Recently the bourses were under the grip of severe bearish trends. This trend has continued since the March 2006 crisis when a steep fall was witnessed in the capital markets. During the last two trading days alone, the index has gone down by almost 1200 points.
This decrease is substantial and there are serious concerns in the investing community as to the why this bearish trend is continuing unchecked and what are the serious problems with the capital markets that needs to be rectified. Let us analyse the factors that may have been responsible for this decline.
SHORT SELLING CONTROVERSY: It is being argued that the Securities and Exchange Commission of Pakistan (SECP) has refused to accept the demands of the board of Karachi stock exchange to lift the ban on short selling that was imposed earlier as one of the corrective measures to protect the market during the March 2006 crash.
The reasons for the March 2006 crisis was said to be the excessive short selling by not only the big stock brokerage houses but also some of the leading mutual funds that are owned by these brokerage house. Realising the sensitivities of this market crash that may have embarrassed the economic managers of the present government, who had been advocating the performance of stock exchanges as a measurement of its economic achievements within and outside Pakistan, the Chairman of SECP rightly decided to hold investigation into this part of the activity and promised to take corrective measures as soon as the investigation report is presented to SECP.
As an interim measure, the SECP issued directives that short selling on future contracts were being banned forthwith till the results of the investigations are finalised and report issued to the stakeholders so that corrective actions would be taken and some other controls and checks would be introduced to discourage or minimise this type of activities in future. These measures taken at that time strengthened the market that was appreciated by small and medium-size investors.
Since then the investigation is being conducted and the investigation teams, supported by auditors, are continuously working on this project.
There is no second opinion that SECP took a timely decision to conduct this investigation but it has yet to be seen what actions may be forthcoming in case the violations of stock exchange trading rules are identified.
There is also some uneasiness that this investigation has taken unnecessarily long time and that has created not only uncertainty in the trading activities of stock exchanges but has created doubts whether this investigation has been handled with sincerity or not, especially when it is being alleged by certain quarters that those involved in this scandal are highly influential people with plenty of resources at their disposal to get away easily.
As no disciplinary action has ever been taken in the history of Karachi Stock Exchange for any violation of rules in the past, this group has become habitual in repeating the manipulative activities to suck the blood of the market without any fear.
In addition SECP has not been able to complete its investigative report for last year's (2005) crash as the forensic investigations are still being carried out. If it is going to take such a lengthy process to investigate the violation of trading rules that reflects that SECP is either unwilling to perform its legal role as a regulator or it has no trained manpower to perform its role as a watch dog body.
CAMPAIGN ON ELECTRONIC MEDIA: Since this ban on short selling was imposed, a group of the board of directors that comprised elected member directors started an organised campaign against the short selling ban on the pretext that short selling is an important element of trading and it must be restored immediately.
The advocates of this theory are those member directors that are well known in short selling business and are under investigation for the March 2005 and 2006 crises. They have been constantly using the electronic media arguing their case that this ban should be lifted by advocating strange arguments that are so ridiculous that one would not take a minute to understand the objectives and motives behind this organised campaign.
The self-serving objectives behind this propagation were simply that they are currently unable to manipulate the future market through blank selling thereby forcing the cash counter to react accordingly.
In pursuance of their objective, this group of elected member directors was instrumental in managing to pass a resolution of the Board of Directors of the Karachi Stock Exchange on 17th August 2006 that sent recommendations to allow short selling on future trades starting from September future business contracts subject to the approval of SECP.
The SECP being timely and efficient immediately refused to allow this permission on the pretext that some additional information was needed before permission would be granted.
These developments relating to disallow short selling are being argued as one of the main reasons of bearish trend. We fail to understand why the board of directors passed this resolution in the first instance that short future selling should be allowed when the matter was still being investigated and the report has not been finalised and made public and that no action has been taken against those that have violated the trading rules.
It is being argued the board's resolution was aimed at diverting the SECP attention from investigation that has been foiled. Therefore, the current bearish trend prevailing in the market is being considered as a manipulative exercise to force the regulator to accede to the demands of the group wishes to repeat the crash of March 2006.
This issue of permission to restart future short selling and SECP's rejection of it may have created some uncertainty in the minds of the investors and this was fully exploited by this interested group to achieve its own motives.
It has become a routine practice that whenever, there is any difference of opinion on any matter among the member directors and the SECP, the issue is fully exploited and the bearish trend is maintained to put pressure on SECP to accept their demands. These practices amount to blackmailing and let us hope that SECP and the board of director reject these practices.
FINANCING RELATED ISSUES: The investors are still waiting for the fulfilment of promises that were made that soon the rules would be finalised that would ensure the full availability of financing to the market without any cap attached. No serious progress has been made on this front also.
The promises were made either in haste or no serious effort took place to fulfil these promises to remove uncertainties from the market about the availability of financing. This is causing alarm in the minds of the investors. We fail to understand what are the problems that need to be resolved before SECP formally announces the lifting of cap on market financing, especially when the brokerage houses are arranging the funds privately. Why we are encouraging an illegal activity when the same could be legalised?
