ECONOMYNEXT – Sri Lanka’s central bank is taking steps to block information on rate decisions leaking to market players, overhauling existing practices and bring transparency to bond trading to expose manipulation, Central Bank Governor Indrajit Coomaraswamy said.
In one move monetary policy meetings, where rate decisions are made will be held after markets are closed.
After market meetings
"Our meeting will be held in such a way that decisions will be taken after markets are closed," Coomaraswamy told reporters.
"So nobody will know before the markets closed. That is a precautionary measure, I am not saying anything happened, but as a precaution we will do that."
There have been concerns in the market that the July rate hike, made after the appointment of the new governor had also leaked, based on some trades that were observed in the run up to the hike.
It is suspected that the view of a technical committee, which recommends at rate hike or cut is leaking to one or more players, several days before the rate decision, allowing them to liquidate their portfolio. However market players do not say officials involved in making decisions or recommendations are leaking any information.
Such ‘insider dealing’ generates only generates losses to other market players.
However losses are made to the state and ultimately to the tax paying public, when auctions are rigged by offering small volumes misleading the market in general and extra volumes are accepted from primary dealers who knew higher volumes would be taken.
Auction Rigging
However because all bonds were auctioned and no private placements were made, such manipulations obvious to observers, exposing the rigging, leading to an outcry.
Before 2015, analysts say large volumes were placed off market and any manipulation was not transparent.
It is believed that bonds may be have been sold up to 20 to 25 basis points above market (bonds sold at prices below the market price ) in negotiated deals, but at below the last auction price.
The private placements increased the discretion for central bank officials. Corruption stems from discretion, analysts say.
Even placing bonds at the last auction price, when secondary market rates are lower, gives excess profits to bond dealers, leaving room for even honest central bank officers to be ‘rewarded’, eventually corrupting some of them, analysts say.
Full auctions where pre-announced volumes are taken, takes away the discretion.
Analysts say placements were made originally not with any fraudulent intent but because central bankers, despite having training in economics are primarily bureaucrats and they distrust markets.
However market forces, market players, human reactions to price signals are the same all over the world, and therefore markets reacts predictably, with unfortunate consequences.
In addition to fraud, analysts say private placements worsen economic instability through a combination of initial financial repression that delays monetary policy transmission and extra-large rate spikes that are then needed to correct the resulting economic imbalances.
EPF Manipulations
The third facet of the so-called ‘bond scams’ was for the Employees Provident Fund, which is managed by the central bank, to buy securities from primary dealers at low rates (high prices) which were originally sold by the government at high rates (low rates).
The central bank officials had earlier refused to make public either the volumes or rates at which the bonds were bought from dealers.
Prior to the EPF purchases, key market players also bought bonds from other dealers to bring the price down and ‘pump up’ the price.
Then portfolios were slashed and ‘dumped’ on the EPF, leaving key dealers in cash, it is alleged. Market rates then went up. Critics say January and February 2016 saw a spike in such manipulations, though there were also other periods.
Sources with knowledge of the market say that deals were made by some EPF officials who engaged in similar trades in listed shares with virtually the same sellers before 2015 and had built long term lucrative relationships.
It is also alleged that EPF ‘missed’ bids in the primary market and information on EPF bid levels were also leaked to one or more players allowing their bids to be placed in the rigged auctions at high prices. Large volumes of long bonds were the then accepted at the auction.
Coomaraswamy suspended EPF purchases from the secondary market soon after he was appointed.
"Even though the EPF has authority to operate in the secondary markets, it is not operating in the secondary market," Coomaraswamy said.
"We are looking at our systems."
He said EPF will not trade in the secondary market until systems are upgraded, to increase transparency, which may happen by November.
Coomaraswamy said the question of long-term relationships with market players is being countered including through transfers and staff rotation.
"There are various ways it can be addressed," he said.
Deal Transparency
In about a year electronic trading will also be brought.
As an immediate remedy, traders have been asked to deal or report all trades on a Bloomberg trading platform all deals made through voice brokers.
Other than one or two dealers, all other dealers already owned Bloomberg terminals, which was the quickest solution seen, central bank officials said.
Allegations of insider dealing could also be tracked in the future, Coomaraswamy said.
"If information is given out from the trading pattern on the screen you will be able to tell fairly quickly if unusual trading patterns are taking place.
"You have alleged that information have gone out of the central bank, but in the future if they go around of the central bank it will be seen very quickly, in terms of trading patterns and types of activity."
"Constantly we are trying to promote and undertake developments which will increase transparency, reduce the potential for manipulation," Coomaraswamy said.
"Of course even in the most sophisticated markets manipulations take place, but we are trying to put in place systems and have greater transparency so that prospects of manipulations are reduced as much as possible." (Colombo/Sept29/2016 – paragraph 7 updated to make clear that there is no evidence or perception that officials involved in making recommendations or decision are leaking information)