The challenge of ethical investing

Following this column’s review of the 2012 Annual Report on the Demerara Tobacco Company Limited in which I stated that I am a small shareholder (500 shares) in the company, a colleague of mine criticised me for profiting from a company whose product is now known to be a killer. I explained to him that the reason for the shareholding is to ensure that I receive the annual report of the company and have the right to attend company meetings. Similarly, for as long as I can remember I have had shares in DDL and Banks DIH Limited despite the fact that I believe there are personal, economic and social consequences for those who engage in excessive use of rum, which is their principal product. After careful consideration and with some regret at my belated decision, I wrote in my review of DDL’s 2012 Annual Report that I would be disposing of my small shareholding in that company, except for a few to allow me to receive the company’s annual reports. My action stems from my conviction that there is such a concept of ethical investing.

Ethical investing or, as it is sometimes referred to, socially responsible investing, has been gaining popularity as individuals seek to align their investments with their personal views, whether they are based on environmental, religious or political precepts. Essentially it comes down to this: should a vegetarian invest whether directly or indirectly in a company that owns and operates abattoirs, or an anti-alcohol group invest in a rum company or a Cancer Society in a tobacco company?

Continue reading The challenge of ethical investing

Making the Stock Exchange work – Part 2

Today I continue the discussion on the Guyana Stock Exchange and what we might do to make it work. I believe that a vibrant stock exchange is an important vehicle to promote growth in the economy and to enable the small investor to share in the national economic pie.

This discussion on making our stock exchange work is more than some abstract financial concept, and relates to some useful initiatives in Jamaica which has one of the oldest exchanges in the region but which up to a couple of years ago had seen trading slowed to a crawl.

If we look at the banking statistics we realise how difficult it is for small and medium-sized enterprises (SME) to raise capital through commercial loans, both because they lack the necessary security to support their loan applications and because they have to pay rates of interest that are often beyond their reach.

The most recent Bank of Guyana report shows the prime lending rate by the commercial banks of 15.06% although a number of borrowers have been negotiating for much lower rates under the threat of taking their business elsewhere.

On the other hand the majority of savings deposit account holders receive interest of less than 3% per annum which is lower than the rate of inflation, even if we ignore the withholding tax of 20%. Part of this dichotomy lies in an examination of some other banking statistics. Table 2.14 of the Banking Statistics at December 31, 2010 shows under ‘Commercial Banks: Liquid Assets’ treasury bills of $64,401.1M, even though this conflicts with Table 2.17 which shows ‘Commercial Banks Holdings of Treasury Bills’ of $65,514.2M.

Add to that the sums of money held by the commercial banks with the Bank of Guyana as “Commercial Banks: Minimum Reserve Requirements”. This stands at $45,101.9Mn compared to a required level of $29,335.0Mn at December 31, 2010, an excess of $15,766.9M. So at the end of 2010 the commercial banks had invested in the government through Treasury Bills and reserve requirements close to $110 billion out of total deposits with them of $248 billion.

It is as if the banks are raising money for the government rather than intermediating funds within the private and business sector to which loans and advances at December 31, 2010 amounted to $76 billion.

In other words, of the deposits received by the commercial banks, the government holds Treasury Bills attracting interest of between 2.67% and 3.78% per annum while the Bank of Guyana holds funds from the banks as reserve requirements another $45 billion which attract no interest at all. On the other hand households and the business sector are loaned $75 billion with a prime rate of 15%! Of course there is small business and low cost housing lending which are at lower rates subsidised by the general tax laws.

I mentioned last week the mindless and costly policy of the government when it comes to managing the financial sector, and am again reminded that the commercial banks are caught between Scylla and Charybdis – the BoG has imposed such onerous lending and provisioning requirements and restrictions on the commercial banks as to discourage lending. These statistics require a separate study outside the scope of a newspaper column.

A viable option
The point is that if we could have an active stock exchange not only would bank depositors have an alternative and possibly better vehicle for their savings, but businesses would be able to access funds at a much lower cost of capital, a term that is common in financial management.

