With over 30 years of senior management and board level experience, Farrukh is an experienced entrepreneur, and a leading business and financial advisor who has advised on many landmark transactions. Currently, he holds directorship positions on BoDs of PIA, Acumen Pakistan, Pakistan Mercantile Exchange among several others.

Previously, he has held senior positions with Acumen in Pakistan & UK, including Country Director, Pakistan, was a member of SECP Policy Board, President of the Overseas Investors Chamber of Commerce & Industry, and a director of Board of Investment, Pakistan. In his previous life, he was the founding partner and CEO of brokerage house BMA Capital Management Limited that received several international awards under his leadership.

In this interview, BR Research picks Farrukh’s brains on investment climate in capital markets amid the ongoing Covid-19 pandemic, proposals for upcoming money bill, and structural challenges that have hindered deepening of equities market in Pakistan. Below is the edited transcript.

BR Research (BRR): How is the Pakistan Stock Exchange (the Exchange) coping with the new normal of Work from Home (WFH)? As the disease contagion worsens across the country, do you believe it is possible for the exchange to function remotely indefinitely?

Farrukh Khan (FK): These are interesting times. When I joined PSX in late Feb-20, one of the first things I reviewed were the Disaster Recovery (DR) facilities and Business Continuity Planning (BCP). When the lockdown was announced exactly a month later, the Exchange was well-set to cope with the fallout. In fact, the Exchange did not see a minute’s shutdown for any technical reasons.

This was made possible thanks to our team that worked hard, even though countrywide lockdown meant that the DR site was also unavailable. Over 90 percent of the team is working remotely, whereas only 10 percent is required to be on site.

It helped that we spoke to our Chinese partners early on, who shared their lessons and learnings. As a result, PSX may have been one of the earliest organizations in the country to implement administrative SOPs and divided all our teams into ‘A’ and ‘B’, which work on-site on alternate weeks. This has ensured that in case a member of one team tests positive for the virus, rest of its members are also tested immediately, while the parallel team is available to take up charge.

But most importantly, we had to also work with the brokers (TREC holders), because PSX’s operational readiness is of no use if the brokers do not have BCP protocols in place. Fortunately, that did not morph into a major challenge.

In case the situation worsens, I believe we are well-equipped to continue work from home (WFH) protocols. I hope that this will not be the case for a prolonged or indefinite period, as the fallout will not only have an economic cost but will also cause tremendous human suffering.

BRR: Launch of Exchange-traded Funds (ETFs) coincided with the beginning of the lockdown and accompanied the slide on KSE-100. What has been the investor response to ETFs since that time?

FK: It was actually inverted; the slide following the disease outbreak had already begun, but we went ahead with the launch anyway. It has been 8 to 10 years since a new product was launched on the Exchange. In our view, the launch was long overdue.

ETF is the single largest asset category in most markets across the world. We had been working with AMCs for the past several years for ETF introduction, who were initially very apprehensive about the product. It was feared that ETFs may cannibalize the existing products of AMCs.

It took hard work to persuade them otherwise, and two AMCs eventually came on board. SECP played a commendable role as regulatory framework and systems had also been developed by the time the lockdown began. After intense discussions with all stakeholders, we decided to proceed with a soft launch rather than heavily marketing it through roadshows or gong ceremony.

This allowed us to smooth out any teething issues away from glaring publicity. In hindsight, we believe it was a good decision; once the uncertainty settles down, both the Exchange and the AMCs shall put more marketing spend behind the effort. It also offers sufficient time to other AMCs to develop their own products and get into the game. The launch of ETFs is an extremely important development for investors and the Pakistan market.

BRR: Proposal for listing of SMEs on the exchange has also been around for some time. Why has it failed to make it off the drawing board?

FK: That is not entirely accurate. The Growth Enterprise Market (GEM Board) is now in place, as are the associated regulations and systems. However, we have slowed down its marketing recently because of the uncertainty that has engulfed the investment climate in the aftermath of Covid-19 outbreak.

Nevertheless, we have held several virtual sessions with business chambers and prospective firms to create awareness. And if a business seeks listing, it shall be able to do so even right now subject to meeting all requirements. Already, we have several firms in the pipeline that we hope will go through with the listing process in the next 6-12 months.

BRR: So far, firms from which clusters/industries have expressed interest in listing on GEM board?

FK: Several technology businesses have expressed interest; however, in Pakistan, these firms are so small that they may not even qualify for GEM listing at this stage. Interestingly, many SME members of KP chamber have approached for GEM listing, as have others from traditional SME sectors such as retail, manufacturers, and exporters. It helps our cause that commercial bank financing for SMEs is limited in the country.

It must be highlighted that since the listing and disclosure requirements for GEM board are less onerous, the market is open to qualified investors only at this time because of higher degree of risk.

BRR: New listings from even traditional large corporate segment have remained painfully low. Even though sponsor groups that listed their businesses in the past have greatly benefited from it. Yet we see a trend towards de-listing. What is your view?

FK: New listings faces both supply- and demand-side challenges. In terms of new securities, Pakistan has a limited supply of new projects being set up, which reflects in fewer listings on the Exchange. Until recently, the problem was compounded by regulatory issues, such as onerous corporate governance requirements that discouraged businesses from raising capital from equities market. To some extent, these have been taken care of, but certain irritants persist till today.

For example, Section 452 of Companies Act, 2017 requires all interests in foreign entities to be declared by executives, board members, and substantial shareholders of the local company. This is not only unprecedented but is also unnecessary. FBR is already empowered to seek and investigate this information at its will; however, turning this into a routine disclosure in periodic SECP filings means sensitive and confidential information regarding sponsors may become available to all and sundry.

