Report of the Committee to look into Central Bank BOND ISSUES

The Prime Minister who is also the Minister of Policy Planning, EconomicAffairs, ChildYouth and CulturalAffairs appointed the Committee based on the following terms of Reference;

The Terms of Reference of the Committee are to investigate into;

The reason for the Department of Public Debt of the Central Bank of Sri Lanka to make an announcement to issue a total of LKR 1 billion;

The sequence of events and key statistics associated with the said Bond Issue with respect to each Primary Dealer;

The bids received and allocations made by the Public Debt Department of the Central Bank in every Bond issue beginning from January 1, 2012 by Auctions and Private Placements.

The Prime Minister who is the Minister of Policy made available the services of W.A. Wijewardena, the former Deputy Governor of the CBSL.W.A.Wijewardena assisted the Committee in technical aspects.

The reason for the Department of Public Debt of the Central Bank of Sri Lanka to make an announcement to issue a total of LKR 1 billion.

The Committee interviewed the Superintendent of Public Debt Department (PDD), Deepa Seneviratne and the Assistant Superintendent of the Public Debt Department (PDD) Dr. Aazim.

According to the said officials of the Public Debt Department, the following sequence of events were revealed;

The Government debt requirement is estimated one month prior by the Public Debt Department (PDD) of the Central Bank (CBSL) in consultation with the Domestic Debt Management Committee (DDMC).We have also been furnished with a copy of a letter dated 20/02/2015 sent to the Superintendent of PDD by the Director General of the Department of Treasury Operations (M.S.D. Ranasiri). The cash flow and borrowing requirement of the month of March has been annexed to the said letter. In terms of the said annexure the borrowing requirement as at 02/03/2015 was Rs. 13,550,000,000/- (Rs. Thirteen point five hundred and fifty billion). In terms of the said document the entirety of funding has to be through Treasury Bonds. A copy is annexed marked “X1” for easy reference.

The Monetary Board at its meeting held on 23.02.2015, copy of which is annexed as “X2” (Meeting No. 4/2015), decided the following:

“2.3. The board was of the view that issuing 30 year treasury bonds would be favourable at this stage to extend the yield curve and re-profile the debt service as there is good interest shown by foreign investors.Accordingly, the board instructed the SPD to conduct a thirty year Treasury BondAuction during the week and arrange to list Sovereign Bonds in Euro Clear Exchange in future.”

The Monetary Board had intimated prior to the 23rd February 2015 of the desire to raise funds through the Bond Auctions and depending on the market appetite, to discourage direct placements. This is in line with the Operational Manual of the PDD (paragraph 3(a)page 10).

DIRECT PLACEMENT (PRIVATE PLACEMENT)

It is pertinent to define the method of direct placement, which is commonly known as private placement. As per the information obtained through the Public Debt Department, the bonds are issued to a value that is lower than the actual Government Funding requirement. The reason for this, as explained by the officials of the PDD, is on the basis that if the market is aware of the actual debt requirement of the Government, the market will forward bids with competitively higher interest rates.

Therefore, the PDD announces a bond, which is lesser than the actual fund requirement of the Government and usually accepts around two to two and a half times more than the value of the bond auctioned. Thereafter, the PDD was planning to call for Direct Placement (private placement) to satisfy the balance requirement of Government funding.

The Committee observed that the monies raised through Private Placements are far greater than the Bond Auctions. Even though the officials of the PDD were of the opinion that the Private Placement is a healthy mechanism, the Primary Dealers interviewed by the Committee were of the opinion that the Private Placement lacks transparency. Samarasiri who is the acting Governor and the Chairman of the Tender Board ratified the said sentiments.

The Committee observes that there is no proper mechanism with regard to private placement. There is no record as to how the decisions with regard to the private placements are made other than records pertaining to the private placements issued on special instructions. As per the document annexed hereto as “X3”, the Committee observes that an average of over 90 percent of the Government debt requirement has been through private placement. The Committee observes that this has affected effective participation by the Primary Dealers at auctions. In fact, prior to 27/02/2015, the usual bids by Primary Dealers range between 30 to 50, occasionally going slightly higher. After 27/02/2015 (upon suspension of private placements) the bids received by the CBSL was ranging between 130 to 170.

When the Governor was interviewed by the Committee, he explained that he made it clear that the restart of auctions was important. He explained that the previous Government had borrowed large sums of money both locally and internationally and it had reached beyond the spill level of debt. He opined that the said maximum levels had been reached in early 2014 and the previous Government had resorted to borrowing through commercial banks. He further pointed out that the previous Governor borrowed from EPF and invested in commercial banks and instructed commercial banks to borrow from overseas. In this context, he stated that BOC had raised one billion dollars. The Governor also stated that when he assumed duties on the 23rd of January, there was a repayment of 500 million dollars and the Central Bank did not have enough foreign currency to meet such payment and that itself created some volatility in the market.

