The Securities and Exchange Commission of Pakistan (SEC) has set-up an Expert Committee, comprising Security Market Experts, both national and international, to formulate a comprehensive plan for the demutualisation and integration of the present three stock exchanges in Pakistan.
Thereby, Pakistan intends to have one national stock exchange to integrate all the trading activities taking place at the existing three stock exchanges of the country.
The Chairman of the SEC has said that the purpose for the demutualisation and integration of the exchanges is to keep pace with international trends, in the interest of national development needs.
The analysis of the working of the existing stock exchanges will lead to an answer as to whether they could contribute towards national development.
The stock exchange is normally considered to be contributing to the financial development of an economy and its expansion.
The SEC chairman believes that the stock index is a barometer of the economy and the share prices reflected the performance of the corporate sector, political stability or otherwise and government policies.
But an analysis of the listed companies and their trading activities, on the stock exchange, shows that the stock exchanges in Pakistan do not fit this profile.
According to the Annual Report of SEC, out of the total companies registered with them which stood on June 30, 2003 at 41,828, 90% of them are private companies and only 3000, equal to 7%, are public companies.
Out of these 3000 public companies registered with the SEC, only 23% of them are listed on the Stock Exchanges.
This data reflects that the sponsors, generally, are not interested in raising finances for their industries through the stock market, but most of the investment has been made through self-financing and bank borrowing except a few of them have opted to raise equity contribution for their companies through the stock market.
Further, during the last two years, at least over two dozen companies have been delisted from the stock-market.
This declining trend of the sponsors to seek equity finance through the stock exchange indicates that their reliance on stock market is reducing.
Further, out of the total 697 listed companies, around 90% of them are non-active and are dormant and out of the active companies, 5% of them cover 90% of the total trading volume on the stock market.
Only 5-6 companies, are categorised as volume leaders who capture this position almost every day.
This trend of activities, which is concentrated on a few scripts on the capital market, does not reflect the process of economic and industrial development of the country.
The activities are mostly concentrated on communication, gas, power sectors, and mutual funds which proves that the capital market does not contribute to the industrialisation of the country or to national development.
Moreover, Pakistan capital markets are driven by rumours and tips. The recent crossing of the target of 5600 proves the case, which was boosted by heavy buying in OGDCL, amid rumours of an imminent launch of its GDRs.
The investors' decision are not based on the economic and financial data of a company but based on their perception.
One of the reasons for this situation is that a group, comprising of brokers, agents and members, controls the activity on the stock market.
Some of them have become so strong, they have established security companies and are running mutual funds, and have the capacity to manipulate the market according to their needs.
These groups have not only tightened their grip on the activities of the capital market; but also on its management.
For instance, a list of the past presidents and board members will show the trend of "toon ja main ata hoon" one member takes over president-ship several times routinely on a rotation basis.
The constitution of exchanges should have restrictive provisions as to the number of times a member can be elected as president so as to pave the way for newcomers.
Thereby, the investors' confidence will be strengthened in the management of the affairs of the stock market, it will also flourish with new ideas, approaches and transparency in stock trading.
The boom in the stock market, when the share index recently crossed the target of 5,500, is considered by some to be rooted in the rising confidence of the investors in the stock market.
But, infact, the boom has been driven almost entirely by local investors who just switched their savings from the National Saving Schemes (NSS) to stocks, in search of higher rates of return.
Because the government, on the behest of the IMF, has slashed the rate of return on three major schemes of the NSS, it has made investment in stocks more popular, which is the only choice for them.
Moreover, fiscal benefits available to a shareholder, compared to the investors in the NSS, is also one of the reasons that has given a boom to the stock market.
The tax incentives attract investment in stocks because the income from NSS is assessed and is taxed at a higher normal rate.
In contrast, the dividend is taxed at reduced fixed rates as a separate block of income, and tax deducted-at-source is treated as final tax. Further, capital gain is also exempted from tax, upto 2005.
The government's policy to slash interest rates on NSS will adversely affect the economical industrial development of the country.
Because the inflow of savings into the NSS is utilised by government into national development projects.
The investors in the NSS have now encashed their saving in the NSS due to poor returns and have reverted to the investment in stocks which gives them a high return but investment in stocks is not channelled into the national development schemes.
Moreover, the government may receive funds through the NSS at the cheaper rate compared to the interest payable on the aid of IMF/WB.
Despite all these advantages, the government has accepted the conditionality of the IMF and has slashed the rate of return on NSS.
Presently, the world donors and the USA are willing to give us aid. Because the Pakistani's governments "Yes sir" policy has made Pakistan dearer to them. But the government must learn from history, that the Taleban or Saddam were once were dear to them but now they are their enemies.
Similarly, the fate of Pakistan would not be different as soon as their political agenda is achieved.
The other reason for the boom in the stock market is because of the remittances of expatriates, after 9/11.
