When Regulation Becomes Interference – The Case Of The Securities And Exchange Commission

By THE EAGLE OF FREEDOM

PART 1 – THE SEC IS NOW AN ECONMIC MOAT FOR THE RICH AND POWERFUL

‘‘THERE IS A STRONG DISTINCTION BETWEEN BARRIERS TO ENTRY AND BARRIERS TO IMITATION.’’
~ Professor C. K. Prahalad [Professor in Corporate Strategy at Michigan Ross University]

Like most / all regulators in the Zambian economy, the Securities and Exchange Commission of Zambia [SEC] has transitioned from a defender of the market to a hired gun of the elite and powerful in the securities industry. Instead of serving the wellbeing of the local market players and citizens of the nation, which are better served through a dynamic, competitive and innovative environment the SEC now serves to protect the powerful and mostly foreign or government backed elites in the Zambian Capital Markets especially in the Fund / Asset Management industry as well as the Brokerage space.

The SEC, like all its fellow regulators, have basically spent their time legally infringing on the Economic freedoms of the participants and stakeholders using;

1. Entry Requirements that are out of the Reach of most Zambian Entrepreneurs
2.  Operational rules and Practices designed to bankrupt the small and often local players.
3.  Anti-Local Private sector / Pro-foreign career Bureaucrat staff who do not appreciate the pain and sacrifice of Entrepreneurship but are very accommodative to the Big and mostly foreign players.
4. It’s continuous support for Monopolies and Oligopolies in the market at the expense of the market and the nation at large.
5. Continuous expansion of its own rules and powers at the expense of the Dynamism of the market.

This hostility towards the market has brought questions about the development of the capital markets. In order to grow the business sector and thus create a vibrant jobs market in Zambia, The nation needs a pro-small business competitive financial sector however the SEC is the sole major encumbrance in that optimal flow of capital in the market and thus the capital stock growth of the market and the nation. In short the SEC is hampering market growth, which is in turn hampering business growth and at the end stagnating wage and job growth in the nation. Instead of taking care of the ‘’ENGINE OF GROWTH’’ the have thrown a spanner in it. The other factor that needs to be addressed is the question of, ‘’is this even in the name of INVESTOR PROTECTION anymore or is it in the name of PERSONAL POWER?’’

The premise here is that the SEC has gone from a market regulator to an agent of Market Interference and they are actively blocking the market for their own POWER PLAYS and EGO even if it comes at the expense of the Zambian people.

In this article we are going to look at the fact the SEC has now officially become the ECONOMIC MOAT for the rich, powerful and established businesses and is serving to protect their interests even if it comes at the expense of the nation. As a moat may protect a kingdom it primarily protects the KING and the SEC is now protecting industry Kings.

The first thing that briefly needs to be tackled is what is an ECONOMIC MOAT? Simply put, an economic moat is factor that makes a business, brand or company defensible from competition and protects its profitability or level of Power or dominance in the market. The term became very popular in the 70s and 80s with the rise of capital markets and the rise of Warren Buffet and Charlie Munger’s Value Investing Approach, which was outlined in their book the INTELLIGENT INVESTOR. In the book they outlined that a good long term investment needs to have an ECONOMIC MOAT and that was stated as a factor that allowed the business or the company to defend itself from competition and rise to or maintain a position of dominance. That factor made the business more valuable and more investible. According to the book the types of Economic moat fell into 3 categories and these were;

1. OPERATIONAL COMPLEXITY – difficult to imitate and compete as markets usually do when competition intensifies.
2. HIGH SWITCHING COSTS – difficulty to win customers from incumbents due to high financial or non-financial costs of switching to a new brand.
3. BRAND LOYALTY / EQUITY – The brand name of the company is a selling point on its own and customers trust and value the brand above the product.

These economic moat factors can also be known as Barriers to competition. In this regard looking at the SEC it is evident that the SEC has somehow placed itself as in the category of an OPERATIONAL COMPLEXITY MOAT for the established players by making it difficult for new entrants to even get in the market in the first place.

