The capital market investors must have heaved a sigh of relief at the Prime Minister's intervention to restore normalcy and end the tug of war between the Securities and Exchange Commission of Pakistan and the brokers community. The daily trading volume had dropped to a three year low and the market remained range-bound (value wise) due to shortage of liquidity for the last two months.
The SECP Chairman may have shown a cheerful face to the media, standing beside the Prime Minister last Friday, but at the earlier meeting in the day with the representatives of the brokers, he was made to read out a statement with the two Federal Ministers (Dr Salman Shah and Omar Ayub) on either side, not out of choice but due to governmental diktat.
It clearly showed that the apex regulator had failed to handle the mess, (including personal friction) causing considerable loss to the investors class. In fact, he had not shown up at earlier meetings in Karachi, on the subject despite being present in the city.
The 14-point roadmap for capital market development announced by the SECP Chairman, has nine clauses whose implementation to go into 'immediate effect.' Implementation could have easily commenced on them at least three weeks ago.
This also poorly reflects on our system of governance. An Advisor with Cabinet rank (permitted by the Constitution), or a Minister of State do not seem to carry the clout of an elected federal minister.
At last, the Prime Minister (also holding the portfolio of finance), after coming back from his Far East visit, had to once again directly take charge to smooth over the disarray, which in normal course should have been the responsibility of the apex regulator.
Chairman Dr Tariq Hasan in his opening statement called it "resolution of the interesting though at times turbulent events of recent months." And, he gave credit for breaking the deadlock (between the SECP and the Exchanges) to the Advisor Dr Salman Shah and Minister of State for Finance Omar Ayub. He further, acknowledged that the consensus was only reached after the Prime Minister's intervention. The truth of the matter is that this consensus was reached not between the exchanges and the apex regulator but between the finance ministry bosses and SECP, after three weeks of delay, on the Prime Minister's intervention.
It may be recalled that Dr Salman Shah had created a committee comprising bankers and brokers under the Pakistan Bank Association, President Shaukat Tarin. Two sub-committees headed by two leading brokers were also constituted. These committees came up with risk parameters and funding proposals to overcome the liquidity problem afflicting the bourses due to COT phase-out. The two reports were merged.
After an independent assessment, Tarin submitted a final report to the Finance Advisor. Tarin also pointed out the areas of conflict of interest that needed to be addressed. With this educational background as well as experience with financial products, Dr Salman Shah is conversant with market needs and has deep knowledge of financial products. He is also aware of the weakness and strength of the Badla financing.
Therefore, he was able to quickly grasp the implications of the proposed Continuous Fund System as a viable alternative to (Badla) COT. With proper ring fencing the risks in Badla could be minimised. Prime Minister Aziz himself being an ex-banker was also quick to grasp what Tarin had proposed. Unfortunately SECP's strength presently lies in legal sphere only.
The market had expected the Tarin proposals to go into effect three weeks ago. But the SECP was not convinced. As Advisor Shah and Minister Ayub could not prevail, the Prime Minister had to order its implementation. The apex body shockingly shows poor understanding of financial and market affairs.
In our editorial of August 3rd under the heading 'Lack of competence' we had expressed our view that lack of transparency and cartelisation in the Badla system needed to be addressed and CFS scheme could only be a stop gap arrangement, until CDC was made a lender of last resort for the capital market (something we had indeed proposed earlier in May).
Those who think that CFS is essentially Badla with a different nomenclature are in for a surprise. CFS is deferred payment with documentation and lesser risk of sudden withdrawal of funds from the system, Tarin's proposals cumulatively address a number of the weaknesses that the discarded COT system suffered from. But something more would be needed to be done.
There should be no netting between shares lodged in CFS and shares traded. Further, all lenders in the CFS system must be identified with their NTN numbers, and the interest earned by them should be liable to normal tax and be ineligible for capital gains exemption.
We also do not see the rationale to cap CFS at Rs 25 billion. Let it develop along with margin financing and let the capital market compete with other borrowers in the financial system. Funds will flow in the direction where the return is the highest and the risk is the lowest to lenders.
Henceforth, there will be a graduating system of margin deposit (increase in index will automatically increase deposit margin) and capping the leveraging by a broker at 15 times the capital balance along with pre-trade verification, will indeed reduce the default risks on the exchanges. Similarly, introducing 60 and 90 days future contracts along with present 30 days contracts by September/October, will develop the futures market on right lines. We, however, hope the trade in futures will be on rolling basis, i.e. anyone wanting to get out of contract earlier than the repurchase date should be able to sell it to a third party for the balance period of the contract and so forth. This will create a secondary level of transactions, and, also develop the options market and create derivatives products bringing real liquidity into the system.
To be objective, all of the above will still not fully achieve the objective of market reforms. The basic issue of conflict of interest due to powerful players wearing multiple hats and enjoying power as sentiment creators needs to be tackled. It is a natural instinct to protect self-interest. Liquidating personal or fund managed holding, when market is under pressure due to withdrawal of funds.
The Prime Minister has rightly advised that SECP, CDC and brokers must join hands to make CDC the lender of last resort, with credit lines from banks, DFIs, insurance companies and high net worth individuals. The government also needs to offload quickly at least 20 percent of its holdings in big listed companies.
This will broaden the base. We also need more institutional players on the bourses with independent decision making capability to buy or sell a scrip instead of moving like a herd corralled by a few cowboys. Until then, a few financiers/brokers enjoying big credit lines in the system will continue to run parallel banking.
The decision to maintain CFS shares and trading shares in separate accounts in CDC will be a good step. There has to be a Chinese wall between trading and financing. Equity mutual funds, with adequate notice, be stopped from lending under CFS and instead be forced to be long term investors. Money market funds can, however, lend in the market. Last but not the least, the process of demutualisation of exchanges with non-broker independent boards has to be expedited. The directors need not be nominated by SECP.
Instead professional bodies must be asked to propose three names. SECP needs to induct brokers representatives on its policy board. Let the board select and nominate the most appropriate and qualified persons for the Exchanges Board. Professional management in exchanges, as the front line regulator, need not be subservient to SECP. However, they have to be answerable to their Board and to faithfully implement directives of the apex regulator.
The present board committees on risk management, trading affairs and surveillance are weak. Their decisions are frowned upon because of the presence of broker directors on them. And, finally the government must amend the SECP Act and shift its headquarters to Karachi. This will make the task of monitoring easier and also bring about a closer liaison with the other regulator, the State Bank of Pakistan. Regulators need to create an enabling environment. It is in the interest of stakeholders themselves to push the envelope (make money) to the limit. But this is how markets develop. Let us join hands and pray that the agreement of Friday last will be implemented in letter and spirit with sincerity on both sides.