Nepalese Stock Market and Investment Options

History and Development of Market

The history of securities market in Nepal dates back to 1937, when Biratnagar Jute Mills Ltd. and Nepal Bank Ltd. floated shares, even before the introduction of 'Company Act' in 1964. In 1964, Nepal moved another step forward in the capital market through issuance of government bonds.

Institutionalization of the securities market only began in 1976 with the establishment of Securities Exchange Center Ltd. (SEC) with the objective of promoting and facilitating the growth of capital markets. Before its conversion into a stock exchange, the SEC was the only capital markets institution undertaking the job of brokering, underwriting, managing public issue, making markets for government bonds and other financial services.

In 1983, Nepal enacted the Securities Exchange Act, which was further revised in 2006. The law allowed the establishment of the Securities Board of Nepal (SEBON) — an apex body to regulate the securities market. SEBON provides advice to the government on matters related to the development of capital market, issues regulations and directives, registers securities of public companies, and regulates and systematizes the issue, transfer, sale and exchange of registered securities, in addition to issuing licenses to operate stock exchange as a stock broker, stock dealer, merchant banker and fund manager, depository company, depository participant (DP) and credit rating agency. It also registers and regulates mutual funds, and prevents insider trading relating to securities transaction.

Stock trading in Nepal however started only on January 13, 1994, following the establishment of Nepal Stock Exchange (NEPSE). Although established under the Company Act, NEPSE is operated under the Securities Exchange Act, and is the sole secondary market operator for listed securities in Nepal. The basic objective of NEPSE is to impart free marketability and liquidity to the government and corporate securities by facilitating transactions in its trading floor through members as well as market intermediaries, such as brokers and market makers.

The modernization of Nepal's security market started in 2007 after NEPSE introduced fully-automated screen-based trading system. CDS and Clearing Limited (CDSC) was established in 2010 to act as a central depository for various instruments (Equity, Bonds, Warrants etc.), especially to handle securities in dematerialized form. This organization is entrusted with the safekeeping, deposit, and withdrawal of securities certificates and transfer of ownership/rights of the said instruments. Shares were dematerialized (DEMAT) by 2015, and by 2017, applications supported by blocked amount (ASBA) had been adopted. ASBA is more simplified and now it it C-ASBA. Anyone willing to apply for initial public offer, must have C-ASBA number called CRN from bank which is used to deduct money for application.

Now a days, after introduction of NEPSE online trading system (NOTS) from 2019, anyone can easily access to trade management system (TMS) of NEPSE and perform stock trading from home or office without vising broker office. For this, online user name and password should be received from broker. For online trading, in addition to user name and password, there must be trading limit that can be received from broker upon providing collateral amount. 

Types of Securities

Nepalese financial market offers the following securities as investment instruments:

a)      Stock/Shares: Shares are units of ownership interest in a company or financial asset that provide for an equal distribution in any profits, if any are declared, in the form of dividends. The two main types of shares are common shares (promoter and public) and preferred shares (redeemable and non-redeemable).

b)      Bonds/Debenture: A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Nepalese financial market has mainly three types of bonds — debenture, government bond, and power bond. Debentures are sold by financial institutions, and government bond is sold by Nepal Rastra Bank, the central bank of Nepal. Whereas, power bonds were sold by Nepal Electricity Authority.

c)       Mutual funds: A mutual fund is an investment vehicle made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus. Currently, there are eleven mutual funds managed by five merchant banks.

Investment in Securities

An investor can invest in these securities through primary and/or secondary market.

a)      Primary market: Primary market refers to the section of capital market that deals with the issuance of new securities. In this market, corporate institutions sell various securities directly or through an authorized agency to collect capital from the public. Therefore, primary markets create long term instruments through which corporate entities raise funds from the capital market. With primary issuances of securities or financial instruments, or the primary market, investors can purchase securities directly from issuers, such as from companies issuing shares through an initial public offering (IPO) or private placement, or from the issue manager of the company, or directly from the federal government in the case of treasuries. After such initial issuance, investors may purchase more of the same instrument from other investors in the secondary market. Although commercial banks sometime sell debentures or bonds, Nepal's primary securities market is predominated by shares of banking and financial institutions, insurance companies and hydropower companies. The central bank also sells bonds and treasury bills in the primary market.

