Image: Alberto Miranda
THE OFFICES of the Securities Board of Nepal (SEBON) are not where one would expect to find a regulatory revolution. From its unassuming headquarters in Kathmandu, the regulator is known for presiding over a market known more for its volatility and dismal liquidity than for its sophistication. Yet a task force recently submitted a formidable list of recommendations to the finance ministry. With startling speed, the regulator announced this week that every single one would be adopted. The 30-point plan, a mix of technical tweaks and profound structural changes, seeks to catapult Nepal’s capital market into the modern era. It is a bold experiment in building a financial system by fiat.
The reforms are nothing if not comprehensive. The short-term measures, to be implemented within three months, read like a crash course in market-making. They include scrapping a Rs2.5bn ($19m) exposure limit for banks investing in a single client’s shares, and removing a cap that prevents them from holding more than 10% of a listed company’s shares or bonds. The central bank will allow interest on margin loans—money borrowed to buy shares—to be deferred until the fiscal year-end. A new, free-float-based benchmark index will be developed. This measure, which weights companies by the value of shares readily available for trading, should provide a clearer picture than the existing all-share index, which is easily distorted by small trades. The taxman will clarify that capital-gains tax on non-business share sales is final, sparing investors further scrutiny.
Further out, the ambitions grow. Within a year, the government intends to restructure the Nepal Stock Exchange (NEPSE) and list it via an initial public offering. It will create a separate trading platform for small and medium-sized enterprises, establish a settlement guarantee fund and introduce regulations for everything from pre-IPO fundraising on social media to the participation of non-resident Nepalis. The long-term vision, stretching beyond a year, is more ambitious still: a new, specialised securities law; strategic partners for NEPSE; and the introduction of intraday trading, short-selling and equity derivatives.
For a market that still feels like a frontier outpost, this is a dizzying prospect. A broker in Kathmandu, surrounded by flickering trading screens, captures the mood. “It is like being given the keys to a Formula One car when you have only ever driven a tractor,” he says. “The potential for speed is exciting. The risk of a catastrophic crash is equally real.”
The risks are indeed peppered throughout the official documents. Removing the single-customer exposure limit for banks, the report notes, could lead to “increased concentration risk”. Letting banks invest more freely might allow them to “monopolise share trading, reducing market liquidity”. Allowing investors to open multiple demat, or dematerialised, shareholding accounts carries the “possibility of double benefits if customer identification is not effective”. The most telling admission concerns the plan for complex derivatives and short-selling: the “risk” is an “increased market risk due to lack of investor sophistication.” It is a rare moment of official understatement.
The plan is a classic example of a developing-economy regulator’s dilemma. To attract capital and mature, a market must offer the sophisticated tools and protections found elsewhere. But introducing those tools into a market dominated by retail investors, who tend to treat stocks as a speculative lottery, is fraught with peril. The reforms seek to tighten governance—for instance, by classifying listed companies by financial strength and governance, and restricting the worst performers from using cash-margin facilities. Yet they simultaneously plan to unleash a wave of potentially destabilising leverage and complexity.
The sheer scope of the reforms also raises questions of capacity. SEBON and NEPSE are not known for their agility. Implementing 30 major changes concurrently, while also restructuring the exchange itself, would be a formidable task for the most advanced regulatory body. Here it seems Herculean. The success of the venture hinges on a fragile assumption: that the competence needed to craft such a plan can be marshalled to execute it.
The driving force appears to be a desperate need to catch up. Nepal’s stockmarket, with a capitalisation of under $33bn, is a minnow. Its recent history is a rollercoaster of booms and busts, driven by rumour and a scarcity of shares rather than corporate fundamentals. The NEPSE index soared to all-time highs in 2021, only to tumble as interest rates were yanked up. The reforms are an attempt to break such cycles, to build a market that allocates capital efficiently rather than simply recycling it. The goal of creating a vibrant bond market, for government and corporate debt, is particularly crucial for a country with such immense infrastructure needs.
Yet for all the technical ambition, the process itself is revealing. A comprehensive regulatory overhaul being approved in its entirety just days later is not how such things are typically done in more established markets. There, change is usually grinding, subject to endless consultation and industry lobbying. The Nepali approach is breathtakingly top-down. It is a gamble on the wisdom of the planner over the messy consensus of the market.
The final irony is one of trust. The entire edifice of a securities market rests on the belief that rules will be enforced fairly and that the system is sound. Nepal’s reform binge is a massive injection of new rules into a system whose ability to absorb them is unproven. The plan is a testament to a regulator’s faith in its own blueprints. The market’s job, as ever, will be to test that faith. ■
