COPE Report: Is it an indictment on the former Central Bank Chief?

By Janitha Devapriya

The financial community, bankers, parliamentarians, civil society leaders and most importantly, the general public were relieved to learn that the much-discussed COPE report on the Treasury Bonds issue of 27 February 2015 which was termed by some quarters as a scam was finally tabled in Parliament without any division on Friday 28 October by its Chairman MP Sunil Handunnetti. 

Certainly it was an arduous task for Chairman Handunnetti and the members of the ‘oversight’ committee of Parliament. They had to study the somewhat complicated concept of Treasury Bonds in raising public debt and to go through many documents, fact sheets, accounting statements and connected data, all part of the evidence furnished in connection with the ‘probe’ on the controversial Bond issue. 

The widely speculated division within COPE did not however manifest itself when the report was finally presented. The present examination of the Bond issue in question by the COPE of the eighth Parliament is a sequel to the previous investigation by a 13-member sub-committee of COPE of the seventh Parliament. The matter was also investigated by a committee of lawyers consisting of Gamini Pitipana, Mahesh Kalugampitiya and Chandimal Mendis appointed by the Prime Minister.

In his preamble, Sunil Handunnetti eloquently explained the unenviable task the 24-member committee had to perform and he stated that this was a victory for people’s power and sovereignty of the Parliament which exercises the people’s will and mandate. One can term it, Handunnetti said, as a historical moment in the fight against corruption. He said it is a question of survival of the financial controls in the country. 

COPE commenced its sittings in May 2016 and continued through October, with several sittings. A fair volume of space was devoted to explain how the Treasury Bonds are sold to primary dealers and the factors taken into consideration when determining the yields and the selling price. The Committee examined verbal evidence of 23 witnesses in addition to the large volume of documents and data. Auditor General’s observations and comments plus 14 recommendations on the Bond issues covering the period 2015 to 2016 became an integral part of the findings. 

The report contains very strong observations on the manner in which the particular Bond issue was handled by the Central Bank with fairly critical comments on the conduct of some of the key officials. The main report is replete with footnotes and many annexures. Some of the footnotes are said to be observations and comments of nine MPs from the UNP, who did not subscribe to the original draft of the Chairman’s report initially but thereafter signed their concurrence when their observations were incorporated as footnotes. 

There was a time when the Chairman walked out of the committee room in disgust when certain thorny issues were argued by the ‘factions’ in the committee leading to a possible stalemate but finally, most issues were sorted out and a consensus report was made possible.

It is relevant to mention that the Lawyers’ Committee headed by Gamini Pitipana in its report had recommended that this matter be further investigated by a competent authority in view of Perpetual Treasuries tendering for 50% of the bonds on offer as it appears unusual in comparison to their earlier bidding pattern, a forensic audit to be conducted on the activities of the Bank of Ceylon’s dealing room, to establish a competent mechanism to control and supervise the functions and relations of the Central Bank’s Government debt department with the primary dealers and to investigate the alleged leakage of confidential information as pointed out by some of the primary dealers. 

This committee has also recommended that it is advisable to re-examine the ‘digital footprints’ of CBSL officials in order to determine whether the Central Bank has fulfilled the expectations of the public in discharging the financial control responsibility and whether it maintains the high level of integrity expected in all its functions. (Item 2, page 10 COPE Report.)

Findings and writer’s observations (in italics)

The committee finds that by changing the methodology of issuing Treasury Bonds from the earlier practice of part auction, part private placement and also increasing the value of Bonds initially advertised as Rs. 1 billion through auction to Rs. 10 billion, the interest rates structure and the yields were significantly changed and the Bonds on offer had to be sold at a discount or lower price, thereby causing the Government to incur additional opportunity costs or notional losses. The Auditor General in his report submitted to COPE has quoted an estimated loss to Government amounting to Rs. 889,358,050. (Page 32 under item 6.1.)

UNP members in the committee have pointed out that a loss to the Government does not necessarily result when Bonds are sold at a ‘discount’ since the price is determined by factors such as interest on the Bond in issue and the yields available on Bonds that are already available in the secondary market with same tenure (time for maturity). This submission was thereafter included in the report. (Page 13 under item 3.2.)

The stated loss had been calculated on the notion that private placements are considered as the accepted procedure to be adopted when issuing Bonds and therefore the evaluation had been made on that basis. However it was submitted to the committee that according to the operations manual of the Public Debt Department page 8 B 1 “Front office has to meet financing needs as much as possible through auctions. The balance fund requirements of the Government as indicated in the approved Borrowing program may be arranged through private placements with Primary Dealers.”

The Auditor General has agreed that the basis for loss assessment he made, namely on the premise that private placements were the accepted norm when issuing Bonds is erroneous and therefore accepted the basis suggested by the group of MPs who submitted footnotes. (Page 32, foot note 20.)