Companies generally collect capital from primary markets through: (i) Initial Public Offering (IPO), (ii) Right Shares (RS), (iii) Further and/or follow-on Public Offering (FPO), and (iv) Auction. Generally, IPO is issued at face value of Rupees 100, disregarding the market value of the issuing company, although companies may sometimes issue IPO at a premium. Right shares are issued at face value of Rupees 100 only to existing shareholders and/or authorized person of the shareholder. FPO may be issued at face value of Rupees 100 and/or with a premium, to collect additional capital or adjust existing ownership structure of a company.

b)      Secondary market: This is the financial market in which previously issued financial instruments such as stocks, bonds and debentures are traded. Here, the securities are sold by and transferred from one investor or trader to another. This market provides liquidity option to primary shareholder, who gets an opportunity to sell the shares, whereas another investor and/or trader gets an opportunity to invest and/or trade in the given securities.  Securities are generally traded at higher or lower than face value, based on the market value of the issuer.

In Nepal, securities trading in the secondary market began on January 13, 1994, through NEPSE with 25 stock brokers.

c)       Mutual funds: An investor can also invest in shares of various companies through mutual funds. Basically, mutual funds collect money from many investors by selling 'units' of the approved fund size, and holders of these units are called 'unitholder' rather than shareholder. They invest larger portion in equity and tradable shares to optimize benefit for unit holders. However, it is an indirect investment managed through professional fund managers.

d)      Portfolio manager: An investor who does not have adequate knowledge on the secondary market, but would like to invest in the stock market, could make relatively safe investments through a portfolio manager. There are many portfolio management service (PMS) providers, who may also be known as merchant bankers. They generally charge an annual maintenance fee, and institute a profit-sharing mechanism when earnings cross an agreed hurdle rate, in addition to charging brokerage commission, and the fees payable to SEBON and CDSC.

Between the two key markets, primary market is comparatively cheaper for investment than the secondary market, as it generally deals in securities at their face value.

Risks and benefits of investment in securities

Investments are made either for short-term or long-term profit. Whereas, profit is received against the risks of investment. Investment always have risks associated with them, and the investor receives profits as per the risks s/he bears. The following are the risks associated with an investment in shares:

a)      Risks associated to the company: There are risks directly associated to the company in which an individual investor invests. The management, promoters, business growth, profit of the company, etc. are some of the factors influencing company-associated risks.

b)      Market risks: Fluctuation in market price of a share is based on investor's psychology, interest rate, return on optional investment opportunities, demand and supply, etc. that influence market risks of investing in shares and also provide an opportunity for capital gain.

c)       Legal risks: Changes in legal provisions and the directives issued by the regulatory body may also create risks. For instance, certain provisions may negatively impact certain companies, thereby leading to decrease in their profitability and eventually adding to the risk of decreasing the market price of a share of such companies.

d)      Economic risks: National and international economic conditions might change due to a variety of factors. Such changes may be both positive and negative. However, any negative changes will create risks to the company and eventually affect the market price of its shares.

Investments in securities generate return on investment and/or capital gain. Generally, bonds provide interest at agreed rate called 'coupon rate' whereas shares offer 'dividend' and/or 'capital gain'.

a)      Return on investment: Bonds provide fixed return at agreed coupon rate (interest rate), whereas shares may provide dividend in the form of cash and/or bonus shares as return on investment (only if the company is in profit). Therefore, bonds are a 'fixed-income' and shares are 'variable-income' instruments. Whether it is earnings from interest, cash dividends and/or bonus shares as return on investment, the current legal system imposes 5% tax on such earnings for individuals, and 15% for institutions.

b)      Capital gain: Investment in securities also provides an opportunity for capital gains generated due to speculation by other interested investors in the financial market. Capital gain is harvested through selling shares at a higher price than their purchase price. Nepal government imposes 5% tax on capital gains for individuals, and 10% for institutions. CGT to individual would be 5% for stock hold more than 365 days and 7.5% for lesser from 16 July 2021 onward.

Securities Trading

Trading in securities is becoming easier and more technology-based than ever before. In the primary market, interested investors can buy shares issued by a company via IPO through physical application form or through ASBA (applications supported by blocked amount) licensed Banks and/or Financial Institutions (BFIs). Currently, there are 52 BFIs authorized for ASBA. However, new regulations stipulate that ASBA is to be made compulsory for IPOs starting July 17, 2017.