Of course, not all companies and particularly the start-ups are ready for the big time on the stock exchange, and they would not be able to compete with the bigger players. And that is the point about the junior stock exchange that has been working so successfully in Jamaica.

Down Jamaica way
But even the Jamaicans will tell you that they did not initiate the concept, and in their own preparations noted the success of the London Stock Exchange junior market – the Alternative Investment Market (AIM) and the Toronto Stock Exchange junior market – Venture X.

These junior markets allow investors to put capital into legitimate small and medium-sized companies that are listed. Experience from those exchanges has shown how the fundraising and development activities of the listed investment securities have been able to grow the local economy by creating established and transparent businesses, jobs and ultimately, economic confidence.

The Jamaican experience followed the same pattern. Within two years there were some nine companies listed on the junior market in Jamaica across the manufacturing, retail, tourism and finance sectors, and there are reportedly ten other companies preparing to enter the market.

For them the major attraction was lowering their cost of funds.

After only a couple of years Jamaica now has an active junior stock exchange with clear rules of entry and engagement, which despite a 92-page document are nothing too onerous.

In order to be admitted to the exchange a company must issue voting shares by way of an initial public offering, subject to a prospectus seeking a minimum subscription of new shares (or allotment of existing shares) of not less than J$50 million and not more than J$500 million only.

The exchange rate of the US dollar to the Jamaican dollar is approximately 85:1. If a company exceeds its maximum market capitalization of J$500 million, it will be required to list on the main JSE Board.

For the purpose of transparency, annual statutory audit, quarterly and annual reports are required in keeping with the submission requirements of the main exchange. The company must appoint to its board a mentor who is approved as ‘Fit & Proper’ by the Financial Services Commission, the equivalent of our Securities Council.

Companies which are not allowed to list on the junior exchange include a company which is wholly or partially a subsidiary of a registered entity on a recognized stock exchange and one which had been listed on the main board of the exchange.

Attracting SMEs to the exchange
It was recognised that SMEs would be attracted to the Junior Market based on the level of support which will be provided to them. Not all of the assistance was financial or fiscal. They could benefit from the Private Sector Development Programme, a technical assistance programme implemented jointly by the European Union and the Government of Jamaica.

Fiscal incentives included a tax incentive for a period not exceeding ten years from the date of listing on the JSE Junior Market as follows:

i. a full income tax holiday for five years after listing and a half income tax holiday for the remaining years;

ii. exemption from tax on dividends or other distributions by Junior Markets;

iii. exemption from transfer tax and stamp duty on transfers of shares in JSE Junior Market companies.

If the company de-lists within 15 years of being listed on the combined exchanges, it will be required to repay to the government the tax benefits enjoyed during this period.

An SME will enjoy the benefits of any approved tax incentive while on the Junior Market during the allowed incentive period. At the end of the allowed incentive period, the SME will be obligated to move to the main board of the JSE. If the SME decides after the period in which the tax holiday was granted not to list on the main board or to delist without compelling reasons, the SME must reimburse the government for the tax incentive provided.

The big challenge in Guyana to get private companies to bring in outside shareholders has to do with transparency, accountability, governance and tax issues. We have already noted that the lion’s share of corporation tax is paid by a handful of companies.

The names of several of our hardware suppliers, contractors and the politically connected or protected simply do not appear anywhere close.

They are busy gobbling up state assets and are oozing with liquidity.

They seem always bent on ensuring that everything is kept in the family. Governance for them applies only to the government and most of them do not bother with annual general meetings or filing annual returns, and they know that the GRA has only limited capacity to do a good audit.

Still a few of them willing to be pioneers and offering say 25% of their shares to the public could be enough to get a junior exchange started.

All the features of the Jamaican model may not be appropriate to us in Guyana. However they offer a template that could be modified to suit our peculiar needs and to attract entrants.

To continue to do nothing is hardly an option. It is time the government shows some interest in our Stock Exchange.

