Role of Capital Markets

and
Chartered Accountants
FERDOUS KHAN, B. SC., MBA, FCA
ICAB, DHAKA, MARCH 2011

Welcome
Madam President, Hon. Chairman of the session,

Hon. Chief Guest, Hon. Vice Presidents, Hon.

Council Members, distinguished Members, ladies
and gentleman; it is my pleasure today to have this
opportunity to make this presentation to you on Role
of Capital Markets and Role of Chartered
Accountants. We have limited time, and I will be able
to present to you high lights.

Capital Markets
Capital markets are where companies which need long-

term finance can meet investors who have finance to

offer. This finance may be equity finance involving
shares, or debt finance in which case companies can
choose from a wide range of loans and debt securities.
Capital markets are also where investors buy and sell
company and government securities. Their trading
decisions reflect information on company performance
provided by financial statements and financial analysis,
dividend announcements by companies, market
expectations - on the future levels of interest rates,
inflation and investment decisions made by companies.

Capital Market
Why capital markets?

To allow for the efficient allocation of capital across industries,

and by extension, society as a whole.
Wealth generation for Savers cum investors by directing their
savings to most efficient use of Capital and Labor in companies
seeking finance, on a long-term basis.

Functions of a capital market

First, they are where long-term funds can be raised by

companies from those with funds to invest, such as financial

institutions and private investors. In fulfilling this function,
they are primary markets for new issues of equity and debt.
Second, capital markets allow investors to sell their shares
and bonds, or buy new ones to change composition of their
portfolios. Here, capital markets act as secondary markets.
The secondary market plays a key role in corporate finance,
because by facilitating the buying and selling, it increases
their liquidity and hence their value (by reducing risks).
Investors would pay less for a security that would be difficult
to sell at a later date. The secondary market is also a source of
pricing information for the primary market and so helps to
increase the efficiency with which the primary market
allocates new funds to their best use.

Determinants of efficiency
An efficient market needs operational efficiency,
allocational efficiency and pricing efficiency

Operational efficiency means that transaction costs should be

low and sales executed quickly.
Pricing efficiency means that share prices fully and fairly
reflect all relevant information and so are fair prices.
Allocational efficiency means that capital markets allocate
funds to their most productive use by companies through cash
generation requirements.

Investment decisions
A Company demands capital when it has projects which can

generate cash flow from operations and make a return on the

capital, higher than its cost of capital;
A saver offers his savings as investment when he considers he will
receive a return higher than the risk free rate from the
share/security;
The regulatory environment is required to ensure that market is not
misled about the potential of projects of a company; and all
value/price sensitive information is rapidly made available to
market.

Insider dealing is prohibited;

Public announcements and regulatory submissions are required;
Sound and Proper persons test for Companies, Auditors, Regulators and market
participants are enforced. Management and Directors of companies are required
to pass stringent sound and proper person tests. And these processes are
continuous.

Value creation and addition

Value is different than price; Value is intrinsic, meaning

within; Value can be created by a company by enhancing

surplus cash generation (reduce costs or enhance
revenue), by reducing risks, by reducing pay back period
and other things that are determinants of value;
Value may be added by undertaking projects which
generates surplus cash at a rate higher than cost of
capital employed.
Value is destroyed when an investment has an IRR below
the cost of capital employed.
There are Zero sum games, like speculative betting, or
Gambling.

Value of shares
Value of a share is discounted net present value of all

cash flow from owning that share.

The discounting rate is the appropriate cost of
capital.
Dividend valuation approach (DVA) - relies on the
equivalence of the market price of a stock, P0, with
the present value of the dividends ( or cash flows)
expected from the stock.

Valuation model
The discount rate in finding the present value is

considered to be the cost of equity capital.

Cost of equity capital = risk-free rate +beta (market
rate - risk- free rate) Re = Rf + (Rm - Rf)
A firms beta is correlationship of its price to market
price movements.

