The Karachi Stock Exchange Chairman Zubyr Soomro's dissenting note on Margin Trading System, approved by the KSE Board of Directors, makes it abundantly clear to the Securities and Exchange Commission of Pakistan (SECP) that the approval of the product by the KSE Board was not unanimous and that SECP still needs to address the apprehensions about the leverage product. In the absence of a Commissioner Securities Division, SECP appears to be profoundly handicapped.
It is pertinent to note that the said proposal has been under consideration since October 2009 when there was a Commissioner Securities Market, Sohail Dayala, but serious deliberations and debate on the said proposal only commenced once the expert had resigned from the Commission.
The need to enhance leverage on the bourses and thereby improve the daily trading volume is acute. But it should not give birth to any possibility of a systemic risk and it cannot be at the cost of small investors who lack the capacity in getting in and out of the market once the volatility peaks. Every investigation on a turmoil in the market, in the past, clearly blamed 'badla' system on KSE and recommended that it should not be reintroduced.
Proposed Margin Trading System is basically screen-based financing and we are told that adequate refinement has been introduced to minimise the risk involved. While lots of issues have been addressed there are still some legitimate concerns as those expressed by Chairman Soomro through his note of dissent. He feels that the final recommended product still suffers from a systemic risk, having flexibility without adequate controls and accountability. Under the new proposal, the KSE system provides the lender with counterparty risk instead of the borrower as the lender does not know the borrower.
At present, there are 40 Unique Identification Numbers (UINs) accounting for 60 percent of trading volume. This clearly indicates concentration in few hands. Audit of the UINs to determine the genuineness of the UIN holder needs to be undertaken. We need to eliminate 'benami' UINs. The law allows people to have benami properties and reportedly issuance of multiple computerised National Identity Cards are quite rampant. NCCPL and CDC cannot just depend on banks for Know-Your-Customer (KYC). Both companies should take responsibility of KYC. SECP also needs to assess if international standards for assessing Minimum Capital base for eligibility to use the product via KSE system have been adopted or not.
According to knowledgeable sources, 40 percent of members of KSE will not be eligible to be lenders under the proposed system. Brokers whether lending themselves to their clients or through an arrangement with financial institutions lending to client borrowers - are a key link in the financing chain and cannot be absolved from liability claims.
Obviously, all the questions raised by Soomro can be addressed. But are all the answers addressing the basic issue whereby trades are concluded prior to arranging of financing? In the business world financing is arranged before and not after conclusion of a deal. The proposed system begs this question!