With the commissioning of the CDC, Pakistan Capital markets will have entered a new era and will have set a platform for rapid development

Sep 01 - 07, 1997

The three stock exchanges of the country, namely Karachi, Lahore and Islamabad are still using the physical system of deliveries and settlement. This age-old system may have had its advantages at one time but now, with the increased trading volumes, the risk of malpractice like forgeries, theft of shares as well as the fear of loss had made this system redundant.

On September 3, 1997, the Central Depository will go on line with MCB as the first scrip to experience scripless trading. Steadily more scrips will be added and if all goes according to schedule all listed companies will have been shifted to the depository by June 1998.

It will be run and maintained by the Central Depository Company of Pakistan Limited (CDC), which is headed by Najam Ali. The core service which the CDC will be performing is efficient delivery, settlement and transfer of securities transactions through' computerized book entry system. Securities will not physically change hands but the transfer of securities from one counterpart to another is completed electronically.

There is no doubt that the implementation of the CDS in Pakistan will usher in a new era of a fast, modern and efficient delivery and settlement system. The investor will be freed from physical handling of certificates and paperwork, while eliminating the chances of manual errors of omission and commission, reducing costs and risks, by providing for instantaneous transfer. The CDS is a convenient, efficient and reliable means to settle your securities transactions. It is being implemented by an IBM led consortium along with the management of CDC. The consortium comprises international depository experts, information technology experts, management and financial consultants, legal advisors and international and local software companies.

What is the Central Depository?

The Central Depository System is an electronic book entry system to record and transfer securities. This system changes ownership of securities without any physical movement of certificates or necessity for execution of transfer deeds. The CDS is normally operated by a Central Depository Company which records and transfers the beneficial ownership of securities and works similar to a bank.

Securities will be deposited into the CDS and transactions will be effected electronically, thereby removing the current need to count, verify, store and transport countless certificates. The components of the CDS include the hardware, software, networking environment, legal frame work, participants and the CDC management.

Some international examples of scripless trading are New York, Hong Kong and the London stock exchanges. These systems all vary from each other in one way or another.

In Hong Kong for instance, the Central Clearing and Settlements System (CCASS) is employed for settlements. The CCASS is a computerised securities and settlements system that has replaced the physical delivery system. Under the CCASS, certificates representing securities traded on the stock exchange In the Kuala Lumpur Stock exchange a semi-scripless system is being used. A specific number of shares have been deposited with the central depository and the rest are traded physically.

Why do we need the Depository?

There are a number of advantages that the CDS brings with it but there are three main reasons for the CDS.

The Stock Markets in Pakistan, in the last few years have registered exceptional growth, especially with the entry of foreign investors in the local market. Trading volumes have increased manifold and are likely to increase further with the passage of time and the physical handling of certificates will become more cumbersome and time consuming. Without automation and immobilization of certificates, the delivery and settlement of securities would become unmanageable, not to mention highly risky.

Secondly, the current delivery, settlement and transfer procedures have traditionally been plagued by lengthy delays, risks of damage, loss, forgeries, duplication and considerable investment in time and capital. Implementation of the CDS will not only minimize these problems, but also assist in the development of the capital market.

Thirdly, the implementation of CDS in Pakistan will fulfill the recommendations made by the Group of Thirty, a private international body whose charter is to raise awareness and understanding of major international and financial issues. Its objective is to standardize the settlement procedures and reduce associated inherent risks on a global basis. The most important recommendation made by the Group of Thirty was to setup securities depositories by major stock exchanges worldwide so as to facilitate delivery and settlement of transactions. The Group of Thirty's recommendations have been adopted by the International Federation of Stock Exchanges and are supported throughout the international securities community.

The CDC will act as a trustee for investors and all securities within the CDC will be registered in its name. CDC however will have no beneficial rights to these securities, it will hold them as a nominee on the investors' behalf. Therefore all rights and benefits, such as dividends, bonus, rights entitlements and voting rights, will remain with the actual owner of those securities.

