In the early part of year 2004 the country's two apex Regulators, State Bank Of Pakistan, for the banking sector, and Securities and Exchange Commission of Pakistan, for the corporate and capital market sector, decided and announced that the then prevailing mechanism of financing available to the ordinary investor in the country's capital/exchange markets, ie Badla, has to be phased out in line with the other fundamental reforms in the country's financial and capital markets. In the intervening period and in place of Badla, an interim financing medium, "Carry Over Transaction (COT), would be put into place.
The ultimate objective of the two Regulators is to totally eliminate COT with Margin Financing. Further, in order to ensure that COT too is gradually eliminated as a vehicle of share/scrip financing over the agreed period of time, ie by June 2005, COT will initially be restricted to only 29 scrips.
Finally, in place of COT, the internationally accepted financing mechanism of Margin Financing will be introduced. This Margin Financing for share/scrip will be provided to the ordinary investor through the country's banking sector and will be generally and freely available to an ordinary investor.
In June 2004, as a result of the aforesaid decisions, the two Regulators announced a time frame for the gradual phasing out of COT and its replacement by the introduction of Margin Financing by the country's commercial banks.
Out of the 29 scrips that where originally available in the COT financing in July 2004, 22 will be phased out by the end of the present month, ie April 30th 2005. The remaining 7 will also be phased out by June 2005 (and now August 2005 as per the directive of SECP)
CONSEQUENTIAL EVENTS: While the gradual phasing out of the COT financing has taken place in line with the time frame stipulated by SECP, the alternative financing mechanism for the ordinary investor, ie Margin Financing by the commercial banks, is hardly available and if available that too to a very limited extent to its preferred clientele. This lack of any financing mechanism of course is giving rise to a vacuum in the market and thereby causing its repercussions to the stock market, in general, and to the ordinary investor, in particular.
This vacuum will further increase and get accentuated in the coming weeks as the remaining scrips/shares in the COT are too phased out in totality (by the beginning of August 2005 as per the revised schedule announced by the SECP on April 19th 2005). This, in the ultimate analysis, could lead to a liquidity risk in the stock/capital market, and subsequent to August 2005 it could lead to systematic risk to the stock/capital market, as no financing mechanism of any nature as such will be available in the market place.
While "Badla" financing which was the standard product in the Indo Pak sub-continent for over 50 years has already been totally phased out from the market, COT too will be eliminated from the market in August 2005. Most importantly, the likelihood of the only alternative to these financing mechanisms, Margin Financing, being generally available to the investor is presently not there. Thus, the two "financing taps" will be closed and any alternative "financing tap" still to being opened. The only conclusion one can thereby derive that a "draught" situation will probably take place.
For Margin Financing to be generally and freely available as a banking product from the country's commercial bank the latter institutions have to initiate a range of steps, after a policy decision has been taken by the Board on the recommendation of the Senior Management of the each individual bank, to enter this sector of the market. Besides the major investment in technology and people, the policies, procedures and regulations have to be put in to place. At the moment, there are hardly any indications that such a product is being actively considered by the banks and, most importantly, will be available from the country's commercial bank within the next two months.
For any market to effectively and smoothly operate and more so for the stock market, as a first step, three critical components have to be in place:
-- The Buyer;
-- The Seller, and
-- The availability of liquidity/financing.
While the first two are of course are there, the existing threat is that a draught may occur as no alternative financing mechanism may be in place in the rather short remaining time period now left with the commercial banks
REQUEST FOR RECONSIDERATION: Considering the aforesaid and, more importantly, the fact that all the country's economic fundamentals are strong and robust with the future economic outlook also being positive (barring the inflationary pressures, for which steps to effectively control it is currently underway), and to avoid any major setback at the country's stock exchanges it is imperative that immediate steps are undertaken to ensure stability as well as an orderly progress in this crucial sector of the economy.
In the developed financial markets the role of providing Margin Financing is not totally restricted to the commercial banks; rather besides the banks specialised financial institutions play a more significant role.
