Merger of stock exchanges: LSE specifies certain pre-conditions for establishment of NMS

Responding to the idea of the Securities and Exchange Commission of Pakistan (SECP) on merger of Lahore Stock Exchange (LSE) and Islamabad Stock Exchange (ISE), the LSE has placed a pre-condition for the establishment of a National Market System (NMS) which is necessary to introduce a level playing field for the best execution of trading orders in Pakistan.
In response to the suggestion of the Chairman SECP for the merger of the two stock exchanges, Aftab Ahmad Chaudhry, Managing Director (MD) Lahore Stock Exchange told this scribe here on Sunday that the idea of merger of all three stock exchanges is very ambitious. On the other hand, the merger of LSE and ISE, representatives of the medium to smaller size brokers, is only possible on meeting certain important pre-conditions.
In order to merge the LSE and ISE and create a competitive challenge to Karachi Stock Exchange (KSE), the SECP would require to implement the best price discovery and execution standards by ordering the establishment of the National Market System and the adoption of universal principles for the exercise of management control for all exchanges as per the spirit of the Demutualization law, MD LSE stated.
The MD LSE said that historically LSE and ISE have done more to expand the stock market culture in the other cities of the country. He said that the LSE had established trading floors in Faisalabad and Sialkot whereas the ISE had established a trading floor in Peshawar. Due to non-competitive environment, LSE had to close down its Sialkot office while the ISE has to close down its Peshawar branch. He said that if National Market System would have in place, both of these exchanges would have played a major part in bringing stock investment culture to the whole of the country.
He further said that even today the number of branches of LSE and ISE brokers is more as compared to the number of branches opened by the KSE. Because of lack of common trading platform, these branches do not show up in the volume of the ISE and LSE. Explaining his demand for the setting up of the National Market System and the uniform handling of the matter of the right of the management control of the exchanges, Aftab stated that all investor orders in Pakistan need best execution and since brokers of all exchanges don't manufacture the best price of the scrips, therefore national market system is the best solution to protect the right of small investors. He said that often the investors of smaller exchanges act as the price takers and don't get best price due to lack of liquidity and thin trading at these exchanges. He said that once the trading platforms of all exchanges are linked, then all orders would be executed from the centralised liquidity pool which would mean that no investor in Pakistan would get inferior pricing for his trading orders.
Aftab also stated that as per the spirit of the Demutualization Act, any investor buying the majority stake in an Exchange is entitled to take over the management control over that Exchange. Accordingly, he said that LSE and ISE who cumulatively have about 23% equity stake in Pakistan Mercantile Exchange (PMEX) vs 17% stake of KSE, should be entitled to take over the management control of the only commodity exchange in Pakistan subject to further investment by these exchanges in the PMEX.
MD LSE was of the view that with the management control over the commodity exchange, the combined LSE-ISE entity would be able to achieve scale economies and would be able to offer one platform for the trading of both asset classes. He said that one reason for the lack of success of PMEX has been the impression that the big brokers of KSE would be able to control the pricing power at the same exchange. He said that with a Lahore based entity as the majority owner of the Exchange, it would become much easier to penetrate in the agricultural hinterland of the country.
Aftab stated that unless the above pre-conditions are met, merger between LSE and ISE would be meaningless as both of these exchanges represent medium to smaller size brokers catering to the retail investors. He said both already have a common order book under the Unified Trading System and the experience has not proved effective in retaining the volume of both the Exchanges on the Unified Trading System (UTS). He said that with the above pre conditions, LSE can start the discussions to merge with ISE on the basis of the swap ratio to be determined on the actuarial valuation by some independent agency.
Aftab further stated that even without any merger, LSE is best placed to find a suitable strategic partner because of its much realistic valuation and cost effectiveness. He said both the other exchanges have inflated their valuations and would take years to break even and show positive returns.
He said that LSE's location in the midst of the industrial, SME and commodity producing areas, makes our exchange as the natural market to start multi product trading of equities, commodities, currencies and power/electricity. He said that LSE's culture is also suitable for innovation as it has a very attractive portfolio of IT services and has a history of better governance standards. He said that KSE would continue to get a discount for its lax governance and for its being under the influence of big brokers while ISE would continue to be seen as a real estate enterprise rather than an exchange.
To a question about the merger of all three stock exchanges, MD LSE termed the same as quite ambitious and said that in all previous discussions KSE demanded reduction in the membership of both the exchanges through mutual mergers between the brokers of the two exchanges. He said that unless the merger of all three exchanges is not a win-win model, the same is unlikely to happen anytime soon, Aftab Ahmad Chaudhry added.