The Securities and Exchange Commission of Pakistan, after a long and arduous exercise spread over a couple of years, has finally obtained Federal Cabinet approval for an ordinance on Demutualisation of the three stock exchanges in the country.
The proposed Ordinance will effectively corporatise the stock exchanges' activity by way of separating the ownership and trading rights in these bourses. The existing member firms (brokerage) will hold 40 percent of the equity; the balance of 60 percent will be divided between general public (getting 20 percent) and 40 percent will be offered to strategic investors - foreign or local financial institutions - within 110 days of promulgation of the ordinance.
The need for demutualised exchanges arose due to the perception of non-transparency in the operations of the KSE and decisions taken at the Board of Directors level, which were found to benefit a group of brokers to the detriment of general investors.
The process of election to the Board ensured, direct or indirect, election of nominees from within the group - year after year - and large corporatised brokerage firms, (which had covered fresh ground through joint ventures with world class overseas firms) were kept out of the Board. The grievance of these professionally run firms had to be addressed by the apex regulator - the SECP - instead of the frontline regulator - the KSE Board.
An Asian Development Bank loan was taken to bring in technology into the exchange. A key criterion for approval of the loan was Demutualisation of the KSE. A dialogue for this purpose with KSE members was started by Khalid Mirza as the Chairman of SECP. Under the original proposal, the three bourses were to be demutualised and also merged into one entity. The opposition from KSE members regarding valuation of their business vis-a-vis Lahore and Islamabad turned into a sore point.
Mirza's successor Dr Tariq Hasan, seeing the Demutualisation process being delayed, rightly decided to drop the merger proposal. But the tension between the broker community and Dr Hasan, in the aftermath of the March 2005 crisis, put the Demutualisation process on the backburner and in the end resulted in his forced departure. It goes to the credit of the present incumbent, Razi-ur-Rahman Khan, that he worked out an amicable understanding with the broker community in January 2006, to put the whole process back on track and take it forward.
As per this understanding with the KSE members, the dormant brokerage firms at the bourses (KSE around 45, LSE 80 and ISE 100) have been given until 2010 to become active or else sell their trading rights.
In case of their failure to be active brokerage firms their trading licences will be withdrawn. Consequently, there will now be a fresh supply of licences available to be offered to new applicants. Between 2010 and 2015, bourses will, under a bidding process, grant 15 new licences every year. This mechanism would ensure a natural availability of trading rights in a transparent manner.
Demutualisation of the exchanges, though desirable and laudable, is however not the ultimate goal of making them an effective vehicle for capital formation. The policy followed during the last eight years has indeed helped the government in successfully off-loading, at attractive prices, some of its public sector holdings to the public.
Both the government and some leading brokers and big investors have made a lot of tax-free money between 1999 and 2007. However, the exchanges have neither been able to attract companies in large numbers for enlistment nor to make available long term funding for capital intensive manufacturing units or for infrastructure projects.
For this to happen, both the SECP and the government need to make changes in the listing process and the prevailing tax system. Differential in tax rates between privately led and publicly listed companies and tax breaks on investment in the desired sectors can create the right environment to give a fillip to investors' interest.
The policy makers must approve SECP's recommendation for changes in tax rules and regulations wherever needed. The SECP approved rules for real estate investment trust have failed to attract companies in large numbers to initiate business activities in the formal factor. Tax registration fee, documentation costs, etc, are issues that still need to be addressed. The macro-economic picture can only change when micro-issues are also tackled.