A concept paper "New Broker Registration Regime" was released by the Securities and Exchange Commission of Pakistan (SECP). Soon after that, the SECP arranged a presentation as a follow-up of this proposed regime to the members of the Karachi Stock Exchange. The proposed regime lays down briefly the changes the SECP may be enforcing in the near future to restructure Pakistan's capital markets in line with changing circumstances.
It was mentioned by the Chairman of SECP that through these proposals he wanted to reduce the number of brokerage houses. The proposed changes are very stringent and its compliance may not be easy for the present brokerage houses. It is estimated that only 5-10 members would remain active under the new regime if implemented in its present form. Other remaining members would disappear due to non-compliance of the new rules. It is interesting to observe that several years were spent for demutualization of the exchanges to enlarge trading activities by creating a new trading rights system under the demutualization scheme, but now it seems that the idea has been scrapped. Sudden changes always hurt the capital markets and minimum discretion should be used in these cases. How far the new rules and regulation affect the existing members and their rights that are already stipulated in the Memorandum and Articles of Associations remains a debatable issue.
The capital markets have lost all stimulus, due to the economic slowdown, introduction of capital gains tax (CGT) on shares trading and the unfriendly attitude of the Federal Board of Revenue. The SECP's increasing disregard of company law provisions has been seen as an effort to micromanage capital markets resulting in gradual lowering of trading volumes. The general perception among the brokerage community is that the present regime is over-regulated in the field of compliance, non-friendly to investors, and the absence of non-transparent trading policies. This is resulting in excessive cost of doing business. The board of directors' performance has been very poor and below expectation. There seems to be no liaison between the directors and KSE members. The directors' positions are being used for self-promotion. This is forcing brokerage houses to close down.
The SECP has proposed the new regime rules at a time when there is a severe economic downturn, lack of interest in capital markets, and closing down of several brokerage houses. This needs a comprehensive debate with the existing members. Instead of focusing on reforms to encourage market players to increase their turnover, the SECP has proposed a new regime to close down the capital markets as a majority of brokerage houses may not be able to comply with this regime.
Interestingly, the new regime does not provide any exit system to those who are unable to comply or regard brokerage business as non-profitable under the new regime. It also remains an arguable point if a distinction can be made by creating different kind of trading rights under the current Memorandum and Articles of Association. It looks as if the proposed demutualization of the exchanges has been shelved.
The new regime raises the minimum limits of paid-up capital and liquid capital adequacy requirements substantially higher. The proposed structure of the paid-up capital requires that a brokerage house that does both trading and clearing must have a minimum 400 million rupees for KSE members against the present requirement of rupees 20 million as required under Article 14 (a) of the Memorandum of the Association of KSE. The increase in paid up capital from 20 million to 400 million rupees seems arbitrary, irrational and does not take into account the requirement of individual houses. No management would like to over-invest in paid-up capital if the capital remains idle and cannot be used efficiently at a time when there is a liquidity crunch in the market. The proposed increase should have been gradual, realistic and related to the quantum of business of that particular brokerage house. It should have also been left upon the directors of the brokerage house to decide the requirements of its paid-up capital according to the needs of each house.
The current minimum requirement of Net Liquid Capital is 2.5 million rupees as against the new proposed limit of rupees 200 million for the KSE brokerage house. A brokerage house is entitled to conduct business twenty five times of its Net Liquid Capital, which amounts to 62.5 million rupees. Currently on average only10%-20% of the prescribed limit is being utilised by the most active brokerage houses. So we do not see any justification to increase this limit to such abnormally high levels. In case any one brokerage house needs to increase its Net Liquid Capital due to business needs, the management and its board of directors may do so any time at their will and according to their business needs. With the new proposed limit, the brokerage house would be conducting business to the tune of 5000 million per clearing. Is the market capable of handling such big volumes of trading? Is there any previous history that leads us to believe that the current limits were insufficient?
The proposed rules provide guidelines regarding organisational structure including human resource management with clear responsibility and authority for risks management, IT system, infrastructure and necessary supervisory system. There should also be policies and procedures to resolve conflict management, unethical conduct and market abuse. It seems the Apex Regulator wants to micromanage brokerage houses. Is it its job to do so? This is the function of the Board of Directors of the corporate member.
All key appointments, including the CEO, directors, head of operations, head of compliance, compliance manager, risk manager, trading terminal operators and head of branch offices would be fit and proper and such appointments would be monitored by the respective stock exchanges and the Commission. There are already requirements in place to issue NOC by the respective stock exchange by filing of statutory return in relation to change in directorship. This is also applicable to nominee directors holding 15% or more shareholding as per the SECP letter dated February 2, 2010. In this respect, the SECP through its own Circular No 34 of 2009 has made it mandatory, certifications from the ICM. Certificates of educational qualification of all directors are also enclosed along with application. This information is also disclosed through Form A. Affidavits are also submitted to the SECP that discloses the qualification of other directors with full evidence. It looks like that the regulator feels that there are brokerage houses the size of J P Morgan, UBS, BNP Paribas, Stanley Morgan and Lehman Brothers operating in Pakistan. The proposed regime may be suitable for that size of business not for the size that is in operation in Pakistan. A business whether it is a brokerage house or any other is successfully operated through the corporate strategy of the board of the company and demands maximum use of its resources that are employed in that given size. Some of the proposed requirements that are under discussion do not even apply to listing companies, having much higher paid-up capital and are much bigger in size than these brokerage houses.
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