Enforcement, supervision: SECP tells PSX, other regulators to ensure compliance

The Securities and Exchange Commission of Pakistan (SECP) has directed all the self-regulatory organisations of the capital market, including Pakistan Stock Exchange (PSX), to come up with an effective enforcement and compliance regime. Official sources told Business Recorder here on Monday that a number of weaknesses have been found during the thematic reviews of various laws administered by the PSX.
It is required that concrete measures are put in place to reduce the gaps in enforcement and supervision by the exchange and improve compliance by the issuers and intermediaries. For this purpose, the SECP has also advised all the self-regulatory organisations of the capital market, including PSX, to come up with an effective enforcement and compliance regimen. As a first step, the SROs have been asked to sort the penal provisions in their respective regulations based on the nature of violations/non-compliances, severity of such violations and the proposed corrective action to be taken in each case. This will help in dealing with violations of the regulatory framework in an effective and appropriate manner and act as deterrent to future instances of non-compliances.
Given the demutualised status of PSX, it is equally imperative to manage the conflicts of interest arising from the multiple functions being performed by the exchange. This can only be ensured through effective segregation of the commercial and regulatory functions of the exchange. The governing body of PSX should be independent from the management and influence from the Trading Rights Entitlement (TREC) holders to ensure transparency in the decision-making process, they said.
Moreover, the restructuring of internal/board committees of PSX would be required to address conflict of interest prevalent in the current constitutions due to presence of the TREC holders. The committees perform various tasks on behalf of the board which are both commercial and regulatory in nature and may also require them to be involved in day to day matters of the exchange. The restructuring should be such that all committees constituted by the board of the exchange be segregated into regulatory and non-regulatory areas, and membership of committees responsible for regulatory functions should strictly be restricted to independent directors on the board and, where required, exchange officials from the regulatory affairs department and/or market experts. Participation of TREC holders in such committees should be discouraged to avoid conflict of interest, in line with international best practices. The said governance reforms are important given the past performance of the exchanges during the various market crises experienced in the past when they were unable to cope with the same in an effective manner or discharge their role as a frontline regulator.
Pakistan Stock Exchange (PSX) is the new unified securities exchange of Pakistan post integration of the three former exchanges. The stakeholders of the Pakistani capital market, in particular the investors, have many expectations from the new exchange. To reap the true benefits of integration and to restore investors' confidence in the capital market, PSX as a frontline regulator needs to focus on a number of areas. Most important of these would be enhancing governance of the exchange, strengthening of its self-regulatory and enforcement functions and enhancing technology and product development to remain competitive in the global arena.
Based on discussions with the SECP which is the apex regulator of the Pakistani securities market, the future reforms agenda includes radical reforms for restoration of investor confidence and protection of investors' interests. This entails reformation of governance at the PSX. A stronger and more efficient role of the PSX board in line with international standards of governance and transparency is imperative to take the investor protection agenda forward.
The investors are satisfied that various measures are being put in place to safeguard their interest in the capital market. The apex regulator is facilitating introduction of key reforms in the market aimed at risk management, investor protection and improving transparency and governance of capital market institutions. These include reforms such as establishment of a centralised investor protection fund by the securities exchanges for settlement of investor claims in case of defaults by brokers, in line with global best practices. Similarly, efforts are underway for the National Clearing Company of Pakistan to attain the status of a Central Counter Party with a Settlement Guarantee Fund of appropriate size in accordance with actuarial valuations to ensure improved risk and default management, thereby enhancing investor protection, the SECP officials said.
It has further been announced that a Centralised KYC Organisation shall be established whose objective will be to register and maintain investors' KYC records in line with the international best practices. This will not only simplify the account opening process for investors but also ensure centralisation, authenticity and integrity of the investors' KYC data, while bringing uniformity and removing duplication in the process. Also, a revised securities broker regime is being introduced which will aim at reducing risk of the brokerage business by classification of brokers according to their capacity to perform different functions. Eligibility criteria for each such class will be specified to improve entry barriers to ensure protection of clients' assets and interest.
The PSX will also be working on various product development initiatives, including revival of the derivatives segment to broaden the product portfolio of the exchange and offer greater and viable liquidity and hedging alternatives to existing and potential investors.
With the said reforms in place and the expected improvement in the governance benchmarks, the investors of the Pakistani capital market are hopeful that they will be able to participate in a modern, efficient, competitive and secure marketplace which will offer them lucrative returns while safeguarding their assets and interests, the SECP added.
As frontline regulators or SROs, exchanges can be differentiated from supervising regulators (government or apex regulators such as securities commissions) in the manner that SROs are mostly self-governing and self-funding on the basis of regulatory fees. Nonetheless, the exchange SROs are bound to report to the supervising regulators. Supervising regulators are responsible for higher-level activities and oversight of the operation and governance of SROs, while SROs are usually responsible for front-line activities. As private sector organisations, SROs are also accountable to their members or shareholders. This dual nature of securities exchange which is pursuing both regulatory and commercial functions may give rise to conflicts of interest which need to be managed and mitigated to safeguard the stakeholders' interests. It is important to note that exchange SROs have a broader responsibility to all stakeholders in the capital markets, especially investors, as also set out in the relevant laws, rules or regulations and/or in the SROs' charters or by-laws.
A study of various reports published by the World Bank and IOSCO-the international standard-setting body for securities regulation- reveals that in the most complete form of self-regulation, an SRO has the authority to establish rules of conduct for its members or participants and supervise compliance with, as well as enforce those rules. A full-fledged SRO performs three main regulatory functions: (i) Establishing rules/regulations governing the conduct of member firms and other regulated persons; (ii) Supervising members and markets to monitor compliance with the said rules/regulations; and (iii) Enforcing compliance with the rules by investigating potential violations and disciplining individuals and firms that violate them.
Sources said that the exchange SROs are usually responsible for specific market regulation and member regulation functions. Market regulation covers rules to protect market integrity, market conduct rules, and exchange trading rules, compliance with which is monitored through activities such as market surveillance, trading analysis, and examinations of firms' trading operations. Member regulation refers to regulation of operations of participants, securities brokers or other intermediaries, compliance with which is monitored through compliance and financial examinations, reporting requirements and mechanisms, and administration of membership rules. In addition, exchange SROs also regulate listed companies in their listing rules/regulations. Exchange SROs also have responsibilities to investors, issuers, and the public, imposed on them by law or regulation. Most exchange SROs also perform other activities such as dispute resolution services, investor education, and education of market professionals.
Officials added that the objectives of self-regulation are mainly protecting investors and maintaining market integrity. It is important to note that the SROs are expected to act in the public interest over the specific interests of their members or, more typically, their shareholders, as also emphasised by IOSCO. Given the fact that the exchange SROs continue to perform significant self-regulatory functions, this also creates the need to address concerns about potential conflicts of interest. To cater to this, world over most exchange SROs have restructured their organisations to ensure that SRO operations are fully or partly independent of business operations (segregation of commercial and regulatory functions). Acting as a frontline regulator or SRO means that the exchanges must take on important responsibilities of regulation-making, supervision and enforcement, as mentioned above, as well as focus on its own structure, governance and functioning to ensure transparency, they concluded.