In a major move to strengthen market integrity and
reduce the incidence of systemic risk, the Securities and Exchange
Commission of Pakistan (SECP) and the State Bank of Pakistan (SBP) have
announced the Margin Trading Rules 2004 and Regulations for Margin
Financing by Banks/DFIs to brokers, respectively. The move will replace
badla financing by next year in a phased manner. For the time being
badla and margin financing run parallel.
The issuance of these Rules and Regulations is a
major milestone to replace badla with Margin Financing, in a phased
manner, will will strengthen market integrity and reduce the incidence
of systemic risk. The Chairman SEC had a meeting last week with the
heads of leading Commercial Banks, and financial institutions and urged
them to fastly develop a mechanism to provide margin-financing facility
for share trading in the stock markets. The meeting was held under the
auspices of State Bank of Pakistan where the participants welcomed the
idea and pledged full support and cooperation for the development of
margin trading mechanism at the earliest.
In Pakistan, financing against shares is not easily
available to small investors through banks and financial institutions,
which has resulted in the development of the COT/badla market. While the
system of COT/badla financing has been partly useful in adding liquidity
to the market, it is viewed as being the root cause behind market crisis
experienced during the last few years.
The simultaneous issuance of Margin Trading Rules and
regulations for Margin Financing will pave the way for a smooth
transition from badla to margin financing. Margin financing is expected
to promote retail investment by increasing purchasing power of investors
in the country. Margin accounts allow investors to buy shares with a
relatively small amount of cash up front by using the assets currently
held in their accounts as collateral.
The introduction of margin financing would also help
in minimizing systemic risk. Under the present system of COT financing,
investor first takes a position and subsequently arranges the funds. In
case he fails to acquire financing, there are chances of market crises.
However, with introduction of margin financing the investor would first
arrange the funds and then undertake trading. Further, banks/DFIs
extending margin financing to brokers will also conduct due diligence of
the brokers who are financed by them.
With the introduction of the Margin Trading Rules,
2004, the risk posed to the clearing house of the exchanges would be
minimized and brokers would be responsible for carrying out due
diligence of their clients before allowing margin financing. Thus,
margin financing will effectively lead to monitoring of risk at the
Exchange/Clearing House level.
The salient features of the Margin Trading Rules are:
• Margin financing and trading can only be
conducted by brokers registered with the SEC having minimum net capital
and meeting capital adequacy requirements as fixed by the SEC in
consultation with the stock exchanges.
• A brokers will enter into a margin agreement with
any person who wishes to become his client. The agreement shall contain
conditions regarding mortgage, pledge or hypothecation of the securities
deposited or bought on behalf of client as well as authorise the broker
to dispose of the collateral in a lawful manner to meet the prescribed
• Brokers have been prohibited from extending
margin financing facilities to any of their partners, directors, agents,
employees etc. as well as to any firm where any of their partners is a
director, partner, or holds any interest.
• Brokers shall maintain the prescribed margin with
the client at all times and give a margin call to the client whenever,
due to market fluctuation, the amount of deposited margin falls below
the prescribed minimum level. The limit of margin financing shall be
fixed by the SEC in consultation with the stock exchanges.
• Brokers are required to keep the credit amount of
margin accounts in a separation bank account on behalf of his client and
also maintain separate central depository accounts for securities
deposited/purchased on behalf of his clients. The deposit of any
government securities shall be used only for the purpose of margin
• Securities kept as collateral will be valued at
last quoted price of the security on the preceding day at the stock
exchange. For government securities the value shall be at the last done
price on the preceding day.
• The aggregate outstanding balances, in the margin
accounts maintained by all clients of a broker shall not exceed the
level fixed by the SEC in consultation with the stock exchanges.
• Stock exchanges shall frame detailed regulations
for brokers, subject to prior approval of the SEC, relating to grant of
margin financing and margin trading facilities in relation to any margin
The salient features of regulations for margin
financing to brokers are:
• Banks/DFIs will prepare comprehensive policies
duly approved by their Board of Directors for margin financing.
• Margin financing will be provided by banks/DFIs
from designated branches, against approved securities including shares
of listed companies approved by the exchange for the purpose.
• Margin financing will be provided by banks/DFIs
against broker's own shares as well against shares of his clients. The
brokers availing margin financing from banks/DFIs will be prohibited
from extending margin financing to be related parties of lending banks/DFIs.
• The margin against the shares of margin financing
will be the same as prescribed by SBP in Prudential Regulations for
Corporate and Commercial Banking.
• Banks/DFIs will try to extend margin financing to
a reasonably large number of brokers to gain diversity.