DIVERSION OF WEALTH FROM THE CAPITAL MARKETS: It is being argued that the large brokerage houses have accumulated their wealth rapidly during the last eight to ten years due to their monopolistic position in the capital markets. This accumulation of health was the result of mainly manipulative practices exercised by these leading brokerage houses through conspiring and acting together in a group to exert pressure on the market for their own benefit.
This huge accumulation of wealth in such a short span of time has been gradually taken out from the market to acquire projects that are being privatised. We have witnessed that this brokers group acquired the important industrial units such as Steel Mill, cement plants and fertiliser units. This was in addition to the commercial banks and a large portion of closed and open-ended mutual funds that they already acquired.
The recent allegations made by the opposition parties that Pakistan Engineering Company Limited (PECO) was also sold to a leading broker through back door without providing any opportunity to other parties to bid for this company seems to have added fuel to fire and speaks for itself that either there is a system failure or the group enjoys enormous strength.
This accumulation of wealth in such a short span of time among the few ones is a matter that is disturbing several economic managers. It is being argued and debated that this wealth has been accumulated by manipulation, exploitation and using their monopolistic position.
It is hoped that the proposed Competition Commission that is being anticipated to start its operations soon, will look into some of the activities that are being carried out against public interest and requires correction through new legislation that should protect public interest. If this expansion remained unchecked, it may be difficult to take corrective measures in future also and that may damage the image of our country.
TAX FREE CAPITAL GAINS: It is being rightly argued that if stock exchange trading is such a lucrative business for these wealthy brokerage houses and mutual fund managers, then the Central Board of Revenue should have come out with proposals to tax this easy earned wealth by excluding the day-to-day stock trading from the ambit of capital gains. There should have been a minimum period of retention of shares before the gains earned are declared as tax-free capital gains.
By taxing the profits of daily trading on shares would have discouraged not only the manipulative activities from the market but would have taxed the enormous wealth that has been created from this source. The taxing of this source of income would have been ethical also to bring at par with other trading income that is being currently taxed. There seems to be a strong case that there should be a specified holding period of securities before the gains earned from the sale of these shares is eligible as tax free gains.
The day-to-day trading, short selling and buying the shares on the same day further enrich the richer at the expense of the small investors. The daily trading should in no way be called "investments" and should be taxed as trading profits.
This taxation should meet the desired objective of controlling manipulative element that works against the public interest.
INSTITUTIONAL ROLE: It is being generally felt that institutions have failed to come up to the expectation of the investors in bailing out the market from the several past crashes. No single institution was present in the market during the last two working days that picked up shares at prices seen most favourable by the research analyst. That surprises the investor's community.
It has been emphasised several times that SECP by allowing a few individuals to operate several mutual funds have provided them a monopolistic power to play with the market as they wish.
Therefore, they would not be able to serve the interest of the general public and would not come to the rescue of the market. National Investment Trust should perform this role and try to check the fall by entering into market at these levels. This also has not been seen probably due to its forthcoming privatisation. In these circumstances its privatisation becomes a question mark and the government should rethink the rationale of its privatisation again.
NOMINEE DIRECTORS: It has been observed that the nominee directors have always been from a group of people who are already directors in other companies and generally there have been complaints that they do not understand the capital markets.
They attend the meetings without any preparations and are normally treated as rubber stamp of SECP. No doubt they do represent the SECP as this Commission has nominated them. However, it should be ensured that the impression that they are just rubber stamp of SECP does not give an impression of impartiality.
They deserve to be respected as impartial and that is the only way that they would be able to demonstrate their effectiveness. SECP should provide them additional training relating to the regulation of capital market and then they should be given free and independent exercise of discretion in the interest of capital markets. This should further boost the investor's confidence in this system.
THE ROLE OF CIRCUIT BREAKERS: The establishing of lower and upper circuit breakers objective was to reduce the volatility of the market. It is being argued, if we have achieved the desired objectives, there may have some justification in the application of lower circuit breakers but the justification of upper circuit breaker seems to be unneceaasy. SECP and Karachi Stock Exchange management and its board should re-think this issue and see if a decision needs to be reversed in this case.
STOCK EXCHANGE MEMBERS AS DIRECTORS: The member directors are frequently using the electronic media to express their views relating to market issues. While there seems to be no legal bar as to their use of electronic media to express their views, there is certainly a conflict of interest when they appear on electronic media to explain the Karachi Stock Exchange Board policies and practices and when they are identified by the media as Karachi Stock Exchange directors.
That gives an impression that they are acting as spokesmen of the KSE. This should be prohibited. SECP should also take a note of this situation and the chairman of the Karachi Stock Exchange should also issue instructions to avoid a conflict of interest situation. Any one is free to express his view as an individual and not as unauthorised director.
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