These are the reasons, which have given a boost to the stocks and estate business. Because the government failed to devise a policy to channelise them into the much needed capital require for financing the process of industrialisation and development projects in Pakistan.
Similarly, over-subscription in the initial public offering of Oil and Gas Development Company Ltd, and other companies, recently, was to make profit quickly, by many people.
It should not be construed that the investors' confidence in the stock market has been strengthened. Institutional support also gives a boost to the market.
The government needs to do more to attract foreign investors to invest in our country. The number of small investors in the corporate sector are low due to the fact that major shareholding is tightly held by the sponsors.
Despite their major shareholding, most of them do not pay dividends to their shareholders.
However, the companies now prefer to raise funds through debt instruments called Term Finance Certificates (TFC). Probably, the reason for raising money through TFC, is that the tax incentive, the interest paid to the TFC holders is tax free, being an admissible expense in the assessment of a company, whereas the distribution of profit by way of dividend does not give tax benefits to the companies.
The government should consider this aspect to encourage investment in equities and to boost the capital market.
In the tax assessment of a company, the contribution made by a company towards workers' profit participation fund is allowed as admissible expense, the resultant share of profit to the workers is not taxed.
Similarly, distribution of dividend to the shareholders may be considered as an admissible expense in the assessment of a company.
This tax incentive will encourage the sponsors to pay dividends to their shareholders and equity through the capital market will give it a boost.
The mandate given to the Export Committee, is to review and examine the present structure of the stock exchanges in Pakistan and advise it on the consolidation, merger and/or their transformation and to examine the legal, regulatory and financial issues involved therein with recommendation of implementation plan thereof.
The SEC chairman has disclosed that the professionals from Australia, Singapore and Hong Kong have been hired to help them in the process of demutualisation of the stock markets.
It is really a unique phenomena that the government or regulator has no faith or confidence in the competency of local professionals.
Though their competency has been tested and found superior than that of foreign consultants.
The recent instance is sufficient to quote in the case of the recently introduced Income Tax Ordinance 2001, which originally was drafted by an Australian professor.
This Ordinance has been amended and modified, introducing 96 and 120 amendments by the Finance Ordinances of 2002 and 2003 respectively, due to poor drafting by the foreign consultant.
Presently, three stock exchanges are registered as companies with liability limited by guarantee.
Apprehensions are there that under the cover of improved governance of the stock exchanges; the existence existing stock exchanges may be converted into a public limited company or Corporation with equity contribution by the federal government.
Thereby, to induct the bureaucrats or corrupt politicians, through nomination to its board, and to tighten the grip and control of the government on the governance of the stock exchanges.
If such a plan is executed, the result will be that there will be no transparency and fairness on account of the enhanced control of the government and the regulators on the affairs of the stock exchanges.
The opportunities for enhancement of resources will be reduced and, as a consequence, the confidence of the investors, issuers and foreigners will shake in the capital market.
Moreover, the present exchanges are working as non-profit organisations. Under the plan, they may be converted into a profit earning organisation.
In such a case, as a result, the performance of the stock exchanges would be like other public enterprises who carry accumulated losses of over Rs 200 billion. The national stock exchange would be listed as one of them.
Although the idea of demutualisation of exchanges, on the prima facie, appears sound but this issue needs to be considered with its pros and cons, without political consideration.
The plan should not have in the backdrop a political motive to impose hegemony of Islamabad on the owners, management and users such as brokers, agents and issuers etc at the Karachi Stock Exchange (KSE).
Although the chairman, Islamabad Stock Exchange (ISE) claims that the ISE has the necessary infrastructure and facilities for its clients and its services are at par with the stock exchanges at Karachi and Lahore.
The fact is that the ISE has not even its own building what to talk of other infrastructure and facilities. Besides, it, all the economic and financial indicators also negate his claim.
Presently, the Karachi and Lahore stock exchanges have a total of listed companies at 697 and 647 respectively, whereas the ISE has less than 300 companies listed on it.
The active companies are around 400, 100 and 170 at the Karachi, Lahore and Islamabad stock exchanges respectively.
The textile sector lists the larger number companies on the KSE, but 70% of them are not listed on ISE.
Similar is the case of listing on it, of other sector companies. It statistically indicates that the ISE is poorly placed in the lower category. Therefore its hegemony will be against the national interest and natural justice.
If the execution plan of de-mutalisation and integration of the existing stock exchanges is derived from political consideration, then the fate of the NSE would be like the decision of Ayub Khan to shift the capital of Pakistan from Karachi to Islamabad which, so far after about four decades, has been reduced to a city of bureaucrats.
The business activities are taking place elsewhere in that part of the country, but the decision-makers are living at Islamabad, in the city of heaven.
Similar would be the case with the investors who will have to run from one corner to the other.
Consequently, the retail investors will be discouraged from to investing in the stock exchange and the confidence of the sponsors for equity financing through the stock market may further be reduced and may divert them for providing finances to the banks. A stock market with less government and regular control would be in the national interest.