The Board of Directors of Karachi Stock Exchange (KSE) has opposed the appearance of names of the members of the Exchange, without any concrete evidence, and said that in order to mitigate risk management it was on the path to replace circuit breakers and had finalised the plan to create free-float index.
The Governing Board of Directors of Karachi Stock Exchange in its meeting on Wednesday reviewed the 'Report of the Task Force' constituted by the Securities & Exchange Commission of Pakistan (SECP) on stock market situation - March 2005.
The Board deliberated all the relevant aspects of the Report, especially in the context of various observations/comments in relation to KSE, its Board of Directors and management.
THE COMMENTS OF THE BOARD ARE AS UNDER: The Board observed that some of the observations of the Task Force are based on hearsay and face value of depositions of actual players in the market.
While the Board fully appreciates that enough time was not available to the Task Force, unfortunately the Report does not suggest any concrete steps to redress its primary objective ie to investigate allegations of market manipulations, insider trading and other market abuses, and suggest regulatory and operational reforms for enhancing investors' protection who had lost billions out of naivety and greed.
The Board observed that while the Task Force talks of appointment of an "independent" non-member Chairman of KSE Board, international practice shows that in Australia, latest demutualised Exchange, Chairman of the Board is one of the members of the Exchange. Also, in many countries, even in demutualised Exchanges, members are holding positions of Directors of the Board.
Similarly, the provision of appointment, renewal and removal of Managing Director of Stock Exchanges is with the approval of SECP and, therefore, the independence of Managing Director is compromised.
The Managing Director, as history bears testimony, is likely to have greater leaning towards the real boss--SECP. This needs to be reviewed to create a balance by following the law of the land and international practices. The task of appointment, renewal and removal of Managing Director should always be with the Board.
The Board is also of the opinion that its authority was compromised by the regulator on a number of occasions by involving non-Directors on all important policy matters relating to the equity market.
Moreover, the composition of SECP Policy Board indicates that no stakeholder is represented on it. Besides the working of Policy, Board is non-transparent as no agenda or its proceedings are made public.
Similarly, the SECP, like in other countries, should be made answerable to a committee of Parliament. Its accounts, duly audited, be made public.
POLICY AND SYSTEMIC FLAWS Unfortunately, the Report is completely silent on the issue of locking the rates early in the morning with large sale orders, although SECP and the management had access to all the information and data in this regard.
WASH TRADES The figures given about wash trades are laughable. The total of each scrip is under a million shares and how could a trade of 500 shares be termed as manipulative. Why shares traded in millions were ignored?
The so-called wash trades are a normal feature in all international markets as they reflect the activities of day traders.
The argument, that they were manipulative, is ludicrous. Another major distortion ignored by Task Force was that whereas margin requirement in futures trade was not more than 20 percent, in some ready shares it was as high as 75 percent.
This serious difference tempted people to trade in futures rather than ready counter.
The SECP declined to allow rollover of positions from March 2005 to April 2005, although it was recommended by the Board, which was well under the powers of the Board under Article 53(vii) to forestall any problem.
KSE MANAGEMENT WEAKNESSES The Board acknowledges weaknesses and resolves to strengthen the staff on more professional lines who have technical competence. The management should have retained the data of trading of March 2005 after it felt that the market was facing problems, especially after formation of Task Force on April 12, 2005.
CONFLICT OF INTERESTS With regard to the observations of the Task Force on the issue of conflict of interests in Board of KSE, the Board clarified that all the deliberations and decisions on all policy matters are taken after due deliberations and proper management input and the same are implemented according to the timeframe notified in advance to the market participants.
Moreover, all capital market reforms suggested by the regulator from time to time, more particularly restructuring of the Board, strengthening of risk management matters etc had been implemented timely. It would be relevant to point out that even the decision on COT phase-out was agreed to by the Board on the understanding that the regulator would make arrangements for margin financing.
Even the Task Force has acknowledged that commensurate arrangements for alternative modes of financing are not in place despite hectic efforts by the Board, and the Task Force has rightly recommended the need for making alternative arrangement towards this end.
PROPOSALS AND RECOMMENDATIONS - AT THE INITIATIVE OF THE BOARD
1. Rewriting of proprietary trading rules is being undertaken.
2. Creation of "free float" index is being done.
3. Replacement of circuit breakers with market halts based on free float indeed will be introduced.
4. A delegation of KSE is due to visit India to study the design of futures contracts based on 30, 60, 90 days and other risk management measures.
5. Task Force concedes that till margin financing or any other alternative financing system is available phase-out of badla be handled in a manageable manner--the view expressed repeatedly by the Board of KSE.
6. Capital adequacy of brokers is strictly monitored and no compromise is made to maintain check on systemic risk.
7. Pre-trade verification is being introduced.
8. In addition to Task Force recommendation on mutual fund and investment bank activity, the Board recommends that as a long-term solution, margin financing be handled by CDC which can be extended funding by banks. CDC has no conflict of interests, handles clearing and settlement and is the custodian of all securities and therefore will have synergy in this respect.
Besides, CDC enjoys the confidence of investors, members of the exchanges, banks and financial institutions and the Regulator to pre-empt any possible abuse by other vested groups.
The Board observed that naming members with statistical data was unnecessary without concrete evidence of any wrongdoing.
Finally, in order to ascertain any wrong doing by any member or financial institution, due process of law be followed and violations, if any, be addressed on the basis of concrete evidence. Across the board issuance of show-cause notices will undermine confidence among market participants. The need to enhance confidence in the market should be kept in mind for its development.
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