The problems with capital markets

The way capital markets declined in February and March this year, it was thought as it may be a repetition of the 2008 crisis. During this period, the KSE Index fell from its peak 35000 to as low as 28927 within six weeks, a fall of almost over 6000 points. This cannot happen without any reasons. It should be an eye opener for investors, Stock Exchange Managements and the apex Regulator Securities and Exchange Commission of Pakistan (SECP). The reasons that triggered this heavy fall must be analyzed seriously.

The Securities and Exchange Commission of Pakistan (SECP) issued notices to various brokerage houses to ensure that the Members make adequate segregation of their clients’ accounts in such a manner, that client’s payable should be kept separately with the other client’s receivables. This was suggested to minimize risk for public losses, a good move from the regulatory authorities. The objective was to ensure that members do not use client’s funds as working capital to finance their business operations for other clients. This was a healthy and prudent measure to strengthen the member’s own ability to remain solvent as well as to protect overall their client’s interests. But the way it was arranged to be enforced, raised questions and backfired the reform process resulting in heavy selling and closure of some brokerage houses due to liquidity issues temporarily.

The brokerage houses argued that the system in practice was already in place since inception and this sudden change has resulted in erosion or reduction of working capitals of small brokerage houses that generate most of the daily trading business. Therefore, it limited trading and investment activities that resulted in heavy price fall in all sectors.

Before introducing any reforms that affects stakeholders financially or otherwise, it has been a usual international practice to consult the same stakeholders who may have been affected. Therefore, a reasonable time should have been given to adjust the stakeholders for the new environment. This is a universal law and there is ample case law to support this position. This change could have been implemented gradually in several different ways achieving the same objectives successfully with minimum financial losses. After all State Bank of Pakistan, as regulator for banking sector, also achieves the same objectives for the banks but in a different manner. The current proposed change has some weaknesses that could have been removed, has there been any mutual discussion among the stakeholders. The Regulators and the Board of Directors failed in their duty to convince stakeholders to make this change a success. Thus, the changes back fired and the directors intervened to shelf these proposed changes for a period of six month. They only acted when the damage was done and that too in postponing the issues rather than settling once for all.

It is generally believed that the current Board of Directors is neither capable nor interested to resolve the long outstanding issues being faced by brokerage and Investing communities. Cost of doing business for brokerage houses is unnecessarily increasing due to more stringent operating measures implemented through unnecessary regulatory controls. This is evident from the fact that it takes seventeen signatures for an investor/trader to open an investor’s account with a brokerage house in addition to bank verifications and provision of other identification data. This may be compared with the other regimes like the UK where, anyone even a non-resident, may open a trading account just on a telephone. The over-regulation of unfriendly and cost-bearing rules breed corrupt practices, eg, unlawful trading in dummy names for several clients, inside Badla activities that are illegal and keeping false and duplicate accounts by brokerage houses.

The apex regulator has also strengthened its demand for various types of audits like Internal Audit, Systems Audit, CDC Audit and Annual statutory Audits. In addition to these audits, a half yearly net capital computation statement duly verified by auditor is required. These are all costs paid by Brokerage Houses for no practical benefits to either part. These reporting requirements are not even applicable to listed companies. Are these costs attached to other sectors of Brokerage Communities? Has the KSE Board ever questioned the utility of these reports? We need to re-visit the desirability of these audits once again if these should be applicable to mall brokerage houses.

The other important issue facing the members is that the Board was assigned to arrange a buyer to complete Demutualization process of the Exchange. It is almost several years now that no progress has been achieved towards this end. While talking to the consultant that was hired for this purpose, I got an impression that the Exchange could have been demutualized and sold much earlier, had there been a consistent and reasonable approach., In his view it may not happen without softening the strict conditions laid down for the prospective buyer. Therefore, it is being feared that this issue is being neglected intentionally. There seems to be a conflict of interest of Exchange managements with the proposed sale as the present managements cannot afford to lose their perks and facilities attached to these positions.

In the recent past, it has been observed that the quality of corporate governance of this Institution has not met itself the international standards. All the ten Directors including Managing Director and Chairman recently travelled to the United Kingdom to visit London Stock Exchange for reasons unknown to members, presumably over a cup of coffee to study their systems and procedures or it may be a goodwill tour. The visit could have been attended by a small body of directors directly responsible for the objective for which the travel took place. These directors stayed in the United Kingdom for almost over a week to enjoy and accomplish their personal objectives. During my association with several Multi National Companies for over thirty years, I have yet to see this type of Corporate Board wasting time and money of the institution that they are suppose to manage.

The country has a population of around 200 million, with three stock exchanges in operation. Still we are unable to increase the size of investors and traders to reflect the proportion with our total population. Despite the best efforts the stakeholders could not increase the size of CDC account holders for more than 250,000. The main reason being that the trading and investing business has become so over-regulated that one feels guilty while fulfilling all the laid down requirements of the apex regulator. Is it not time to deregulate unnecessary compliance to boost business activity?

The Board has been unable to devise ways and means to strengthen the surveillance teams to discourage front running and insiders trading. These have recently been practiced that disturbed the small investors. No serious action resulted to combat this serious offence. During the course of recent fresh IPOs, the gross corruption and irregularities committed by various institutions including both Regulators were shameful. Who will in future trust the IPOs under this regime? Till date no effective investigation took place to determine the scale of the corrupt practices. Had there been a strong, effective and skilled Board, the matter should have been investigated to ensure transparency in the floatation of new IPOs.

These unresolved issues raise questions regarding the capability of the present Board members and the way they are appointed in their positions. The Securities and Exchange Commission of Pakistan nominates five directors out of nine in addition to the Managing Directors. There is ample evidence on record verifiable by Central Depository Authority (CDC) that several current nominated directors have huge portfolios of shares of their own and they do trading on daily basis on the stock exchanges. Is it not a serious conflict of interest? In addition to this, some of the directors on the KSE Board are also directors of several other listed companies and when they actively trade, how the board members may remain transparent? Under these circumstances, how the apex regulator may minimize or eliminate insider trading?

(The writer is a fellow member of Chartered Institute of Management Accountants UK, Chartered Global Management Accountant UK, LLM. Commercial Law from Northumbria University UK. The views expressed in this article are not necessarily those of the newspaper)