In secondary market, however, securities are traded through licensed brokers working on behalf of the shareholder and/or investor. NEPSE is the only platform for trading securities in the secondary market. It coordinates and manages transfer of shares from one shareholder to another, and ensures payments are actually made to sellers by the buyers. There are 50 licensed brokering companies, 23 merchant bankers, 68 depository participators, 1 central depository and clearing service provider, and 4 clearing banks to facilitate and perform securities transactions on behalf of investors. An investor who would like to buy or sell needs to arrange the following documents and adopt the given process:

a)      Membership with broker firm: Currently, there are 50 licensed brokers of NEPSE. An investor and/or trader first needs to register with any of these brokers to start security trading.

b)      Bank account: Financial transaction related to securities is preferred through banking institutions. Moreover, payment for sale of securities is received through account payee cheques. Therefore, having a bank account is compulsory.

c)       DEMAT and MeroShare account: More recently, DEMAT account has been made compulsory to buy shares of public companies approved and listed with NEPSE. As Nepal has adopted compulsory dematerialization of shares since 2015, only dematerialized shares are traded in the secondary market. There are 68 depository participators (DP) licensed institutions. Investor must open a DEMAT account with any one of them. Further, subscription to MeroShare from CDSC is advised as it gives freedom and facility to apply IPO, right share and FPOs during issue and also to transfer sold stock to broker through eDIS (electronic DIS). Facilities for MeroShare is available from DPs upon payment of Rs. 50 annual fee. For DP also annual fee of Rs. 100 must be paid by the end of each fiscal year. 

d)      Dematerialized shares: Another prerequisite for selling shares is maintaining the balance of shares in DEMAT account. If an investor has physical certificates of shares, s/he can deposit it to the DP for dematerialization. In case of recently purchased shares, they are automatically deposited to the respective investor's DEMAT account.

e)      Debit Instruction Slip (DIS): DIS is a kind of cheque issued by the DP to DEMAT account holders. This slip authorizes the broker to sell instructed shares. DIS can be received from DP. Once an investor sells shares, s/he must submit DIS to the broker. Anyone who fails to submit DIS with appropriate information and formal signature will be liable for a penalty.

f)  Process:

1.       Buy share — first place a buy order to your broker indicating the name of the company and quantity of shares desired to be bought, also indicating price, such as fixed price, range of price or open price. Once your share is bought, make payment to the broker next day. Bought shares will be automatically deposited into your given DEMAT account. Investor can place buy order for one day or good till cancelation (generally, called continuous and valid for 15 days unless transaction executed).

2.       Sell share — first place a sell order to your broker indicating the name of the company and quantity of shares desired to be sold, also indicating the rate, such as fixed rate, range of price or open price. Once, your share is sold, submit the DIS to the broker. Sold shares will be automatically debited from your given DEMAT account. Your payment will be made through A/C payee cheque after a few days through your broker. Shareholders can place sell order for one day or good till cancelation (generally, called continuous and valid for 15 days unless transaction executed).

3.       Fee and penalty — According to the Securities Exchange Act, buyers and sellers must pay a brokerage commission, a fee to SEBON and an ownership transfer charge to the CDSC. Existing rate of brokerage commission for equity investments are:

Transaction amount	Old Broker Commission (include NEPSE)	Previous Broker Commission (include NEPSE) (25.12.2020 to 13.05.2024)	New Broker Commission (include NEPSE) (14.05.2024)	SEBON Fee	DP Fee
Up to NPR 50,000	0.6% or Min Rs 25	0.4% or Min Rs 10	0.36% or Min Rs 10	0.00015% of transaction amount	NPR 25 per company per day
NPR 50,001 to 500,000	0.55%	0.37%	0.33%
NPR 5,00,001 to 20,00,000	0.5%	0.34%	0.31%
NPR 20,00,001 to 1,00,00,000	0.45%	0.3%	0.27%
Above NPR 1,00,00,000	0.4%	0.27%	0.24%

For bond and mutual fund, the fee is 0.15% up to 5,00,000; 0.12% on 5,00,001 to 50,00,000; and 0.1% for amounts exceeding 50,00,000.

