The objectives of reforms were
to bring in good governance and corporate culture
From SHAMIM AHMED
June 24 - 30, 2002
That the capital market in Pakistan has stabilized is
amply proved from the fact that despite passing through a sequence of
descriptive events within and outside the country it has not only
survived but has, in fact, improved. The stock market have successfully
absorbed the constants shocks during the last over nine months and which
are still continuing and emerged victorious showing its depth, grit and
"This is indeed a source of satisfaction to note
that despite mounting tensions between India and Pakistan, deteriorating
law and order situation and the fall out of political ups and downs in
the region, the stock market registered an increase of about 40 per cent
in equity index", commented an stock market analyst adding that
credit mostly go to Securities and Exchange Commission of Pakistan (SECP)
which initiated and vigorously carried out various reforms during the
last 2 years to stabilize the stock market in Pakistan. Investor's
confidence has been regained by making market transparent and safe.
When approached by this correspondent for comments,
the Chairman, SECP, Mr. Khalid A. Mirza said "I am thankful to God
that the position of the Commission has been vindicated". We faced
very tough opposition when we initiated the reform programme", he
Explaining the background of reforms he said "In
April, 2000, when I took over as Chairman, SECP, there were essentially
two issues affecting investor confidence:"
First, very little faith in the integrity of the
market, in the price discovery process, in the trade settlement process
— the fact that the stock exchanges were basically run by stock
brokers, for stock brokers, appeared to be at the root of the problem.
Second, very little faith as to whether the companies listed were being
managed for the benefit of all stakeholders and were actually sharing
the "goodies" with all concerned, particularly portfolio
investors. The perception was that there was no transparency, the
majority owners were "hogging" all the benefits, and investor
"Also, within a couple of months of my arrival,
there was a stock exchange crisis — essentially a settlement crisis
— caused by excessive overtrading and weak risk management at the
stock exchanges. This gave an ideal opportunity to implement a reform
"We first addressed governance and risk
management issues at the stock exchanges and took following steps:
- Independent "professional" Chief
Executives were installed at the Stock Exchanges + 40% independent
- Margin requirements strengthened — now going on
to "value-at-risk" basis;
- capital adequacy limits imposed on broker exposure;
- net capital requirements redefined and
- practice of "blank sales" replaced by
generally accepted and carefully regulated "short-selling";
- appropriate circuit breakers installed;
- system of disclosed trading abolished;
- T+3 system implemented in place of the archaic
weekly settlement cycle;
- an automated National Clearing and Settlement
System has been developed and is under active implementation — this,
together with the already established Central Depository System,
represents a major step to modernize the market; and
- direct regulatory nexus established between the
brokerage community and the regulator by requiring all brokers to
register with the SECP and requiring all brokers to adhere to a Code of
Conduct established under the Brokers Registration Rules.
Now we have initiated the Second phase of reforms
agenda is to ensure good governance of the corporate sector and
transparent management — especially of audit and accounts of the
listed companies, SECP has already taken the following steps
Companies have been asked
to publish quarterly financial reports
A Code of Corporate
Governance has been enforced
To ensure reliable
accounting statements and audits, we have:
listed companies to facilitate quality control reviews of their auditors
by permitting the release of audit papers for this purpose;
listed companies not to engage their auditors to perform other services;
mandatory rotation of auditors after five years implemented with
forbearance up to December, 2003; and
(d) required that
an auditor found guilty of professional misconduct not to audit listed
companies for 3 years.
To assess the situation from independent sources PAGE
formulated the following four questions and requested Mr. Omar Iqbal
Pasha, a broker/Chairman of Islamabad Stock Exchange and Mr. Samir
Ahmed, a non-broker independent Managing Director of Lahore Stock
Following are the questions and answers received by
the two gentlemen respectively
1. SECP claims
that the numerous measures it has taken to reform the capital market
have left a very positive impact on it. What are your comments?
OMAR IQBAL PASHA:
The Chairman of the Islamabad Stock Exchange, Mr.
Omar Iqbal Pasha, was highly appreciative of the reforms carried out by
the SECP, which had helped a lot in stabilizing the Capital Market in
Pakistan and building the confidence of the investors.
Mr. Pasha, who has been associated with ISE for the
last many years as Director and Vice Chairman, appeared
pro-transparency, contrary to the traditional secretive behavior of the
brokers community. He strongly supported the SECP reforms that had
opened the bourses governance to the vigil from outside in the form of
non-broker directors and appointment of outside professionals as an
independent Managing Director.
Replying to question number one he said that what has
been achieved by the SECP during the last 30 months to improve the
working of capital market in Pakistan outweighs the efforts during the
preceding 4 decades.
Recounting the reform measures, Mr. Pasha said, 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
3. Introduction of
4. Ban on Blank Short
5. Introduction of T+3
trading and settlement system.
6. Prohibition of Free
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 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.
As a result, today's capital market in Pakistan is more stabilized,
transparent and secure, enjoying the confidence of investors.