The loss quoted is notional or an estimation and is far below the loss figures of Rs. 50 billion bandied about by the Opposition critics in the run up to the general election in August 2015.

Deviation from Rs. 1 billion to 10 billion

In terms of the Government’s funding requirements for the month of March 2015, the Government Debt Management Committee recommended that Treasury Bonds for the value of Rs. 1 billion out of Rs. 172 billion at 12.5% interest be offered for auction on 27 February and the balance needs to be procured through private placements. Accordingly this was publicised through the internet as well as newspaper advertisements on 25 and 26 February 2015. A day prior to the auction, the Central Bank officials have called primary dealers by phone including Perpetual Treasuries whether they would accept Rs. 10 billion if offered.

According to verbal evidence recorded by COPE, the then Governor Arjuna Mahendran had visited the Debt Management Division at 10:45 a.m. and inquired about the value of offers received. The time for acceptance of bids, that is 11 a.m. was extended by five minutes to accommodate a special request by HSBC to submit their bid. The then Governor had made a visit again at 12:30 p.m. with two Deputy Governors and inquired about the matters relating to the auction. He had perused the list of bids and pointing to the 20 billion level inquired why 20 billion was not taken up. The officials have pointed out the possible adverse effects to the Governor and after discussing about the September 2014 rate for Bonds which was 11.75, he had pointed to the Rs. 10 billion level and instructed to go up to 10 billion.

In earlier evidence, though it was reported that he had said “do it,” the Director Public Debt Management Division through her evidence had stated that what the Governor said was, “Why don’t you go for 10?” (Page 24 of COPE Report – footnote.) When the Chairman of the Tender Committee, Deputy Governor Samarasiri inquired from the Governor why he had instructed to go for 10, the Governor had responded that the Government requires an enormous amount of funds and the Special Standing Deposit Rate was likely to be withdrawn and interest rates were anyway going to rise to 2014 September level. (Page 25, 26, verbatim records COPE report.)

This the COPE observes is contrary to the Monetary Board decision of 23 February 2015 to continue with the existing rates till the next meeting in a month’s time. (Page 26 COPE report.) Dr. A.Z.M. Azim in his evidence reiterated that the decision to go up for Rs. 10 billion Bond auction was a Tender Board decision. He also had stated that the senior management of the CBSL was considering gradual entry into full scale public auction. He also stated that in view of the offers being received was 20 times of what was offered, it was an ‘ideal opportunity’ to procure the requisite funds. (Page 24, footnote – COPE report.)

Much hype was made about Governor Mahendran entering the PDD when the bids were being processed but evidence placed before the COPE does not indicate that he had tried to interfere or influence the CBSL officials to favour any particular primary dealer. The privilege of the Governor Central Bank to visit any department in the bank cannot be questioned. However, his decisions to change the modalities of Bond auctions appear somewhat arbitrary and he should have displayed circumspection and a better professional approach in this matter.

Perpetual Treasuries

This also created opportunities for a particular primary dealer, namely Perpetual Treasuries Ltd., to procure nearly 50% of the total value of the Bonds on sale which they would not have got if the auction had been restricted to one billion. This amounted to an unfair advantage to the said primary dealer according to the COPE report. The primary dealer made last minute offers on 27 February 2015 through Bank of Ceylon, another major player of the money market and a primary dealer itself. (Rs. 3b at 12.5%, Rs. 5 b at 12.75%, Rs. 5 b at 13%)

COPE was very disturbed by the behaviour of this primary dealer, more so because one of its Directors was closely related to the former Governor, Arjuna Mahendran. The son-in-law of the Governor had apparently resigned just before the Governor took office, possibly to avoid conflict of interest. It was fairly widely reckoned that this connection made it possible for the company to obtain sensitive information and if it was a fact, it is a very serious offence of insider trading which attracts severe penalties. There was no evidence presented before COPE in this regard.

If the Primary dealer Perpetual Treasuries was able to glean sensitive information from the Central Bank, the source may not necessarily be the former Governor but it could be any other person or persons in the Central Bank.

COPE noted that Perpetual Treasuries had recorded enormous profits by trading in Government debt securities. The company was able to buy Bonds up to 44% from the entire stock on auction on 29 March 2016 and COPE recommends that this matter should be probed further as no submissions were made in this regard in the present investigation.

Any probe should look into the manner in which this company got registered as a primary dealer at the Central Bank, who the Directors were at the time, whether there was adequate capital and the officials in the Central Bank who recommended or approved their application.

Recommendations

The committee finds significant irregularities, shortcomings and lacuna in the Central Bank’s procedures in issuing public debt securities to procure funds on behalf of the Government.

