The market floor is capped since August 28th 2008 and there seems to be no indication that the cap would be lifted soon. Several senior brokers and business analysts believe that the floor should be allowed to function freely in the third week of November 2008. However, there seems to be no signs indicating this time frame.
The KSE management, the Apex Regulator and the Ministry of Finance have not given any assurances that should lead us to believe that the floor would be removed soon. There seems to be no study group working on this project that should analyse the pros and cons of opening the market. No one seems to know the depth of the market problems.
Some suggest that it relates to CFS (Badla) issues that are dragging the market since it's capped. Others argue that it is the fear of foreign selling that is forcing the Regulators to keep a status quo till the government has sufficient foreign exchange funds to remit abroad, once the selling orders are executed.
Others argue that the government has not been able to raise the desired 20 billion rupee fund that it promised and there are serious legal issues that remain unresolved relating to 30 billion rupee Put Options solution. This solution may not be workable in the absence of a sovereign guarantee that those who exercise the Put Option would be guaranteed the conversion of current exchange rates.
Without going into the depth of these reasons, it may be concluded that there seems very little possibility that the Regulator and KSE management may not be able to remove the floor before the end of the current calendar year, especially in the light of the recent statement made by NCCPL that the maturity of CFS II has been extended up to five business days after the removal of the floor.
This statement is indicative of the fact that there seems to be no possibility of the removal of the floras, no date has been given in this statement to this respect. There seems to be no second opinion that the delay in removing the capped floor is causing confidence deficit among the stakeholders and is being used to strengthen parallel unofficial market which is not at all a healthy sign for the future of the capital markets.
Even though the market floor remained capped since the end of August, the market has been witnessing several underlined trades at much lower level than the capped floor. These transactions are taking place about 20-25% lower than the officially capped index. The management of KSE and the directors has not acted in any way to stop or discourage these trades to enforce the decision of the KSE Board of Directors.
These underlined trades indicate that as soon as the floor is removed and the market is allowed to operate in its natural way, there is every likelihood that the market would go down to the level where unofficial trading is taking place. Therefore, the market is likely to depreciate around 25%.
The anticipated market depreciation of around 20-25% is likely to generate further margin calls from the lending institutions that have provided running finance to brokerage houses and other clients against their portfolio investments. Under the current market conditions, it seems difficult that these cash call margins would be honoured.
It seems that the additional margin requirements may force the investors and the brokerage community to sell some part of their holdings. It is also being feared that as there is tendency to do heavily leveraged trading by our brokerage houses through CFS, Futures and Institutional borrowing, they may not be able to raise additional finance to meet margin calls from these lenders.
Under these conditions, it is being feared that at least 25-30 brokerage houses would not be able to meet their liabilities towards their lenders and clients. Thus they are likely to default in which case their assets that include their portfolio investments, membership cards and offices would be up for sale.
This is likely to generate further loss of confidence as these brokerage houses have already misappropriated their clients' deposits, accounts payables and shares lying in the investors sub accounts to safeguard their position with the financial institutions.
It is further being feared that these brokerage houses have grossly misused their fiduciary position of trust for their own selfish motives and have transferred huge funds to overseas at the expense of their clients. According to reliable sources, there are huge claims being filed with the KSE Arbitration Committee by the small and medium investors alleging non payment of money for the sale of shares, misappropriation of clients' portfolios and dishonoured cheques issued by these brokerage houses.
The amounts misappropriated are colossal and may fall into billions of rupees. The KSE Arbitration Committee is being criticised severely and has been labelled as KSE Corrupt Committee, that only takes care of its members and does not protect the interest of investors. It has been further learnt that several well known brokerage houses are facing legal notices from their clients to account for their assets that have been misappropriated by these houses.
It is being wondered why KSE has kept silence on the misappropriation of clients' property. However, it remains an arguable point why SECP has not devised rules and regulations to protect the small investors who have given cash margins, shares in shape of margins and shares lying with the brokerage houses? Why adequate enforcement of the rules and regulations, if any, did not take place on timely basis to the satisfaction of the general investors?
