SECP Analysis and ion

SECP- Analysis of Institutions

A modern and efficient capital market is the backbone of an economy. It plays a crucial role in mobilizing domestic and foreign resources, and channeling them to promote investment

activities both for the short and the long-term periods. No country can prosper without developing its equity market.

(Rizvi, 2002)

INTRODUCTION

SECP stands for Securities and Exchange Commission of Pakistan. The Securities and Exchange Commission of Pakistan (SECP) is a government agency whose purpose is to develop a modern and efficient corporate sector and a capital market based on sound regulatory principles, in order to foster economic growth and prosperity in Pakistan.

Why does a Country Need a Security & Exchange Commission?

A well- developed stock market reduces investment risk by offering opportunities for portfolio diversification. The availability of different investment opportunities with differing risk

characteristics encourages savers to acquire diverse investment assets, as this ensures minimum risk exposure.

(Levine, 1991)

Weak institutions—tangled laws, corrupt courts, deeply biased credit systems, and elaborate business registration requirements—hurt people and hinder development. Without effective

institutions, people and developing countries are excluded from the benefits of markets. Countries that systematically deal with such problems and create new institutions suited to local

needs can dramatically increase incomes and reduce poverty. These institutions range from unwritten customs and traditions to complex legal codes that regulate international commerce.

(Ryou, 2001)

History:

Pre-independence Scenario:

Indian Stock Markets are one of the oldest in Asia. Its history dates back to nearly 200 years ago. The earliest records of security dealings in India are insufficient and obscure. The East India Company was the dominant institution in those days and business in its loan securities used to be transacted towards the close of the 18th century.

Lahore Stock Exchange was formed in 1934 and it had a brief life. It was merged with the Punjab Stock Exchange Limited, which was incorporated in 1936.

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Most of the exchanges suffered almost a total eclipse during depression. Lahore Exchange was closed during partition of the country and later migrated to Delhi and merged with Delhi Stock Exchange.

Karachi Stock Exchange was founded in 1947. It is Pakistan’s largest and oldest Stock Exchange, with many Pakistani as well as overseas listings. Its current premises are situated on Stock Exchange Road, in the heart of Karachi’s business district.

The Lahore Stock Exchange came into existence in October 1970, under the SEC ordinance of 1969, by the Government of Pakistan, in response to the need of the provincial metropolis of the province of Punjab.

Islamabad Stock Exchange is also one of the three Stock Exchanges of Pakistan and is located in the capital. It was incorporated on October 25, 1989, and it became fully operational on August 10, 1992.

Corporate Law Authority:

The Securities and Exchange Commission of Pakistan (SECP) has succeeded the Corporate Law Authority (CLA) since 1981, for the purpose of the administration of the Companies Act 1913. It was an affiliated department of the Finance Division (Ministry of Finance).

It had two (2) wings:

Monopoly Control Wing It constituted the Monopoly Control Authority (MCA), formed in 971, which is responsible for the implementation of the rules and regulations to prevent a concentration of the financial and commercial activity

Corporate Regulatory WingIt dealt explicitly with the enforcement of the companies’ law, security and market regulation, etc.

The Corporate Law Authority (CLA), the regulatory arm of the Government of Pakistan (GOP) for the implementation of the companies’ legislation and the regulator of the anti-trust through the autonomous Monopoly Control Authority (MCA) was replaced by the Security & Exchange Commission of Pakistan (SECP) in 1999.

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Need of SECP Formation

The government of Pakistan and its respective regulatory agencies has been striving hard to tame negative speculations, restore investors' confidence and stabilize stock market for the last many years and numerous regulatory, financial and other corrective measures have already been taken to obtain these objectives. But even then, by the end of 1997, the index was at the bottom, market was indecisive between the spell of greed and gloom, investors were living in the state of despair and the country's financial image had been shattered. The market mechanism has not been working under the principle of demand and supply, as well as the economic fundamentals for as long as can be remembered.

(State Bank Report, 2000)

In the development of its capital markets, Pakistan has faced issues similar to those in other emerging markets in Asia. But the economic turmoil presents Pakistan with some unique problems.

\The decline in the capital market dates back to late 1994.

1994-1995:

- Macroeconomic imbalances and deep-rooted structural problems, - Shortcomings in policy implementation

This brought the country to the brink of a foreign exchange crisis in October 1995.

