Mitigating investment-related risks: brokers will be required to meet capital adequacy requirement

Piqued by the damaging impacts of stocks market crises in 2005 and 2008, the apex and front regulators are going to put various restrictions on brokerage houses to mitigate investment-related risks on the country's booming but volatile equity market to a maximum possible extent.
The "risk mitigating" measures, as Muhammad Hanif Jakhura, chief executive officer of Central Depository Company (CDC) described it, are ranging from limiting the brokers' custodial capacity towards their clients' shares to authorising CDC to also take care of investors' cash, besides shares.
CDC, a kind of bank that deals with the shares traded daily on the stocks market in the mated form, at present maintains at least 52,000 investor accounts and 250,000 sub accounts.
The Asset Under Custody (AUC) initiative envisages the regulators defining a capital adequacy level to be maintained by the brokerage houses to express their financial soundness, same like the local commercial banks do.
"They (brokers) would be allowed to hold securities 25 times of the size of their capital adequacy level," Hanif told Business Recorder in an exclusive interview.
Cleared by the Securities and Exchange Commission of Pakistan (SECP) and the CDC Board, the AUC would link the brokers' custodial capacity to their capital adequacy level.
Previously, the CDC chief said, the brokers would maintain any number of shares in their clients' accounts, no matter what their capital size was.
"Yes", he replied, when asked if it was a sort of 'cap'. The move is aimed at making those institutions stronger that are in custody of investors shares, said Hanif, a founding member having been on CDC's helm since 2002.
Existed in many countries, the AUC regime would keep the brokers wary of the fact that to do business they were required to possess a certain amount of cash.
The "risk mitigating" measure, the CDC executive said, would be implemented within next two to three months.
To a query, Hanif said, the CDC was evaluating as to how many brokers would get affected by the AUC and that how many were currently crossing the 25-time limit.
Those not fulfilling the criterion would have the option to either decrease the number of their shareholdings or increase capital.
"They would be given enough time to execute their options," said Hanif, a serving member on the Executive Board of South Asian Federation of Exchanges.
Direct Settlement System (DSS), he said, was another upcoming interesting product of the CDC to protect the investors' interest.
"Like their shares, the investors would keep their cash with the CDC," he explained. The move would make sure complete security of investors' assets.
"We don't deal with the investors' cash but under DSS we would keep their cash for settlement purposes," said the chairman executive committee of Asia-Pacific Central Securities Depositories Group for 2014-16.
After making the settlements we would send that cash to the Stock Exchange or the clearing company to be deposited ultimately in the bank accounts of investors.
Dwelling on the rationale, Hanif said: "Many people (investors) deem it insecure to keep their cash with brokers and want us to secure that like we do with their shares."
Trust-shaking setbacks, like the market crash of 2005 and 2008, keep many investors still feeling not "comfortable" with their cash lying with brokers.
Asked to compare today's stocks market boom with that of 2008 which had eventuated into a market crash, the CDC chief said a major difference was that unlike 2008's leveraged today's was a cash market.
"Market can crash when the leverage money shrinks. But now buying is on cash and there are little or no leveraged products on the market," viewed Hanif, the first CEO of NCCPL (2002-2005).
However, he added, the otherwise booming market would see "correction" if foreign investors pulled out for any reason. He says the market never moves in a single direction and keeps undergoing ups and downs.
"But still, even if you add negatives like 2008 crash the fact remains that the market growth over past decade has averaged on 25 percent," he said.
To restore investors' confidence, Hanif said, a number of measures aimed at investors protection had been taken.
These steps include the launch of Investor Account service in 1999, closing of Group Accounts and Street Name Shares regime, introduction of Reason Code, UIN regime and CDC Access initiatives, a mandatory '100 percent' audit of brokers and so on.
"After the introduction of Reason Code we are carrying out real-time monitoring of the shares' movement for all purposes," the CDC chief said.
The UIN regime, he says, enables regulators to oversee the entire trail of a transaction right from trading to the direct settlement of a share into investors' account. Also, the CDC has set up a state-of-the-art Security Operation System to maintain logs of any trading activity.
"Any predefined activity generates an immediate alert in the system with CDC's internal system immediately detecting any irregularity," said he.
From December 31 last year, it is a must for the share traders to provide the company with their cell phone or email contacts so they be notified of any activity in their accounts.
"We are allowing online transactions. Presently, we have a cheque based system to deal with what we call transaction orders. We would add the online option to it," said Hanif.
The risk has been mitigated to a larger extent now, the CDC executive opined.
In its efforts to expand the investor base, the CDC has been conducting road-shows in and outside Pakistan to lure the masses towards stocks market where, Hanif said, returns had averaged on 20 percent during last two decades.
Latest move to this effect was the constitution of a committee by the SECP chairman during his recent visit to CDC.
Headed by Hanif, the body is to develop a pilot project for setting up "capital market hubs" in different cities of the country.
To be worked out formally though, the body would initially target, as Hanif said, to bring at least one percent of country's 180 million population into the net. Specially the retail investors.
The thirst of CDC's awareness drive, he said, was to attract retailers. The market, Hanif observed, was currently benefiting either the high net worth individuals, institutional or foreign investors.
"This is retail investors who add significantly to the trading volume," he said.
Having recently achieved the Rs500bn trusteeship milestone, the CDC's shares profile stands beyond 4.5 trillion.