Nepal's Capital Market Needs More Than Trading Tools — It Needs Instruments That Build an Economy

When India's National Commodity and Derivatives Exchange recently launched RainMumbai, a weather-based derivative contract allowing financial hedging against rainfall patterns, it sparked a conversation that Nepal's capital market community would do well to join. The United States developed weather derivatives nearly three decades ago. India has now taken its first formal step in that direction. Nepal, meanwhile, is still debating whether to introduce basic derivative instruments at all — a gap that reflects something deeper than regulatory lag. It reflects a fundamental confusion about what capital market instruments are actually for.

The discussion about financial instruments in Nepal has for too long been dominated by a single question: what new products can we trade on the secondary market? Derivatives get mentioned repeatedly in policy documents and analyst commentaries as the missing piece. But derivatives, by their very nature, are secondary market instruments — they derive their value from something else and exist primarily to manage price risk for participants already in a market. Focusing exclusively on trading instruments while neglecting the far more consequential question of which instruments can mobilize productive capital into industries, create employment, support sustainable development goals and strengthen corporate governance is a category error that Nepal's policymakers cannot afford to keep making.

Since 2050 BS, Nepal's capital market has mobilized an estimated Rs 800 billion through various instruments. Ordinary shares have dominated this figure by a substantial margin, supplemented by bonds, preference shares, mutual funds and, more recently, private equity and venture capital funds. The total market capitalization of 294 listed companies stood at Rs 4.656 trillion as of Baisakh 2083, with Rs 1.056 trillion in trading turnover during that period. These are not small numbers. But the composition of that capital mobilization reveals structural imbalances that deserve honest examination.

Ordinary shares remain the instrument of choice by an overwhelming margin, and their role in Nepal's economic development is genuine. Companies in banking, hydropower, insurance, and increasingly in hotels, agriculture, pharmaceuticals and manufacturing have used equity issuance to bring ordinary citizens into ownership of productive assets. The Securities Exchange Center established in 2033 BS, now the Nepal Stock Exchange, gave these shares a marketplace. Nepal Rastra Bank's mandatory listing requirements pushed banks and financial institutions into the equity market. The result is a market that has grown substantially, even if unevenly.

Bonds represent the second pillar of Nepal's capital market instrument landscape, though their development has been considerably slower than equity. Institutional bonds — primarily from banks and financial institutions — have mobilized approximately Rs 244.32 billion to date, though many have already matured. Trading in bonds during the current fiscal year through Baisakh amounted to just Rs 3.37 billion. Development bonds issued by the government are listed on the secondary market, but the absence of a functioning secondary market for government securities remains one of the most glaring structural gaps in the entire system. More recently, green bonds have begun to appear, aligned with sustainable development goals and environmental financing needs — a welcome but still modest development.

Preference shares are the newest addition to Nepal's listed instrument universe. Five commercial banks and one development bank have issued perpetual non-cumulative preference shares, mobilizing Rs 16.85 billion in the process. The perpetual, non-cumulative structure — meaning no fixed redemption date and no accumulation of unpaid dividends — was designed specifically to help banks manage capital adequacy pressures without the complexity of fixed-maturity instruments. One commercial bank had previously issued convertible preference shares, all of which have since been converted to ordinary equity. An earlier wave of preference share issuances between fiscal years 2050/51 and 2063/64 raised approximately Rs 636.5 million across five companies, demonstrating that this instrument has precedent even if its recent revival has a different character.

Mutual funds occupy a growing but still modest corner of Nepal's capital market. Fourteen open-ended schemes currently operate with a combined size of Rs 34.57 billion. Including closed-ended schemes, total mutual fund assets are expected to surpass Rs 100 billion in the near future — representing approximately two percent of total market capitalization. The Securities Board has approved mutual fund schemes worth approximately Rs 105.9 billion in total, with some having already matured. Systematic investment plans have become a standard feature of most open-ended schemes, giving retail investors a disciplined entry mechanism. This is meaningful progress, even if the sector remains small relative to the equity market.