The various measures taken by the SECP have had a
significant effect on the capital markets. At the stock exchanges'
level, the most critical area was on the corporate governance side. It
was necessary that the management of the Exchanges be separated from the
membership of the Exchanges. This separation is necessary to remove the
conflict the interest, which arises when members also manage the affairs
of the Exchange.
This has been achieved in different degrees at the
three Stock Exchanges. Lahore Stock Exchange (LSE) has taken the lead by
achieving a clear separation and inducting an independent professional
non-member Managing Director, who has all the operational powers in
running the affairs of the Stock Exchange. One of the main areas in
which this has separation had an impact, is the issue of investors'
complaints. There used to be a feeling among the investors that their
interests were not adequately looked after. At LSE in the current
financial year, more than 150 investors' claims amount to Rs. 25 million
have been paid of.
Another area, where a major impact has been made, is
in ensuring that all members are complying with the Rules and
Regulations of the Exchanges and no exceptions are made for anyone. This
has resulted in enforcement of Rules regarding capital adequacy
requirement for brokers, and also in the taking of adequate exposure
margins from all trading members, thus reducing the risk being borne by
the clearing house of the Exchange.
LSE has implemented the Trade Risk Filter (TRF),
which is a pre-trade verification feature in our software. The TRF
automatically ensures that no trading members are able to exceed their
trading limits, and in the process put the Exchange's Clearing House at
Another major reform was the induction of the T+3
Rolling settlement System. This has further reduced the risk by reducing
the period between trading and settlement to 3 days, which is in line
with international standards.
The badla market has been identified as a potential
risk factor and the Exchange have recently started taking margins from
brokers for all their badla transactions. LSE has gone a step further
than other Exchanges and limited the badla to only 35 of the most liquid
2. Now the SECP, in its second phase of reforms, is
concentrating on improving corporate governance. What are your views on
this ongoing exercise? How is it going to help the corporate sector?
OMAR IQBAL PASHA:
The ongoing efforts of the SECP to ensure good
corporate governance of international standard are most commendable.
This is the most important step taken towards development of capital
market. It is encouraging to note that despite opposition from certain
quarters SECP is pursuing the implementation of the Code of Corporate
Governance vigorously. An improved governance of the corporate sector
will attract more capital lending to development of capital market. Even
those who are opposing these reforms now will soon realize that it would
be in the interest of all stakeholders.
Significant progress has been made in the corporate
governance of the Stock Exchanges in the last two years. The next phase
seeks to improve the corporate governance of the listed companies. The
Code of Corporate Governance was incorporated in the listed companies.
The Code of Corporate Governance was incorporated in the Listing
Regulations of the three stock exchanges in April 2002. The Code is a
major step forward for the betterment of the capital markets as it will
ensure that the interests of all stakeholders especially the minority
shareholders are adequately looked after. While there are a large number
of well managed companies, which have been paying good returns to their
investors, there is a much larger number of companies, which have failed
in this regard. The Code by specifying requirement like Audit Committee,
Internal Audit function and also qualification and eligibility of key
corporate officials like the Chief Financial Officer and Company
secretary, will have a positive impact on the working of company. The
Code also puts responsibility for compliance with the Board of Directors
and External Auditors, which will further ensure that companies are
managing the interests of all stakeholders.
Finance Institutions are going to be under the regulatory purview of
SECP by next month. How will it help in developing this sector?
OMAR IQBAL PASHA:
The SECP has fully demonstrated its capacity by
reforming the capital market. NBFIs are directly linked with" the
formation of capital and capital market activities. The decision of the
government to put NBFIs under the regulatory purview of SECP is well
thought out. I have no doubt in my mind that it would prove beneficial
for national economy as well as to the stakeholders.
The SECP is in the process of bringing out a detailed
regulatory framework for the NBFIs, which will govern the working of
various types of organizations like Investment Banks, Mutual Funds and
leasing companies etc. Proper regulatory framework and strong
enforcement should ensure that these companies are managed for the
purpose, for which they were created, and also functioning with adequate
capital and internal controls. The financial sector is very sensitive
and it is necessary that all organizations are managed in a way that
they do not cause any systematic risk to the financial system.
4. Do you feel
that continuity of these reforms must be ensured to reach a logical end
and to reap its full dividends?
OMAR IQBAL PASHA:
In my opinion, continuity of these reforms is
necessary. Reform is continuous and ongoing process. I however feel that
we should follow a slow and steady process. The SECP has already
initiated a number of measures in different direction. Now it should
relax for some time and instead of introducing new regulatory measures
it should monitor the implementation and consolidation of the reform
measures already initiated.
While significant progress has been made in the last
couple of years, there is still a long way to go before we can claim
that we are at par with international standards. In any case, reform is
a continuous and ongoing process, which never ends. Our markets and our
regulators have to be alive to the changing circumstances. It is
necessary that the reforms, which have been initiated are consolidated
and improved upon for the next few years to enable them to take root in
our country. Any back tracking or slippage in the reforms process, will
have a very negative impact on the economy as a whole.