Time and again, it has been emphasised in the national newspapers, especially in the Business Recorder by several writers during the last few months that there was an urgent need to remove the weaknesses in the composition and effectiveness of the boards of directors of the stock exchanges of Pakistan. For unknown reasons no serious attention has been paid to this area due to rising capital markets where the index touched over 10500 points in the third week of last month.
SECP and Karachi Stock Exchange management tried successfully to propagate and get the entire credit for the rising markets.
All started praising the performance of the bourses and it was emphasised that the rising trend depicted that all was well on the economic front and that it was a true measure of the state of the economy.
The bullish trend suddenly busted and there was a steep fall in the share prices, resulting in 40% drop in the value of total capitalisation in only ten days. This was a most serious crisis in the history of Pakistan because the drop in prices was so sudden that there was no exit available to any individual, especially the small investors.
Many analysts and commentators expressed their views on this crash. Most of them thought that institutional investors and the big brokerage houses that had excess money at their disposal by having arrangements of billions of rupees funding through banking institutions, controlling almost 80% of the trade in bourses with a large network of their clients, managing over 30 billion rupees closed-ended mutual funds and unlimited resources through open-ended mutual funds, with complete control over the COT trade, were responsible for this manipulation and bought OGDC, NBP, PTCL and other high valued energy shares at the cash counter and sold these shares at a high premium of over 40% prevailing at Futures counters.
They made huge and easy profits at the expense of small investors who normally used to buy and sell at Futures counter due to shortage of liquidity. The four or five big brokerage houses conducted this operation at the expense of the entire market.
There were huge losses to non-institutional investors. Confidence was badly shaken in this process, but one thing was certain that these seasoned players made huge profits and never bothered to see if their behaviour was ethical or not and its long-term impact on the performance of capital markets.
Our greed for money and becoming billionaire overnight remained intact as usual without realising if we would be able to bring back these investors into the ring again. This collapse of capital markets damaged the governments programme of privatisation also as it was generally argued that it was strange that Pakistan's capital markets never even allowed the investors an honourable exit, if one wanted to do so.
The Public Accounts Committee of the National Assembly rightly took the desired steps to probe this collapse and the Securities and Exchange Commission of Pakistan decided to appoint a committee to go into the affairs of KSE and the conduct of its members but so far, no committee has been composed for unknown reasons till today probably because of the feeling that the SECP does not want to upset those big brokerage houses that had manipulated the market who are now completely out of control of any regulatory authority by virtue of their strength in the capital markets.
It is the general feeling of the investment community that SECP along with the KSE management is fully involved in this crisis and there is strong evidence to confirm this feeling in the following facts.
1. The Board of Directors of KSE did not meet to discuss this crisis till one day before the March settlement. This was strange as for full one week the market was locked due to lower circuit breakers that prevented any exit from the market to those who wished to do so in order to cut down and reduce their losses. This was a callous behaviour.
2. The Board decided to postpone the March settlement for another one-week and extended the period till April 6th. On this decision, there was a strong protest from small brokerage houses as well as from the investors, who were not able to clear their futures positions and were incurring continuous losses on a daily basis.
This meant that those affected would pass through another week of uncertainty, stress and undue pressure without knowing the outcome of this crisis. But when this decision of the board was conveyed to SECP, the board was immediately asked to reverse its decision and only early next day, the board met again, reviewed its earlier decision under the pressure of SECP and reversed it and restored the original settlement date.
3. Since that day, we have been hearing continuously that SECP intended to probe this issue extensively but no serious efforts have been made to achieve this desire.
At one point, the representatives of the same brokerage houses that were fully involved in this unethical and manipulated trade were propagating through electronic media to divert the attention of general public and the regulators that there was no crisis at all and only vested interests magnified this issue to such an extent as to show that the market would in fact crash within the next few weeks due to severe loopholes in the risk management.
The market was continuously showing a bearish trend since the crisis started and it was feared that the crash had done more damage to the capital markets than was originally thought. It is true that small investors or the so-called speculators have a short memory to forget and they may come back soon to invest in the stock exchange, but it is also true that throughout the last thirty years of capital market history, the crisis of this magnitude did not surface, where according to an estimate almost over 25000 middle class families have lost an average amount ranging from one million to 10 million rupees per family, whereas previously, the casualties were restricted to only a few players or few big investors.
WHY THINGS WENT WRONG? There are several weak areas that required attention by SECP to formulate very clear rules to streamline the capital markets. A few have been identified as follows:
ORGANIZATIONAL ISSUES: SECP did not act at all to improve the organisational weaknesses of the three bourses. The management, headed by an executive managing director, looks after the affairs of the stock exchanges on a day-to-day basis. The management is responsible to the board for the implementation of board's policy and guidelines.