Private equity and venture capital funds, operating under the specialized investment fund framework, represent perhaps the most structurally significant addition to Nepal's capital market toolkit in recent years. Fifteen private equity funds are currently operational, with Securities Board approval covering Rs 41.75 billion in capital mobilization across nineteen fund managers. These funds have invested in agriculture, technology, manufacturing, financial services, hospitality and energy — exactly the sectors where conventional listed equity and bank lending have struggled to reach. Most funds exit their investments by listing portfolio companies on the stock exchange, while some use management or founder buybacks. The government's announced intention to enact limited liability partnership and trust legislation in the upcoming budget could trigger a genuine paradigm shift in this space, potentially opening Nepal's private equity market to foreign capital inflows in ways that bank-intermediated foreign investment cannot achieve.

The theoretical framework for understanding how companies choose between these instruments is illuminating and directly applicable to Nepal's context. Trade-Off Theory holds that companies balance the tax advantages of debt against the costs of financial distress to find an optimal capital structure. Pecking Order Theory suggests that companies prefer internal financing first, then debt, then equity as a last resort — because equity issuance sends a negative signal to markets about management's confidence in the company's future. Market Timing Theory observes that companies tend to issue equity during bull markets when valuations are high and avoid issuance during downturns. Research has found that the Pecking Order approach tends to describe corporate financing behavior more accurately in practice, particularly for larger and more mature companies that prefer debt over equity dilution.

For Nepal, these theories carry a practical implication that is frequently overlooked. If sophisticated management teams treat equity issuance as a last resort, then the companies most actively seeking IPO approval in Nepal may systematically be those whose internal financing and debt options are limited — not necessarily those with the strongest growth prospects. This does not mean that all IPO issuers are weak, but it does mean that investors relying on regulatory approval as a proxy for investment quality are making a logical error. The regulator's role is disclosure and compliance verification, not quality certification. That distinction matters enormously for retail investor protection.

The instrument innovation agenda that Nepal's capital market needs goes well beyond derivatives. Bonds and preference shares can be customized to serve specific financing purposes in ways that ordinary equity cannot. Infrastructure bonds with defined cash flow profiles matching project revenue streams could provide an appropriate instrument for hydropower project financing — avoiding the structural contradiction of perpetual equity in a business with a mandated transfer date. Green bonds can channel investment toward climate-aligned projects while giving environmentally conscious investors a targeted option. Real estate investment trusts and infrastructure investment trusts, referenced in the policy discussion as REITs and InvITs, could unlock institutional capital for property and infrastructure development that currently sits outside the listed market entirely. Commercial paper could give creditworthy companies a short-term market-based borrowing option that reduces dependence on bank overdrafts.

The deeper lesson from studying financial crises worldwide — from the Great Depression of the 1930s to the global financial crisis of 2007-09 to the dot-com collapse — is that capital market instruments are not inherently stabilizing forces. They can amplify risk as easily as they distribute it. Every major crisis has featured some version of two parallel failures: excessive public enthusiasm concentrated in a single instrument class, and financial innovation outpacing the financial literacy of those purchasing the new products. Nepal's own capital market shows early signs of both patterns, with retail investors crowding into hydropower shares they do not fully understand and with companies repeatedly issuing equity for debt repayment purposes that blur the line between genuine capital formation and financial engineering at public expense.

The conclusion that emerges from a comprehensive look at Nepal's capital market instruments — their history, their current scale, their theoretical underpinnings, and their gaps — is that the country stands at a genuine crossroads. The instruments currently available have mobilized meaningful capital and brought real economic benefits. But the instrument mix is too narrow, too concentrated in ordinary equity, and too disconnected from the diverse financing needs of a developing economy with ambitious industrial, environmental and social goals. The path forward requires not just adding new trading instruments for secondary market participants, but deliberately designing a menu of financing tools matched to the actual characteristics of Nepal's industries, its risk profile, and the capacity of its investor base to understand what they are buying. Self-regulation, transparency and financial literacy are not soft add-ons to this agenda. They are the foundation without which any new instrument, however well-designed, becomes another vehicle for the kind of concentrated systemic risk that Nepal's capital market can ill afford.