While getting various types of financial institutions to effectively participate in the arena of Margin Financing will probably take time, in the meanwhile, it is absolutely critical that all the stakeholders in the country's capital market, particularly the two apex Regulators, handle this matter on an urgent and fast track basis.
Pending the results of these efforts, the writer is of the opinion that an alternative and interim financing mechanism should be in place. Whatever these range of financing mechanisms maybe in the future, it is critical that a "vacuum " or "draught like" situation must be avoided.
For the time being an interim financing mechanism must be in place and more importantly on a timely place. Further, the stakeholders should avoid putting into place a new set of products, rules and/or regulations at the last moment which gives an impression of "patch work".
In order for the market to operate smoothly it is essential that enough time should be given for the market to absorb the new information and then respond to it. Further, both the market and the ordinary investor definitely require some type of financing so that the market can operate smoothly and effectively.
PROPOSAL: In lieu of the presently available mechanism of financing, ie COT or Badla or Margin Financing, and till such time as the country's banking sector is geared to undertake the Margin Financing the following is proposed:
-- The Brokerage Companies that are members of the country's stock exchanges will only provide this product and financing to all of their customers.
-- Each one of the Brokerage Companies that opts to provide this financing to all of its customer(s) will have two separate accounts with following two institutions
1. CDC, and
2. NCECL
While one of the accounts will exclusively be for the brokerage company's own "proprietary " trading, thereby the underlying scrips are for its own accounts and are lodged with these two bodies for the that purpose only, the other set of accounts will exclusively be for trading on behalf and on account of its clients and the underlying scrips/shares will be with the custodian for this purpose only.
PRODUCTS: Each one of the Brokerage Companies will offer following three products for a particular scrip/share or for a particular customer:
WEEKLY FINANCING: This will be available for a maximum period of one week only
MONTHLY FINANCING: This will be available for a maximum period of one month only
REGULAR FINANCING: This will be available for a maximum period of six months (at the end of this period, there will have to be a clean up for a minimum period of one week)
TERMS AND CONDITIONS:
A) For Weekly Financing:
i. Minimum Margin: 25 to 35%
ii. Marked to Market: At the end of every trading day; and shortfall if any, to be covered within one working day
iii. Pricing: 4 to 4.5% over the prevailing KIBOR
iv. Incidental Charges: At actual with a maximum ceiling of Rs ------Per transaction.
B) For Monthly Financing:
i. Minimum Margin: 30 to 40%
ii. Marked to Market: At the end of every trading day; and shortfall if any, to be covered within one working day
iii. Pricing: 4.5 to 5% over the prevailing KIBOR
iv. Incidental Charges: At actual with a maximum ceiling of Rs -----Per transaction
C) For Regular Financing:
i. Minimum Margin: 35 to 45%
ii. Marked to Market: At the end of every trading every day; and shortfall if any, to be covered within one working day
iii. Pricing: 5 to 5.5% over the prevailing KIBOR
iv. Incidental Charges: At actual with a maximum ceiling of Rs -----Per transaction.
GENERAL TERMS AND CONDITIONS:
1) These products and financing mechanism shall be extended only by those Stock Brokerage Companies that opt for it, meet the terms and conditions stipulated in hereinabove under item No IV Proposal (hereinafter referred to as "Qualified Brokerage Company) and are so notified by the Karachi Stock Exchange
2) These products and mechanism will be available for such time and period as permitted by the SECP.
3) These products and financing mechanism will be available from the date the same are notified by the SECP but not later than May 14th 2005.
4) Initially this period will be one year ending May 30th 2006.
5) Extension, if any, shall be notified by the SECP at least three months prior to the end of this initial period.
6) All the shares presently or in future to be listed on the Karachi Stock Exchange will be eligible.
7) Standard documentation will be developed by the KSE and/or the brokerage companies and lodged with the SECP for their records. Subsequent changes if any too will be submitted to SECP for their records.
8) There shall no lower or upper cap/limit on the financing extended by the Qualified Brokerage Company subject to the provision that at all times all the Prudential Regulations of the SBP, present and in the future, and the regulations of the SECP, present and in the future, are fully complied with.