Value creation strategies

Value-creating strategies can be applied in practice:

Net operating profit after tax can be increased by eliminating

unnecessary costs. Undertaking projects which generate
returns in excess of the companys cost of capital can be
achieved by using net present value (NPV) and internal rate of
return (IRR) as investment appraisal methods.
A companys cost of capital can be reduced by the sensible use
of debt.
The amount of invested capital can be reduced by disposing of
unwanted assets and by returning unwanted cash to
shareholders via a share repurchase scheme.

Price of Finance
Price in a capital market, like any other market is

determined by supply and demand.

Demand in this context in a normal capital market means

demand for funds/finance from companies or issuers of
securities. Secondary market demand also affect prices.
Supply in this context means supply of savings from investors
in a long-term investments, mostly directed through structured
savings arrangements such as Pensions and Insurance
arrangements.

Investment Principles for Savers

First principle of investment is never loose your savings.

So, one invests in risk free capital, such as in Government bonds or

securities, when seeking risk free investments like when in pension
age. Depending on risk profile, investors then add risk to investment
profile and seek enhanced return to match the price of risks.

Secord principle of investment advise is always get paid

back. Pay back period, price/earnings ratios, interest

cover, dividend cover etc. are all different ways for an
investor to determine how long it would take to get paid
back. Risk enhances with time, and longer the pay back
period, lower is the desirability of the investment.

Chartered Accountants
Qualified Chartered Accounts have been playing a

tremendous role in enhancement of Governance,

Trust, Efficiency and Transparency in a Capital
Markets.
Chartered Accountants with their ethics, integrity,
and professionalism can provide the foundation of
the basics of efficiency in the capital markets through
assisting operational, pricing and allocational
efficiency .

Integrity, Ethics, Independence and Skills

In a typical capital market scenario, Intermediaries,

Investors, Issuers, Corporate and Regulatory

Authorities rely on Ethics, Integrity, Independence,
and Skills of the Chartered Accountants in
discharging their respective obligations to the
investors. The entire field of Financial Services rely
heavily on Trust of the work of Chartered
Accountants.

Roles
Chartered Accountants play the following roles,

among others, in the capital markets.

As an auditor to the company tapping the capital markets;

Emerging practice role;
As an advisor to the company tapping the capital markets;
As a regulator working for SEC or Stock Exchanges;
As an Entrepreneurial role - intermediary;
As an Investment Banker;
In the IPO Process;
As in other emerging roles

Auditor role
Providing, professional opinion on completeness, accuracy,

compliance, and presentation could be independent auditor

or an internal auditor;
Ethics, and Integrity of the professional is key, as also the
professionalism, independence in opinion;
Provides the basis of trust in evaluation of transactions in
financial markets.
Auditors by their independent external and internal audit
provide assurance on the quality and quantity of risk in the
financials of the company, thus reducing the risk premium
required in investing in the company. London Stock Exchange
still requires all their listed companies Financial Statements
to be Audited by Chartered Accountants, whilst rest could be
Audited by any Registered Auditors.

Advisor role
The advisory role has evolved from being an advisor on

tax and related matters to positioning the company

amongst the knowledgeable investors, advising the
company on the value chain which they need to pursue,
and continued feedback on the key acts which the
Company must do to sustain its valuation, attract quality
investors interest etc.
Keeping in view the complications and stiff pulls and
pressures of burgeoning capital markets, the skills and
expertise of trained Chartered Accountants are highly
relied upon by the financial services sector,
intermediaries, investors, issuers, corporate and SEC,
DSE AND CSE. And now, more opportunities await the
professionals in this area.

Emerging practice role

The whole approach towards risk management, controls have

changed.
Managements are increasingly providing a better budget for
risk management and Chartered Accountants plays an
important role as Chief Risk Officer, or Chief Internal Control.
Knowledge of accounts, accounting, finance, financial analysis
and law pertaining to issues of securities with regards to
provisions of the Companies Act, Securities Exchange
Commission Act etc.
In addition, knowledge of the client or the Issuers business
helps in profiling and positioning of the business to the
outside world at large. This is the key ingredient to any fund
raising plan.