Making the Stock Exchange work

We have not heard much from or about it recently. Passing its offices at High and Robb Streets it is hard to believe that this is the institution that was set up with much hype, expectations and hope that it will make access to capital easier and cheaper, widen shareholder ownership and raise the bar of corporate governance. The Guyana Stock Exchange, or to use its more formal name the Guyana Association of Securities Companies and Intermediaries Inc, was incorporated on June 4, 2001 after several studies with the principal aim of encouraging companies to “go public,” a term generally used to mean companies offering their shares to the public. To encourage such companies the government offered them favourable tax treatment including waiver of duties payable on the transfer of shares in quoted companies and exemption from Capital Gains Tax on gains made on the disposal of shares in public companies.

The Stock Exchange has had only limited success, being largely ignored by the government and failing to attract any attention from this Finance Minister. With a private sector body that seems to have a view only if prompted by the government, its chief spokespersons in the Private Sector Commission have been similarly silent. In fact I find it hard to believe from any of their utterances that they even remember that the exchange exists.

Access to capital
This column has constantly proclaimed the importance and possibilities of a vibrant and functioning stock exchange to a market economy. Real interest rates, ie, the rate charged over the rate of inflation is still extremely high and actually discourages borrowings by the business community since the cost of funds make many investments unattractive ab initio. Then we have the government’s endless policy of mopping up liquidity that costs the taxpayers billions of dollars in interest payments. This policy encourages the financial intermediaries to make their money by charging high rates of interest on one class of lending – its borrowings group – thereby making it financially justifiable to invest the rest in government securities at rates that are less than the rate of inflation. But since the government does not see this, the private sector is automatically handicapped.

This in no ways suggests that the commercial banks should open their vaults to all and sundry or indeed that it is sensible to do so. Financed mainly by customers’ deposits, banks and other deposit taking financial institutions operate like trustees, and it takes only a couple of their larger loans to go bad to create havoc with their financial results and balance sheets. More recently the Anti-Money Laundering and Countering the Financing of Terrorism Act 2009 has added to the challenges and risks facing such entities, since the act requires lenders to have the most intimate detail about their customers.

‘Well done, Mr Minister’
Dr Ashni Singh wrapped up the debate on the 2011 budget by sweeping and disparaging remarks about the parliamentary opposition’s poor contribution during the debate. Yet, his budget speeches are themselves devoid of any real underlying vision or philosophy, more rhetoric than substance, and even in budget measures there was clearly a failure to apply any intellect or effort at analysis. It is disrespectful and arrogant of Dr Singh to believe that he alone has the capacity to speak or think through a proper national budget. In fact had it not been for the annual stealing of VAT from the people of this country, the ineptitude of the President and his successive Finance Ministers would have been on national display.

In none of his four budget speeches has Dr Singh shown any understanding of the role of a stock exchange or concern about its failure to take off, or to explore and exploit the opportunities and possibilities which a stock exchange can bring. Has the PSC not seen this or the National Competitiveness Council or the Chamber of Commerce or anyone else? Would Dr Singh include them as part of that group that makes no constructive contribution to the budget, or is their endorsement, “Well done Mr Minister,” what he considers constructive criticism?

If only we were more imaginative and innovative, if only we understand that there is trading in government paper all year round, if only we really believed that the private sector is the engine of growth and a functioning capital market its fuel, GPS and steering system, we will still be able to bring the stock exchange back to life.

As the stock exchange enters its eighth year of operation, policy holders may wish to look at the steps taken by Jamaica, where its exchange too had slowed almost to a crawl. Jamaica’s answer was the creation of a Junior Stock Exchange that within a couple of years has seen eight companies entering the market with another ten lined up for listing in 2011.

A brief history
The Exchange began trading on July 8, 2003 at which time the market value of the shares of companies to be traded was approximately $17.7 billion. At December 31, 2010, this had increased to $69.4 billion. Trading on the Exchange has been slow not only because the concept of public ownership of shares is still not strongly promoted or embraced, but also because many of the country’s public companies are controlled companies and the number of shares available for trading is therefore limited. Yet, the total value of trades on the Exchange since its inception has exceeded two billion dollars with four companies accounting for 83% – Banks DIH, (50%); DEMTOCO (13.2%), DDL (10.8%); and GBTI (10.7%).

