Stock Taking

Delayed Transfers

By Rabindra Bhattarai

Clearing and settlement of the securities should complete as soon as possible after the buyer and seller agree to the transaction because the prices of the securities are very much sensitive and fluctuate many times even within a day. Since these fluctuations provide the investor the opportunities to gain from the investment, they should be allowed to benefit from such fluctuations. Delays in the settlement and failure in exchange cause losses to the investors by denying them these opportunities. When the exchange of fund and securities is delayed, the buyer loses if the market price of the securities goes up and the seller loses if the market price goes down.

Once the executed trades are matched and cleared they should be settled within certain days after the trade. It was T+5 (within five days after trade day) till recently in Nepal, but it has been now reduced to T+3 since the beginning of the fiscal year 2003/04. This initiative is appreciable as it enhances efficiency in the market by reducing the market risk of the investors to some extent. Earlier it used to be five days for which the investor had to lose the opportunities, now it has reduced to three days. Apart from the investor, this has also benefited different sectors of the economy. This increases the market liquidity, increases the trading volume in the market, causes more commission income to the brokers, and brings about higher revenue to the exchange as well to the government.

But are both parties of the trade equally benefited by this change? No. Though the seller is immediately benefited when the settlement occurs (he benefits if the price of securities he sold fall after the settlement and with the liquidity in hand he can enjoy other market opportunities available), but the equal partner in the trade (the buying investor) will lose market opportunities if the price of the securities he bought goes up.

More losses are being caused to the buyer by the delay in the transfer of the ownership of the securities he buys.

The rules of the NEPSE require that you can sell only those securities that are in your name. The buying party of the trade can not sell the securities immediately after settlement of the transaction. First it needs to transfer the title.

After the transactions are settled, the broker forwards the securities to the company to change the name of the owner of the security. But the time wasted in this process is surprisingly lengthy in Nepal. A registered broker of NEPSE puts this time at about five to six days in average. In reality it may take much longer than that as is illustrated from the table in this page in which data from a broker in Kathmandu are presented regarding the time between trading date and the date of arrival of the document from the company at the broker's office after the transfer is effected formally in the company's books.

The record of the brokerage firm indicates that it took between 11 and 86 days after trading date to forward the traded securities to the company. And the companies have taken additional 35 to 80 days to record the transfer and return the document to the broker.

'Stock Exchange Membership and Transaction Bylaw', sec 11, (2) (2) requires the transfer to be completed "as soon as possible". Such a loose provision allows the brokers to move the securities at a time as they may feel comfortable. There is no other reason that may cause such lengthy delay in just sending the documents to the company head offices from the brokers' offices when both of these offices are in Kathmandu within a distance of less than five kilometers.

The second part of the delay in transferring the ownership of securities is from the company and it has something to do with the answer to the question: When the securities are forwarded to the company office so as to effect the transfer of the ownership, how fast should the company transfer the title and return the document to the buyer? The Securities Exchange Act is silent about it. But the Company Act 2053, Sec 32 and sec 33, state that if the transfer is not possible for some reason, the company should inform the buyer and seller about it within 15 days after the application is received (it was 35 days earlier).

But unfortunately, this provision of Company Act is not clear whether the time of 15 days is to complete the execution of the transfer of the title or it is only the deadline for informing the buyer and seller of the securities to reject the registration of the title. This unclear provision has allowed the companies the freedom to transfer the title at their will, thus causing lengthy delay.

This delay has been causing the investors huge losses in terms of opportunities.

First, they are not able to sell the securities if they want to. Thus they lack liquidity. Second, they are losing the opportunities to sell when the price of the securities go up. Third, the investors who want to pledge the securities to borrow funds are restricted till they get the securities in their hand.

It is not only the investors who lose from the delay in securities processing cycle. A large number of the securities are blocked in the process and it restricts also the trading volume. If the volume increases, the market will have more liquidity, government revenue from capital gain tax and income tax (from investors and brokerage firms) would grow and the stock exchange too would earn more as the fee which is set as a percentage of the transaction value.

Efficiency in the stock exchange can be gained by improving efficiency in the parts of the exchange. While one part of the exchange's business is providing the trading place, the other part consists of the post-trade function, i.e. clearing and settlement. To bring about efficiency in the post-trade portion, NEPSE should go for the automated system which means central securities depository system, in which the transfer is possible through book entries and the cumbersome paper based system is avoided. The registration period, currently taking more than 100 days, will drop to 3 days or less.

Even under the existing system, the efficiency can be enhanced substantially if following measures are taken. (1) The present system of temporary transfer (popularly known as blank transfer, which has been going on by an administrative order of NEPSE) should be incorporated in the law. The order form to be filled up by the investor ordering the broker to buy a certain security should include a column offering the buyer a choice to go for blank transfer or permanent transfer. (2) The brokers should be strictly monitored so that they forward the securities to the companies immediately to transfer the title and the deadline to forward the securities should be incorporated in the stock exchange's membership and transaction bylaw. (3) Clearing and settlement of securities are completed with the transfer of title, but this is being regulated by the two regulators in Nepal (up to settlement by NEPSE and after that by company registrar office). Both of these should be brought under a single regulator. The transfer of title should logically be under the purview of NEPSE.

(Bhattarai teaches financial management in Shankar Dev Campus)

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