Major Changes in the Capital Market: Government's 21-Point Reform Plan

Kathmandu - The government has publicly announced the 21-point ‘Capital Market Strengthening and Revival Action Plan, 2083’ with the objective of making Nepal's capital market dynamic, modern, and investment-friendly. The action plan includes measures ranging from determining eligibility for initial public offerings (IPOs) to allowing non-residential Nepalis to enter the secondary market, improving capital gains taxes, and establishing a minimum holding period of 45 days for shares in banks and financial institutions.

The action plan, issued by the Ministry of Finance on Bhadra 29, 2083, has been established based on the economic stagnation, and the downturn observed in the banking and financial sector, industry, trade, infrastructure, investment, and the capital market. The damage caused to listed hydropower projects and physical infrastructure due to the flood in the Bhotekoshi River has also increased pressure on the economy and the capital market, as stated by the ministry.

Separate Eligibility Criteria for IPOs by Sector

The Securities Board of Nepal will soon issue guidelines pertaining to the general eligibility criteria needed for IPO issuance in the primary market. Following that, distinct eligibility criteria will be established for hydropower, production and processing, hotels and tourism, agriculture, and pharmaceutical industries for public offerings based on a market-oriented price system.

Since the nature of companies in these sectors, their income status, project development stage, and risks vary, it aims to create sector-specific arrangements instead of using a single standard. Measures regarding price discovery, security distribution, and other policy and legal frameworks will also be improved. The new system with sector-specific criteria aims to be implemented by the end of Poush 2083.

Transforming Mutual Funds into a Long-Term Market Foundation

Improvements will be made to the structure of mutual funds to develop new instruments, such as debt markets, currency markets, and exchange-traded funds (ETFs). The government plans to make mutual funds professional, diversified, transparent, risk-aware, and technology-friendly long-term investors.

The Securities Board will soon publish related policies and will prepare guidelines and necessary infrastructure by the end of Mangsir 2083. This is expected to allow the role of mutual funds to expand beyond just being institutions applying for public offerings into ones investing in various financial instruments.

Transformation of Broker Companies into Multifaceted Financial Institutions

A policy for institutional reform and strengthening of the brokerage business will also be released soon. The aim is to transform broker companies into institutions providing multifaceted securities financial services, modern, professional, strengthened, and technology-friendly, based on international practices.

In the future, this will prepare the groundwork for not only carrying out transactions through brokers but also for margin loans, investment-related services, and the operation of new market instruments.

Opening Up Margin Trading, Intraday Trading, and Short Selling

The government has decided to make timely reforms in the Securities Act of 2063. Separate draft bills related to securities regulation and market infrastructure will be prepared.

After the legal reforms, the way for operating instruments such as margin lending, intraday trading, securities borrowing and lending, and short selling will be opened. This will also require developing rules, technology, risk management, and trading and settlement systems.

Immediate Restructuring of NEPSE to Advance

The institutional strengthening, structural improvements, and capacity enhancement of the Nepal Stock Exchange (NEPSE) will be carried out. The action plan mentions immediate advancement in the restructuring process of NEPSE based on the report submitted by the task force formed by the government on Poush 25, 2082.

However, the detailed form of restructuring, ownership structure, and arrangements regarding strategic partners have not been disclosed in the action plan.

NEPSE to Maintain an All-Equity Structure, New Benchmark Index Coming

The current NEPSE index will be maintained as the ‘All Equity Index’. Along with this, a new fundamental or benchmark index will be prepared, which will more effectively reflect the real state of the market.

When preparing the new index, factors such as tradable shares, market capitalization, the financial condition of companies, liquidity of transactions, institutional governance, and information flow will be used as a basis. The aim is to implement such an index by the end of Mangsir 2083.

Non-residential Nepalis to Enter the Secondary Market

Preparations have been made to allow non-residential Nepalis to participate in Nepal's securities secondary market. Necessary amendments will be made to the Foreign Investment and Technology Transfer Act, 2075 and the Foreign Exchange (Regulation) Act, 2019.

The amendment proposal aims to be presented to the Council of Ministers by the end of Ashwin 2083. Direct participation of NRNs will be implemented only after the legal amendments and procedures for bringing in and repatriating funds are completed.

Development of the Institutional Debt Securities Market

The institutional debt securities market will be developed to promote market-based financing by reducing reliance on bank-based financing. The Securities Board has planned to implement the debt-related regulations it has published with necessary amendments by the end of Ashwin 2083.

This is expected to allow banks and other institutions to make greater use of the debt securities market for long-term resource mobilization.

Encouraging Green, Social, and Disaster Bonds

The government has decided to encourage the issuance of specialized instruments such as green bonds, disaster bonds, social bonds, project-specific bonds, and environmental bonds.

A policy regarding where to invest the funds raised from such bonds and how to inform investors about the use of these funds will be prepared by the end of Ashwin 2083.

Activating the Secondary Market for Treasury Bills and Development Bonds

Transaction fees will be reviewed to ensure the active secondary market for treasury bills and development bonds. The Securities Board will prepare the necessary policies and market infrastructure by the end of Ashwin 2083.

This is expected to make buying and selling government securities easier, reducing the obligation for investors to hold until maturity and increasing liquidity in the market.

Preparation to Implement Share Splits and Buybacks

Provisions will be made to practically allow listed companies to consolidate or split share capital at values higher or lower than par value. The ‘share buyback’ provision will also be implemented, allowing companies to purchase their own shares from accumulated profits to be distributed as dividends.