The brokerage commission rates presented above include 20% stake of NEPSE, 0.6% SEBON regulatory fee and TDS for the broker company.

When selling shares, the seller needs to pay capital gains tax (CGT) at the rate of 5% for individuals and 10% for institutions, in addition to the brokerage commission and fee to SEBON. CGT to individual would be 5% for stock hold morethan 365 days and 7.5% for lesser from 16 July 2021. 

In addition, while selling shares, anyone who fails to transfer through EDIS or submit DIS for sold stock to broker next working day (i.e., T+1) will be liable for a significant penalty – a fine of 20%.

Issues to consider while investing in securities

Definitely, each securities instrument has varying level of risks associated with it, depending upon its nature. Therefore, prospective investors who are interested to invest in any types of securities must analyze the characteristics of the securities, associated risks, possible returns and her/his personal risk appetite. The following issues are some of the considerations worth assessing before selecting any securities and making the investment decision:

a)      Objectives: Securities are purchased with the objectives of wealth maximization and/or financial gains. An individual should clearly set the goal of the investment, and accordingly select appropriate securities. For example, bonds, preference shares and mutual funds might be better options for an investor interested in cash returns. Similarly, an investor looking for wealth maximization should be choosing common shares of companies that provide regular bonus shares. A person investing with the objective of harvesting capital gains should be looking for securities which are prone to high price fluctuations.

b)      Available fund size: The individual must work out on the amount of funds available for investment. Based on the fund size, the investor may then allocate different portions of the fund to different types of securities. For example, if an investor has allocated a fund of one million Rupees, s/he may decide to invest 20 percent in fixed income instruments (bonds, debentures, or a fixed deposit), 70 percent in variable income securities (shares) and keep 10 percent as liquid cash for risk management. Out of the 70 percent, i.e., 0.7 million Rupees, the investor may again allocate about 70 percent to wealth maximizing shares, and 30 percent in trading for capital gains.

c)       Time period: Wealth maximization is achieved with longer period of investment, whereas capital gain is received in trading or short-term investment. Therefore, along with the clarity of objectives and the available fund size, the investor's desired mix of securities will also depend on the tentative time period for investment.

d)      Fundamental aspects of the company: An investor must analyze the fundamental aspects of the company in which s/he wishes to invest. Earning per share (EPS), price equity (PE) ratio, Net Worth, etc. are the basic fundamentals of a company that show its financial health. In addition, sources of earning, business volume, available reserves, dividend history and dividend payout ratio, etc. should also be assessed before making the investment decision.

e)      Demand and supply: Demand and supply of shares of a specific company would directly affect the market price of its shares. In cases where the intention is to earn capital gains, the investor must analyze the demand and supply situation of shares in the market and trade accordingly.

f)       Potential risks and returns: As discussed earlier, there are different types of risks associated with the company, the market, as well as the legal and economic environment. Investors must therefore analyze the existing risks associated with the specific securities, as well as attempt to forecast the future risk level based on favorable and/or unfavorable environment or trends in the market, legal and regulatory provisions, economic conditions, etc.

g)      Opportunity costs: Opportunity cost refers to a benefit that an investor could have received, but gave up or didn’t choose to receive, by choosing another stock or type of securities. This cost is, therefore, most relevant for two mutually exclusive events. When investing, the difference in return between a chosen investment and one that is necessarily passed up must be analyzed. It can also be referred to, or treated as the comparative advantage of choosing one option over the other.

h)      Other factors: Nepalese stock market has also had issues such as insider trading, market manipulation, and short-notice changes in regulator policies and directives to deal with these issues, which will potentially affect the prices, risks and returns from investments.

Conclusion

Securities definitely are an interesting and potentially attractive investment opportunity. However, much has to be considered before an investment decision in securities is made. The investor must consider present and future risks associated with the company, the market and the regulatory and economic environment. The investor must stand prepared to deal with or manage these risks. This is primarily why it is suggested not to put all your eggs in the same basket. Following an analysis of the the market, risks, opportunity costs or comparative gains, and the time value of money, as well as based on the objectives of investment and the funds and time available, the investor can diversify her/his investment through managing the funds into different securities and/or company or sectors.

Dilip Kumar Munankarmi
dilip.muna@gmail.com
blog: dilipmuna.blogsopt.com

revised/updated 4 July 2021, NST 15.32