Why one sided emphasis was always placed to protect the interest of the brokerage houses only? Why the two interests were not balanced? Those who lost their hard earned capital through dishonest and bad practices of these brokerage houses see no remedy to recover their capital invested in this market.
Under these circumstances, how SECP would justify its recent reminder to the brokerage houses to obtain the required margins from their clients before any trade takes place. Under the current state of affairs, who would be ready to hand over his assets to these bankrupt and dishonest brokerage houses who have violated client trustee relationship?
If there is no adequate protection for the investors that their margins are fully protected, safe and would be returned to the investors as and when desired, SECP may have to revisit its Regulations in this context or distrust and loss of confidence would result in minimal trading activities at the capital markets.
This can only be done through proper and transparent rules and regulations that ensure that brokerage houses should not be allowed to use the clients shares or funds for the benefit of brokerage houses or its associates. There should be complete bar on the brokerage houses to keep clients shares in their sub accounts or in group accounts and if any investor does not have an account with Central Depository Company (CDC), he may not be allowed to trade on the exchanges.
Soon after the trade takes place, the CDC account of the trader must reflect the transaction and the brokerage house should cease to act as custodian of the client. Recently SECP has issued directions to the Money Market Mutual Funds to revalue their holdings of TFCS according to its ratings. Thus, the Money Market Funds will have to devalue their TFCS valuation between 5- 30% of their current valuations.
This amounts to a substantial depreciation with immediate effect. Although the Association of Money Market Mutual Funds has opposed this direction and is currently in a dialogue with SECP to withdraw its directions, but Money Fund managed by UBL has lowered the valuation of its TFCS in line with the SECP's directive.
The implementation of this directive may have serious repercussions on the capital market operations at a time when the market is facing the worst crisis of confidence of its history. We fail to understand the timing of this directive as SECP was already aware of the different types of ratings for the TFCs long ago and the practice how these were being valued.
It remains an arguable point why SECP kept silent intentionally on this issue in the past and did not devise any regulations to safeguards the interest of the small investors. The small investors paid a price for a Unit based upon 100% valuation compared to its newly directed value that ranges between 70-95% today.
It remains to be seen if SECP could be taken to the court for acting negligently and not safeguarding the small investors' interests. Prima facie, it seems that SECP has acted negligently against the interest of the Unit holders and thus has benefited the Mutual Fund management unnecessarily.
The small investors should have been protected through prudent regulations that should have taken into account the different types of TFCs ratings. Those who invested in these Money Market Mutual Funds have lost substantial amounts only on one direction of SECP. The sudden devaluation in the value of Money Market Funds is likely to have long term impact on this sector.
The loss of confidence in this emerging sector of the capital markets in Pakistan is likely to dry up the availability of capital being raised for industrial and commercial activities through this source. This should be regarded as a serious loss to the capital markets. This would divert small saving towards other unproductive channels.
It is being feared that the latest measures taken by SECP may result in the collapse of Money Market Mutual Funds as an industry and the industry would gradually witness a serious recession. It is feared that several Money Market Mutual Funds are likely to cease their future operations.
So far SECP has put a temporary ban on the encashment of Units of Equity Mutual Funds. Therefore, problems relating to this sector are not known to the investors so far. But when the market re-opens at approximately 20-25% lower from its capped floor, it is being feared that Unit holders of Equity Mutual Funds would lodge their encashment to cut their losses due to depreciating market.
This act may trigger heavy selling from Equity Mutual Funds to meet their encashment requirements. It is estimated that the market may witness around five billion rupees worth of selling at initial stages from this sector alone in addition to what is already on the card.
Some analysts argue that the Equity Mutual Funds are loaded with shares of the companies managed by the same groups that are managing these Mutual Funds and, therefore, there is likelihood that there may not be enough buyers for these shares in the market easily at a reasonable price. This may drag the NAV of these Equity Mutual Funds much lower than most of us can imagine at this point of time.
As the shares may not be readily saleable, raising liquidity for the encashment of these Units may be difficult and could result in crisis confidence. There seems to be no strategy in place to deal with this situation. This indicates that there is likelihood that the trust and confidence in the equity fund industry will also be lost and it seems that this sector would be difficult to revive for years to come.