THE APEX REGULATOR AND MARKET TODAY
FOZIA AROOJ (firstname.lastname@example.org)
July 14 - 20, 2008
The level of capital market development is an important determinant of a country's level of saving, efficiency of investment and ultimately its role of economic growth. Capital market plays a crucial role to mobilize domestic resources. In Pakistan capital market has been undergoing various ups and downs during the last decade primarily in the back drop of political instability, mounting chaos to the law and order situation, and lack of investor confidence. A couple of years back the market took off phenomenally and became one of the best performing markets in Asia. During 2007 KSE 100 index kept on hovering around 15000 mark and also broke the same psychological barrier. However it could not sustain the same momentum in the current financial year and the index started dropping by leaps and bounds. At the moment the KSE 100 index is under 12,000 with market capitalization of Rs.3.5 trillion.
Government has been intervening to restore the glitzy situation of market through the regulatory mechanism. The apex regulator in this regard is the Securities and Exchange Commission of Pakistan (SECP). It is an autonomous statutory body that is entrusted with the integrated administration and regulation of, inter alia, the capital markets, corporate sector and financial (non-banking) sectors in Pakistan. Recently SECP has made several changes in the rules and regulatory frame work of the market mechanism including change of circuit breakers on trading from 5% of the opening price to 1% as lower lock limit and 10% as upper lock limit. However this new limit did not turn up with desired results and the market keeps on plunging deeper and deeper. Government has also tried to gear up the volume by extending support of Equity Market Opportunity Fund (EMOF). As per the plan under consideration EMOF will inject Rs.50 billion in KSE 30 index scrip that are eligible for Continuous Funding System (CFS) and CFS MK II for the five trading days in Phase I under the management of National Investment Trust (NIT). To save the market SECP and Karachi Stock Exchange (KSE) management are in the process of generating fund for the safe exit of small investors.
SECP is also evolving a formula to support the market and Rs. 20 billion is being planned. According to this strategic plan one can sell his or her holdings at less than 20% rate of last six month average value of the share. However investors are denoting it a negative step as it will cause a special counter to be established in bourses, and force them to stay away from the buying course. According to another clause of the formula the buyers will not be allowed to sell their stocks unless the market shows 30% improvement. This proposed formula is another downbeat which would further aggravate the market situation. In the current circumstances the SECP should take rational and prudential steps keeping in view the ground realities for saving the stocks business in Pakistan rather than adopting artificial measures. Traders are demanding that in the present situation SECP should withdraw withholding tax and CVT on shares transaction because these levies have dropped the volume due to increase in transaction cost.
During May 2008 till the announcement of finance bill 2008-09 there has been a bleak spell in the market owing to an apprehension of probable imposition of Capital Gain Tax (CGT). The negative sentiment prevailed in the market for more than a month and rumor mongering flourished a good deal. However the pressure groups succeeded to prevent government from levy of this new tax at a point where situation was seriously grim. According to SECP sources there are a number of CGT models from which Pakistan can learn while introducing it. Some countries give total CGT exemption to stock exchanges, whereas in others either the CGT or the Capital Value Tax (CVT) is levied. There are others which have imposed both the CVT and the CGT simultaneously. Normally, the capital gains are realized from the sale of stocks, bonds, precious metals and property, and that is what the government wanted to target this year while levying the CGT.
In another move to reinforce market and enhance market capitalization SECP has allowed associated companies of the fund managers to invest in mutual funds. The decision has been taken in the best interest of the capital markets, will bring mutual funds at par with the commercial banks. According to SECP investor companies will now have the option to invest in mutual funds and expect better returns. Previously, such companies were constrained to place the surplus funds with commercial banks, which offer comparatively lower rate of profit.
To rebuild the foreign investor's confidence and incorporate transparency SECP has decided to determine non-resident investor's net flows in the local capital market on a daily basis and to pass on the knowledge to the public. The aggregate foreign investment in the local stock market stood at $4.8 billion in Feb, 2008 which represented 25% of the free float of scrip in which the foreigners invested; the figure did not include GDRs.
In order to curtail the manipulation and unfair trade practices SECP is carrying out a detailed investigation. In this regard the commission has urged market participants to desist from rumor mongering. SECP is also probing into the previous market crash incidences and completing detailed forensic investigations where required and prosecuting those responsible for violating any laws and regulations. There are several recommendations which are of an operational as well as policy and structural nature. Further, cases of insider trading, wash trades ad price manipulation by withdrawal of funds have been identified for the SECP to investigate further. In this regard, the SECP has already initiated actions in these cases. At the same time, the SECP is deliberating upon changes in the existing system and regulations that will make it difficult for manipulators to engage in such market abuses. The move of some large brokers to bail out potential defaulters, conflicts of interest in the board of Karachi Stock Exchange (KSE), the negative role of circuit-breakers and the ability of brokers to undertake excessive day trading and 'wash sale' caused the stock market crash in preceding years. Commission is also highlighting the role of circuit breakers, the lack of gross margining and offset futures traders at the broker and client levels, mutual funds, commercial and investment banks and the weak implementation of policy reforms and the consequent crash of the stock market.
As a move to further develop and foster market SECP is deliberating to introduce the various derivatives products presently traded in international markets through exchanges as well as on Over the Counter (OTCs). Such products will bring diversification and investments options in the local markets for various types of investors. The participant institutions are to make small investments in such products in the international markets to develop better understanding of the benefits.
As the regulator of an emerging market the SECP's regulatory philosophy is to be based on the principle of developmental regulation. Therefore it must lay considerable emphasis on market development while administering and enforcing various corporate and securities laws. The regulations should be based on Consultative rule making, Facilitating implementation and Stringent enforcement.