'We need to have debate on broking models in Pakistan: interview with Richard Morin, CEO, Pakistan Stock Exchange (PSX)

Richard Morin took charge as the CEO of PSX in January 2018. He has 30 years of experience spreading across various emerging markets, and in Canada. Throughout his career, Morin has contributed in various segments of financial markets including formulation of securities markets regulation and supervision mechanisms, market development, operations, risk management, derivative markets, central depositories, clearing systems, and government securities markets. He has also been on the other side of the markets, as Managing Director of Canada's investment industry association, and founded two private wealth management companies in the past.
Hoping that four months is enough time to come up to speed on PSX affairs, BR Research recently had a sit down with Richard to find out his thoughts about Pakistan's market and his plans to turn around the local bourse. He doesn't share the exact details of the plan, since he hadn't even presented it to his board when we met, but he does talk about its broad contours. Below are the edited transcripts.
BR Research: A business plan was shared at the time of the PSX bid. Can you walk us through those plans for the next 3 to 5 years?
Richard Morin: We have just completed our annual review of the strategic plan, and we are yet to present it to the board. I cannot comment on the details right now. But the number one strategic objective that the PSX must reach, and a number of things need to be done to achieve that objective, is to increase investor penetration in Pakistan.
Until we achieve that objective, the economic contribution of the exchange will not be fulfilled. We can't say we contribute towards capital formation and economic development of Pakistan as much as we should with only 50,000 active retail investors and about quarter of a million registered investors.
BRR: What is the number of retail investors that you would be happy to present to your board in three years? What's PSX's target?
RM: I cannot share PSX's targets at the moment out of respect for my board of directors who have not seen the review of our annual strategic plan. However, my personal opinion is that a target of half a million local retail investors is rational, and an optimistic target would be to have a million investors in three years.
BRR: Isn't that too optimistic?
RM: The reason why I think Pakistanis will come to the PSX is because the prize is too big not to go after. Anyone who invested Rs 10 million rupees in this market, 10 years ago has Rs 80 million rupees today. This is despite anything that you hear....... that the market is too volatile, it is manipulated, etc.- and I'm not saying that all of it is false - but for the retail investor it is mainly noise. This is why we are confident that more and more investors will become part of the market.
BRR: How do you plan to achieve half a million investors in three years?
RM: Well, Rome wasn't built in one day.
BRR: Sure! But what bricks are you going to lay?
RM: First of all, a series of bottlenecks need to be removed. Despite juicy returns, there are some reasons why investors may not come to the market; and I believe that the biggest bottleneck is investor protection.
The ultimate objective is to assure investors that their capital is safe with the PSX stock broker. For that, in close collaboration with SECP, we have a two-pronged approach of strengthening broker regulations and fixing the rules around investor protection fund. Both are of importance, because if investors are not convinced that their capital is safe, no amount of slick marketing can convince investors to invest in the market.
BRR: Details! Details!
RM: In the past 20 years, Pakistan has had an average of two broker bankruptcies every year. That is far higher than most markets. We will never get to a point where no broker ever goes bankrupt; that never happens in any market. But we need to reduce those risks through better broker regulations for capital requirements, operational requirements and so forth; though we have been making significant progress in introducing broker regulations to reduce those risks since even before I got here.
But better regulatory framework does not mean heavy set of regulations; instead we are moving toward lighter regulation. Right now, brokers are subject to up to four audits and regulatory reporting to the SECP, the NCCPL, the CDC and the PSX. But the SECP plans to set up an entity called Capital Markets Oversight Limited, and the four organisations are going to centralise their regulatory function into CMOL.
That entity will do audits, investigation and adjudication. We may also have a single set of rules down the road. That is part and parcel of our effort to reduce the risk of broker bankruptcy.
BRR: What are your plans about the investor protection fund?
RM: No market can completely remove the risk of broker bankruptcy. This is why we are proposing to remove the cap on PSX's investor protection fund. The size of investor protection fund in Pakistan today is Rs 3 billion, which is more than adequate for the size of retail investors at the moment, but we have just not been using it properly in the most effective way. We are thinking to eliminate the Rs 25 million cap per broker and replace it with a cap per investor.