Answering the reason to go for a 30-year bond, he said the monetary board and the PDD decided to start with the longest tenure bond and work backwards. He explained that if you start at a shorter end, the interest rate will shoot up due to the duration of the curve and market will start building up the interest rates.

When questioned about the effect on the interest rates rising sharply, he explained that the previous Governor’s practice of controlling interest rates at 5% for the whole month except for three days was actually confusing the market. However, the market was unclear at that time because the CBSL had not been clear in declaring its Monetary Policy. He also said that he believes that the market should determine the interest rates and was not agreeable with the artificial depression of interest rates from September 2014 until the elections. So his instructions to the staff of CBSLhas been to ensure that they move towards a market based system to raise funds and the price determined to pay for that funding is market driven.

When questioned about the success of new Monetary Policy, he said that there is effective participation in the market and the CBSL are raising record amounts of money in the market. When he was asked if he acted in a manner, which favoured any particular Primary Dealer, his answer was that he did not do so and that his concern was to raise money for the Government and not to see who is funding it. He said that the prior month failures and additional funding requirements of the Government were the main objectives he wished to fulfil.

Therefore, given the fact that the funding requirement of the Government as at 02/03/2015 was 13.550 billion rupees, the PDD had decided to announce the said 30-year bond upto an amount of 1 billion rupees. Even though the minutes of the Monetary Board Number 4/2015 specifies to issue a 30-year treasury bond, the amount of the bond has not been decided by the Monetary Board. This exercise is vested with the PDD per the Operational Manual of the PDD.

The sequence of events and key statistics associated with the said Bond Issue with respect to each Primary Dealer.

The advertisement and press release with regard to the 30-year bond (12.50% 2045A) had been published.At the time of closing the bids on 27/02/2015, the PDD had received 36 bids and the statistics of the same are as follows:

BIDS SUBMITTED BY PRIMARY DEALER FOR THE AUCTION HELD ON 27TH FEBRUARY 2015

Refer chart 01.

In terms of the aforesaid, the cumulative amount tendered was amounting to Rs. 20,708,000,000. Since the earlier instructions of the Monetary Board in line with the manual of PDD (page 10, para 3(a)), the Governor had requested to seek the possibility to accept the Government funding requirement from the market.

The Public Debt Department thereafter forwarded a document to theTender Board, which is annexed to this report for easy perusal marked as X$ together with their recommendations. In terms of that report, The Tender Board at its meeting held on 27/02/2015 (meeting no: 02/2015) considered the options and granted the approval for accepting Rs. 10,058,000,000 at the net of tax WAYR of 11.73%, Upon considering; a) Tight financial requirement of the Government; b) Prevailing high liquidity level in the market as reflect in the bids; c) The term structure of interest rates prevailed prior to September 2014.

The Committee considered the structure of theAuction Committee (Tender Board) members from 01.01.2012 to date:

The Treasury Bond Tender Board is comprised of the following members: Deputy Governor In Charge of the PDD - Chairperson, Assistant Governor in Charge of PDD, Assistant Governor in Charge of Price Stability Sector, Superintendent of Public Department, Director, Economic Research Department, Director, Domestic Operations Dept and Additional Superintendent of Public Debt.

When questioned about the success of new Monetary Policy, he said that there is effective participation in the market and the CBSL are raising record amounts of money in the market

In terms of the minutes of meeting number 2/2015, the decision to accept Rs. 10,058,000,000 has been approved by the members of the Treasury Bond Tender Committee meeting and the attendance of the same as reflected by the attendance sheet are as follows: P. Samarasiri DG(S), S. Rathnayake AG(S), C.P.A. KarunathilakeAG(KL), C.M.D.N.K. Seneviratne SPD (PDD), P.W.V.N.R. Rodrigo DDO (DOD), S. GunaratneDER(ERD),U.L.Muthugala ASPD (PDD) and Dr. M.Z.M. Aazim ASPD (PDD).

The Committee observes that the Bank of Ceylon being a Primary Dealer had placed bids amounting to Rs. 13,000,000,000 for and on behalf of Perpetual Treasuries.At the interviews, both the Chief Dealer of BOC and the CEO of Perpetual Treasuries stated that this is the first time ever that a Primary Dealer had forwarded bids at an auction for and on behalf of another Primary dealer to the best of their knowledge.

The Chief Dealer of BOC informed the Committee that no Board approval was sought in forwarding bids on behalf of another Primary Dealer amounting to Rs. 13,000,000,000 and failed to apprise the board of BOC even thereafter. He further stated that this is not a credit facility. When the Committee questioned the Chief Dealer of BOC, he further stated that Perpetual Treasuries made a call with regard to placing the said bids and mentioned that the funding for such bid is by an Insurance Company. The Chief Dealer of BOC also stated that he inquired from the CEO of Perpetual Treasuries as to the reason of high amount of yield net of tax and the reply he received from the CEO of Perpetual Treasuries was “awoth atha thami” (the rough meaning is a colossal profit, if successful).

