July 05 - 11, 2004





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 margin requirements.

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 trading.

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 account.

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.