`EPF lost profits due to secondary market bond purchases´

* Mahendran observed that the Direct Placement Method was used to control the interest rate previously between two parties with no existence of proper transparency and was of the view that in a market based economy the interest rate should not be controlled or the system would breakup

* At the Oct 30 auction Perpetual Treasuries Ltd had succeeded in a large amount of bids and subsequently within a few days in the next month (November) had sold them to the EPF in the secondary market through an intermediary (PABC)

By Shehan Chamika Silva

Deputy Solicitor General (DSG) Milinda Gunatilleke during the cross examination of former Central Bank Governor Arjuna Mahendran yesterday expressed the view that the EPF could have gained much higher profits it had bid at the primary auctions (October 30, 2015 and January 28, 2016) at the same time as other primary dealers did without purchasing the same bonds at lower rates in the secondary market from those same primary dealers (mainly PTL) soon after the auction.

The cross-examination of Former Governor Arjuna Mahendran was continued yesterday by Senior State Counsel Shaida Barrie and Senior Deputy Solicitor General Milinda Gunatilleke on the considerations of the suspension of the Direct Placement Method and the Secondary Market Transactions of the EPF.

During the examination by Senior State Counsel Shaida Barrie, the witness observed that the Direct Placement Method was used to control the interest rate previously between two parties with no existence of proper transparency. The witness was of the view that in a market based economy the interest rate should not be controlled or the system would breakup.

The witness continued to describe to the Commission about the reasons which made him take the decision to suspend the Direct Placement Method and raise Government money through Public Auctions only.

However, summing up the questioning, Justice Prasanna Jayawardena questioned the witness.

Justice Prasanna Jayawardena: During the February 27, 2015 auction, the Government did have a huge appetite for borrowing, right?

Witness Mahendran: Yes

Justice Jayawardena: You have seen the Public Auction system as reasonable to raise funds, right?

Witness: Yes

J: In your view, was it prudent to make such a big change at that point to raise money?

W: Yes. My humble submission is we didn’t have any alternative

Deputy Solicitor General Milinda Gunatilleke thereafter questioned the former Governor over the secondary market transactions relating to the EPF.

Referring to several documents pertaining to the auction held on October 30, 2015, DSG Gunatilleke explained that the EPF had not bid at the auction even though it had an excess of funds available on that particular day as per its cash flow statements.

However, on November 2, 6 and 9, 2015 the EPF had engaged in Secondary Market transactions and had bought some of the same bonds advertised by the CBSL at the October 30 auction at a lower yield rate.

In this auction Perpetual Treasuries Ltd had succeeded in a large amount of bids and subsequently within a few days in the next month (November) had sold them to the EPF in the secondary market through an intermediary (PABC).

Referring to a certain ISIN (International Securities Identification Number), DSG Gunatilleke showed the pattern in which the EPF had bought the same tenure bonds in the Secondary Market at a higher price (lower yield rate).

Sample of Secondary Market purchases of EPF

-EPF could have bought the bond at a ‘dirty price’ of Rs. 105 at the auction (October 30, 2015) but did not bid despite possessing the available funds as per cash flow statements.

-EPF then bought the same bond at a higher ‘dirty price’ (Rs. 110) on November 2, 2015 in the secondary market (from PTL through PABC).

-EPF again sold the same bond to another counter party (to PTL through PABC) on November 3 at a ‘dirty price’ of Rs. 110.5 gaining a small capital gain.

-EPF finally again bought the same bond back on November 9 at a ‘dirty price’ of Rs. 119 (from PTL through PABC).

DSG Gunatilleke: Do you know as to why EPF would have bought bonds from the PABC (intermediary) in the Secondary Market at a higher price without bidding for those bonds at the Primary Auction on October 30, 2015?

Witness: I can’t comment on that without referring to sufficient other data.

When Justice Jayawardena questioned the witness as to why in his view the EPF did not bid at the primary auction even though it had excess of funds as per the cash flow statements, the witness elaborated his observation, that the cash flow statements of the EPF could not be solely used to determine the decision taken by the EPF to not bid at the auction because there are other factors influential to its fund operation.

Therefore the witness said that he has to study it further to comment about the specific reason.

DSG Gunatilleke also referring to the auction held on January 28, 2016, explained another similar scenario in relation with the EPF bond trading in the secondary market.

The DSG said that EPF had not bid at the auction again (January 28, 2016) despite having the available excess of funds at that time as per the cash flow statements, but had bought some of the same bonds in the secondary market at a lower rate.

DSG Gunatilleke was of the view that the EPF could have gained much higher profits if it had bid at the primary auctions (October 30, 2015 and January 28, 2016) at the same time as other primary dealers, rather than purchasing the same bonds at lower rates in the secondary market from other primary dealers.

It was revealed that on both these occasions, in November, 2015 and January 2016, Mr. Indika Saman Kumara was the dealer who operated on behalf of the EPF. (Saman Kumara was subsequently interdicted following revelations made before the PCoI in July, 2017)

It was also revealed during the cross-examination that the EPF’s dealing decisions had been sent to the Governor (Mahendran) at that time in a form of daily reports.

DSG Gunatilleke thereafter referred to the controversial February 27, 2015 auction and explained the EPF’s and the other state institutions’ (SLIC, NSB and UGC) secondary market transactions pertaining to the bonds released at the February 27 auction.

The DSG said that on February 27, 2015 auction the advertised amount was only amounting to Rs. 1 billion. However, ultimately Rs. 10.05 billion was accepted.

DSG Gunatilleke said that the EPF and other state institutions had only bid considering the advertised amount.

However, later in June 2015, after a few moths from the controversial bond auction, some of the same long tenure bonds had been purchased by the state institutes (EPF, SLIC and NSB on behalf of UGC). That purchase was amounting to over Rs. 5 billion.

DSG Gunatilleke was of the view that if those state institutions (like EPF) had sufficient funds at the auction day they could have bought more bonds from the auction and meet the Rs. 10 billion requirement if the advertised amount was correct.

The PCoI comprising Justice K.T. Chitrasiri (Chairman), Justice Prasanna Jayawardena and K. Velupillai Kandasami will resume sittings at 10 am tomorrow.