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Reforms in the Capital Markets

Lahore Stock Exchange and Islamabad Stock Exchange point of view

From Shamim Ahmed Rizvi, Islamabad
May 21 - Jun 03, 2001

The policies of liberalization implemented in the l990's led to rapid expansion in Pakistan's Capital Markets which called for a more professional approach for regulation. This long over-due process started in January 99 when an autonomous Securities and Exchange Commission was set up to replace the Corporate Law Authority (CLA) a subordinate department of Ministry of Finance which could not possibly meet the new challenges arising out of the dynamic market development. The Commission became financially autonomous in July 99 - six months after its establishment.

The period of about 22 months in the life of Commission is characterized by momentous development in terms of reshaping of the legal framework and regulatory system, development of market institutions and infrastructure, and streamlining of government policies in this regard. Some of these measures constituted a fundamental departure from the past. As a result of these measures there has been marked increase last year in the number of companies declaring and paying dividend as compared with the position noted about three years back. Regular flow of dividend declarations has made positive impact on the market conditions. The significant improvement in the working of capital markets has been noticed both within and outside the country

In an exclusive interview to PAGE, the Chairman of SECP, Mr. Khalid A. Mirza told this correspondent that the first phase of ongoing reforms in the capital market initiated by the Commission has nearly been completed. The work already done together with the T-+3 system currently under implementation would mean that a solid foundation has been laid to ensure healthy growth of the capital market. The Commission is engaged in efforts to strengthen integrity and efficiency of the capital market so that the investors develop a sense of confidence in its operation. A well-equipped regulator conforming to international standard with adequate capacity to monitor the market, has been set up in the form of Securities and Exchange Commission of Pakistan, he added. Continuing the Chairman said that there had been momentous developments in terms of laying down in improving the legal and regulatory framework, development of market institutions, and infrastructure. As a result of these measures, there has been a marked improvement in the conditions prevailing in the capital market. Commissions officials were able to demonstrate through a large number of measures taken over a broad front that the SEC has been able to advise a corporate sector and capital market that is far more responsive to needs of small shareholders and investors. Also, the marked improvement in efficiency and effectiveness of the Company Law Division has meant greatly improved service to the general public as evidenced by company registrations occurring within 3 days, change registration within one day, and name availability on line. Particular mention was made regarding appointment of independent directors on the Boards of the stock exchanges and independent non-broker Chief Executives to manage the stock exchanges which are likely to send positive signals to international investors besides creating confidence among the investors within the country. Implementation of T+3 is a major achievement that would, with the passage of time improved the efficiency and transparency in the capital market.

In order to assess the exact impact of these on-going reform the PAGE requested the Chairmen of all the three stock exchanges in the country to provide brief write-up on the performance of their exchanges during the past one year with special reference to the reform agenda of SECP. They were also requested to answer the following four specific questions.

Q.1. Radical capital market reforms have been introduced in the recent past. As a result, the role of SECP has become much more visible in implementation of reforms. What is your opinion?

Q. 2. It is also being alleged that introduction of T+3 system, in some selective scrips, is responsible for the recent decline and depressed conditions in the stock market. Do your agree with this view, if not, what are, in your opinion the causes for the recent decline?

Q.3. SECP as well as their foreign consultants are of the firm view that the management of the stock market, must be handled by a non-broker outside professional in order to ensure transparency and good governance of stock exchanges. What are your views?

Q.4. Levy of some fee by the SECP on trade transaction (about .0009 per cent) is also being criticized as being unjustified. Do you feel it is unjustified or its rate as high? If Commission is barred from making such levies to generate resources, how the Commission is supposed to meet its expenses as it is not getting any budgetary support from the Government of Pakistan? What is the practice in other countries?

Following are the replies received.

From Dr. Yasir Mahmood, Chairman Lahore Stock Exchange:

The May 2000 crisis seriously affected the performance of the Lahore Stock Exchange. The problems faced by the Exchange were unparallel and out of proportion. The sort of situation and circumstances faced, required review of the existing rules and regulations and, to bring about necessary changes for orderly and smooth working of the stock markets in Pakistan.

In this regard, the Securities and Exchange Commission of Pakistan (SECP), as regulatory body, introduced series of reforms, the first phase of these reforms has been completed. These reforms included measures for proper governance, like restructuring of the Governing Board, induction of seven non-member directors on the Board and appointment of professional Managing Director. In order to strengthen the financial position of the members, the capital adequacy requirement of the members, was increased from Rs. 0.25 million to Rs. 1.5 million. Free exposure limits for the members were prohibited, restriction was placed on short selling. The most important measure was the implementation of T+3 trading and settlement system with continuous net settlement. A National Clearing and Settlement System is also in process of being-implemented.

The measures when implemented in full, will enhance the confidence of the investors in integrity of the system operated by the Stock Exchanges. This will also reduce the risk and, curtail speculative trading.

LSE is committed to improve the operational efficiency of the Exchange and its members. Most of the reforms have been implemented and, some are in process of being implemented. LSE is continuing with its programme of full implementation of T+3. The members are now working on eight companies on T+3 system, gradually the number of companies on T+3, will be increased. The T+3 is generally criticized as the system, which has depressed the market, but I believe that with practice and better understanding, the investors and members will appreciate the system.

I have firm belief that the reforms introduced, were necessary for bringing our stock market to the international operational, technical and regulatory standards and, to gain and maintain the confidence of investors as one of the best regional stock market.