However answering questions by the Committee, the CEO of Perpetual Treasuries denied that he mentioned that their source of funding is by an Insurance Company. He also disputed that it is he who said “Awoth atha thamai” and said that it is the Chief Dealer of BOC who said “Awoth atha thamai”. The Committee observes the said discrepancies in the following context.

Though there is no legal bar, it is unusual for a Primary Dealer to forward bids through another Primary Dealer;

The Chief Dealer of BOC has acted without Board approval and has failed and neglected to apprise the Board of BOC thereafter.

The Chief Dealer of BOC had failed to exercise due diligence in checking the source of funding;

The lack of transparency and disparity in statements of the Chief Dealer of BOC and CEO of Perpetual Treasuries;

THE DISCREPANCY OF STATEMENTS MADE BY EACHOTHER

The Committee further observes that the bidding pattern of Perpetual Treasuries at this bond auction is unusual for two reasons.

(a) Considering their previous bidding patterns, bids amounting to Rs. 2,000,000,000 when the value of the Bond is Rs. 1,000,000,000.

(b) Seeking the assistance of BOC to forward bids amounting to Rs. 13,000,000,000 given the fact that the value of the bond announced was 1 billion. When the Committee interviewed the CEO of Perpetual Treasuries specifically of the unusual bidding pattern at this auction by Perpetual Treasuries, his explanation was as follows:

(a) They were well aware that the Government would be raising unusually high funds for payments of several projects.

(b) Answering the questions by the Committee as to whether they possessed any inside information to that effect, his answer was that the said information was available in the public domain and does not amount to insider information.

(c) The reason to request BOC to forward bids on behalf of Perpetual Treasuries, he said, that due to the cash influx needed for settlement and the capacity of BOC that he thought fit to seek the support of BOC. He further said that he sought the assistance of Acuity Holdings, but failed to do so due to the unavailability of the Director.

(d) Perpetual Treasuries always had an aggressive approach and this was no different. He also said that the Central Bank had, at times, rejected Perpetual Treasuries, because they were too aggressive on TAP issues.

(e) They were successful of securing 50 percent of the accepted bids due to their careful analysis of the market elements and all factors considered. The Committee at this stage can only make an observation that the bidding pattern of Perpetual Treasuries and securing 50 percent of the accepted bids as unusual. Given the limited scope of the TOR this Committee is not empowered to make any assumption with regard to the aforesaid. However, in the interest of the public since the said transaction involves public funds and fiscal regulations of the government, the Committee observes that a full-scale investigation by a proper Government Authority is warranted.

The Committee further observes that the Board of Directors of BOC shall initiate a full-scale investigation and if necessary a forensic audit into the activities of the Dealer room of BOC given the fact that it is a State Bank. The Committee further observes that the Board of Directors of BOC may call for explanation from the Chief Dealer and his superior officers with regard to ad-hoc decisions made considering the large portfolio of BOC funds that are involved as stated above.

Though not directly within the mandate of the TOR, the Committee questioned Deepa Seneviratne, the Superintendent of PDD, Dr. Aazim, The Assistant SPD of PDD, and Samarasiri theActing Governor of the CBSLwhether this bond issue had caused any loss to the Government and if so a rough estimate of the same. All three stated that they do not agree that there is a loss to the Government given the fact that market conditions vary with regard to the Treasury Bonds depending on various factors and the volume of funds raised. Samarasiri furnished a copy of the judgement of Supreme Court in Case No: SC FR 457/2012 (The Greek Bonds case). He requested the Committee to take note of a particular paragraph which the Committee thinks fit to quote in verbatim;

He explained that the previous Government had borrowed large sums of money both locally and internationally and it had reached beyond the spill level of debt

SRI PAVAN J (AS HE WAS THEN)

“We must not forget that in complex economic policy matters, every decision is necessarily empirical and therefore, its validity cannot be tested on any rigid formula or strict consideration....”

The Committee observes that there is no impediment for the Government and or Parliament and or any Organization with public interest to engage in necessary mechanism in establishing the loss to the Government, if existent.

The Committee also observes, from the information placed before the Committee, that there is a serious lack of transparency pertaining to the activities of the PDD of the CBSL. There is no proper supervision of the activities between the Primary Dealers and the PDD. There is no recording of calls, there is no log of any documents received, no supervision of electronic footprint; such as text messages and emails between the officials of the PDD and the Primary Dealers.

Since the PDD is dealing with the most sensitive information of the Government, the Committee is of the opinion that a proper supervisory and monitoring mechanism has to be immediately implemented with regard to the activities of the PDD and the Primary Dealers.

