Framing the Issues: Modernizing the Public Equity Market in Nepal JOHN SCHELLHASE, STACI WARDEN ABOUT THE MILKEN INSTITUTE CONTENTS The Milken Institute is a nonprofit, nonpartisan think tank. 2 INTRODUCTION AND OVERVIEW For the past three decades, the Milken Institute has served as a catalyst for practical, scalable solutions to global challenges by connecting human, financial, and 5 PART I FOUNDATIONS FOR CAPITAL MARKET DEVELOPMENT: educational resources to those who need them. Guided by a conviction that the POLITICAL AND MACROECONOMIC STABILITY AND A STRONG, STABLE BANKING SECTOR best ideas, under-resourced, cannot succeed, we conduct research and analysis and convene top experts, innovators, and influencers from different backgrounds and 7 Political and Macroeconomic Stability competing viewpoints. We leverage this expertise and insight to construct programs 8 The Banking Sector and policy initiatives. 13 PART II DEVELOPING THE NEPSE: ATTRACTING ISSUERS, These activities are designed to help people build meaningful lives in which EXPANDING THE INVESTMENT BASE, AND IMPROVING THE they can experience health and well-being, pursue effective education and TRADING ENVIRONMENT gainful employment, and access the resources required to create ever-expanding 14 Attracting Issuers opportunities for themselves and their broader communities. 25 Attracting Investors 31 Improving the Trading Environment and Increasing Liquidity ABOUT THE GLOBAL MARKET DEVELOPMENT PRACTICE 37 PART III OWNERSHIP, GOVERNANCE, AND REGULATION The Milken Institute’s Global Market Development practice works to catalyze private-sector-led growth and economic prosperity in developing countries and 38 Reforming the NEPSE’s Ownership Structure emerging markets. The practice pursues this mission by facilitating informed and 39 Governance and the NEPSE Board of Directors coordinated policymaking processes across government institutions, private-sector 42 Regulatory Independence and Capacity stakeholders, and civil society, and by training a generation of leaders in central banks, finance ministries, and securities regulators, among otherfi nancial institutions. 45 CONCLUSION 46 Table of Recommendations ABOUT THE ASIA CENTER Based in Singapore, the Milken Institute Asia Center extends the reach and impact of Milken Institute programs, events, and research to the Asia-Pacific region. It identifies opportunities to leverage the Institute’s global network to tackle regional challenges, as well as to integrate the region’s perspectives into the development of solutions to persistent global challenges. ©2019 Milken Institute This work is made available under the terms of the Creative Commons AttributionNonCommercialNoDerivs 3.0 Unported License, available at creativecommons.org/licenses/by-nc-nd/3.0/. MILKEN INSTITUTE MODERNIZING THE PUBLIC EQUITY MARKET IN NEPAL 1 The following report summarizes the ideas, recommendations, and outstanding Introduction and Overview concerns of roundtable participants. It is organized into three parts: I. FOUNDATIONS FOR CAPITAL MARKET DEVELOPMENT: POLITICAL The government of Nepal, the first elected under the new AND MACROECONOMIC STABILITY AND A STRONG, STABLE BANKING 2015 constitution, is undertaking an ambitious development SECTOR: Roundtable participants assessed the extent to which Nepal met key agenda to transition the economy from dependency on aid prerequisites for capital market development, with a focus on political stability, and remittances to a private-sector-led growth model. As macroeconomic indicators, and the state of the banking sector. They also evaluated the remaining challenges in these areas. In particular, they identified policymakers widely recognize, this transformation will require several interrelated challenges for the banking sector, including the issues significant additional levels of both domestic and international smaller firms face in accessing bank credit, the fact that the banking sector investment. To this end, the government is contemplating a is running up against maximum regulatory lending limits, and the potential concentration risks that emerge from the dominance of banking sector broad agenda for capital market development, including the issuances in the debt and equity capital markets. modernization of the Nepal Stock Exchange (NEPSE). II. DEVELOPING THE NEPSE: ATTRACTING ISSUERS, EXPANDING THE INVESTMENT BASE, AND IMPROVING THE TRADING ENVIRONMENT: Within the wider financial ecosystem, a well-functioning stock market can make Roundtable participants discussed what steps NEPSE could take and what a significant contribution to economic growth and diversification by enabling regulatory barriers needed to be removed to attract new non-financial firms to make long-term investments in