For the past six months, financial journalism has been obsessed with KSE's meltdown of mid-March 2005 and its aftermath. Every body and his uncle too has gotten into the act.
Even the country's usually somnolent legislators waxed eloquent on the need for reigning in the large brokerage houses that acted as buyers and sellers of securities, often combining their customers transactions with their own in jumbo trades, while running some of the largest Mutual Funds holding the same equities, and concurrently acting as bankers (Badla providers) for such trades. Their tirades on the assembly floors did not even spare SECP, which had made genuine efforts to break the hold of the large brokerages on our equity markets by enforcing a progressive reduction in the volume of Badla financing from a level of PKR 22 billion last September to PKR 12 billion in March 2005. For its part, KSE promptly vilified withdrawal of these gaming chips for the March fiasco and for the loss of oomph at the exchanges ever since.
Two investigative Commissions later (Justice Saleem Akhtar and Shaukat Tarin Committees) the Government finally cracked under pressure.
To lift the KSE-100 index, Badla financing, the bane of the stock exchanges, has been resanctioned at double its reduced level ad infinitum. SECP was literally stood on a stool with a dunce cap on its head and ordered to write hundred lines of "mea culpa" in abject apology. What's more, no one was indicted for the billions of Rupees lost by small investors, and no one is likely to be named. But, guilt, remorse, or apology for reprehensible behaviour was never this nation's strong suit. So, the Lord be praised, and let the devil take the hindmost while we revel in our penchant for skulduggery!
Our Capital market's real tragedy is not that Karachi's broker mafia has yet again triumphed over SECP, but that, over the past several decades, all its players, whether investors, brokers, or regulators, have persistently missed the wood for the trees. After all, what happens on KSE has very little relevance to our real economy.
If five major scrips on the big board (OGDC, PTCL, PSO, PPL, and NBP) rally to take the KSE-100 beyond the 10,000 mark with PKR 30-40 billion worth of Badla gas once again, does it mean our GDP growth will jump a couple of percentage points? Of course not. But, sadly enough, our shallow economic managers apparently think so. They doggedly refuse to acknowledge that we have an agri-based economy. Our GDP growth will, for several decades to come, remain rooted in the performance of our cash crops like wheat, rice, cotton, and sugarcane.
They should have been focusing on building state-of-the-art warehousing for this output, and creating commodity exchanges wherein this produce could be actively traded.
India, which was eons behind Pakistan in terms of capital market developments just five years ago, has already vaulted over us. Over 70 commodities have been sanctioned for futures trading and nearly a third of this list has been actively traded at the Commodity Derivatives Exchange (NCDEX) for the past year.
To sensitise the reader to global norms on the captioned subject, the three financial services markets that are legislated to protect market participants from manipulation, abusive trade practices and fraud are:
1. Instruments of Money and Debt markets. These include Local Currency Deposit and Debt instruments, Government bonds, Foreign Exchange, Forward Rate Agreements, interest and currency Swaps, etc.
2. Instruments of Equity markets (Stock Exchanges) that include Spot (Ready) shares, futures on stock-indices, and options on stocks and stock futures. And
3. Commodity market Instruments such as options and futures on wheat, rice, cotton, sugar, soybeans, meat, metals, fuels, and minerals.
While single and dual regulators are extant in some countries, in most cases, while Central Banks regulate money, banking and debt Markets, respective Securities and Exchange Authorities supervise Equity Markets (brokerages, equity exchanges, mutual funds, and insurance industry products).
The third, and by far the largest in financial size and turnover, ie, Commodities Markets, are usually regulated by respective Ministries of Commerce (MOCs). For instance, in USA, the Department of Commerce regulates commodity trade thru its Commodity Futures Trading Commission (CFTC). The general diagrammatic form of this trichotomy is depicted below:
On the commodities front, we have approximately the following volumes of produce traded each year:

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Wheat...20 million tons @ PKR 10,000 per ton     =        PKR 200 billion,
Cotton...14 million bales @ PKR 10,000 per bale  =        PKR 140 billion,
Sugar...3.75 million tons @ PKR 25,000 per ton   =     PKR 94 billion. and
Rice...4.5 million tons @ PKR 15,000 per ton     =         PKR 68 billion,
Total for just four agri-products (approx)     =        PKR 502 billion.
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In Pakistan, unfortunately, while SBP manages its domain quite effectively, and MOF oversees the equity sector via SECP, MOC has remained dormant. Consequently, the vital issues that it ought to have regulated remained unaddressed.
