By Imesh Ranasinghe  Employee Provident Fund (EPF), which was established in 1958, is the largest single fund in Sri Lanka at about Rs. 2 trillion. The fund is the retirement savings of the private sector workers and some Government workers in the country where the employer contributes 12% and the employee contributes 8% monthly out of their wages to the EPF.  A fund of this size is extremely important to have a governance structure that manages it well and history shows the EPF was involved in two scandals surrounding the stock market between 2010 and 2013, and the bond scandal in 2015 and 2016.  The webinar held by Colombo-based independent think tank Verité Research talked about the losses and scandals involving the EPF that came to light following the forensic audit report that came out in 2019 just before the Presidential Election.  EPF losses and scandals  Explaining the findings of the report, Verité Research Analyst Anushan Kapilan said that the forensic audit had five different reports out of which two reports were about the EPF. One report focused on the bond market transaction between 2002-2015, and the other report focused on the share market transaction between 1997-2017.  The audit report shows that the EPF transaction in the primary bond market between 2002 to 2015 had a net loss of Rs. 2,556 million, while the main reason for the loss was due to EPF purchasing treasury bonds issued by the Public Debt Department at a lower price than in the secondary market.  So the Public Debt Department had gained this amount through bond market transactions. Additionally, the forensic audit shows how the EPF was being used as a money pump for third parties in the secondary bond market and share market. Through the pump and dump method, the EPF had lost Rs. 9,470 million on listed entities in the share market between 1998-2017 which has been impaired or realised (the investments or shares the EPF has realised they will never be able to gain).  For example, when EPF invested in SriLankan Airlines in 2010, they (EPF) invested Rs. 500 million at a time the airline itself didn’t have any worth, and currently, SriLankan Airlines is having a negative net asset value, so by that the EPF has impaired or realised those losses.  Meanwhile, the EPF has made a loss of Rs. 389 million on unlisted entities in the share market.  Kapilan said that by the end of 2019 EPF had a market to market loss of Rs. 24 billion, but by end of June 2021 the loss had come down to Rs. 500 million due to the fact that the share market is performing well in 2021.  “But still the EPF is making a loss despite the share market being at its highest point,” he added.  Referring to how the pump and dump process happened in the period of 2010-2012 in the stock market, he said that the EPF had bought shares of 19 companies during the said period when the share market was really doing well.  For example, the shares of Browns and Company PLC had a very low stock value in the beginning and EPF bought bonds in 2021, when the share price was at its highest but once the EPF purchased it, the prices started to come down. EPF had impaired this loss and realised that it would not make any returns, so they made a loss around Rs. 130 million.  Another example the forensic audit shows is the purchase of shares of Laugfs at Rs. 48 by the EPF when the investment committee stipulated the price at Rs 4. The reason for this exposed by the forensic audit is that Laugfs had made a presentation to then and current Central Bank Governor Ajith Nivard Cabraal who made a recommendation to purchase these bonds.  “But the forensic audit has not stated it as a loss because it still hasn’t been realised or impaired, but currently the share price of Laugfs is at Rs. 12 which shows how much losses the EPF has made by purchasing these bonds,” Kapilan said.  Further, he said between 1 January 2002 to 28 February 2015, third parties benefited a net gain of Rs. 752 million from selling bonds to the EPF, and Perpetual Treasuries (PLT) gained most of it. Ninety percent of this net loss to the EPF was incurred between 2013 and 2014. According to the report by the Presidential Commission of Inquiry (PCol) appointed to look into the bond scam, the total gain by PLT from EPF between 1 January 2015 to 31 March 2016 was Rs. 640 million. But even after that, PLT was engaged in EPF even after 2016.  Kapilan pointed out that EPF does not provide fund holders information to hold it accountable and the  losses only came out through the forensic audit report, the PCol report and the COPE reports. But however, he said according to Section Five of the EPF Act No. 15 of 1958, EPF should publish an annual report but the latest annual report came out in 2016. Additionally, he said the same section states a statement of receipts and payments, a statement of income and expenditure, a statement of assets and liabilities and statement of investments showing the face value, market value and purchase price of each investment should be included in the annual report regarding each investment.  He noted that even though Verité Research filed a Right to Information (RTI) application to the EPF to get the above information in 2012, it has still been unsuccessful.  Contextual matters as well as some misconceptions  Speaking at the webinar, former DFCC Bank CEO and Central Bank of Sri Lanka (CBSL) Monetary Board Member (between 2016 to 2020) Nihal Fonseka stated that there are several contextual matters as well as some misconceptions of the EPF.  He noted that the EPF is by far the largest fund in Sri Lanka and it will have a disproportionate clout in the capital market and possibly monetary policy transmission, if it is allowed to operate without a carefully crafted investment framework.  Fonseka stated that the CBSL is actually caught between a rock and a hard place when it comes to managing the funds of the EPF, which it undertakes as one of its several agency functions. He added that when the EPF was established in 1958, the CBSL resisted the function of managing the funds of the EPF because it realised that having the EPF under its wing meant that the Monetary Board and CBSL officers had responsibility for three conflicting things.  Firstly, he said the primary responsibility of the CBSL is responsibility for price stability which requires it to control inflation using monetary policy where the main policy tool is the increase or decrease of policy or market interest rates under the Monetary Law Act.  Secondly, as an agency function the CBSL is responsible for raising and managing the Government’s public debt denominated in both local and foreign currency and making the required funds available to the treasury. “Now, in this job the Central Bank has to act in the best interest of the Treasury, when carrying out this activity as an agent of the Government. It translates to mean that it should raise funds at the least possible cost to the Government at an acceptable level of risk,” Fonseka said.  