When there is a cap per broker, then let's say I give a broker Rs 1 million and if my broker goes bankrupt then I don't know how much of my money will be protected; because if the cost of bankruptcy is Rs 50 million, the cap of the fund is Rs 25 million, and I only get 50 cents on the dollar. Therefore, we need to guarantee an amount for investors. In India, it is Rs 1.5 million per investor; in Canada, the amount of protection offered per investor is a million dollars per type of account. We won't get there in day one, but we have run the numbers, and we have enough financial resources to replace the per broker cap with per investor cap.
BRR: The number of brokers in Pakistan has come down from about 400 before demutualisation to about 228 at the moment. Do you have a target for the number of brokers?
RM: I think market forces will decide that. Neither myself nor the PSX has any objective of consolidation or the number of brokers. But if you look at peer markets in Vietnam, Sri Lanka, India the number of brokers is quite less.
Sri Lanka has 700,000 retail investors in country of 29 million population and 28 stock brokers. Canada may not be the best comparison because it is a developed market, but still in a 36-million-population there are 8 million registered investor accounts served by 150 brokers.
BRR: Attracting half a million retail investors will require a whole lot of marketing efforts. How do you plan to achieve that?
RM: In the next two weeks, I'm meeting about 15 people for two key positions, one of which is the Head of Marketing and Business Development. This stock exchange has never had a marketing professional doing nothing, but marketing and business development. We have never had that. We plan to have a professionally run marketing department that understands the needs of various investor segments, and tailor the products and communication strategy, according to the needs of each investor segment.
BRR: What's the update with the much pending trading platform, and the stock options?
RM: The new trading platform was needed not only for trading but also for market surveillance and data vending. We issued the request for expressions of interest a few weeks ago. We have received a significant number of expressions of interest, and we are currently reviewing those RFIs. In the best-case scenario, the new trading platform would be in place by December 2018 or by June 2019 at the most. Stock options will follow the trading platform because the current trading platform cannot support the stock options.
BRR: Will it also fix data leaks because that has plagued the market for some time?
RM: I've heard stories of data leaks and it is absolutely appalling. The PSX trading infrastructure system, the KATS terminal, the matching engine, and all the processing in between rely on antiquated technology that is well beyond its useful life. The new system will guarantee that there are no leakages at PSX level.
However, since the new head IT joined PSX, he dedicated most of his time to address the issue of data leakages. We collaborated with a team of 13 auditors from SECP; on top of that we hired KPMG to conduct a comprehensive audit to ensure that data leakage does not happen. We are pursuing all avenues to deal with this problem.
BRR: Tell us about the ETF license the PSX has given to the Chinese AMC?
RM: An excellent way to bring Chinese investors into Pakistan is through the exchange traded funds; I don't expect the Chinese investors to do a lot of research on particular Pakistani equities; the EPS is a good way instead.
We have licensed the use of KSE-30 for use by an ETF provider in China; the AMC is called True Value and it specialises in the issuance of ETFs. They have an exclusive licence for one year. After that one-year period, other Chinese ETFs can also approach the PSX to issue ETFs. True Value is ready to launch, pending approvals from the regulator in China. As you would expect, the regulation issue for this ETF would be complex because it is giving access to Chinese investors to invest money offshore.
BRR: Have other AMCs approached PSX for next year onward?
RM: We are not actively pursuing that. We are instead actively pursuing the launch of ETFs in Pakistan. While in terms of launching products, stock options are important, but as a strategy to attract non-savvy retail investors in Pakistan, it is absolutely necessary to launch the ETFs. Keeping in mind the objective of reaching out to middle class Pakistanis, the priority is more on the ETF front than the stock option front.
BRR: Will you be launching new indices for it to track those ETFs?
RM: We will review our entire index and data vending business. This exchange has never had a senior resource dedicated to product management and research. The second key position I am scheduled to finalise soon is Head of Product Management and Research.
There will be an entire team under that person, and one part of that team will be dedicated to index management. We have also begun very preliminary exploration to have third-party index vendors such as FTSE, S&P, Dow Jones, to look at our market and revamp our entire index business. We have not decided to move in that direction as yet, but it is an avenue that we are exploring.
But the plan is to review our indices to close any gaps that might be between what we currently use and what best international practices are, and that's an item on the 3-year agenda. In fact, it will be the top priority for the resource we hire for the head of product management and research.
The person's job for the first year will be to launch domestic ETF, review indices and launch new indices if need be, and data vending. Next year's priorities will be stock options, index options, bond market, shariah compliant products and so forth.
BRR: What about new listings. What's your 3-year target for that?
RM: That would be the job of marketing department. Their mission in life is to increase the number of investors and to bring listed companies. Their job will also be to bring investors foreign investors in Pakistan, and also oversee the corporate services wing within their department.