The board is composed of 9 directors; four out of 9 represent the Regulator and are the nominees of the Regulator. Five directors are elected out of the 9 who are members of the Stock Exchanges. It has been argued several times in past that there is a severe conflict of interest in this composition.
Those who are players have been appointed referees and those who are regulators are involved in the management of this institution. It is arguable if this could meet the code of corporate governance requirements suggested and implemented by SECP itself.
INDEPENDENCE OF DIRECTORS: When questioned about the split in the directors of the KSE board on the current issues, a nominee director admitted openly that because, he was nominated by the Securities and Exchange Commission of Pakistan, he had to vote on the matters as per the instructions received from the Regulator. If that is true, how could directors maintain an independent role they are expected to maintain in view of the requirement as laid down by the Code of Corporate Governance? It is also questionable, if SECP as a Regulator is unable to enforce the Code by its own nominee directors as independent directors then how could the Code be seriously implemented and observed by the private sector.
Regulators' own behaviour demonstrates and reconfirms that its suggested code of corporate governance cannot be implemented and Regulator has no serious desire to observe and respect this Code. This leads us to think that why SECP should not appoint one of his own officials to manage the affairs of stock exchanges?
DIRECTOR'S KNOWLEDGE AND EXPERTISE: It is also being alleged that the nominee directors have so poor knowledge of the capital markets that they are unable to really play any meaningful role to improve the working rules and regulations.
It is generally felt that there will be no improvement if the nominated directors play the same role as they are playing now because of their limited exposure to the working of the capital markets and because they are not truly independent directors and are being instructed by the Regulators to vote on issues that suit the Regulators.
This requires a careful scrutiny of the past records of the nominee directors to ensure quality contribution from them. Anyway, it is not a picnic party that directors come, sit, chat and disappear after having their snacks. It is serious business and must be done seriously.
ELECTED DIRECTORS: The other five elected directors are also not independent as they represent the interest of brokerage houses. In most cases, the big brokerage houses on their own strength get them elected as they control more than a dozen memberships in each case.
These elected directors would always try to formulate rules and regulations that suit the brokerage community and may be harmful for the investment community. This seems contrary to the good governance principles and we should expect no miracles from this composition.
These two elements of board composition are odd and unless they are brought in line with the good corporate governance principles and induct a more moderate group of people who are dedicated to work and resolve the issues on a timely basis, no meaningful progress will be possible.
REPRESENTATION OF NON-INSTITUTIONAL INVESTORS: In the present composition of the board, there seems to be no representation from non-institutional investors. This is a group that has never been consulted or taken into confidence. This group is sick of listening to statements on risk management, protection for small investors and implementing rules that are favourable to investors community, but no serious effort has been made to involve this non-institutional investor in any decision making process. It seems SECP has always regarded that it is the brokerage houses that matter and not the non-institutional investors.
CONDUCT OF THE CHAIRMAN: The elected members themselves being in majority appoint one of them as a chairman. He happens to be again someone who is an active member having a brokerage house. How could the chairman be termed as a neutral and independent person whose main task is to co-ordinate the activities of the board? So this arrangement is also flawed and must fail in the long run.
The conduct of the chairman in this crisis has been criticised and questioned and it was morally obligatory on the chairman to vacate his post by offering resignation especially, if he was unable to get implemented board's decision on issues that were decided by the board through proper voting.
INADEQUATE RULES AND REGULATIONS: The Securities and Exchange Commission of Pakistan has so far paid no serious and honest attention to ensure that the rules and regulations for the conduct of the capital markets are in the best interest of the market as a whole, particularly in the interest of investors.
Rules framed for Future trading in haste without realising their inherent drawbacks that existed.
In addition to this weakness, every day new rules are being circulated for implementation exactly in the same way as any other government department works. It is not realised that uncertainty is the worst enemy of capital markets and that should be avoided.
CREATION OF MONOPOLIES: SECP pursued policies that encouraged the creation of monopolies and its behaviour was harmful for capital market and for the investors alike. These policies helped to create bigger brokerage houses that acted against the public interest. They became so big that five or six big brokerage houses hold almost 80% of the total market business.
They have access to billions of rupees running finances from financial institutions and these funds are used to manipulate markets by ruthless buying and selling and using these resources to provide COT. This has added to investor's miseries.
These brokerage houses own their commercial and investment banks that are supporting their manipulative activities for COT business.
It is generally felt that the size of these few brokerage houses, their activities and their control of the market size may violate monopolies laws but that has never been noticed by any regulatory authority. It may be right time to investigate into these affairs and assure the public and the investors that this group is being prevented from acting against the best interest of the public.