Thirdly, he added that the CBSL is also responsible for the management of investments of the EPF, not the general administration of the EPF but especially in relation to the investment side, which is also undertaken as an agency function.  But he said the wording in the law implies even a higher level of responsibility which is more aligned with trusteeship, and the EPF act refers to the Monetary Board being the custodian of the funds of the EPF and gives it authority to make investments as it deems fit.  “But this does not mean that the Monetary Board has the freedown to do whatever it likes with the money since the principles of trusteeship and public law doctrine imposes on the board the responsibility to act in the best collective interest of its members all the time,” he said.  Although, he said at the time, when the mentioned conflicting arrangements were legalised, balancing these different objectives may have not been overly complex given the macroeconomic fundamentals prevailing at the time. However, he stressed that with the decades passed, progressive increase in fiscal dominance and ever increasing budget deficits the situation changed.  “I must add that these conflicts that I mentioned primarily related to the investments and debt raised through fixed income securities such as treasury bonds and it required a carefully drafted, diligently implemented set of controls, checks and balances to avoid problems. What forensic audit and other investigation reports show is that there were insufficient controls and even what was there was not properly implemented,” he said.  Pointing out the misconceptions, Fonseka said that there is a belief at the highest levels of public and political administration in Sri Lanka that the EPF is a state entity and state fund, which in fact is not.  The second misconception, he said, is that every loss in EPF is considered as a fraud or a scam, which is not the case. “In any investment activity there is some degree of risk that could be specific to the financial performance of the investor or rising from other circumstances,” he said.  The third misconception is that there were no checks and balances relating to the investment activities of EPF, which is not correct. He stated that they were always there but unfortunately the level of fund management skills and expertise was not sufficient and not quite well understood by some of the senior officers who were placed there through the CBSL’s staff rotation policies.  Measures taken by CBSL and EPF  When dealing with institutional conflicts that came up with the EPF, the former Monetary Board member said that the EPF had developed investment policies, put in place the investment committee, decision making limits with hierarchy and a separation of front and back office. But Fonseka said audits and investigations showed the process that had to be followed was not followed and too much power was vested on relatively lower level officers without sufficient oversight.  “What the Central Bank did was to take immediate steps to change the officers and take disciplinary actions against some officers against whom there was credible evidence of exceeding their authority and causing losses through irregular trading and investment activities,” he explained.  Further, he added that the EPF did not have any security measurements such as CCTV recording and other which made surveillance and post-audit activity almost impossible. Moreover, Fonseka said that one of the issues that led to this situation was the insufficient price discovery mechanism for treasury bonds which shows in the market. According to him, this was actually not the fault of the EPF, but arose because the Government securities’ secondary market transactions were over the counter and not on any kind of exchange or public platform.  Solutions for protecting the EPF  Verité Research Executive Director Nishan De Mel spoke extensively about five solutions in order to protect the EPF fund in the future.  The first solution, he said, is to have higher standards for information disclosure in EPF. “Whenever a private company is listed in the Colombo Stock Exchange (CSE), there are certain requirements for information disclosure. Banks have a higher level of disclosure requirements for information disclosure to the public. So minimally it makes a lot of sense to expect that the EPF has the same level of information disclosure as listed companies as banks. It can be a very good starting point in protecting the EPF,” he said.  Also, he said EPF should entrench better oversight and appoint the Bank Supervision Department of the CBSL, which has a very high degree of competence and rigor, to supervise the EPF.  He said the Bank Supervision Department does an excellent job in supervising the banks, and through this move it would ensure at least the same level of scrutiny as faced by other primary dealers. Then, he said the EPF should perform independent forensic audits every three years which will ensure constant and independent watch on EPF investments. According to him, this will help to separate the question of fraud and loss in the EPF.  Also, he said holding public meetings to discuss findings and recommendations of findings from the forensic audit reports are essential and will ensure concerns in audits are addressed by the management. “It is not acceptable for the EPF to say that it is the fault of the Ministry of Labour that its annual reports are not out while all Government institutions and departments are bringing in annual reports. The single biggest fund with about Rs. 2 trillion is managing somehow not to have annual reports for over four years,” he added.  As the third solution, he said that it requires disclosure on corrective actions, to answer for action not taken against individuals exposed by the current audits, for follow up actions as recommendations in the forensic audits and answer through reports and meetings (twice a year) to the Parliament. “It is quite imperative that the Central Bank publishes answers for actions taken and not taken against individuals exposed by the audits,” he added.  The next solution, he said, is to halt secondary market bond transactions by the EPF and finally to halt share market purchases by the EPF. He said that when the CBSL made a decision to, after having halted it for a period of time till it improves its governance, to go back to the share market with the EPF, it cited two reasons.  The first reason is that the primary market or the Government debt market is not going to have enough supply based on the projected EPF demand. Therefore, if the EPF had to invest the money that was coming into the EPF it had no choice but to go into the share market.  The second reason was the idea that you could get higher returns in the share market. He added that share investments have in any case had lower returns with higher risks. Therefore, he said: “The decision to go into the stock market should not be a decision of few people, workers have their money in the EPF they know what they are likely to get with investing in government bonds and it needs to be a transparent decision in which trade unions and workers are consulted and given a choice.”