1995-1998:

- Between the end of 1995 and April 1998, the rupee depreciated by 24 percent.- Since 1995 the threat of currency de-valuation has deterred foreign portfolio

investment. - From 1996 onward, deteriorating law and order in Karachi, the Government’s

prolonged tussle with foreign independent power producers (IPPs), and the constitutional crisis in late 1997 all dampened growth of the capital market.

- In March 1998, the withdrawal of tax exemption granted to corporate holders of Term Finance Certificates (TFCs) also hit the corporate bond market (Chou, 1998).

The country has already achieved a moderate level of capital mobilization through the bond and equity markets at 43 and 22 percent of gross domestic product (GDP), respectively, at the end of 1997. However, the figures are deceptive as government issues dominate the corporate bond market—with corporate bonds accounting for only 1 percent of GDP. Similarly, the equity market became more skewed from 1996-1998, resulting in the top five stocks representing more than 70 percent of market capitalization by May 1998.

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Nuclear tests of 28–30 May 1998

Finally, in the outcome of the nuclear tests of 28–30 May 1998, foreign currency accounts were frozen and sanctions were imposed by G-8 countries. As a result,

Activities in the foreign exchange market almost closed down and so did foreign portfolio flows.

The currency plunged in the market along with fears of future debt default. Under the threat of a recession, the bond and equity markets received a crucial setback.

The negative market sentiment was reflected in the decline of the key Karachi Stock Exchange (KSE)-100 index, which plunged 56 percent during 1998, reaching a record low in July of that year.

The first vital step taken by the government to counter all these problems was the dissolution of Corporate Law Authority in 1997 due to its total failure to manage the stock market and the involvement of some of its bosses in financial bungling (ghaplay). Securities and Exchange Commission of Pakistan (SECP) was established as an independent and powerful regulatory body to cleanse rotten system, create level-playing field and bring all stakeholders under a new regulatory framework.

SECURITIES & EXCHANGE COMMISSION PAKISTAN

The SECP was established on January 1, 1999, in pursuance of the Securities and Exchange Commission of Pakistan Act, 1997. The establishment of the SECP was the outcome of a loan agreement between GoP and Asian Development Bank (ADB) whereby $US 250 million was sanctioned for the development of the capital market in Pakistan.

The establishment of the SECP was an important milestone in the evolution of the regulatory framework for the capital market in Pakistan.The SECP was set up as an autonomous body “for the beneficial regulation of the capital markets supervision and control of the corporate entities and for the matters connected therewith and incidental thereto”

SECP Vision Statement :

The development of modern and efficient corporate sector and capital market based on sound regulatory principles, that provides impetus for high economic growth and foster social harmony

in the Country.

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SECP Mission Statement :

“To promote an efficient and transparent capital market, develop the corporate sector and protect the investor through responsive policy measures, effective regulation and enforcement of

best governance practices.”

Structure of SECP:

The SECP was set up as two tiered organization consisting of:

Security & Exchange Policy Board Security & Exchange Commission

Security and Exchange Policy Board:

The Policy Board is entrusted with the responsibility to provide guidance to the Commission in all matters relating to its functions and to formulate policies in consultation with the Commission.

In addition, it is responsible for advising the Government on matters falling within the purview of the Act and other corporate laws and to express its opinion on policy matters referred to it by the Government or the Commission.

The Act provides that the Policy Board should consist of a maximum of nine members appointed by the Federal Government, including five (5) ex-officio members and four from the private sector.

The ex-officio members are:

(i) Secretary, Finance Division;

(ii) Secretary, Law, Justice and Human Rights Division;

(iii) Secretary, Commerce Division;

(iv) Chairman of the Commission; and

(v) Deputy Governor of the State Bank of Pakistan (SBP).

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Security and Exchange Commission:

The commission has full financial, administrative and operational autonomy and comprised of five commissioners including Chairman.

The commissioners are appointed by the Federal government and are responsible for the division like securities exchange, investment company law and the most importantly, enforcement. Of the five commissioners, three, including the chairman, are from the private sector and two would be from government.

The work of the Commission has been distributed amongst its six (6) divisions, each of which is headed by an Executive Director and divided into Wings for effective administration.