The Auditor General had made 14 recommendations and some of the salient ones are,

01.Whenever the Central Bank takes policy decisions or changes existing procedures, priority consideration should be given to the positive or negative effects on the economy, long and short term impact on the Central Bank’s policies backed by credible and accessible information.

02.Since the data is not available to regulate the operations of the secondary market, all back up data should be maintained by the Central Bank.

03.The CBSL should maintain data and information on Bonds from the issue up to redemption.

04.In order to maintain the integrity of the Central Bank locally and internationally, the decisions of the officials should be taken in a transparent manner and to act in the best interests and to avoid conflicts with related parties.

05.Since the Decisions of Central Bank officials can have an impact on the economy as a whole, they should be subject to assessment or scrutiny by independent bodies without being subject to legal constrains and where necessary, Monetary Law Act Section 45 should be suitably amended.

06.EPF though not a primary dealer, is permitted to enter into public debt securities market. It often resorts to other primary dealers and therefore EPF should be allowed to operate as a primary dealer free from Central Bank control.

07.The Central Bank should have effective regulatory supervision on the primary dealers in view of one primary dealer going into bankruptcy during the period under review. 

The Auditor General concludes that the avoidable losses from the bond auctions of 27 February 2015 and 29 March 2016 amount to Rs. 1,674,256,805 and the authorities should be held responsible for the failure to take steps to prevent such avoidable losses. A possible escalation of such losses cannot be ignored if the bond sales during the period 27 February 2015 to May 2016 are considered.

The AG also concludes that taking into consideration all facts divulged in this investigation, it is not possible to confirm that the Governor had exercised professional due care. 

The AG had prepared his report within the authority and parameters assigned to him and if any irregular or acts of criminal nature had been committed, such matters were not pursued and assistance from competent institutions should be obtained if deemed necessary. 

Footnotes

The footnotes added by the COPE members indicate that certain inaccurate inferences of the AG have been arrived at due lack of access to proper data and information particularly with regard to continuation of private placements in Bond sales and it is not undermining his judgement but for purposes of clarity these footnotes are added. It is observed that the Bond sales by private placements during the period 2009 to 2014 have been carried out without a legal basis. It is therefore submitted that the inferences of the AG on possible losses is contradictory to the facts, the legal position and the evidence presented (Page 50 of COPE report). 

Another point to be considered in this Bond issue matter is that it is not one official but others involved in the process as well who should be collectively or individually held responsible. It should be considered whether those officials who are entrusted with confidential information are maintaining the secrecy and whether there were possible leaks for interested parties to gain undue advantage. Digital footprints of certain officials need to be perused. 

It is observed that certain officials of Central Bank, EPF and other institutions including Bank of Ceylon are acting in cohort like a rogue ring. Steps should immediately be taken to prevent this continuing. Perpetual Treasuries had gained unreasonable gains by borrowing from the Central Bank at low cost to purchase bonds. Those responsible should be held accountable. (Pages 50, 51 and 52 of COPE report.)

Recommendations of COPE

01.Officials of Central Bank have permitted a single firm, Perpetual Treasuries to obtain unreasonable gains. This is very undesirable and a recognised institution with legal authority should undertake further inquiry and take steps to prevent recurrence of such situations.

02.The Operations Manual should have provisions to allow Government financial institutions to provide funds to the Government to cater to exigent financial needs.

03.It is the responsibility of the Central Bank to establish a mechanism to investigate how Perpetual Treasuries that entered the market as a primary dealer in a short time gained such huge profits and to probe the possible financial loss to the Central Bank and the Government.

04.A mechanism should be initiated to monitor the activities of primary dealers and operations of the secondary market and to monitor how the Central Bank procures required funds to meet Government requirements.

05.The Central Bank should update the manual of operations of the Public Debt department and include provisions to enable state financial institutions to provide funds to meet Government needs through bond issues.

06.Former Governor Arjuna Mahendran is held directly responsible for this Bond transaction in issue and to take legal action against him and connected officials.

07.In order to maintain transparency and uphold the confidence of the Central Bank, an effective mechanism should be established and make necessary amendments to the related laws and acts including the Securities and Exchange Commission act.

Conclusion

By studying the entire COPE report which is quite comprehensive, one observes that the evidence recorded and facts presented with the conclusions and recommendations, the case against former Governor Arjuna Mahendran is not firmly established though his conduct is subject to further scrutiny. We haven’t heard from Perpetual Treasuries as yet and it would be interesting to hear what they have got to say about all this but reasonable doubt is created about their conduct and integrity. So the Attorney General is going to have an unenviable task in this connection, especially when the Indemnity clauses in the Monetary Law Act covering Central Bank officials and staff are also taken into consideration.