EPF acting against its own words
“The Fund cannot invest in stocks of the banking and financial sector since the Monetary Board regulates both EPF and banks and financial institutions. But investment in unlisted equity securities of banks and financial institutions shall be permissible only insofar (a) new investment institution with a long-term motive of the investment. (b) The investment account is passively managed and the relevant index contains such securities.”
By Asela Gunawardena
The Employees’ Provident Fund (EPF), the largest social security scheme in Sri Lanka became the focus of the media last week, due to its recent investments in banks listed in the Colombo Stock Exchange (CSE). The media spotlight on this contentious issue began after this matter was highlighted to the press quite cleverly by the UNP National List MP, Dr. Harsha de Silva. He argued that purchase of shares of listed banking entities by EPF is in contravention of the EPF Investment Policy Statement & Standards of Professional Conduct (Revised on December 2002).
Since the beginning of this year, EPF started to purchase shares of listed companies, predominantly within the Banking and Leisure sectors, which signalled a paradigm shift from its long held practice of investing the funds of EPF members in government, gilt edged, securities. Observers have pointed out that a conflict of interest arises when the EPF acquires stakes in Banks as EPF is under the custody of the Central Bank of Sri Lanka (CBSL), which is also the regulator of the Licensed Commercial Banks in Sri Lanka. This is quite clearly spelt out in the EPF Investment Policy Statement & Standards of Professional Conduct – Section 2.6.2.2 under Investment in Equities.
“The Fund cannot invest in stocks of the banking and financial sector since the Monetary Board regulates both EPF and banks and financial institutions. But investment in unlisted equity securities of banks and financial institutions shall be permissible only insofar (a) new investment institution with a long-term motive of the investment. (b) The investment account is passively managed and the relevant index contains such securities.”
Even in the exception clause of the above paragraph, it is only the investment of unlisted equity securities of banks and financial institutions which is permitted and that too under specified circumstances. Hence the acquisition of listed banking shares by the EPF is clearly against the Section 2.6.2.2 of the EPF Investment Policy Statement & Standards of Professional Conduct. In this backdrop it was quite surprising to observe the justification of EPF investments in listed banks by the Governor of the Central Bank, Ajith Nivard Cabraal to Daily News last Thursday in a response to a question posed by the interviewer.
Daily News: Can a fund like EPF invest in banking and financial institutions?
Governor: Of course it can.
The ownership of voting shares by the EPF in the four largest privately owned and listed licensed commercial banks as at March 31, 2010
Is the Commercial Banking system becoming a captive source of finance to the government and State Owned Enterprises like CEB and CPC?
The private commercial banks mentioned in the above table accounted for approximately 35.5% of the total assets of the entire system of licensed commercial banks in Sri Lanka as at December 31, 2009. The Bank of Ceylon (BoC) and Peoples Bank are the two largest commercial banks in the country and they are fully state owned.
“The Fund must make sure that investment in any company is made only with an intention to increase the return of the Fund and not to take control over the Company. As discretion of the Investment Committee, the Fund can vote at annual general meetings of the invested companies.”- EPF Investment Policy Statement & Standards of Professional Conduct – Section 2.6.2.2 under Investment in Equities.
As evident from the above section the EPF is entitled to vote at the Annual General Meetings of banks at the discretion of the investment committee. For instance the EPF can work in concert with other state shareholders of the Commercial Bank, such as BoC and Sri Lanka Insurance Corporation and vote in understanding with regard to re-election of directors and appointment of external auditors at the bank’s AGM. Thus the EPF is positioned to grant the government the opportunity to exercise influence over the internal administration of commercial banks via its shareholding stakes.
A former Central Bank staff officer on conditions of strict anonymity told The Bottom Line that this Investment Policy statement is not a legally binding document but rather a measure of self restraint or a code of conduct. However, he said that investment in banks by EPF although might be legal is immoral and unethical.
Traditionally more than 90% of the EPF’s investment portfolio has been placed in government securities. This figure was 97% in 2009. However yield rates of treasury bills and treasury bonds have come down quite substantially from high yield rates which prevailed in 2008 to mid 2009. Thus investment of EPF funds in the equity market is justifiable in order to grant higher returns to EPF contributions as the equity market is widely expected to perform impressively within a regime of low interest rates and low inflation. In fact this aspect is mentioned in the Investment Policy statement of the EPF and it also suggests that the investment portfolio must be diversified and that amendments must be brought in to enable EPF to make investments in banks and even in offshore markets.
“In the prevailing market situation, the Fund does not have a problem in invest total value of the fund within Sri Lanka. But if the Sri Lankan Government reduces borrowings from the local market, it would cause severe problems to the Fund. This situation further will be exaggerated due to underdeveloped corporate debt market and local share market. If the peace process success, certainly the government borrowings will come down significantly and it will affect the interest rate and amount of fixed income investments of the Fund. To overcome this problem the Fund should diversify its portfolio with a long-term view. At the same time, EPF Act should be amended to invest in, off shore markets, Banking Sector stocks in local share market etc. Further, the Fund should train EPF staff to handle international investments while obtaining the services from the external resource persons.” (section 8 additional guidelines/suggestions.)
Questionable Investments
Last May the EPF bought a huge stake in debt stricken, Galadari Hotels from Nawaloka Hospitals. This deal granted a huge capital gain to Nawaloka Hospitals. The price at which this stake was acquired came under criticism and some analysts alleged that it was bought at a highly over valued price given the huge debts the hotel had in its balance sheet. The EPF also acquired a sizable stake in Light House Hotel PLC (LHL) and Ceylon Hotels (CHOT) in the same manner.
Last Wednesday, EPF purchased a sizeable portion of shares in Dipped Products plc, a company which is involved in manufacture and marketing of industrial and medical rubber gloves in addition to managing tea and rubber plantations. The company made a loss of Rs. 36.572 million for the quarter ended June 30, 2010, which reflects a 298% deterioration of its bottom line from a year ago as the firm was adversely affected by the extremely high natural rubber prices in the local and international markets. However, its group profits grew by 49% to Rs. 95.294 million for the June quarter due to better fortunes from its plantation businesses.
The Bottom Line could not contact anybody at the EPF department of CB, as the new media policy of the CB prevents officials in the bank from giving telephone interviews to the media.