In fact, over three years ago, SECP encroached upon MOC's turf by launching National Commodity Exchange Limited (NCEL)...which was supposed to commence trade in commodity futures...and promptly handed it over to its favourite brokerages that run the Karachi Stock Exchange. Obviously, not being interested in promoting rival exchanges that might compete with KSE for investor funds, these powerful brokerages (that's right, the same that caused KSE meltdown last March) have since put NCEL in cold storage.
I am sure the reader can now appreciate how this situation is actually a "fail" on part of our Ministry of Commerce, and bloody-mindedness on that of the Ministry of Finance.
We are desperately in need of powerful commodity exchanges that can create vibrant markets for at least wheat, rice, cotton, and sugar. While the decrepit Karachi Cotton Association (KCA) remains dysfunctional, our only so-called commodity exchange, National Commodity Exchange Limited (NCEL) that was licensed in early 2002 has so far done nothing but buy a building in Karachi.
Perhaps it believes its real business is to dabble in profitable real estate. The remainder of its energies have been expended on agonising over the esoteric parameters of a "Gold Futures Contract". Perhaps the value of gold that we mine in the mountains of Baluchistan is far greater than that of all our food grains put together! Also, with all agri-crops being produced and traded upcountry, it was obviously a stroke of genius to headquarter NCEL in Karachi.
Seriously though, at this juncture in time, shouldn't MOC be grappling with what is at stake here...regulation of a heretofore unregulated inland trade that can generate revenues of billions of Rupees per annum for the Government while succouring our harried farmers who are forever guessing what crop prices will be come harvest time? So, who's minding the shop? SECP of course.
Despite having received a drubbing at the hands of KSE's mafia, it is now poised to take its draft "Futures Trading Act 2005", to parliament. But, given its track record with the two fiascos to date, KSE and NCEL, it would perhaps be well advised to hand this baby over to the Ministry of Commerce, which should have been working on this initiative anyway.
In the global marketplace, when you mention the word futures, 9 out 10 times you are referring to commodity futures and not to equity or equity index futures. How one wishes that in Pakistan's context when one hears the mention of futures it was to discuss what inclement weather did to wheat futures and not what Badla finance did to OGDC futures.
Going back to the subject of who should be the regulator, the danger in letting SECP also become the legislated regulator of all inland commodity trade via the Futures Trading Act is that it may make a hash of it simply because it already has too much on its plate. If over the next several years it can reorganise our equity exchanges, it will have done an admirable job. Organising and running commodity exchanges as well is an additional burden that it simply is not equipped to handle, and one that it should dump in MOC's lap pronto. However, if the latter does assume this challenge, it too will have its plate full as it will urgently need to:
1. Initiate a fast track legislative process for setting up a Commodity Futures Trading Commission (CFTC) and push for legislation of a Commodities Futures Act. And once this is accomplished,
2. Request MOF to transfer regulatory authority over the still-born NCEL from SECP to the newly created CFTC. And, finally
3. Instruct CFTC (whose regulatory structure will be akin to SECP), in partnership with the private sector, to urgently establish around 5-7 million tons of state-of-the-art warehousing capacity in the heart of our agri-belt, define commodity standards for trade, and license a clutch of other Commodity Exchanges upcountry to promote inland trade.
But why should the Government let MOC perform the task, which it should have been performing anyway, instead of SECP? Other than the fact that SECP is clearly stretched too thin, is that expediting the process via MOC will quickly generate additional revenues for the Government.
CBR already taxes transactions in the three Exchanges of the country (KSE, LSE, and ISE). The average per transaction is 0.02 %. With annual volume of trade of the order of PKR 7.5 trillion, this fetches approximately PKR 3 billion per annum for CBR (2 x 7,500 x 0.0002) as direct revenue.
In the global commodity futures market, physical volumes are transacted 10-15 times in the shape of futures contracts. For the foregoing commodities in Pakistan this would translate into annual turnover of Commodities Exchanges of the order of PKR 10-15 trillion, ie, nearly twice that generate by the Badla inflated volumes of our equity exchanges.
The same tax of 0.02% on each buy and sell trade, as in the case of equities, would similarly generate PKR 4-6 billion in CBR revenues. This could be directly collected by the Exchanges on behalf of CFTC. Furthermore, if the Government allowed CFTC to retain as little as 5% of the levy to defray its operating costs, it would have a self-financing budget of PKR 200-300 million per annum...more than sufficient for it to be a very effective regulator.
The foregoing does not account for additional revenues for CBR in taxing the incomes of the brokerages and traders who participate in businesses of these commodity exchanges. And to top it all, such a source of revenue would automatically generate the agri-taxes that all governments have failed to do so far. Brings to mind the phrase all honest to goodness Pakistanis love, "Eat your cake and have it too", doesn't it?