Certifying
Accountants play a key role in advising on/certifying the

following:

1. Compliance with the corporate governance.

2. Promoter contribution in a project.
3. Amount deployed/spent on project.

Requirements to capitalize with the expansion in the

role, approach and accountability there is a tremendous

responsibility cast on the Chartered Accountants to play
their role effectively and stay ahead in the competition.
Again, Chartered Accountants by their Ethics, Integrity
and
independent Professional position provides
assurance on quality and quantity of risks in those
opinions and financials.

As a regulator
Chartered Accountants can work as a regulator either for

Stock Exchanges or for SEC. They also work for Bangladesh

Bank, and Government. As a regulator, chartered accountants
can be skillfully employed in policymaking, monitoring
review, surveillance and investigation.
ICAB members have been acting for the SEC and are also on
the boards of DSE and CSE;
ICAB members have been co-opted in the investigation
committee set up by the Government recently to investigate
the affairs of the capital markets;
There is increased realization in market participants that
having a chartered accountant on Board pays It pays to pay
a Chartered Accountant. Or keep his company as such.

As an Entrepreneurial role - intermediary

New Investment banking firms, broking entities and

the improving regulatory environment has

encouraged Chartered Accountants to become
entrepreneur by themselves. With the better
understanding of the financial products, Chartered
Accountants have become an effective entrepreneurs
in distribution, wealth management etc.

Investment Banker
As an Investment Banker, a Chartered Accountant

also helps in formulating financial strategy to

successfully tap the capital markets and ensure
success for the fund raising plan of companies.
Putting together an efficient capital structure,
creating financial model, profiling business
promoters and management and advising on
valuation are the other key ingredients for successful
capital market entry.

Contribution to Efficiency of Capital Markets

No stock market anywhere in the world is a perfect

market. However, companies and investors rather

need capital markets to be efficient and to offer fair
prices and good regulatory environment so they can
make reasoned investment and financing decisions
and executions.
Chartered Accountants with their Integrity first and
their professionalism in the second, provides the
basis building blocks for the Trust that is required
for the efficiency in the Capital Markets.

IPO Process roles

Initial public offerings (IPO) are often considered to be

the ultimate goal for any entrepreneurial venture. An IPO

is offering stock to the public on an open market for the
first time. Once a company decides to go public, it needs
to pick its IPO team, consisting of the lead investment
bank, an accountant and a law firm.
The prospectus is an offer document that is used to
describe all aspects of the company - its financial data for
the past five years, the management team, the target
market, competitors and growth strategy.
Chartered Accountants here also play a key assurance
role.

IPO Process roles

The independent accountants role in the IPO process includes

auditing the financial statements, restating them in

compliance with SEC requirements, and resolving accounting
issues. Increasing emphasis is being placed on the scope of
comfort letters which a companys auditor provides to the
underwriters and the companys board as part of their due
diligence.
Commentary on accounting policies and problems, improper
revenue recognition, avoiding changes merely for the purpose
of inflating profits are few of the areas, the accountants
insight are sought.
Accountants can also leverage their experience during the
planning phase to help ensure that the RJSC records are in
order before the IPO process.

Other emerging roles

Financial analyst, media expert covering the capital

markets, investment advisor, financial services

marketing are some of the emerging roles for the
young Chartered Accountants to deploy their skills
effectively.

Self Assessment
There are room for improvement in what we do.
We

are all products of our environment and the

environment affects us. We need to do critical self
examination as to how well we do what we do.
Are we united, have a proper voice, and delivering our
potential.
All our work alone could not have prevented the Stock
Market going up and then coming down, thats what
markets do.
Audit is the principle monopoly activity of this body.

Thanks
Thank

you for allowing me to make this

presentation. Thank you for listening. You are all
experts in the same field that others say I claim also
to be an expert.
I welcome any clarification that you may seek on the
presentation.
If it is not in the presentation, I shall try to answer
the question to my best of abilities.