The Loss Making Culture of the CBSL - A Throwback (2006-2015)

 

This article is based on three final forensic audit reports, prepared by BDO India LLP for The Monetary Board of Central Bank of Sri Lanka (2019)

Forensic Audit Reveals:

 

Before 2015                                                               

Loss: 10.7 Billion                    

Under Direct Placements                                         

 

EPF loss 8.7 Billion

2007-2015

Bond Scam and Public Debt Raising 

 

When you purchase a T-Bond you are in fact lending money to the Government. Conversely, Section 2 (1) (d) of the Registered Stock and Securities Ordinance No. 7 of 1937 authorizes the Government to issue of "Securities" in the form of Treasury Bonds, for the purpose of raising Public Debt. T- Bonds are issued in Primary Market where the Central Bank of Sri Lanka (CBSL) sells the T- Bonds. The issuance of Treasury Bonds on Primary Market was done either at Auctions of Treasury Bonds or by way of the acceptance of Direct Placement.  Primary Dealers (PDs) and EPF are largely permitted to purchase Treasury Bonds at the time they are issued by the CBSL on the Primary Market.

Thus, the only Participants in the Primary Market are the CBSL, Primary Dealers and the EPF. In the year 2015, there were 16 licensed Primary Dealers. At present, there are 15 Primary Dealers. Corporate institutions and individuals who wish to purchase Treasury Bonds, can do so in the Secondary Market through Accounts they maintain with Primary Dealers. 

Importantly, Section 106 (1) of Chapter VI of the Monetary Law Act sets out the role of the CBSL as the Fiscal Agent of the Government, while Section 112 states that, the CBSL shall act as the Agent of the Government and for the account of the Government, when issuing such Government Securities.Section 113 also stipulates that the CBSL shall, as the Agent of the Government, be responsible for the management of the Public Debt. All these functions are carried out by the Public Debt Department (PDD)in the CBSL.

In 2015, there were huge public concern over the process of this issuance of T-Bonds following some alleged irregularities transpired between CBSL high officials and Primary Dealers.

After almost a year of scrutiny, the Presidential Commission of Inquiry into the Issuance of T-Bonds recommended the CBSL in its report that, it is appropriate to conduct a “forensic audit” ascertaining significant irregularities and closely examine the proceduresfollowed in the PDD and decision- making process applied for raising public debt. 

 

Final Report of the Forensic Audit on issuance of T-Bonds during the period 1 January 2002 to 28 February 2015 by the public debt department

Irregularities under Direct Placement 

·       Deviations from the laws, policies and guidelines 

The Forensic reports says that the Monetary Board has not specifically approved issuance of T-Bonds through Direct Placements to Primary Dealers (PDs) other than the EPF and “Other Captive Sources”. 

However, from February 2008 onwards, the Public Debt Department (PDD) was issuing Government securities through Direct Placements to Primary Dealers (other than EPF and “other Captive Sources”). 

This practice of PDD accepting Direct Placements from non-captive PDs was never questioned by the Monetary Board. However, it appears that the issuance was in the knowledge of the Monetary Board and the practice of accepting the Direct Placements from other than "captive sources" was continued by the PDD from 2008 onwards. (2.1.3. A, B)

·       Deviation from the approved yield rates – “loss 889 mn”

Forensic Report explains that for the period October 2012 – February 2015, yield rate structures were prepared and approved by the Deputy Governor overseeing PDD.  During this period, it was noted that 142 placements amounting to Rs. 337.30 Billion were made above the proposed yield ratesincluding the volume-based inducements. In summary, in 42 Direct Placements, a loss of Rs. 889.81 Million was caused to the Government of Sri Lanka due to the deviations in the issue rates over and above the prevailing secondary market yield rates of similar maturities. (2.1.4. A, B, F)

·       Settlement of direct placements made beyond five days from transaction date 

It was further analyzed that out of the 145 placements, 141 placements amounting to Rs. 198.72 Billion, the difference between the transaction date and the settlement date was ranging between 6-9 days. In four placements aggregating to Rs. 4.43 Billion, the difference between the transaction date and the settlement date was more than 10 days. The four placements wherein the difference between is identified as more than 10 days. (6.1.10)  