Ans. (1). After the May 2000 crisis, it was felt that with changing times, there was need for some reforms, so that the Exchanges should be in position, to face the new challenges. The SECP being the regulatory body, introduced these reforms. The primary objective of these reforms was to enhance the confidence of the investing public, in the integrity of the governance and operational systems in the Stock Exchanges. These also include risk management and controlling the unbridled speculative members capital adequacy requirement, prohibition of free exposure limits, restricting blank selling, restructuring of Governing Board, appointment of professional Managing Director and introduction of T+3 Trading & Settlement with Continuous Net Settlement. It is natural that in those circumstances, the SECP, being the regulatory body, has become more visible. I believe that after the implementation of these reforms the Exchanges will become front line regulators. In the long run, the onus of having and maintaining public's confidence, will lie with on the Stock Exchanges themselves.

Ans (2). I do not believe that the introduction of T+3 in some selective scrips, is solely responsible for the recent decline and, depressed conditions in the stock market. I believe that the state of country's economy, is mainly responsible for the depressed conditions in the stock market. The stock market reflects the state of economy.

It has been noted that the turnover of the companies brought on the T+3 system, has decreased but this cannot be attributed to T+3 only. The T+3 system has been recommended by the Group of 30. More and more countries are adopting it including Bangladesh. The reduced turnovers are reflected due to the lack of understanding, lack of practice, natural resistance to unknown and, parallel availability of the old system.

There was lot resistance when LSE took the lead in introducing automated trading in Pakistan, later on, the same was adopted by the KSE & ISE. I believe, that the T+3 system, will be a better trading system than the present one as it will reduce risk and speculation. We, at LSE, are continuing with T+3. We are not taking any breaks. We have distributed a schedule of companies, which will be brought on T+3. LSE's Governing Board is fully committed for early implementation of T+3 system.

Ans. (3). I concur with this view. The Governing Board of Directors has been restructured. A non-broker professional Managing Director was appointed by the Board, to ensure transparency and good governance. At the same time, seven non-members directors have been appointed in consultation with the SECP. We are also in process of discussing some further improvements in due course of time.

Ans. (4). LSE is paying .0009 per cent of the transaction fee to the SECP. There is lot of controversy in the Capital Market circles about it. LSE agrees with the concept that the Regulatory body may charge regulates for contributions towards its expresses at the same time, the independence and autonomy of the Regulator, must be ensured. For this purpose, we believe that the Regulator should not become dependent upon large and regular contributions from any one category of regulates.

LSE is making regular contribution as transaction fee, however, we feel that the rate should be reviewed downward after some time and also an upper limit should be set on the weekly contributions. In our view, SECP should prepare regular budgeting estimates so that the proper discussions and budgetary control can be agreed at that time by all concerned. In India, the Regulatory body levies some charges, but the scale of capital markets of two countries, are not comparable.

From Mian Mohammad Akram, Chairman Islamabad Stock Exchange

At the behest of Asian Development Bank, SECP initiated a series of reforms with the view to strengthen its role as a regulator of the capital market as well as to put the country's securities market on sound footing. These reforms included, among other things, the following:

1. Restructuring of the Governing Board and appointment of professional Managing Director by the stock exchanges
2. Enhancement in Net Capital Balance
3. Introduction of Capital Adequacy
4. Ban on Blank Short selling
5. Introduction of T+3 trading and settlement system
6. Prohibition of Free Exposure Limit.

The over all objectives of the above reforms have been: to bring in good governance, corporate culture, transparency in the affairs/operations of the stock exchanges; to curb the speculative trading which up till recently was rampant in the market; to strengthen the risk management regime of the stock exchanges in order to safeguard the interest of the investors and the Institution; and over and above to bring the existing trading system at par with the developed countries by replacing the balance order settlement system with T+3 trading and settlement system. Most of these reforms have already been implemented.

We have always supported the reforms because we believe that these are the means for achieving development, expansion and modernization of capital market in Pakistan.

We at ISE are committed to improve the operational efficiency of the Exchange. We strongly believe that these reforms will go a long way in transforming our stock exchanges into vibrant institutions capable of meeting the challenges of the new millennium.

Ans (1). In our opinion, SECP has become more visible in its role as regulator of the capital market. Whether it was the May 2000 stock market crisis or amendments in the Charter of the exchanges or appointment of non-member directors on the Board of the Exchanges, we have seen SECP fully proactive.

Ans (2). We have reservation that the introduction of T+3 system in some scrips is the only reason of recent decline and depressed market conditions in the stock markets.

Rather the timings of introduction of such system, lack of proper implementation, fear of unknown and lack of awareness of the long term benefits to the users of such system are the main but not the least causes for the downward slide of the capital market.

On the other hand the new system is being experimented at a time when country is passing through critical economic conditions, which have its own repercussions on the capital market.

We believe that T+3 system is a better replacement of current trading system but to make it a complete success in the stock exchanges, SECP and the management of stock exchanges have to improvise such measures which would not only educate the people in capital market but also give them the feeling that such system can meet the challenges of present era.

Ans (3). Certainly this would bring about positive sentiments in the overall stature of the stock exchanges, which includes good governance, professional and transparent approach in terms of stock exchange operations.

Ans (4). SECP has levied a transaction fee of 0.0009% which the ISE is paying on weekly trading basis. We are of the opinion that the timing as well as the rate of the fee was not in concurrence to the wishes/expectations of the wishes/expectations of the stock exchanges.

We wish to add that SECP has taken cognizance of the sensitivity of the issue and as a result it has already reduced transaction fee from 0.00125% to 0.0009%. In addition, taking into consideration the fact that SECP has also imposed registration fee on the brokers, the transaction fee needs to be further revised downward.