The corporate services team will have a dual role of servicing the listed companies on a number of initiatives - from corporate governance, investor relations, financial reporting, and offering value added services to the companies that are already listed. In parallel with that the job of the team will be to increase the number of IPOs, giving proper advice to prospective issuers in terms of finding investment bankers and so forth.
I cannot share the target at the moment out of respect for my board of directors who have not had the opportunity to comment on those numbers as yet, but obviously the target for new listings would be higher than the current number, which is between 5 and 10 per year.
BRR: We haven't touched upon the SME board. What are your plans about that?
RM: We have no resources devoted to make the SME board work at the moment. Our corporate services team will fill that gap. However, we have to be careful about the size of the companies for that board.
It is important for Pakistan that small and medium sized companies are able to find the finances through the exchange, but I'm not convinced that a company with the market capital of a quarter million dollars should be listed at the exchange on the SME board. As we dedicate the resources to each of our market segments, I will not exclude the possibility of reviewing the listing requirement for the SME board, and whether we should consider a "premium counter" in addition to the regular counter where our 550 plus companies are listed. These are the kind of questions that our team will deal with.
BRR: What kind of trading volumes are you targeting for the next three years?
RM: Let me give you some numbers as benchmarks. Pakistan's market capitalisation to GDP ratio is about 75 percent. In India that ratio is about 120 percent, in other developed countries it is more than 150 percent. One way to increase the volume is to increase the market cap to GDP ratio, by increasing the float, new listings, and so forth.
The second metric is the turnover value to market cap ratio. The average ratio of turnover value to market cap in emerging markets is 55 percent. Before the 2008 crash, that ratio in Pakistan was 300 percent, which is absolutely unsustainable and bound to end in tears as it did. I don't think anyone wants to go back there.
Today our annual traded value to market cap ratio is around 35 percent. The first step is to increase that ratio towards 55 percent. I think that's a reasonable objective to reach, and I think the brokers will be happy with that number.
BRR: Will the PSX's strategic plan be shared with the public?
RM: Once the board approves the strategic plan, it will decide which portion of the strategic plan will be shared with the stakeholders, including the public.
BRR: Will the PSX force listed companies to issue market guidance, and will the PSX issue guidance now that it is a listed company?
RM: Regulators and exchanges don't impose listed companies to issue guidance. It is encouraged, and it is a good practice. Whether or not we will issue guidance, that's a decision we have to make. We recognize that as a listed company we must set the example for Pakistani listed companies, and the board will take that responsibility very seriously.
BRR: Have Chinese or other foreign brokers approached the PSX since demutualisation and the sale of strategic stake to the Chinese?
RM: There seems to be renewed interest on the part of foreign brokers to get involved with Pakistani market. If a Chinese broker comes to Pakistan or gets a stake in local brokerage, that would be an immensely positive development, and I would encourage any prospective Chinese broker to give me a call. This market will go through a profound transformation in the next few years, and I think it will be in the best interest of every stakeholder including the local brokers to get foreigners involved.
BRR: There is no reason for a broker in Pakistan to provide great research and advice because their earnings are linked to the number of times a client will trade. Is a change in brokerage models on your agenda?
RM: One of the things holding back the development of this industry, and the ability of intermediaries to develop their business is regulatory silos. A broker is allowed to offer only trade execution; he is not allowed to give advice and charge for advice as well. The problem with that model is that it no longer works globally; and it won't work in Pakistan as well.
The marginal cost of a broker to execute a transaction is pretty close to zero because the staff and the systems are already there. The technology has brought the cost down to zero, so there will always be pressure on the price to execute the trade. This is why there are very few full service brokers internationally who only charge trading commissions. This is an important issue for our market and we must find a solution with the brokers and SECP.
BRR: Would you take it up with the SECP?
RM: One of my hopes is that moving forward in Pakistan, there are more debates around the way the regulatory structure evolves rather than directives being issued. And I think we need to have a debate on the broking model in Pakistan including execution, advice, and asset management. It is in our best interest to ensure that the debate moves in the right direction.
Brokers are our partners in developing this market, they are our key stakeholders, and the PSX has vested interest that the brokerage community thrives in Pakistan. Today brokers are not making money in Pakistan; it is a strategic issue that we need to deal with. The PSX won't have success, if brokers do not have success and therefore we want to have a debate around the brokerage business model.