The current system and its flaws

In the current physical system members face several problems like:

  1. Increased volume of book keeping.

  2. Increased volume of paper work.

  3. Aggravated delivery problems due to increased volume.

  4. Greater risks of forgeries, etc.

 Investors also are not totally happy with the current system and face difficulties like:

  1. Large space requirements for safe keeping of certificates.

  2. The requirements as to the time of transfer (could be up to 45 days), and formalities such as verification of transfer deeds.

  3. In case of new issues, the time taken (at least two months) for the successful applicants to receive certificates and subsequent preparation, signature and verification of transfer deeds in order to render the certificates deliverable.

  4. Investors' need for checking genuineness of certificates.

 Then the issuers of the certificates have their own set of complaints

  1. Problems faced by issuers of securities:

  2. Printing and despatch of certificates of new issues to the allotees.

  3. Printing and despatch of certificates consequent to bonus and right issues.

  4. Issuance of duplicate certificates.

  5. Large space requirements for storing certificates.

  6. The carrying out of the following activities at the time of book closure when thousands of certificates are lodged for transfer:

  • Checking genuineness of certificates

  • Signature verification

  • Checking correct value of transfer stamps

  • Signature of Director for confirmation of transfer

 How will the CDS help?

Presently, brokerage houses, custodian banks and other financial institutions spend a lot of valuable time on the physical handling of certificates and paperwork. The CDS will cause a sharp decline in back office work by providing a convenient, efficient and reliable means to settle securities transactions. Sudden increases in settlement volume will no longer make a major impact on back office manpower requirements and not result in problems of delivery, increased paperwork volume and book keeping.

Investors will not be required to register securities in their name in order to claim entitlements. This is because ownership will be theirs as soon as securities are transferred into their account. This will save valuable time which was previously spent in having certificates transferred or waiting for certificates of new issues to be received. Security of investment need no longer depend on genuineness of certificates In fact, according to Najam Ali, CEO, transfer will be instantaneous compared to 45 days or longer with the physical system.

The lengthy and tedious activities undertaken by issuers at the time of book closure, will be eliminated. Issuers need no longer be concerned with the dispatch and printing of certificates at the time of new allotments or at the time of distribution of bonus and right issues. The beneficiaries of the CDS will be the entire financial services industry, specifically all the major players of the capital market. These are investors, participants of the CDC, issuers of capital and their designated registrars/transfer agents (R/TA)

The main operations performed in the CDS are as follows:

  • Deposit of existing and new securities into the depository

  • Withdrawal of securities in the form of certificates from the depository to cater for investors who prefer to have physical possession of certificates.

  • Free transfer or book entry transfer of securities without any associated cash movement.

  • Pledge/release/call like placing a lien on securities in favour of a lender which can only be released/called by the lender.

  • Stock borrowing or lending through the mechanism of transfer with or without associated money movement through the depository system.

  • Corporate action like bonus issues, rights entitlements, sub-division, consolidation and any other action that changes the number of securities held in a participant's account or involves the determination of entitlement to beneficial owners.

  • Delivery versus payment, book entry transfer of ownership Of a security in exchange for payment to settle a transaction .

  • Cash only movement, movement of cash from one account to another without any associated securities movement.

 Who will trade then?

As soon as a company is put on the CDS all physical trade will no longer be possible. Now it will be the participants who will trade for their clients. These participants will be limited to securities institutions such as stock brokers, financial institutions and some qualified private investors. Retail investors will participate through these institutions .

The participants of CDC will be able to settle their transactions within the CDS through five types of accounts, namely:

Main Account: Each participant in the system will be allocated a main account by virtue of being a participant in the CDS. This account will mainly be used as a transit account for movement of securities.

House Account: Used for securities owned beneficially by participants. Holding a house account is optional and any number of such accounts may be created by a participant.