The Securities Board will prepare regulatory and policy infrastructure related to share splitting, consolidation, and buybacks by the end of Falgun 2083 after consulting stakeholders.

Implementation of Three Major Regulations

The Ministry of Finance will approve and arrange for the implementation of regulations and guidelines including the debt securities regulations, margin loan trading regulations, and intraday trading regulations by the end of Ashwin 2083.

This is expected to prepare the basis for the practical operation of some market instruments that have been limited to paper.

Margin Loans through Brokers

The share purchasing system will be modernized and organized, allowing investment in shares through loans taken from brokers authorized by the Securities Board. According to the margin loan trading regulations, the service aims to start operating by the end of Poush 2083. However, the standards regarding broker capital, risk management, collateral valuation, and investor protection need to be clarified through directives.

Investigation of Securities Offenses by the Board

Provisions will be made to conduct investigations and inquiries into securities offenses through the Securities Board itself. Work will proceed with amendments to the Securities Act of 2063, including provisions to allow private companies to also issue debt securities.

This will increase the authority of the board to investigate irregularities in the market and provide private companies with opportunities to raise resources through means other than bank loans.

Entrance of Institutional Investors in Primary and Secondary Markets

Policies, laws, and infrastructure improvements will be made to increase the participation of institutional investors in the primary and secondary markets. The action plan states that preliminary arrangements in this regard will be advanced by the end of Ashwin 2083.

The necessary legal improvements will be made to prepare investment policies, transaction structures, and infrastructure for institutional investors, in line with the rules, guidelines, and regulatory arrangements that the board will draft. Some of these improvements have a deadline until the end of Mangsir 2083. A separate policy and guideline will also be introduced to facilitate the participation of institutional investors in the primary market.

Portfolio Rebalancing of Large Institutional Investors

The government has concluded that institutions such as employees' provident funds, citizen investment funds, social security funds, insurance companies, and mutual funds are overly focused on bank deposits in their investments.

To increase investment in securities, legal, policy, and structural facilitation will be provided by the end of Mangsir 2083 to rebalance the portfolios of these institutions. It is expected that this will lead to the entry of long-term institutional capital into the market.

Study of CDS and Clearing Capacity

To operate new financial services effectively in the securities market, the institutional capacity of CDS and Clearing Limited will be enhanced. The study related to structural improvements of the company aims to be completed by the end of Falgun 2083.

This improvement seems crucial to manage the burden on deposit, clearing, and record-keeping systems as new transaction instruments are added.

New Framework for Private Equity and Venture Capital

Regulations will be improved for private equity and venture capital that provide capital for early-stage enterprises, businesses based on innovation, small and medium enterprises with high growth potential, technology-focused businesses, and projects that offer high returns alongside high risks.

In line with international practices, classification, risk-based regulatory frameworks, capital mobilization, investment, dividends, capital return, and exit strategies will be made smooth, transparent, and governed. Following consultation with stakeholders and study, the board will prepare legal and market frameworks by the end of Poush 2083.

Review of Share Investment Arrangements by Banks and Financial Institutions

The current arrangements regarding investments made by banks and financial institutions in the capital market will be reviewed. This review will consider direct and indirect risks, interrelations between institutions, cumulative impacts, systemic risks, liquidity, returns, and depositor protection.

Arrangements related to investment limits, risk weights, and collateral adequacy will be reviewed jointly by the Securities Board of Nepal and Nepal Rastra Bank by the end of Kartik 2083.

3.75% Tax on Long-Term Gains and 5% on Short-Term

The existing tax rate will be maintained on the profits derived from share or other interest sales by resident natural persons of listed entities. It is arranged that a 3.75% tax will apply to securities held for over 365 days and a 5% tax on those held for 365 days or less.

The action plan has proposed significant improvements in the profit-loss adjustment process rather than just tax rates. It will be studied and implemented allowing resident natural persons or resident entities to adjust the losses incurred from listed securities in the same income year with the profits of that year.

The proposal suggests that capital gains tax will be taken as a final tax only if there is a net gain after adjusting profit and loss through transaction and settlement systems. The detailed calculation methods and processes for matching or refunding in case of excess tax deductions will be clarified after legal and technical reforms.

Minimum Holding Period of 45 Days for Bank Share Investments

Banks and financial institutions are being prepared to maintain a minimum 45-day holding period for shares invested in the secondary market. The board of directors of the relevant institutions will need to formulate investment policies that minimize betting risks.

The Nepal Rastra Bank has mentioned in the action plan that this arrangement will be settled as soon as possible. The proposal of 45 days will not automatically be implemented until necessary guidance is issued from the central bank.

Legal and Technical Readiness Crucial for Implementation

The action plan has captured IPOs, secondary markets, taxes, institutional investments, debt securities, market infrastructure, and regulations in a single reform package. Coordination among the Securities Board, Nepal Rastra Bank, Ministry of Finance, NEPSE, and CDS and Clearing will be essential for most programs.

With the action plan being made public, not all arrangements will be immediately applied; investors will be able to use the proposed facilities only after the amendments to laws, approval of guidelines, issuance of directives, and development of technology are completed. It appears that if legal and technical work is completed within the stipulated timeframe, this will create a basis for new instruments, institutional capital, and additional transactions to enter Nepal's capital market.