Let’s say you are a young vibrant financial analyst who has seen an opportunity in the market to start trading or managing portfolios of government bonds and you would like to start a bond fund helping the average Zambian channel their savings [let’s say for their children’s College / Tertiary Education, like many Zambian parents want to] here are the requirements you need to fulfil before you can even start to market yourself to the public after you have registered your company at PACRA and ZRA:

• You need to get a Dealer’s License from SEC which requires the following
  ? K20,000 paid upfront for the FIRM
  ? The firm must be a member of the Capital Markets Association of Zambia which will cost the firm K8,000 Annually
  ? The firm must have an operational base office which the SEC will come and inspect to insure that it is an actual Office that you pay for.
  ? Three full-time employees or partners who will act as dealers representatives who must have
  ? Completed education in Investment and Securities course at ZBIC or at least have relevant Economics and Financial Markets education
  ? The must be Members of Capital Markets Association which is K2,000 per representative employee
  ? One of the must be your COMPLIANCE OFFICER for Financial Intelligence Act Adherence
  ? SEC Practicing License which costs K4,000 per employee
  ? You Must have a 3 year business plan which has 3 years projections
  ? You must have an Anti-Money Laundering Policy which is subject to SEC Approval
  ? You must have at least 2 independent Directors who have passed police and financial scans over the last 5 years
  ? You must have a minimum of K50, 000 in cash reserves in a bank account which must remain untouched at all times.
  ? You must already have a credible audit firm assigned to your company and that can cost you anywhere upwards of K20, 000 per year.
• You Need a collective Investment Scheme License which requires the following
  ? K100,000 for SEC Approval of the scheme
  ? A trust Deed for the fund put together by an official LAW FIRM
  ? You must have tentative agreements with a Trustee and Custodian Bank
  ? You must already have automated fund management system which will cost you anywhere north of USD25, 000 per year and a setup fee of USD10, 000 of which the SEC will still need to test and approve.
  ? You need marketing material that will cost you K5, 000 to K10, 000 for graphic design work of which the SEC still needs to approve.
• You need at least 90 days of cash on hand above the K50, 000 to hold you as the SEC will take 90 days to go through your requirements that 90 days only starts when you have successfully submitted all the requirements above and paid all the fees above.

When totaled up the SEC Set up fees alone can come to K250, 000 of cash that needs to be dispensed before commencement then there is the system fee which give the current exchange rate environment you are looking at K700, 000. So if you are looking at starting a collective investment scheme you must be prepared for a Year 1 outlay of K1 million before you have even made One Kwacha of revenue. Even with this expenditure of K1 million your approval is still subject to the discretion of the SEC and its bureaucratic structures that require 3 levels of meetings before approving this.

The SEC has 2 arguments to protect the extent to which it conducts such stringent entry requirement:

• The first one is that it is claiming to do so in the name of the investor protection which it states is its central mandate.
• The second one is that it is claiming that these requirements are not as expensive other jurisdictions in the world such as Namibia and Botswana.

Dealing with the second argument first of comparatively inexpensive is one that is on face value correct but does not take into consideration the context of Zambia and the average Zambia entrepreneur. This is the mistake made by many regulators in Zambia and is the reason why 60% to 80% of our private sector is controlled by 250 foreign companies. The entry standards an inexpensive for FDI investors but local startups such requirements are way out of the reach of the average Zambian entrepreneur.

In an online survey of over +100 entrepreneurs it was found that the Median [50th percentile] local entrepreneur starts their business with K5, 000 – K20, 000 while another private survey of local entrepreneurs found that the average [Mean] entrepreneur starts their business with USD20,000. With the SEC’s entry level requirements for a CIS business getting as high as USD50,000 this means that only a select group of local entrepreneurs can get into the investment space thus making the requirements out of reach for most of the entrepreneurial community. Added to this access to capital in Zambia is at best expensive if not impossible to acquire. With the government basically lending the private sector, especially small businesses, out of the market lending rates have gotten as high as 40% and that’s if the cash is even available to lend in the first place as lending and credit markets are pretty much dried up. This leaves the markets only available for foreign companies especially the current crop of new entrants because only they have lending / credit markets that give them access to such a quantum of cash and the flexible repayment to manage themselves. Comparing the requirements to other jurisdictions is absolutely incorrect because it must be compared to environment that entrepreneurs in Zambia are in or else our own regulators are seeking to exclude our own people and therefore who do they serve THE PEOPLE OF ZAMBIA or the GLOBAL CAPITAL ENVIRONRMENT.