Sub-account ( Client Account ): This account is used for keeping securities belonging individually to each of the clients of a participant. A participant may open any number of subaccounts he requires and maintain these sub-accounts on behalf of his clients.

Group Client Account: This account is used for keeping securities which are beneficially owned by the participant's clients. It will be used for clients who are not willing to utilize the facility of opening separate sub-accounts. Each group account will contain the securities owned by a group of clients. The detailed break-up of the securities held by each client of such a group will be held by the participant and no such record will be maintained within the CDS.

Cash Account: Each participant in the system who opts to avail the Delivery vs. Payment (DVP) facility will be required to deposit, in advance, a rolling settlement fund to be used for the settlement of his DVP obligations. The balance of the participant's rolling settlement fund will be stored in this account.

How does it work?

This is perhaps the most common question and pops up in every mind. The first step of course will be to deposit the certificates in the CDC if a transaction is to be made. The CDC will declare securities eligible for deposit in the CDS. A participant will initiate a deposit transaction either on his own behalf or on behalf of his client. The certificates after due verification by the issuer will be canceled and the nominee holding of CDC will be increased in the relevant register of the issuer. At the same time, the beneficial owners' account will be credited in the CDS.

However there are investors who might want to keep their certificates. There is no compulsion that all certificates be deposited with the CDC. So this option will be provided by the CDC to cater for investors who prefer to keep certificates. Withdrawn certificates however will not be eligible to be used to settle a market trade. In order to be traded in the market they will have to be redeposited into the CDS.

Participants may also apply to issuers or their appointed registrar/ transfer agent in order to withdraw securities by sending them the prescribed withdrawal form. Sub-account holders, will effect withdrawals through their participants. Once the withdrawal form has been approved by the issuer, he will issue a certificate/s in the name of it's beneficial owner and reduce CDC's nominee holding accordingly.

Securities can also be pledged through the CDC. A participant, acting either on his own behalf or on behalf of his client, can place securities under pledge with an eligible pledgee from whom a loan is to be taken. Placing securities under pledge will result in securities being flagged as no longer available for transfer /delivery until such time as they are released from pledge or transferred on the instructions of the eligible pledgee to the account of a participant. Any benefits will however, still accrue to the pledgor.

Sub accounts can be maintained by participants on behalf of their clients. The client, however, will not be able to operate the account himself. The relevant participant will handle all his transactions for him through this sub-account. The participant will open, maintain and operate this subaccount in the name of the sub-account holder, so as to record his title to the securities in his account. A subaccount holder will receive confirmation of his account balance from the relevant participant. Moreover, he can also request the CDC to directly confirm his balance.

The Central Depositories legislation has specific provisions for protecting the sub-account holder. For example, a participant is not legally allowed to undertake any transfers, pledges or withdrawals from sub-accounts without specific instructions from the sub-account holder. Violation of this clause by a participant is punishable by a significant fine and imprisonment.

Corporate actions will be handled by the CDC in the following manner:

Notice of meetings: The law requires that notice of a general meeting be given by the issuer to it's shareholders at least 21 days before the meeting. The depository will produce a list of beneficial owners containing the relevant details. This will enable the issuer or it's appointed registrar, to issue notices of meetings to the right people.

Dividends: The CDC will prepare a list of beneficial owners who are to receive entitlements from the issuer. This report will be prepared on the last day before the start of the book closure period announced by the concerned company. These lists will be sent to the concerned issuer or his appointed R/ TA, and dividends will be dispatched accordingly.

Bonus Shares: In case of bonus shares, upon receipt of information from the issuer, the depository will increase the positions held by each participant by the amount of bonus share issued.

Rights Issues: Will be dealt with in a manner similar to bonus shares. Beneficial owners will be credited automatically with their entitlements. This will ensure that trading in 'unpaid rights' can start immediately.

Share Sub-division & Consolidation: In the case of share sub-division & consolidation, the CDC wilt calculate the new share balances which the shareholders in the Depository System will be entitled to, based on their existing share holdings. On the date when the sub-division or consolidation is approved by the issuer, a program will be run which will replace the old balances with the new share balances calculated above.