·      ISINs (International Securities Identification Number) offered in direct placements without conducting auctions – “loss 800 mn”

It was further identified in the Report that out of 431 issuances of Treasury Bonds through Direct Placements during this review period, 94 placements amounting to Rs. 55.15 Billion were made over and above the prevailing Secondary Market yield rates of similar maturities resulting to the loss of Rs. 0.81 Billion to the Government. (6.2.9) 

 

·      Same ISIN offered to same PD at different prices on the same transaction date and same settlement date – “loss 53 mn”

The Forensic report also had noticed that in 54 instances the Direct Placements accepted from same PDs on same transaction date having same settlement date and same ISIN were made at different prices (6.3.1).   Out of the above 54 issuances, 16 placements amounting to Rs. 8.47 Billion were made over and above the prevailing Secondary Market yield rates of similar maturities resulting to a loss of Rs. 53.37 Million to the Government. (6.3.6)

·       Same ISIN offered to different PD at different prices on same date – “loss 835 mn”

It was also noticed in the report that in 207 instances the Direct Placements accepted from different PDs on same transaction date having same settlement date and same ISIN but were made at different prices. (6.4.1). Out of the above 207 issues, 80 placements amounting to Rs. 63.49 Billion were made over and above the prevailing Secondary Market yield rates of similar maturities resulting to loss of Rs. 835.49 Million to the Government. (6.4.5)

·       Lack of formal announcements for direct placements 

The report says that, unlike the formal announcements made for issue of Treasury Bonds under the Auctions, there were no announcements made regarding the issue of Treasury Bonds through Direct Placements during this period.

‘It can be concluded that a definite system for inviting bids from PDs for Direct Placements was not available in the PDD Operations Manual of PDD and all PDs were not given equal opportunity to participate in the Direct Placement’. (9.1.2. B)

It was also stated that there was no definite system for identification and selection of the PDs for issue of T- Bonds through Direct Placements. The PDD Operational Manual states that “Front Office communicates with relevant institutions to make arrangements for placements”. (9.1.2. A)

  

Total Loss through Direct Placements to the Government during 2005-2015

During the review period, 4,670 Direct Placements transactions were made by PDD pertaining to the Period 1 January 2005 to 28 February 2015. (2.3.5). 

‘Based on comparison of the issue rates of Direct Placements and Base rates on transaction dates, the after-tax issue price was lower than the Base Price calculated in 1,105 Direct Placement transactions and the same has resulted in loss of Rs. 10.47 Billion to the Government of Sri Lanka during the period 1 January 2005 to 28 February 2015. (8.2.8)

 

Mr. Ajith Nivard Cabraal (Former Governor, 2006-2015)

Mr. Ajith Nivard Cabraal was the former Governor of the CBSL and Chairman of the Monetary Board from July 2006 till January 2015. “It was mentioned in PCOI report and as noted during the public domain searches that the relatives of Mr. Ajith Nivard Cabraal held influential positions in Primary Dealers and/ or related company of Primary Dealers, during his tenure as a Governor of the CBSL.” (11.1.4)

 

 Irregularities in Primary Dealers during 2002-2015 (11.1.9)

 

·       Acuity Securities Limited 

“Out of the total placements made to Acuity Securities Limited during the Review Period, 80% of the said placements were made in the year 2013 – 2014 itself. It was observed that the placements during the period 2013 – 2014 were made at a higher rate due to which the CBSL incurred a loss of around Rs. 60 Million.” It was also noted that “Acuity, is promoted as an equally owned Joint Venture between DFCC and HNB. During the year 2014, Mr. Ravindra Balakantha Thambiah was associated with DFCC as a Director and Mr. Amal Cabraal joined HNB as a Director in April 2014.”

·       Commercial Bank of Ceylon 

“A significant increase in the value of placements made to Commercial Bank of Ceylon was noted from Rs. 3.55 Billion in 2008 to Rs. 25.11 Billion in the year 2009. During 2009, Mr. Nihal Fonseka and Ms. Siromi Noel Wickramasinghe were associated with Commercial Bank of Ceylon.”