COT BUSINESS: This business is so lucrative that the borrowing is done by these brokerage houses at a rate that ranges between 7-9% and lent through C.O.T. system at almost double the rate. Currently this rate is fixed at 24% for the month of April. This shows the amount of manipulation that can take place through this channel.
In addition to this huge profitability, COT is used to manipulate the market. Everyone understands that whenever, it is the intention of these brokerage houses to sell their securities, COT facility is provided to investors liberally and if these brokerage houses wish to buy back these shares, COT is withdrawn thereby forcing the weak holders to sell at lower levels.
This is not rocket science that the regulators do not understand these manipulative activities. It seems surprising that it took such a long time for the regulator to put in place a system to phase out COT system gradually by replacing it with Margin Financing.
The proposed Margin Financing is going to be a complete failure as far as small investors are concerned, because the rules have not been finalised, no arrangements have been firmed up with the banking institutions and no assurance has been obtained that substantial funds would be made available for stock market Margin Financing to non-institutional investors.
In the absence of these requirements, it seems almost impossible to ensure that an ordinary investor would be provided the requisite funding. This new arrangements would further help the big brokerage houses and they as usual would avail these Margin Financing and accommodate the small investors at high interest rates.
Currently most of the small investors are being refused Margin Financing by the banks because no clear systems or rules emerged for this facility. If the intention is to exclude retail or small investors from direct investment in equities and leave this field for only big players, then it would be a big mistake and the effects of this decision should be visible in the coming days that may be disastrous for our capital markets.
MANAGEMENT OF MUTUAL FUNDS: SECP did not show any concern that the brokerage houses, on the basis of conflict of interest between these two functions, should be barred from managing the mutual funds. Therefore no restrictions were ever imposed on them to conduct this business. It has been argued time and again and SECP'S attention has been drawn to this area that there is a conflict of interest that the brokerage houses are being allowed to manage directly or indirectly mutual funds assets that are being used for manipulating the stock prices.
SECP has not responded to these fears but instead, it supported and encouraged this policy. This is evident from the fact that when ICP Mutual funds were privatised, most of the mutual funds went to the two brokerage houses that were already managing almost a dozen of mutual funds. The privatisation of ICP funds further strengthened their market position.
MUTUAL FUNDS ASSETS EMPLOYED IN COT BUSINESS: The resources of these Mutual Funds are employed in COT trade without informing the public regarding this fact. It is being questioned how SECP could allow the management of Mutual Funds to lend money for COT trade when the core objective of these funds is to support the equity markets through genuine investment strategies.
People invest in Mutual Fund industry believing that their investment is equity based and not interest based. This has not been disclosed to the investors. Beside this, the mutual funds are not banking institutions that should be allowed to lend money at exorbitant rates. SECP should take note of this activity.
RESULTING STRENGTH: These groups are so strong now that it is being generally felt that the monopolies created by SECP are beyond its control and SECP is helpless. That is why so far no investigation has been conducted into the activities of these big brokerage houses that manipulate the market.
This is evident from the fact that despite a public desire to investigate the recent crisis, no such committee has been constituted to probe into the activities of these brokerage houses that were responsible for this crisis. SECP has to explain its own position in this respect.
Unless SECP comes up with a stronger hand to clean the mess created by the individuals (whether they are nominee or elected directors or belong to management of stock exchanges or are representatives of regulators and having extreme views due to their egotism) who must be removed from the scene.
These institutions must be cleaned and a new team must be put in place to listen, express, contribute and implement the desired rules and regulations that are necessary for the development of the capital markets.
SECP must pay attention to limit the growth of the few brokerage houses that are indulging in manipulation of the market. No new permissions should be granted to the existing mutual fund management's. The brokerage houses must be stopped for reasons of conflict of interest, from managing mutual funds.
There must be limitation imposed upon the borrowing powers of the big brokerage houses to stop them from acting in a manner that can be construed manipulation. SECP must ensure that no rules that are framed in haste are implemented and the investors and brokerage houses must be given enough time to adjust their positions, before these new rules are implemented.
There should be a proper consultative process in which non-institutional investors must be brought into the consultative fold to listen to their point of view. We always talk about risk management but have never defined if it is for the stock exchange, brokerage community or for the small investors whose entire holding of securities are kept by these brokerage houses together with cash margins.
It may be a right time to think if T+1 may be the solution of this crisis once COT disappears from the market and provided margin financing does not serve the purpose for which it is being introduced. A continuous and frequent dialogue is desired to put the things right.
Comments
Comments are closed.