When one buys or sells the whole process will be exactly the same as it is today. Securities will continue to be bought and sold through brokers and there will be no change in the existing trading practices. The only change will be at the time of settlement; instead of physical deliveries, electronic book entry settlement will be made.

As opposed to most misconceptions, trading activities and other practices like "badla, borrowing or lending of shares, short selling and blank selling are independent of the workings of the CDS. This system is simply an electronic vehicle to facilitate the delivery, settlement and transfer of securities. Trading practices in securities will remain as they were before. Investors will still instruct their brokers to buy or sell, settlement and clearing will continue as per the existing system. Electronic book entry deliveries will still be made by the participants and not by the CDC staff. There are group accounts which will replace the current "benami" accounts. The CDC will not check short selling or blank selling. It is not the CDC's job to interfere in transactions, only to ensure that deliveries are made on time, and that payments are made.

Apart from these, there will not be any change in the practices or malpractices at the stock market

Security and confidentiality

Strict confidentiality is one of the key features of CDS. No unauthorized person will have access to information, including CDC employees. Legal safeguards will also ensure that strict confidentiality is maintained. Security measures have been implemented at various levels. IBM RS/6000 is accessible through a series of passwords. The Local Area Network (LAN)~~ as well as the Wide Area Network (WAN), have been equipped with sophisticated protective mechanisms to secure the entire system against piracy or breach of confidentiality. A series of checks have been installed in the network so as to restrict unauthorized access and minimize security risk. In addition, backups of the data will be made daily to reduce data loss risk. The system is connected to a UPS with further backup by two standby generators. The database also maintains audit trails and log reports daily. There is a disaster recovery program in the event of disruption of service to the users.

Unique features of the CDS

There are some unique features to the CDS in Pakistan which have been implemented in Pakistan. A lot of credit for this goes o the foreign consultant Albert Anderson who had learnt a lot from the failed Taurus project in England.

One unique feature is that participants will be able to interact independently with the CDS with no involvement whatsoever of the CDC employees. Their job will be simply to keep the system up and running. Apart from that all buying, selling pledging of shares will be done by the participants as per the instructions of their clients.

Another unique feature is that the shares that are to be deposited will not be sent to the CDC but to the registrars who will check to see that all is in order, intimate the CDC and the shares will be registered. The participant has a record of the shares and the owner is issued a slip of paper which shows his ownership. This reduces the work load on the CDC and also allows them to concentrate more on the task at hand, maintaining the depository.

The second and perhaps most unique feature of the CDC is that all shares that are deposited with the depositories around the world are then secured in a vault. The number of shares keeps on increasing as years go by and additional space is needed. Not only is this a hassle with security concerns plaguing the management but it also a great additional cost. In the depository system that has been incorporated in Pakistan, the need for a vault has been eliminated because the shares, once they have been registered with the CDC after the approval of the registrars will be destroyed. If some shareholder decides to withdraw his shares from the CDC later on, he will be issued a jumbo certificate for all the shares that he owns. In other words, even if he owns a million shares, he will have just one certificate denoting his ownership with all the relevant details.

Among other things this has contributed substantially to reducing expenses for the CDC.

The future

In the future, the development of computerised trading will complement the CDS which is designed to take on the load of the predicted increase in trading volumes. Also there are plans to establish a clearing corporation somewhere down the line which will further bring the three exchanges closer together and geographical boundaries will more or less cease to exist. There is no doubt that this is the future. It may take time to be fully optimized but we foresee no more than simple teething problems. The CDS is the only answer to the myriad problems facing the small investors at the market and several leading brokers are in favour of its early implementation, encompassing all the listed securities.

Acknowledgment: We wish to acknowledge the kind cooperation of Mr. Najam Ali, Mr. Ejaz Ali Shah and Mr. Mirza Anwar Hussain for their support in the compiling of this article.