·       First Capital Treasuries Limited 

“In the years 2008 and 2009, a significant amount of investment was made by First Capital Treasuries Limited amounting Rs. 20.51 Billion in 2008 to Rs. 19.98 Billion in 2009. It was also noticed that the First Capital Treasuries Limited made the highest investments in Treasury Bonds through Direct Placement among non-captive PDs in 2008 and 2009.”

***The Forensic Report (11.1.9. D.) further says that “based on the above facts, it may be noted that the increase in issuance of Treasury Bonds through Direct Placements to above identified PDs and resulting loss was at a circumstance when the identified individuals were associated with identified PDs. 

However, the documentary and digital evidences reviewed and limited number of voice recordings of dealer rooms of PDs did not suggest that the relationships and / or associations identified above have led to the Direct Placements being made at the higher yield rates. (11.1.9. D.)

No voice recording system in PDD 

The Report says that, the facilities for recording of calls or the call logs were not installed in respective offices and dealing rooms of the PDD to authenticate the negotiations between the officials. Also, the facilities for keeping a video record of the activities performed by the various divisional officials of the PDD were not available during the Review Period. (9.1.2.D)

 

Digital forensic reveals deletion of files

The Forensic Report also says that in the case of Dr. M Z M Aazim (Assistant Governor), the confidential list of devices to be procured for digital imaging was originally sent on 18 June 2019 and subsequently, the “.ost file” was found to be deleted on his device. 

“It raises a concern if there was any potential leak of confidential communication between BDO India and the CBSL. Further, Dr. M Z M Aazim received a Memo on 21 June 2019 from the Governor of the CBSL mentioning that the electronic device issued to him would be obtained by the Forensic Auditors for a digital image. However, the procurement of his device was delayed and procured on 25 June 2019 due to his official commitments.” (10.3.1. G)

Report says that “It cannot also be construed that the deletion activity was performed by officials other than those, who these devices were assigned-to. Despite the active denial / rejection by the selected officials, of having performed the deletion activity, the possibility of deletion of the data files by the users themselves cannot be ruled-out.” (10.3.1. G)

 

Final Report of Forensic Audit on primary and secondary market transactions of EPF during the period from 1 January 2002 to 28 February

 

THE EPF LOSS under direct placements during 2007-2015was 8.7 BILLION

 

·      Lower yield rate offered by the PDD to the EPF in direct placements 

During the review, it was noted that the PDD offered lower yield rate to the EPF (2.15). In 46 out of 203 instances the PDDoffered yield rate was lower than the previous ‘Auction Weighted Average Yield Rate’. Due to lower yield rate, the EPF had incurred loss of Rs. 256.37 Million. (2.16)  

In 94 out of 346 instances, the PDD offered yield rate was lower than the Secondary Market yield rate. Hence, due to lower yield rate, the EPF had incurred loss of Rs. 8,716.48 Million. (2.17)  

Minutes of the Monetary Board meeting of 7 October 2008 stated that “...Issuing Treasury Bonds to EPF and other captive sources at an interest rate 5 basis points above the Secondary Market rates through private placements.”. (2.19). 

However, during the period 2008 to 2011, the EPF yield rate was significantly lower in comparison to the Secondary Market yield rate even though the Monetary Board has approved the issue of Treasury Bonds to the EPF and other captive sources at an interest rate of five basis point above prevailing the Secondary Market yield rate. “It is evident that the PDD has not offered the prevailing market rate to the EPF”. (2.20)

 

·      EPF Loss in Secondary Market was 620 million

In 177 out of 651 purchase transactions, the purchase price of the EPF was higher than the Secondary Market price resulting in loss of Rs. 620.81 Million. (2.38). 

Investments made during 2014contributed 91.03% of the total loss incurred by the EPF amounting to Rs. 565.15 Million. The difference between the purchase yield rate and prevailing Market yield rate was ranging between 1 to 80 basis points. (2.39). 

It was noted that the loss from transaction with PTL, PABC and WTL in 2014 amounts to approximately Rs. 321 Million (52% on the overall loss for the period) with the variance in the yield rate ranging from 4 to 80 basis points. (2.40)  

By Shehan Chamika Silva