That is confirmed by the following chart which shows the number of shares traded by year (the acronyms are expanded in the table following).

DIH – Banks DIH Limited
CCI – Caribbean Container Inc.
CBI – Citizens Bank Guyana Inc.
DBL – Demerara Bank Limited
DDL – Demerara Distillers Limited
DTC – Demerara Tobacco Company Limited
BTI – Guyana Bank for Trade and Industry Limited
PHI – Property Holdings Inc.
GSI – Guyana Stockfeeds Inc.
RBL – Republic Bank (Guyana) Limited
SPL – Sterling Products Limited

Source: Guyana Stock Exchange

Another expectation was that the Stock Exchange would have a positive impact on share prices. In the first couple of years the results exceeded expectations with substantial increases on the prices of almost every company with gains ranging from 29% to 500% in one extreme case. The market made adjustments for the shares in Demerara Tobacco Limited, the Guyana Bank for Trade and Industry and Republic Bank Limited, while a significant movement in the shares of Banks DIH Limited accompanied the interest in the take-over of that company by the Trinidad company Ansa McAl.

To be continued

IFRS for SMEs: One cheer for the accounting profession!

After more than six years of drafting, consultations, redrafting, deliberations, field testing and debates across a number of countries of the world, the International Accounting Standards Board (IASB), the body responsible for international standard-setting for the accounting profession, has issued an International Financial Reporting Standard (IFRS) designed for use by small and medium-sized entities (SMEs). Guyana is a member of the International Federation of Accountants and such standards automatically apply to Guyana.

The accounting regulator in Guyana, the Institute of Chartered Accountants of Guyana is now considering adoption. While it has not pronounced on the new standard it is expected that the standard would be available for use in the 2009 financial statements of all Guyanese SMEs. While not the most satisfactory situation, some members of the accounting profession have opined that even in the absence of such pronouncement, businesses and their auditors should take the lead and apply the new standard immediately.

The release of the new IFRS should be seen as one of the most welcome developments and contribution of the accounting profession in modern times. It simplifies many of the rules governing the preparation, contents and presentation of financial statements for all but a dozen or so of our companies. Up to this time the same rules that applied to the multi-billion dollar company like Demerara Distillers Limited also applied to the small one person operation – a requirement that is expensive, impracticable and nonsensical. The financial sector would be particularly gratified as the new standard removes one of the excuses of the profession about the cost, time and complexity involved in the preparation of financial statements submitted to them in support of credit applications and renewal.

The IFRS for SMEs is a self-contained standard of about 230 pages tailored for the needs and capabilities of smaller businesses. Many of the principles in full IFRSs for recognising and measuring assets, liabilities, income and expenses have been simplified, topics not relevant to SMEs have been omitted, and the number of required disclosures has been significantly reduced.

Main features
The following principal changes to existing accounting rules for SMEs arising from the new IFRS are highlighted:

1. Some topics in IFRSs are omitted because they are not relevant to the typical SMEs. These include: earnings per share; interim financial reporting; segment reporting; and special accounting for assets held for sale. To the extent that they do apply, non-mandatory reference could be made to the existing IFRS’s, which does compromise the stand-alone precept.

2. Some accounting policy options permitted under full IFRSs are not allowed under the SME IFRS because a more simplified method is available under the new standard. These include: financial instrument options including available-for-sale, held-to-maturity and fair value options; the revaluation model for property, plant and equipment and for intangible assets; proportionate consolidation for investments in jointly controlled entities; for investment property, measurement is driven by circumstances rather than allowing an accounting policy choice between the cost and fair value models; and various options for government grants.

I have highlighted the revaluation issue because this has become a common practice in Guyana following our experience with hyper-inflation in the late seventies and eighties.

3. Recognition and measurement simplifications: The main simplifications to the recognition and measurement principles in full IFRSs include the accounting principles and disclosure rules for financial instruments; goodwill and other indefinite life intangible assets which must be amortised over their estimated useful lives (ten years if useful life cannot be estimated reliably); research and development costs which must be recognised as expenses; borrowing costs which must be recognised as expenses; property, plant and equipment and intangible assets; and defined benefit plans the past service cost of which must be recognised immediately in profit or loss while all actuarial gains and losses must be recognised immediately either in profit or loss or other comprehensive income.

