hounding the country's bourses is not that of badla phasing-out; it is
about the 'system' that is to replace badla (repo) financing at the
bourses and the consequent repercussions and ramifications of that
system on the overall risk management system at the bourses.
The very fact that
badla is being phased-out without any significant phasing-in of margin
financing has already started claiming its toll on the liquidity
position at the bourses. It is this liquidity crunch that is
compelling investors to stay on the other side of the fence and adopt
a wait and see approach rather than taking new positions in the
market. While a lot of scrips do look attractive on fundamentals, yet
investors are not willing to even look at those scrips - thanks to the
current liquidity crunch at the market. On the bottom line, this
situation is claiming its toll on the volumes at the bourses.
The stock prices
for the last over a month had moved in a narrow band despite the fact
that the country's key economic indicators have improved, bolstering
the confidence of the overseas investors and rating of the country.
The major obstacle in the smooth sailing of the equity market is the
new mechanism "the margin financing" aimed to curb speculation and
avert market crash, switching the traditional badla system.
requires investors to arrange funds before buying shares. Under ''badla,''
an investor can arrange for funds after buying shares, and defer final
payment as long as he pays a daily financing cost.
Securities and Exchange Commission, the market regulator, in
consultation with the stock market last year issued directives to
commence margin financing. Since October 2004, 22 companies were out
from the ambit of the badla system and switched to margin financing.
But the problem started when seven, which almost contributed more than
75 percent of the daily turnover, were shifted from badla to margin.
Several letters were sent to the stock market regulator and
presentations were held to get extension for at least six months
period. After intervention from Prime Minister Shaukat Aziz and State
Minister Omar Ayub, the matter was resolved amicably in April and
margin financing will replace badla on August 26. Investors who
purchased shares through badla have to reduce their holdings by 8.25
percent each week, starting June 3. Pakistan Telecommunication Co.,
the nation's largest telephone company, Pakistan State Oil Ltd., the
country's largest supplier of fuels, Hub Power Co., an electricity
producer, National Bank of Pakistan Ltd., the biggest lender by
assets, Pakistan Oilfields Ltd., the third-largest explorer of fuels,
D.G. Khan Cement Co., the country's No. 1 cement maker, and Oil & Gas
Development Co., the biggest explorer of fuels were the scrips to be
gradually phased out from badla mechanism.
According to a
leading trader, the representatives of the stockbrokers community, the
board of directors of the KSE on the first place should not have
agreed to the said mechanism. "The liquidity is day by day drying
which showed that our able brokers have not done their homework
properly, moreover the regulator who claims to be the supporter and
well wisher of small investors community must have allowed parallel
badla system so that banks and financial institutions could have
easily placed innovative products to run margin financing".
To eliminate the
badla investment, which stood around Rs 22 billion on an average per
day, the market has received a massive erosion of nearly Rs 100
billion since April this year, he added.
"We have received
a number of good news from Islamabad in the past one month, the budget
gave us the leeway and capital value tax was not raised, duties on raw
material were reduced, banks' tax was cut and above all the government
sold 26 percent shares of Pakistan Telecommunication to the tune of
$2.6 billion, but the market failed to react. "If this badla system
would not have been in vogue the market at present would have easily
crossed the 8000 mark," the same trader explained.
through the badla system is continuously declining. From the average
of Rs 24 billion it had declined to 12.7 billion rupees ($213 million)
on July 1 from 14.9 billion rupees a week ago.
Mohammad, Director MAC Securities, said that several banks had
announced and allocated amounts for margin financing, but they failed
to make the product understandable and in line with the requirement it
would never take over the financing market. On the other hand, the
phasing out of the conventional but easy financing known as badla is
creating a huge gap and causing trade volumes to shrink, he added.
"They assured us
that they would provide a credit line of Rs 20 to Rs 30 billion, but
failed to create awareness, their balance sheets have the capacity to
raise the financing facility to Rs 160 billion, but they have their
own limitations. The investors could avail the facility by providing
30 percent margin to the banks, but the banks are reluctant rather
fearing to lend us support because in the past we have witnessed
several crises and the market share values suffered heavy
causalities," said Jan Mohammad.
Research Analyst at Arif Habib Securities, said that the fact that
margin financing has not been able to phase-out in the past few months
is primarily because of multi-pronged reasons. These are:- Investors'
ignorance about margin financing, resistance to change - maintaining
the status quo and communication gap between banks and brokers.
Banks engaged in
margin financing: How many banks would provide margin financing
facility? Do these banks understand the modus operandi surrounding
margin financing? Are these banks eager to provide margin financing?
To answer these
questions, we would quote what Shaukat Tarin, President Union Bank had
to say about margin financing. He said: "Eighteen banks have shown
willingness to provide Rs. 20 billion to ordinary investors through
margin financing. This shows the preparedness of banks to introduce
margin financing for phasing-out present COT. Banks are prepared and
equipped to introduce the product and implement margin financing
However, as of
today the banks providing margin financing facility are : National
Bank of Pakistan, Muslim Commercial Bank, PICIC, Saudi Pak Commercial
Bank, Faysal Bank and Union Bank. Mechanism of margin financing: Just
to understand, the following are the broad parameters of margin
financing to be conducted at the bourses.
Assume an investor
wants to purchase PTCL shares worth Rs. 100,000 on margin financing.
The following would be the mechanism under margin financing:
approaches his broker to purchase PTCL shares worth Rs. 100,000 on
bank to help investor purchase PTCL worth Rs. 100,000 on margin
30% of the value of stocks - PTCL worth Rs. 100,000 - as margin with
30% margin i.e. Rs. 30,000 the investor buys PTCL worth Rs. 100,000 on
margin financing. This means, the bank finances the investor to the
tune of 70% i.e. Rs. 70,000.
- PTCL worth Rs. 100,000 - are pledged with the bank. So now, the bank
has a margin of 30% (in cash) and securities (in kind) in full (100%).
•Now two events
can happen: Assume an investor had purchased the PTCL for Rs.
60/scrip. It can either gain or lose value per scrip. As long as the
PTCL scrip gains value per scrip, all stakeholders in the margin
financing deal are perfectly comfortable. If, however, the PTCL scrip
loses value, then at the end of the day, the bank would ask the
investor to compensate for the loss in value of the scrip so suffered
(market-to-market). This would be communicated to the investor by the
bank through a "margin call". If the investor can compensate for the
loss in value of the scrip so suffered (market-to-market), he can
continue with this margin financing deal; otherwise the bank would
liquidate this deal and compensate itself from the 30% cash margin so
submitted by the investor and sell the investors' scrips (PTCL in this
case) - already pledged with the bank - in the market.
What should be
done: In an attempt to facilitate the smooth phasing-out of badla and
its subsequent replacement by the margin financing, Hasnain believes,
the following steps should be taken:
The banks should
reduce the rates on margin financing (this is currently being reported
by certain quarters at close to 14 percent against the average repo
rate of 7.5 percent at the bourses).
The SBP should
report the number of shares held in margin financing, the amount of
margin financing and average rate of margin financing deals daily,
preferably on its website or KSE's website. Any communication gap
between stakeholders engaged in margin financing should be reduced.