Regulation and the monitoring function needs further to be strengthened

Nov 16 - 22, 1996

Islamabad Stock Exchange was incorporated under the Companies Ordinance, 1984 on October 25, 1989 as a company limited by guarantee and registered on December 2, 1989, under Securities and Exchange Ordinance, 1969. Certificate of registration was issued to ISE on January 7, 1992 after prolongs legal troubles. Normal operations of the Exchange started w.f. August 8, 1992.

The ISE has 265 listed companies on its board with a paidup capital of Rs 78.215 billion. It has 100 members (brokers/dealers). The activity of the stock exchange has increased manifold and tempo has accelerated with the entry of foreign fund managers. With depth in the market going to be enhanced, as per initiatives of the government, as several public sector companies are to be listed and capitalization is likely to attain a level between US $ 20-25 billion, the activity is further likely to take a quantum leap. However, there are some inherent weaknesses in the Islamabad Stock Exchange owing to which the Exchange could not exploit its full potential.


One of the basic preconditions for the establishment of ISE was the appointment of a general manager. The ISE has not to date appointed a general manager and thus has not complied with the condition. As trading activity in ISE is likely to increase manifold in the near future, it is essential that a close watch is kept so that business takes place within the parameters of the regulations, particularly, exposures and loss limits have to be closely monitored. This function cannot be satisfactorily performed by the office-bearers, because firstly they are themselves active brokers and secondly it is against the fiduciary behaviour that they oversee the position of fellow members. So in all fairness, such monitoring should be the sole responsibility of the general manager. For the same reason the Corporate Law Authority has directed the ISE to appoint a general manager in the minimum possible time in the interest of the exchange and the investors.

It has also been decided by the CLA that ISE establishes a research section by recruiting professionals and posts highly qualified persons like system analysts and programmers in the computer section to obviate the possibility of recurrence of incidents like the one in which the system remained out of order for a number of weeks jeopardizing the very existence of the exchange.

If efforts are not made properly to comply with rules and regulations then this will lead to the collapse of the entire functioning of the exchange. The ISE has been slow in enforcing regulations. As happened in the case of regulation of provisional listed companies and enforcement of loss limits. There are certain other areas where regulations have yet to be properly put in place. There appears to be no harmony between the regulations which have been enforced by the Karachi Stock Exchange (KSE) and the other stock exchanges. There are numerous loopholes which the defaulting members exploit to their advantage.

According to sources in the ISE, regulations of provisionally listed companies were approved by the CLA at the time of registration of the Exchange but no company was provisionally listed due primarily to following reasons:

Initially, the Exchange could not get any company which could be listed on the provisional counter.

Necessary structure was not available for trading in provisional listing.

At the moment, the regulations for trading in provisionally listed companies are the same as prevalent in Karachi but there is no company which has been provisionally listed as the management felt that this trade should be allowed only after strengthening the Exchange and after clearing the current problems. The Exposure Regulations were made in January 1995 while these were got approved by CLA in April 1995 and were enforced since April 1996. Strict enforcement of these regulations is being ensured since then. Agreeing to the fact that members default regulations are sketchy and inadequate in ISE, the ISE nevertheless feels that if these are enforced in the present stage, they might be instrumental in leading the concerned parties to unnecessary litigation and would consequently bring a bad name to the institution and the trade.

Other issues

According to sources, the CLA is also considering raising members' netcapital requirement and deposit for the clearing house. The CLA plans to announce the minimum standards commensurate with the working of a particular exchange. The present member's netcapital requirement at Rs 2.5 lacs in the case of individual members and Rs 50 lacs for a corporate member is too low and needs to be raised to a reasonable level after consultation with the three stock exchanges. Similarly, the deposit for the clearing house is also very meagre and needs to be raised up.

The CLA has also directed the ISE to review the partnership regulation anomalies. In ISE several members have formed partnerships, which of course is allowed under ISE regulations. There is, however, the big question of liability for which the matter has to thrashed out in greater detail and likely repercussions have thus to be considered in true perspective so as to avoid future complications.

