL closing price of Poush 15 is considered. Market capitalization= closing price (Poush 15) × no. of total shares listed by CHCL In this Way, market capitalization of companies that are listed in NEPSE will be calculated individually, by adding such individual market capitalization, total market capitalization is calculated. For example: 214 companies are listed its ordinary shares in NEPSE. First of all NEPSE calculate market capitalization of 214 companies shares individually and sum the 214 companies individual calculation and find total market capitalization. Market capitalization of company 1

xxx

Market capitalization of company 2

xxx

Market capitalization of company 3

xxx

.......................................................

xxx

.......................................................

xxx

Market capitalization of company 214

xxx

Total market capitalization

xxxx

From 30 Magh 2050, NEPSE INDEX was started to be calculated and first day index is supposed to be 100. 42

Numerical example: Suppose 3 companies A, B, C are listed in NEPSE(on 30 th Magh 2050). Number of shares and closing market price of individual shares are given bellow. Company No.

Closing price

Market capitalization

of (No of shares listed × closing

share

price)

listed Magh

Falgun

Falgun

30

1

2

Magh30

Falgun

Falgun 2

1

A

200

10

12

11

2,000

2,400

2,200

B

300

20

18

15

6,000

5,400

4,500

C

400

50

55

52

20,000

22,000

20,800

28,000

29,800

27,500

Total market capitalization

Base Nepse Index(IB)= [Total Market Capitalization/Total Amount Of share Issued (face value).]*100%

So Nepse Index at margh 30,2050 BS(IB)=[(28000)/(28000)]*100%=100 Now after Magh 30 ,NEPSE index is calculated as follows. It= MVt/ MVb × IB Where, It

=

MVt

=

Index at time Market value (market capitalization at time)

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MVb IB

= =

Market value at base period Index at base period

Here, Base price is Magh 30 Now, NEPSE index of Magh 30 : It= MVt/ MVb × IB = 28000/28000 × 100 = 100 NEPSE index of Falgun 1 : It= MVt/ MVb × IB = 29800/28000 ×100 = 106.43 NEPSE index of Falgun 2 : It= MVt/ MVb × IB = 27500/28000 ×100 = 98.21 In Magh 30, NEPSE index calculation is started therefore market capitalization at time is equal to market value of base period so, NEPSE is 100. In Falgun 1, NEPSE is 106.43, in comparison to NEPSE index of Magh 1, it is increased by 6.43. This is because total market capitalization is increased from 28000 to 29800. In Falgun 2, NEPSE is 98.21, in comparison to NEPSE index of Magh 2, therefore NEPSE is decreased by 8.22. This is because total market capitalization decrease from 29800 to 27500.

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In this way, fluctuation in share price in market, NEPSE index also fluctuates accordingly. Suppose in Falgun 2, D company is listed with 100 kitta shares with RS 100 per share, now there are 4 companies, so to calculate NEPSE index of 4 companies, adjustment in based period of total market capitalization have to be made with following formula. Adjusted base value of market capitalization= [New market capitalization/ old market capitalization] × Base of market capitalization before listing new shares =[ (27,500+100*100)/27500] × 28000 = 38181.32 Now to calculate the index in Falgun 3 base price will be 38181.32 until new shares (bonus shares or right shares) and new companies listed in NEPSE. If new companies listed than adjusted base value will be calculated as above. After including new 100 kitta of company “D “ NEPSE will be calculated as follows . Company No. of

Closing

Market capitalization

price (No of shares listed × closing price)

share listed

Magh

Falgun Falgun Falgun Magh30

30

1

2

3

Falgun

Falgun 2

Falgun 3

1

A

200

10

12

11

11

2,000

2,400

2,200

2,200

B

300

20

18

15

15

6,000

5,400

4,500

4,500

C

400

50

55

52

52

20,000

22,000

20,800

20,800

D

100

-

-

-

100

-

-

-

10,000

28,000

29,800

27,500

37,500

Total market capitalization NEPSE index of Falgun 3 : It= MVt/ MVb × IB 45

= 37500/38181.32 ×100 = 98.21 In Falgun 3, NEPSE is 98.21, equal to NEPSE index of Falgun 2, therefore NEPSE is Constant . This is because there is no change in market capitalization except the new listed share of Rs 10000 .

Other Index Float Index: NEPSE started calculating float index from Bhadra 26, 2065 (Base Date). This index represents the market capitalization of securities which are floated to public. Float index excludes promoter’s holding, government holding, strategic holding and other locked in shares like employees share- that will not come to the market for trading in the normal course. It takes into account the securities held by general public that are readily available for trading in the market. HOW TO CALCULATE ? Float Index =[ Current MV of all shares listed in NEPSE floated to general public/ MV of shares in Base year] *100 Base year is 26th Bhadra, 2065 or 11th September 2008. Sensitive Index: Sensitive index is the index calculated from the market capitalization of companies classified under group “A”.

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HOW TO CALCULATE ? Sensitive Index =[ Current MV of all shares listed in NEPSE under Group “A”/ MV of shares in Base year ] *100

Base year is 26th Bhadra, 2065 or 11th September 2008. Sensitive Float Index: Sensitive float index represents the market capitalization of securities of companies listed under group “A” which are floated to public. HOW TO CALCULATE ? Sensitive Float Index = [Current MV of all shares listed in NEPSE under Group “A” Floated to public / MV of shares in Base year] *100 Base year is 26th Bhadra, 2065 or 11th September 2008. WHY OTHER INDEX ?? The standard NEPSE index is designed on a “Market Capitalization- Weighted” methodology, where stocks with the largest market capitalization carries the greatest weight in the index, thus making the value of the index very vulnerable to the price movement of such companies. The companies like Nepal Telecom, Nabil Bank and Standard Chartered Bank comprises approximately 32% of the entire market in terms of market capitalization. So any changes in price of the shares of these company impacts the index substantially. Commercial banks, development banks and finance companies together comprise of almost 70% of the entire market in terms of market capitalization and Nepal Telecommunication claims 18% of the weight of the market. Most of the shares of these companies are held by promoters and by government in case of NT, which are not available in market for trading. 47

The NEPSE index takes into account all the promoter shares, government holdings, strategic shares, employee shares and all other locked in shares while calculating the index which gives a distorted picture of the overall market performance to the investors. So, NEPSE introduced float index and sensitive float index to give more realistic picture of the market performance to the investors. Free –float methodology refers to an index construction methodology that takes in to consideration only the free float market capitalization of a company for the purpose of index calculation and assigning weight to stocks in index. A free float index reflects the market trends more rationally as it takes into consideration only those shares that are available for trading in the market or the shares issued to general public. It excludes promoters’ holding, government holding, strategic holding and other locked in shares like employee shares. The market capitalization of each company is reduced to the extent of its readily available shares in the market and reduces the concentration of the top few companies. In this way big companies with sizeable amount of locked in shares are also included while preventing their undue influence on the index at the same time. The undue influence of large number of locked in shares is checked. It will give the investors more clear picture of the real market and boost their confidence. Source: Soban Kumar Khadka

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