REFORMS IN THE CAPITAL MARKET
From SHAMIM AHMED RIZVI,
Mar 17 - 23, 2003
The regulatory measures carried out by the Securities and Exchange Commission of Pakistan (SEC) during the last three years have not only received international acclaim but has also made a very positive impact on the stock market and the corporate sector in Pakistan. The effectiveness of the regulatory system is evident from the fact that Pakistan's stock market has been termed as one of the best performing markets in the world with no systemic issues despite several shocks.
The former Chairman of the SEC Mr. Khalid A. Mirza, who captained the regulatory team during this epoch making period in the history of the Commission has left after completing his three-year term to join back the World Bank. His key role as a strong and fearless regulator will, however, always be remembered as he vigorously pursued the well conceived reform agenda despite stiff resistance and opposition from the entrenched interests.
Capital market experts have paid generous tribute to Khalid A. Mirza for the pioneer work he did to reform and improve the capital market in Pakistan. He was a man with a vision and achieved a lot during a short period. He wanted to do a lot more but unfortunately he had to leave for personal reasons.
Paying tribute to Mirza, an expert of capital market said, "During his tenure, Pakistan's capital markets have witnessed major metamorphosis. Significant milestones have been achieved during this era to make our capital markets, particularly the stock market investor-friendly. Markets must offer a fair opportunity to market participants. While the late 1990s depicted Pakistan's stock exchanges' showing major developments from the technological point of view, many loopholes from the regulatory perspective remained. In particular, our markets were prone to allegations of insider trading, front running, manipulation and so on. Today, the situation is completely different. Regulatory developments during the past three years have not only virtually transformed the functioning of the market as a whole but also significantly altered perceptions towards the available risk-return tradeoffs. All this has followed the various measures undertaken by the SEC."
In his message for the second annual report of the SEC released recently, Mr. Khalid Mirza also noted down the items on his unfinished agenda which included: deepening the market and improving risk management at the exchanges, further strengthening audit practice and enforcement of IASs; to clarify, reinforce, and enhance standards of corporate governance; facilitate with strong underrating and distributive capacity; develop and strengthen the mutual funds, the pension funds and the insurance industry to provide the market institutional underpinning; develop and implement a phased programme for replacement of carry-over transactions or "Badla" by margin financing and future contracts; and to encourage on-line trading, electronic communication networks (ECNs) and alternate trading systems and develop a regulatory framework for on-line trading. ECN is seen to be on the future agenda of the Commission.
According to annual report, the SEC has covered a long journey to establish itself as a strong regulatory authority from an ineffective subordinate department under the Ministry of Finance known as Corporate Law Authority. The SEC was established in pursuance of the Securities and Exchange Commission of Pakistan Act, 1997 and became operational on January 1, 1999. The Commission operationally comprises six divisions, namely, Securities Market Division, Specialized Companies Division, Enforcement Division, Company Law Administration Division, Insurance Division and Support Services Division. The reforms have been carried out in all the sectors but main focus has been on stock market reforms.
SEC has implemented a well thought out reform program to bring stability, transparency and efficiency in the capital market. These reforms were also necessitated due to the stock market crisis of May 2000. The crisis occurred as a consequence of extreme overtrading, weak risk management, and poor governance at the stock exchanges.
The objective of the reform program was to achieve market integrity and establish a fair, transparent, and efficient market that engenders investor confidence. The first phase of SEC's reform agenda, has been successfully completed with the implementation of the T+3 Settlement System at all three stock exchanges. Prior to this, the SEC had already implemented the following measures: (i) improvement in stock exchange governance, (ii) broker registration, (iii) setting up of market surveillance wing by SEC (iv) strengthening of margin requirements (v) introducing trading in derivatives (vi) stipulating capital adequacy and enhancing the required minimum capital balance for brokers (vii) restraining blank sale, and (viii) undisclosed market system.
FOLLOWING STEPS WERE TAKEN TO IMPROVE THE GOVERNANCE OF STOCK EXCHANGES:
- Restructuring of the composition of the Boards of Directors of the stock exchanges — five directors to be elected from amongst the members by the general body and four non-member directors to be nominated and appointed by the SEC (in consultation with the exchange).
- Chairman of the exchange to be elected from amongst the elected directors.
- Stock Exchange Managing Directors to be appointed, removed and terminated with SEC approval.
- No operational authority can be delegated to any director other than managing director.
- All brokers and agents to be registered with the SEC.
- Introduction of a two-tier arbitration procedure for KSE.
Risk management measures
- Net capital balance requirement in conformity with international acceptable norms — redefined and enhanced 10 times.
- Capital Adequacy introduced — exposure of brokers must not exceed 25 times net capital balance.
- Margin requirements strengthened (margin requirement raised, free exposure limit abolished).
- Prohibition on "blank selling" of any kind.
- T+3 system fully implemented at the three stock exchanges.
- Introduced regulations for short selling.
- Improved COT regulations (COT allowed in specific liquid shares, higher margins to be mandated for COT, COT for a minimum period of 10 days).
- Investor Protection Fund and Clearing House Protection Fund to be fully funded by June 30, 2007.
In order to strengthen the regulatory framework of the Capital Market, the implementation of the SEC's reform agenda, a number of rules and regulations were issued, which include:
- Brokers, Agents Registration Rules.
- Members, Agents and Traders (Eligibility Standards) Rules.
- Insider Trading Guidelines.
- Stock Exchange Members (Inspection of Books & Records) Rules.
- Public Companies (Employees Stock Option Scheme) Rules.
- Share Transfer Agents, Underwriters, Balloters and Consultant to the Issue Rules.
- Companies Share Capital (Variations in Rights and Privileges) Rules.
- Regulations for Futures Trading in Provisionally Listed Companies.
- Guidelines for the preparation of prospectus and supporting documents.
- Regulations for short selling.
- Establishment of Futures Contracts Market
- National Clearing & Settlement System: The National Clearing Company of Pakistan Limited was incorporated on July 3, 2001 and has commenced operations w.e.f. December 24, 2001 and so far 27 scrips have been added to the NCSS.
- Approval for establishment of National Commodity Exchange Limited.
- Approval, in principle, of an OTC market.
In addition, steps are being taken towards the demutualization of the stock exchanges, which will strengthen corporate governance and boost investor confidence.
Enhanced disclosure requirements
- The Commission has directed all the listed companies to submit their quarterly account in an effort to improve transparency and disclosure by companies.
- The companies are required to submit these accounts to their registrars and shareholders as well as to the Stock Exchange and the Commission.
Steps taken for the improvement of the primary market
- Maximum Disclosure has been ensured in the prospectus for information of prospective investors.
- SEC has taken a number of measures to simplify and expedite the processing/approval of public offerings.
- Stock exchange listing fee, brokerage and bankers to the issue commissions have been reduced.
- Shelf registration has been allowed.
- TFCs can now be issued in tranches.
- Publication of abridged prospectus has been allowed.
- The review of prospectus for further improving the quality of disclosure in the prospectus has been initiated.
- Rationalization of documents to be sent to SEC along with the application for approval of prospectus.
For future, it is extremely critical that the regulatory tone set by the Commission under leadership of Mr. Khalid Mirza must continue. The Commission has a lot more to achieve and it is hoped that same degree of commitment and professionalism will be maintained in future. The government who has been taking credit for developing SEC as a world class regulator must appoint a new Chairman at the earliest. The head of this rather sensitive and highly technical organization must be an individual of high integrity and professional skills.