Now let’s address the argument of Investor protection. The most powerful protection you can give a consumer [saver / investor] is a competitive environment in which firms / businesses actively compete for clients and make sure they not only put their best foot forward but deliver the best services they can to ensure customer retention and most importantly a very good reputation on the market amongst consumers. By creating such a rigid sieve the SEC has limited the level competition on the market to the point where it’s detrimental to the market and to the consumers / investors. This can be seen in the average pricing of services in the Securities market, especially in the CIS Management industry. A high structure of 5% on Assets under Management or Funds under Management has been normalized in Zambia because the customers don’t have that many CIS operators / Managers to pick from while the SEC is even actively working to thin the numbers even more. So in accordance with PORTERS 5 FORCES MODEL the SEC is putting the power not in the hands of the customers but in the hands of the RICH and POWERFUL incumbent businesses in the industry. Ironically in the name of Investor protection the SEC is the one reason why consumers can get sloppy and poor service in the market. The other thing happening is that Innovation is being stifled because innovation in many industries usually comes from cash strapped new entrants looking for a new offering they can use to penetrate a market that has established players. With limitations on new players the Regulator is actually creating limitations on financial markets innovations. This is the reason why we do not have Mobile App based Exchange Traded Funds in Zambia or Mobile Banking based investment schemes which would reach more people and is one of the reasons why we have struggled to get more of the local household savings of the nation into the Treasuries and Government Securities market and thus our government bond market is dominated by institutional and foreign investors putting our nation at risk. All to serve the pride and egos of some regulatory bureaucrats who don’t want to admit that they are the real problem and would rather have the market suffer than to surrender their need for power.

With or without knowledge of it the SEC has actually become the attack dog of the established firms protecting their positions of power rather than protecting the integrity of the market. They are the tool by which the rich get richer.

Like many industries the securities and asset management industries are siting with virtual monopolies or at best very powerful Oligopolies:

• 60% of Assets Under Management in Collective Investment Schemes are with African Life Financial’s Mpile Umbrella Fund
• The Lusaka Securities Exchange is the only active Exchange on the Market with 2 that have attempted to set up but have felt the iron fist of the SEC. Giving the LuSE A monopoly on publically traded stocks and secondary trading of Bonds in the whole country.
• The Securities Brokerage industry has 5 active players and is generally controlled by 2 brokerage firms who handle all almost of the listings and over 60% brokerage volumes between the 2 of them. The brokerage industry has even gotten to the point where the Consumer Protection and Competition Commission once opened a Cartel investigation into the brokerage industry of Zambia.

These market dynamics have kept a lot of local players and potential new comers out of the market and thus reduced the competitiveness of the market and left the customers or potential customers at the mercy of the current market players and leaders who have no incentive to improve and grow the market and thus offer substandard efforts at innovation at change because they know that they don’t have to do anything and the SEC will keep players out for them.

As mentioned before that market innovation in any industry use comes from Price sensitive new entrants or small businesses looking to capture clients / customers with very little resources available to them and a determination to penetrate the market effectively. Without this active threat the incentive to grow and change in order to suite market is not there and the markets will not grow.

The Lack of indexed innovation has left to the market experiencing;

• Slow Growth in Assets Under Management and Low levels of AUM in comparison with other jurisdictions and the with the potential of the Zambian market.
• Lack of Low income inclusive market products / services leading to lack of capital markets for the lower income such as Exchange Traded Funds which are the best entry level investment products in other countries.
• Lack of Asset Class innovation in the market which has led to the same stale products which fail to resonate and connect with the Zambian investors.
• Slow growth in listed companies to the point that 23 years after the launch of the LUSE there are still less than 25 listed companies on the market which is also explained by the rigid listing standards of the market.
• Lack of integration between the market and online or mobile technology which has rapidly become the fastest and most effective way to distributed financial services.

This slow growth in innovation has really led to slow uptake of capital market services in the market and has failed to make the markets appealing even to the growing formal sector employed middle class of Zambia who are currently over 1 million and even they barely have capital markets accounts except through their occupational pensions and NAPSA accounts.

The other problem that has occurred is that Jobs in Capital markets have been slow and few to speak of because of lack of market growth and thus failing to accommodate the growing number of educated but employed youth in the country who have dreams of one day becoming a stock broker or an fund manager after watching a show like BILLIONS on TV but now find that Zambia has a slow and unaccommodating market mainly because the SEC is more interesting in dream crushing and its own power plays than it is about making the market work for the people.