The Committee also observes that an internal document of the Central Bank that contains statistics that are highly confidential is in the public domain. The availability of the said document on the web, newspapers, private circulation, complete with all signatures of the CBSL officials leave room to doubt the sanctity of sensitive confidential information within a secure environment of the CBSL. The Committee had been informed by the officials of the CBSL that no internal inquiry had been initiated upto date with regard to the question of the said document appearing in the public domain.

The Committee further observes that the sentiments expressed by seven Primary Dealers establishes a conjecture that sensitive information of the Central Bank and the secrecy of the same may have been compromised on occasions. The Committee is careful to take note that this is only an assumption bordering on an allegation and nothing more. However, given the fact that a document containing sensitive information is available in the public domain, there may be a possibility of the secrecy of information possessed by the CBSL being compromised. In view of the aforesaid the Committee observes that a full-scale investigation by a proper GovernmentAuthority is warranted upon the activities of the PDD and its officials and any other Department of CBSL and its officers, to ascertain whether there is any truth in the assumptions pertaining to the sensitive information of the CBSL being compromised.

Given the sanctity and the obligations vested with the CBSL in managing the lifeblood of commerce in Sri Lanka and the onerous responsibility that calls for conduct beyond reproach, the Committee observes that it is not unfair for the public to expect a high level of integrity in the conduct of the officials of the CBSL that includes the Deputy Governors and the Governor. Therefore, the monitoring of the digital footprints of the officials of the CBSLwill espouse the cause in maintaining public trust.

The bids received and allocations made by the Public Debt Department of the Central Bank in every Bond issue beginning from January 1st 2012 by Auctions and Private Placements.

The Committee observed that whilst there is only one volume of papers with regard to bond issues by auction for the period of 2012 upto date, there were over four volumes of files available with regard to direct placements.

The Committee also took note of a composite document given by Samarasiri that contained the following statistics.

In terms of the said chart Samarasiri explained that majority of the Treasury bond issues had been through private placement thus hindering the effective participation of the Primary Dealers. He further explained that the practice of direct placement servicing the financing needs does not comply with the policies of the CBSL.

The Committee observes that the Operational Manual of the PDD specifies that arrangement to meet financing needs has to be through auction as much as possible. Even the Primary Dealers confirmed that private placement overtaking the auctions may not be good practice due to issues of transparency and effective market participation.

In another event of concern Samarasiri in stating that the practices prior to 2015 did lack transparency and undermined the effectiveness of the Tender Board Committee. He furnished a document (marked as “X5”) with regard to the issuance of Treasury bond auctions held on 27th May 2014 wherein there had been no discussion or participation by the members of the Tender Committee. Whereas the document containing the observations had been signed only by the Superintendent of PDD and the Governor.

Samarasiri pointed out that the Tender Board Committee had not been privy to the content of this document since ex facie the signatures of the members of the Tender Board is not on record nor is there a minute of the meeting of the Tender Board Committee.

The Committees observed that the private placements (Direct Placements) when made are erratic and has no rationale. Prior bonds issued through auction are placed as direct placement sometimes many years later, thus creating issues of consistency, transparency, and effective participation.

Even though the PDD explained to the Committee that all Dealers are given the opportunity for director placement, they were unable to furnish any proof of such claim due to the absence of the availability of phone records, e-mails or any other documentation. The Committee takes serious note of the lack of paper trail with transactions running up to 2012.

The Committee having observed the nature, in which the auctions had been carried out without the proper function of the Tender Board Committee and the lack of paper trail and or recorded calls regard to Direct Placements, thinks prudent that a full-scale investigation has to be done with regard to direct placements up to 2012.

Due to the enormity of the documents involved in director placements from 01.01.2012 up to date, it is vexatious and an exercise in futility to reproduce the statistics in this report. However, the Committee has carefully studied the direct placements from; a) 01st January 2012 up to June contained in volume 11, b) 2012 July to December contained in volume 12, c) 2013 January to December container in volume 13, d) 2014 January to December contained in volume 14.

The Committee also perused documents containing bids received and accepted in bond issues by auction; a) 2012 January to July contained in volume 16, b) 2013 till 17.03.2015 contained in volumes 2 and 3. The Committees reiterates that the bonds that are issued are never closed, and the bonds issued several years before are re-adjusted on maturity period and privately placed many years later. This amounts to lack of transparency and opening out for manipulation and suspicion.

The Committee re-iterates that this is only a fact finding Committee with a bribed mandate granted on the Terms of Reference as above. The Committee makes a humble request to the Prime Minister who is also the Minister of Policy Planning, Economic Affairs, Child, Youth and Cultural Affairs to take all necessary steps within the powers vested in him in taking further remedial measures that may be necessary. Chairman Gamini Pitipana, Committee Members Mahesh Kalugampitiya and Chandimal Mendis.