research and development and market corporations to list shares on the NEPSE. They also explored ways to deepen expansion, while also promoting strong standards of corporate governance and and widen the NEPSE’s domestic retail investor base while also attracting transparency. Stock markets also encourage savings and provide opportunities for international investor flows. Additionally, roundtable participants stressed average citizens, as well as institutional and foreign investors, to participate in the the importance of ensuring market integrity, improving market infrastructure, growth of the national economy by investing in listed companies, either directly or and further developing the ecosystem of market intermediaries as part of a through collective investment products such as mutual funds. As documented in this cohesive strategy for improving the overall trading environment and increasing report, market stakeholders in Nepal believe that key institutional and regulatory market liquidity. reforms could help further empower the NEPSE to play this important role in Nepal’s economic transformation. III. OWNERSHIP, GOVERNANCE, AND REGULATION: Roundtable participants generally agreed that modernizing and improving the NEPSE To explore the major priorities for—and key obstacles to—developing the public will likely require reforming its ownership and governance structures. They equity market in Nepal, the NEPSE partnered with the Milken Institute to organize discussed the importance of privatization and what form government a strategic planning roundtable in Kathmandu on May 31, 2019, during a meeting divestment might take, while also emphasizing the need to reform the of the executive committee of the South Asian Federation of Exchanges (SAFE).1 composition of the NEPSE board to include more independent directors. The day-long event convened government officials, NEPSE management and board Finally, roundtable participants emphasized that ensuring the Securities Board members, banking executives, stockbrokers and investors, international development of Nepal’s operational independence and strengthening its regulatory capacity partners, and SAFE members.2 Roundtable participants discussed the options would be crucial for overall capital markets development. available and lessons learned from other markets for modernizing the public equity market in Nepal.3 The report concludes with a summary of the main themes discussed by roundtable participants and a detailed table of the concrete recommendations that emerged 1 To encourage a candid exchange of ideas, the discussion was held under the “Chatham House rule.” In this format, participants can share information and ideas from the roundtable with external audiences. However, participants may from the discussion. not publicly attribute a particular statement to an individual or institution by name. 2 The South Asian Federation of Exchanges is an association of stock exchanges that promotes the development of securities markets in the region through knowledge sharing and developing common regional standards for listing, trading, clearance, settlement, and investor protection. 3 The NEPSE and the Milken Institute undertook a survey of Nepali businesses in May 2019 to better understand the current business environment, corporate financing needs, and perceptions of the NEPSE among listed and unlisted companies. Results of this study, which received 126 responses, are included throughout the report. MILKEN INSTITUTE MODERNIZING THE PUBLIC EQUITY MARKET IN NEPAL 2 MILKEN INSTITUTE MODERNIZING THE PUBLIC EQUITY MARKET IN NEPAL 3 PART ONE Foundations for Capital Market Development: Political and Macroeconomic Stability and a Strong, Stable Banking Sector Global experience has shown that capital markets typically develop only after certain prerequisite conditions are met. These prerequisites include political stability, macroeconomic stability (notably sound fiscal policy and a low inflationary environment), and a strong, stable banking sector. All contribute to a predictable macroenvironment that enables economic growth and incentivizes long-term savings and investment. While roundtable participants identified potential challenges for Nepal, as detailed below, they generally agreed that the essential foundations for further capital market development are now in place. MILKEN INSTITUTE MODERNIZING THE PUBLIC EQUITY MARKET IN NEPAL 5 BOX A. The Business Environment in Nepal: New Survey Evidence POLITICAL AND MACROECONOMIC STABILITY To provide policymakers with more accurate data on the current business environment, the NEPSE and the Milken Several roundtable participants observed that the discussion of modernizing the Institute fielded a survey to Nepali companies in May 2019 and