Vanished Market Makers

By Krishna Shrestha

One of the new things introduced in Nepal before India did the same was the concept of Market Maker in the stock market. But the failure of such institutions to live up to the expectations is partially to blame for the twists and jerks in the securities market. The basic concept of market maker is a good one but to make it functioning properly, anomalies should be sorted out and conducive environment should be created, say policy makers, implementing agencies, regulators and brokers.

A market maker is an institution responsible for providing liquidity to the stocks listed in the stock exchange. It takes the risk of being a buyer (or seller) of last resort.

The government had introduced the provision of market maker in Nepali securities market seven years ago but till to date no achievement has been gained from the new provision. When the system was introduced, it was supposed that the market makers would create and maintain securities market stable, and protect investors’ interests. But the dream has completely been shattered as things stand today.

"The basic concept of market maker is very good but there should be a conducive. Environment for its proper functioning," says Madan Raj Joshi, General Manager of Nepal Stock Exchange Ltd. (NEPSE), a non-profit organisation operating under Securities Exchange Act, 1983 with the objective of imparting ‘free marketability and liquidity to the government and corporate securities by facilitating transactions in its trading floor through market intermediaries."

Yogendra Prasad Shrestha, Chairman of Nepal Share Markets Co. Ltd. (NSM), the only unit still functioning as a market maker in NEPSE, also agrees that many barriers exist in the way of market makers.

"We need market making environment. We are told to swim in a swimming pool without water," says Chairman Shrestha.

Securities Exchange Regulation 2050 (1993) expected that market maker would carry out "the transactions of securities in the Stock Exchange on the basis of the commitment of providing liquidity to the securities issued by His Majesty’s Government and listed on the Stock Exchange."

But the legal provision has not materialised. Six years back, there were six market makers but today, there is only one. In 1995/96 Citizen Investment Trust (CIT), NIDC Capital Markets Ltd. (NCM), NSM, National Finance Co. Ltd., Rastriya Banijya Bank, and Gauri Shankar Finance Co. Ltd. were there as market makers. In 1998/98 the number declined to four with only four Nepal Merchant Banking and Finance Ltd. (NMBF), CIT NSM and Universal Finance and Capital Markets Ltd., existing in this business. The number further declined to two with in 1999/2000 only NMBF and NSM left in the market. Today, NSM is the only market maker in Nepali stock market. Others have decided to discontinue the job due to one reason or another.

"Market makers never came ahead effectively. They could hardly be seen in the trading floor. They would visit the trading floor only to fulfil the legal provision, as they needed to participate in the business at least once in three months. As far as maintaining the market stability is concerned, no market maker has become able to do so," says Navaraj Pokharel of Nepal Stock Brokers Association.

Besides, market makers have been blamed for creating distortion in the market by creating artificial price hike and taking undue advantage from innocent investors. "The market makers have rather distorted the market," says Damodar Prasad Regmi, Chairman of Kathmandu Finance Limited.

It is very hard to point out whether any market maker has distorted the market or not. But what is certain is that, not even a single market maker has become able to create and maintain the stability in the market. During the last seven years period of introduction of the ‘Open Out-Cry’ system, Nepali stock market has faced severe problems not less than half a dozen times needing help from market makers. Some but they never came ahead to intervene.

In the month of Falgun (February-March), Nepali investors were shocked to find a steep decline in share prices. Frustrated investors gheraoed the General Manager of NEPSE and demanded for intervention in the market to stop the price decline. NEPSE index had nosedived to 375.17 on March 1, 2000 from the height of 548.82 reached on November 23. But the only market maker, NSM, was not in a position to intervene and create stability in the market.

Market makers are supposed to quote best bid and best offer at trading floor before the stockbrokers assemble for trading. When the price goes up, market makers are supposed to intervene by offering shares held by themselves, thus increasing the supply and helping for price stability. Likewise, they are supposed to purchase the shares when the prices of shares start going down, thus increasing the demand. But, such cases have rarely happened in Nepal stock Exchange, point out the stock Exchange sources.

Who should be blamed for this all? Not the market makers alone, because lack of a conducive environment has compelled the market makers to discontinue their business. "It was mainly because of the liquidity problem we discontinued market making function," says Surendra Pradhan, General Manager of NCM. It could not cushion the shock of the decline in the prices of shares it held.

However, the reason for CIT leaving the business is different. If left opportunity of market making for government bonds. "We shifted our priority area. We rather focused on fund mobilisation," says Arjun Lal Rajbanshi, Manager of CIT.

"One of the major problems faced by market makers is the problem of maintaining minimum portfolio," says Dhambar Prasad Dhungel, Chairman of Securities Board, Nepal, the capital market developer and regulator of the country.

"The commercial banks have fixed the ceiling on number of shares that could be held by market making companies. Such ceiling ranges from 500 to 1000 units of shares. Purchasing or selling such a small number of shares can make no visible impact", says Shrestha of NSM.

Beside fund shortage and shortage of scrips, some market makers did not have expertise of conducting the business, says Pramod Bhattarai, one of the senior officers of NEPSE.

These problems of market makers were identified in the second year of the operation itself. But neither the government nor the Securities Board seriously considered the issue. No concrete steps were taken to create working environment. No pre-requisites for the functioning of market makers were fulfilled. The result was exodus of market makers and passive participation from the existing ones.

"The problems of market makers were identified in the second year of the opening of the market but no corrective measures have been taken till to date," says Madan Raj Joshi, General Manager of NEPSE. But he is still hopeful.

"There are possibilities of improving the situation," says Joshi showing his optimism. But how? Here is what Joshi suggests.

"Capital base of the market makers should be increased as low capital based companies can not perform well the work of a market maker. The ceiling on the shares of commercial banks that can be held by market makers should be reconsidered at least in the case of market makers. Certain percent of shares of issued capital in the primary market should be reserved for market makers. Banks and finance companies should provide short-term loans against the securities purchased by the market makers," suggests General Manager Joshi in a single breath.

NSM's Chairman Shrestha too is optimistic that the situation may improve in the coming days. He says, "The situation may improve as the government is going to amend the Securities Act."

However, until and unless the situation is improved and conducive environment is created, no market maker will be able to create and maintain stability in the stock market.

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