4. Substantially fewer disclosures: No longer should the financial statements look like a formidable book written in a language to confuse rather than inform. Pro-forma financial statements compatible with the new IFRS have been developed and published by the IASB and are available on their website.

5. Simplified redrafting: A significant feature of the new standard is that it will only be subject to triennial reviews so that there is more certainty and uniformity in the preparation and presentation of financial statements. No need to worry about annual reviews and changes and the implications for comparative figures. Hopefully as well, instead of spending a whole lot of time on what was essentially non-added value work, auditors will assist their clients in offering advice on internal controls and business issues.

One of the main questions that obviously came to mind in developing the new standard is what will be considered an SME, since there was no agreed or universally accepted definition. SMEs come in many shapes and shades and it would be a challenge for the profession and the law to capture in a single definition the range of such entities. An SME in a developed country could be a major player in a developing one and therefore a definition based on quantitative factors such as number of employees or level of sales was rejected.

An SME is defined in the standard as an entity which publishes general purpose financial statements for external users but does not have public accountability. An entity has public accountability if (a) its debt (borrowings) or equity (shares) instruments are traded in a public market or it is in the process of issuing such instruments for trading in a public market; or (b) it holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses. All companies traded on the Guyana Stock Exchange, banks, insurance companies, securities brokers/dealers, unit trusts, etc, would be considered to have public accountability and cannot therefore prepare their financial statements using the IFRS for SMEs.

What about those SMEs that seem to be neither fish nor fowl and how do we deal with the public interest companies for which special reporting requirements are desirable? Where for example does a Guysuco, a GPL or a GT&T come, and are consumers any less important than investors?

The IASB considered whether to include in the definition of public accountability those companies which provide an essential public service such as a public utility. Respondents to the discussion paper however felt that in many jurisdictions such entities could be very small.

Consideration was also given to those entities which were economically significant in their home jurisdiction but the IASB felt that “economic significance may be more relevant to matters of political and societal accountability” and therefore felt that the final decision should be left to the individual jurisdictions.

Time for action
The issue of this standard should be addressed not only by the accounting profession in relation to its clients but by the Ministry of Finance, the Guyana Revenue Authority and the lending community. The Companies Act envisaged that the Minister of Finance would set certain levels of income, assets or staff below which the requirement of the audit of a company could be dispensed with. The act has now been on the law books for eighteen years but no such pronouncement has been done. It is time that this be done.

The Guyana Revenue Authority too has to consider whether it should be insisting that a one-man company with a small turnover and few assets should require an audit but the multi-billion dollar self-employed person does not. Yes, it is a legislative matter but it is up to the GRA to make recommendations based on practice and experience.

The lending community now has an opportunity to decide whether it will continue to accept some of the sloppily and inaccurately prepared financial statements submitted in support of lending applications or whether it will now sit with its clients and the accounting profession and insist on a higher standard of accounting and reporting. The accounting profession locally has generally been very slow and a ditherer on the occasions on which leadership was required. It should now piggy-back on the initiative of its international brotherhood – for that is what it is – and take decisive action on this matter to justify the wide powers it enjoys under statute.

The new IFRS is clearly both an opportunity and a challenge and to use that overdone term, every stakeholder should see and use this to rectify many of the serious mistakes that have been perpetrated and tolerated for decades.

Mistakes that have caused the loss of billions of dollars of revenue to the state, the loss of reputation of a profession that has become associated with tax evasion and aggressive tax planning and the inability of the layperson to read and understand financial statements, an important requirement for a developing capital market.

At the same time, the new IFRS is not a panacea and outstanding issues such as corporate governance, money-laundering, tax evasion and poor and unethical standards of accounting and auditing will remain to be addressed. This new IFRS is however welcomed by Business Page as a useful development. One cheer for the accounting profession!