This document summarizes concerns around a controversial bond issue by Sri Lanka's Central Bank of Sri Lanka (CBSL). It outlines several failures including ignoring internal advice, lack of transparency around volume, price, and duration, and potential conflicts of interest due to the governor's relationship with a primary dealer. Regulators responded slowly, and estimates of losses do not fully capture reputational damage and increased borrowing costs. Overall, it appears procedures were ignored and governance issues existed at high levels of the CBSL regarding this bond issue.
1. Sri Lanka’s controversial bond issue:
ethics, judgement and governance in
financial services
26 July 2015
Fresh look at bond saga in Sri Lanka - Strategist 27/07/2015
2. The purpose
This presentation is an attempt to shed light on the
potential dark side of a recent bond issue in Sri
Lanka. While relying on secondary information we
also review some “unusual” events that have taken
place. Like in many other countries regulators in
Sri Lanka cannot make an absolutely safe
environment for financial services. Financial
services sector in general and central banking in
particular depend on, to a large extent, on ethics,
judgement and morals of participants. Here we
look at whether it is the system or the responsible
persons have failed.
3. Background
A recent government bond issue by the Central Bank
of Sri Lanka has become a key discussion topic in Sri
Lanka and overseas. The issue appears to have the
hallmarks of mismanagement at best and fraud at
worst. Many academics and professionals have
participated in the discussion. The estimated
accounting loss is estimated at Rs 6 billion. However,
most of the analysts have not taken into account the
resultant reputational damage and likely negative
impact on future bond issues and economy in
general.
4. Sri Lanka’s controversial bond
issue in perspective
SL’s controversial bond issue is almost
unprecedented
When a central banker had come under
scrutiny governments have acted swiftly
to remove or suspend them
Nigeria’s Central Bank governor was
suspended by the president for financial
irregularities
http://www.bbc.com/news/world-africa-
26270561
5. Governance and compliance
There seems to be governance issues at high level
Communication of facts has failed and/or facts
were communicated but ignored
Processes and procedures may not have been the
best but they were sufficient
Real issue appears to be the failure to comply with
existing processes and procedures.
6. Wrong start - political appointee not a
central banker
Appointment of a foreign citizen – unusual move
Candidate with commercial experience but very
little central banking experience at senior level
Candidate was not aware of the procedures of the
Central Bank.
Knowledge and skill of monetary policy setting was
also questionable.
Consideration was not given to internal candidates
Politics was a hindrance to rational thinking
Recruitment and appointment process was flawed
7. Triple “mistakes” – Volume, Price,
Duration and Mix
Importance of metrics ignored - one cannot
manage what one cannot measure
Volume: before purchase one needs to know how
much to purchase. This should have been
documented. It is the policy of any treasury
operation. Transparency was lacking.
Communication of the volume is paramount to
market efficiency – foundation of financial
markets.
It appears reasonable effort was not made to
communicate the volume needed in an impartial
manner
8. Triple “mistakes” – Volume, Price,
Duration and Mix
It appears that some of the participants were
aware of the volume. This disadvantaged the other
participants
Bank staff have raised this issue
Once again market efficiency was compromised
9. Determining price - know thy price
Trading price or price range should be realistic
It should be meaningful relative to the prevailing
market conditions
Efficient markets should deliver efficient prices
Extreme price volatility is a sign of market
distortions
Up to 300 b.p. (basis points) above the market is
an unacceptable variation
Price does not reflect the prevailing interest rate
structure
10. Determining price – market efficiency
Market distortion created by “unlimited information
to limited number of participants” created a
privileged position for some
Arms length rule was not followed
Relationship between the governor and a
participant was not disclosed
Related party transaction gives rise to insider
trading claims which in turn is a serious offence
Punishment for insider trading is a prison sentence
in many countries
11. Determining price – use of available
information
Price is relative to the prevailing environment
Prevailing environment should have been analysed
using available information
Dealing and research teams had the required
information
Did decision makers “intentionally” ignore the
information and recommendations?
In a well-developed central banking system why
was the communication so poor between the
governor and his advisors?
12. Duration – transparent information
Duration is basic information that any treasury
manager should know
Duration of the portfolio should have been
analysed and discussed in debt management
strategy meetings
Yield curve – relationship between interest rates
and time to maturity of the bonds – should have
been available on documents and on computer
screens (or even mobile phones)
Given the published information available better
decisions on duration could have been made.
13. Duration – internal strategy ignored?
Required information was available
Duration was clear
Current interest structure and expectations were
reasonably clear – global interest rates were
unlikely to increase sharply
Available information has not been taken into
account
14. Unusual Trinity – Was interest of CBSL
compromised by Governor/Son-in-law
relationship?
Central Bank
of Sri Lanka
(CBSL)
Perpetual
Treasuries
(PT)Bank of
Ceylon
15. Triple failures
Failure 1: Related party was not
disclosed
Failure 2: Unusual related party
transaction was not disclosed giving
rise to an insider trading claim
Failure 3: Expert advice ignored
16. Slow response from regulators
Regulators’ response has been slow
Only after extreme pressure from the lawmakers
the Prime Minister agreed to a parliamentary
enquiry
It is reasonable to assume that “political obstacles”
forced regulators go slow.
17. President the whistle blower
President identified the problem
Some may argue President does possess the
required knowledge without giving credit to his
senior advisors
Common procedure is for the CB Governor to step
down.
Failure to do so created further interest.
18. Unprecedented damage is
underestimated
There are estimates of US$ billion of
damage
These estimated do not take into account
the reputational damage and resultant
increased in interest rates for future
issues
Also they do not take into account cost of
high interest to the wider economy