Members default and procedure for recovery of losses regulations have not yet been framed and enforced by ISE. There is an urgent need for having comprehensive default rules, keeping these rules independent of Articles of Association and General Rules to avoid confusion and misuse, as is being done by LSE. Such rules have to be clearcut, providing various stages of action to be initiated in case of default by a member.

As per conditions imposed at the time of licensing of the ISE, restriction has been placed on sale and transferability of the membership card. The purpose apparently was to forestall the possibility of entry of such people who don't have the necessary experience and background.

The CLA has decided that it would be worthwhile if stock exchanges are conferred with the authority to confiscate the card of a defaulting member and sell the same to a corporate member or any other individual, who fulfil the criteria set by the CLA. the via media can also be extended for a member who wants to exit and the stock exchange can transfer the card to a corporate member or an individual member in accordance with the criteria and the amounts so received can be given to the concerned member after discounting @ 10% to 20%. In this way hitherto complete ban can be relaxed to a certain extent which can be extremely beneficial and shall have an overall healthy effect.

The relief on the one hand will help in the induction of new members who will be willing to start their business operations immediately and on the other hand the easy transfer of the membership card will provide liquidity, marketability and enhancement in the price of the membership seat. This could be used as security against members' default. Additionally, we would also suggest that the ISE should allocate office premises to all the members in the proposed new building so that the rights of the members to such office premises could be transferred. This will facilitate in creating additional assets of the members which can be utilised by the ISE for settlement of any claim in the event of default by any member of the ISE.

According to sources, the CLA is also considering reduction of the period of nontransferability to three or five years and a price tag is attached with the card so that members indulging in over-speculative activity should have the realization that their card which has a price tag of millions of rupees can be at stake. This prospect of financial loss shall serve as a deterrent.

Transaction members' account

There has been a general complaint that a substantial portion of the transactions recorded in the ISE are on members' account rather than the genuine investors. There are several reasons for this. The primary reason being that a member has the privilege to trade with other members of the local stock exchange as well as the KSE and LSE without having to deposit the margin, which is usually charged from the clients. Since no money is involved, most of the members indulge in speculative trading with the aim of earning profit both in the bearish and bullish market. The problem arises when the market moves too swiftly and members who enter into transactions while intending to exit in time fail to do so and are trapped and required to take up delivery or tender delivery of shares. Both situations prove disastrous. This tendency of trading on their own account has entrenched itself quite deep in the ISE culture with the result that general investors with small orders have suffered. It is unfortunate that this is also the prevalent practice in other exchanges as well. This has also introduced an element of instability and risk and, therefore, the possibility of over exposure and default has increased manifold. The ISE should keep a strict watch over this tendency and raise the net capital balance of members, particularly of those who indulge in this type of trading in a more aggressive manner. There is an urgent and imperative need for continuous monitoring of exposure/loss limit and taking immediate cognizance of breach. The trading of members crossing safe limit should be stopped forthwith.

Start of active operations

At the time of the establishment of ISE, the CLA Order contained that 25% of the total seats would be offered to members of other stock exchanges which would bring the necessary experience and the seeding. Quite a large number of seats were allocated for the experienced members of the other stock exchanges. Except for a corporate brokerage house none other is operating at the present time. The CLA has strongly recommended that a three-month period may be given to all such members to open their offices and start active operation failing which their membership card may be cancelled and allotted to those who intend to start active operations. Similarly, other nonactive members may also be served notices warning them to start operations failing which they would run the risk of losing their membership card.

Internal audit

The concept of "internal audit" needs to be introduced like in the case of banks and other financial institutions in all the three stock exchanges and particularly in ISE. The internal auditor so recruited should be a Chartered Accountant/Financial Analyst. The internal auditor can ensure compliance of the regulations of the stock exchange, proper maintenance of the bank offices of the members and these internal auditors can be instrumental in investigating suspicious trading and excessively speculative trading. Introduction of such a system will minimise excessive trading on members' account. The internal auditors should report to the board of directors of the exchange and the exchange can report matters of serious nature to the CLA.