This is a problem that needs to actively be dealt with from the top and thus needs drastic regulatory roll back and reduction of legal barriers that the SEC has actively erected in the name of keeping the big firms BIG and eventually making them even Bigger. One cannot trust change to come with personnel because there is an old saying that goes,

‘’Never give a Politician or Government Bureaucrat a power you don’t intend them to use’’

With excessive regulation being a nationwide problem to all industries here are some regulatory reforms that need to be enacted to protect against excessive regulation such as with the SEC in the capital markets:

• PLACE EXPRESS ECONOMIC RIGHTS AND BUSINESS FREEDOMS IN OUR NATIONAL CONSTITUTION and in that make the right to start a business an expressly stated civil right that is enshrined the constitution in order to create a legal grounding for protection against Regulatory overreach and unreasonable regulatory barriers. As Zambia is a constitutional supremacy and Entrepreneurship is pivotal to poverty alleviation and Job creation. The regulators are regulating the industries but who is regulating the regulators and thus we must assign the constitution to regulator the regulators.
• PROHIBIT ALL REGULATORY AUTHORITIES AND ENTITIES FROM ERECTING FINANCIAL AND NON-FINANCIAL BARRIERS to operationalizing a business such as fees, excessive time taken to process applications [e.g. Turnaround time should be less than 14 working days for applications] and burdensome requirements out of the reach and means of the average citizen of Zambia.
• PROHIBIT FORCED ASSOCIATION MEMBERSHIP, individuals and entities must be allowed to enter industries but they should not be forced to join associations by decree of the regulator.
• ADOPT A NATIONAL POLICY OF LIGHT TOUCH REGULATION in which growth of industry and job creation is prioritized as the most important outcome of regulators. Regulators must adopt or sign onto the Light Touch Policy to ensure that industries are brought to a state of maturity and that regulation serves its intended purpose without being cumbersome. Seek to make a combination of high and intense competition and basic rules the front-line form of regulation. Empower the courts to better handle customer and competitive disputes and only bring the regulator where competition and the courts are not able to handle the situation but always and only temporarily.
• PROHIBIT ENTRY FEES for operationalization in the first year of businesses and only allow regulators to tax or charge profits and not revenue. Regulators should not be making for money than the actual market participants as they take no risk as the Entrepreneurs do.
• INTRODUCE A MOVEMENT OF REGULATION THROUGH PLATFORM PROVISION. Tech platforms in America have proven than they are the most market efficient forms of regulators that are small business friendly. Platforms such as Amazon, YouTube, Facebook, Bloomberg, Reuters have proven that platforms help regulate markets while providing a service to the market. Regulators should create public option tech platforms that help absorb some of the capital costs they would otherwise require.
• REJECTED APPLICATIONS SHOULD BE JUSTIFIED IN WRITING TO THE APPROPRIATE MINISTRY and to the MINISTRY OF FINANCE AND TRADE AND COMMERCE. One should be able to justify why applications were rejected and regulators should provide good reasons and not just discretions and these should be allowed to be challenged in a court of LAW.

Here are some industry specific reforms to the capital markets to help improve entry levels in the capital market:

• The Securities and Exchange Commission of Zambia needs to totally do away with or at least waive the entry level license fees for the first 2 – 3 years to allow practioners to start generating revenue that they can pay license fees from and grant entry level practioners 2-3 year starter licenses that will valid until expiration or until they get to a certain revenue level.
• The Licensing process should now be reduced to a maximum of 22 working days and no longer 91 working days because that is beyond the cash on hand capabilities of most businesses, especially startups or small businesses.
• The SEC Needs a digital compliance and onboarding system that allows the individuals to submit their applications digitally and through self-management like many online service providers.
• The SEC Needs to invest in a digital cloud-based market management system that deals with fund management, trading, exchange management, customer on-boarding and other market requirement. This will be a platform that they can offer and through this they can have better control of quality in the market and interconnect the different sub-markets they want to have operating. It will also justify some sort of fee requirement rather than for licensing but for on-boarding and system operations.
• The SEC Must abolish forced membership to the capital markets association it serves no purpose and just acts as a deterrent and extra cost to keep new entrants out.
• The SEC must justify in writing any rejections of licensing and any lines to the Minister of Finance, Trade and Commerce in writing.
• A regulatory overreach tribunal / court should be set up between the Ministry of Justice and the Courts to allow for complaints by market practitioners of regulatory overreach by actions or by laws.
• A GROWTH-FIRST Policy needs to be adopted by the SEC to ensure market growth above bureaucracy and this will also include a policy of light touch and last resort regulations.

Such changes should yield a more innovative environment that promotes financial innovation and financial inclusion that will allow the capital market to play the role of engine of growth rather than center of elitism and power. This requires that we must call for a strong and stern reduction regulatory power and the reduction of regulatory bureaucracy by calling for legal changes and more PRO-BUSINESS approach to governance.