Similarly, a 2016 Sindh High Court judgement bifurcated the definition of securities. The court took the view that shareholding of pre-IPO investors shall remain unlisted even after the public offering is completed. This means that the tax treatment shall be different for these ‘unlisted shareholders’, even if they sell off their holding 10 years after firm’s listing on the bourse.

Furthermore, one of the most important attractions for listing used to be the right to pledge listed shares with commercial banks to obtain financing. This was withdrawn (although relaxed temporarily during Covid-19), meaning sponsors can no longer pledge their shareholding in listed firms to obtain bank financing to invest in a new project, for example. This is an erroneous move, as it removes the distinction between sponsor and the firm as two separate legal persons.

Lastly, the tax incentive to listed firms have been taken away. Remember, the cost of going public - such as compliance with Code of Corporate Governance and other documentation - is much higher compared to a firm that chooses to remain private. It is in FBR’s own interest to offer incentives because when firms list they become fully documented, as do their shareholders and investors. The documentation required thereafter ensures that businesses can hide precious little; at the very least, it is much easier to catch them in the act.

We have taken these issues with the regulators repeatedly, and hope that these unnecessary legal lacunas shall be removed in the upcoming money bill (or through amendment of Prudential Regulations where applicable).

BRR: What about the demand-side? A disproportionate share of private savings is absorbed by investment in real estate. Is that not proof of untapped demand?

FK: PSX is one of the oldest exchanges in Asia, but it would be fair to say that it has not realised its full potential. Although various historic factors have kept retail investors away, it may not be the best option for large number of retail investors to pump their savings directly into the stock markets.

Globally, equity exposure of individual investors is largely through three pools of funds: mutual funds, pension schemes, and insurance companies. All three sectors are still small and nowhere near where they need to be. The market really cannot grow without these sectors also growing.

To meet the goal of market broadening, our focus is to streamline the regulatory and governance side to propel growth in these three segments. New products such as ETFs, pension products, etc will help increase the investor base as well. At the same time, we are reaching out to the general public including students, salaried, and self-employed persons as well as chambers of commerce & industry through investor awareness sessions, webinars and other forums to create awareness.

The other aspect is that the brokerage segment needs to be more aggressive in terms of getting out on the streets and increase their outreach to develop new clients. With availability of app-based technology, distance or remote trading can become completely automated. Thus, building a large retail base is no longer as challenging. Brokers must invest in technology and marketing.

Both SBP and MoF have been very supportive in helping draw the framework for digital banking and allowing Overseas Pakistanis to use their accounts to invest in the stock market and mutual funds. The ball is now in the brokerage community’s court; they must step up to reach potential investors, link their systems, make research more readily available, build apps that are technologically secure and have an investor friendly user interface.

BRR: Many in the policy circle believe that a handful of brokers have cornered the market; and that establishment of PSX has effectively handed over control to few big brokers from Karachi to the exclusion of brokers from Lahore and Islamabad. What is your view?

FK: That is factually inaccurate. In the past five years, the exchange has been de-mutualized, which subsequently led to a successful strategic sale to a group of leading Chinese exchanges. PSX has followed into the footsteps of exchanges across the world such as Hong Kong and Bombay that also originally started as communities of brokers. This is done to eliminate all perceived or real conflicts of interest, so that trading and ownership of exchange are made independent of each other.

Today, fifty-five percent of ownership is with international investors (inclusive of the forty percent with the Chinese strategic investors). This is reflected in the structure of the board, which is thoroughly independent. Brokers are now the customers of the exchange. As a key stakeholder in the ecosystem, they are taken on board before any strategic decisions, but so are institutional investors, the management, in addition to the BoD. Thus, brokers no longer have overwhelming influence on decision-making, compared to in the past when they owned the exchange.

In terms of trading business, it may be correct that those who were originally Karachi-based brokers are now large national players. However, this opportunity is open to anyone from any part of Pakistan. Brokerage is a free market, anyone can purchase a TREC license for a nominal fee, bring in innovation, invest in business efficiency, grow, and become a dominant national player.

BRR: Development of secondary debt capital market has been a case of failure to launch. Is a turnaround finally on the corner?

FK: The debt capital market has lagged severely at PSX even though the Bonds Automated Trading System (BATS terminal) has been around for some time. Commercial banks’ voracious appetite to buy and hold debt till maturity has to a degree hindered the development of a secondary debt market. This is especially true for government debt market, which is overwhelmingly owned by commercial banks.

On the other hand, corporate debt is where the Exchange could have done more. Corporate TFCs are also largely placed with banks, which is a dangerous trend because increasing government debt appetite will keep squeezing out the private sector.

Recently, the hugely successful issue of power sector Sukuk on PSX was a landmark event, and the supportive role of SECP, MoF, and DG debt must be appreciated as they experimented with a debt issue on book building basis; a proposition that had high degree of reputational risk for the government during uncertain economic times.

The final pricing of the Sukuk issue was 90bps lower than what the government was offered by bank syndication, which is incredible as it will accrue savings of about Rs1.8billion in interest payment annually to GoP. The impressive interest shown by NBFIs such as insurance cos., mutual funds, pension schemes, and corporates is also a very encouraging sign.

These organizations are not likely to hold these instruments up to maturity, which will help develop the secondary market. Once trading gets going, it will generate interest of other prospective borrowers, and hopefully book building shall become the new norm for corporates to raise debt. It will help improve price discovery, attract a broader investor base for debt issue, and develop secondary trading market that will improve transparency in pricing of debt issues subsequently.