The Divisions are:

1. Company Law Division2. Securities Market division3. Specialized Companies division4. Finance and Admin Division5. HR & Training Division6. Insurance Division7. IS &T Division

Company Law Division:

The Company Law Division (CLD) is entrusted with wide array of responsibilities that encompass regulation, monitoring and enforcement of laws pertinent to the corporate sector. It is headed by the Executive Director. In recent years, the CLD has brought about necessary amendments in existing laws as well as enacted new laws to cater to the changing business needs and scenarios. It also undertakes strict monitoring and vigilance of the corporate sector with a view to promoting transparency, accountability and good corporate governance practices, thereby protecting the interests of investors.

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Organizational Division

Company Law

Division

Security Market

Division

Specialized Company Division

Finance &

Company Division

HR & Training Division

Insurance Division

IS & IT Division


The CLD operates with the following departments.

Registration Department:

The Registration Department is responsible for registration of new companies and ensuring compliance with legal and regulatory requirements through examination of statutory returns and accounts filed by companies. It also supervises and coordinates the working of Company Registration Offices.

The Registration Department comprises the following Wings:

Registration and Licensing Investigation and Compliance

Management Information System

Enforcement Department:

The Enforcement Department is responsible for monitoring listed companies, except NBFCs, modarabas, and insurance companies. It examines their published accounts, monitor compliance with applicable laws, rules and regulations and takes necessary actions against erring companies, their directors, management and auditors, as appropriate.

The Enforcement Department consists of the following Wings:

Enforcement – I Enforcement – II

Enforcement –III

Insurance Division:

The Insurance Division (ID) regulates and monitors the insurance sector and administers the relevant insurance laws. The Executive Director heads the ID, which consists of the following Wings:

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Company Law Division

Registration Department Enforcement Department


Non-Life Insurance Life Insurance

Finance & Admin Division:

The Finance & Admin Division is headed by Javed K. Siddiqui, Executive Director. It is responsible for directing and controlling the areas of accounting, facilitating overall operations of the SECP and ensuring its smooth functioning.

This division has been organized into the following departments:

Finance & Accounts Department Administration Department

Human Resource & Training Division:

The Human Resource & Training Division is headed by Mansur Ahsan, Executive Director. It is responsible for various activities that include manpower planning, recruitment, selection and capacity building of the SECP’s employees.

This division has been organized into the following departments:

Human Resource Department Training Department

Specialized Companies Division:

The Specialized Companies Division (SCD) is responsible for regulation of leasing companies, modarabas and modaraba management companies, mutual funds and other specialized companies (except insurance companies). Its functions include licensing, monitoring, regulatory compliance and enforcement of all applicable laws.

Pension Wing: A separate Pensions Wing was established within the SCD for regulation of contractual savings in the country. It would initially be implementing and administrating the Voluntary Pension System, on a longer term, it would devise a regulatory framework for existing occupational saving schemes.

Non-Banking Finance Companies Department

The Non-Banking Finance Companies Department (NBFCD) is headed by Executive Director Mr.Akif Saeed.The NBFCD is responsible for licensing and regulation of entities under its

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purview and their enforcement and compliance with applicable laws, rules and regulations. These include NBFCs (companies engaged in the business of leasing, investment finance services, discounting services, housing finance services, venture capital investment, asset management services or investment advisory services), mutual funds, venture capital funds, modaraba management companies and modarabas.

The NBFCD consists of the following Wings:

NBFC-I NBFC-II

Modaraba

Monitoring and Inspection

Securities Market Division:

The Securities Market Division (SMD) is responsible for monitoring, regulating and developing the securities market. It is headed by the Executive Director.

The SMD regulates the primary and secondary markets as well as market intermediaries through registration, surveillance, investigation, enforcement and rule making, with the objective of protecting investor interest. The SMD also processes and grants approvals to prospectuses for

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public offering of both debt and equity securities. In addition, it is entrusted with instituting appropriate regulatory reforms to develop and promote the market, engender investor confidence and instill transparency, effective risk management and good governance at stock exchanges, commodity exchange, central depository company and national clearing company.

The SMD is divided into the following Wings:

Stock Exchanges, Depository and Clearing, Policy and Regulation

Monitoring and Surveillance and Beneficial Ownership

Capital Issues

Brokers’ Registration, Inspection and Investor Complaints

Commodity Exchange

STOCK MARKET

A sound and efficient Capital Market is a backbone of a country. Capital Markets play a crucial role in mobilizing domestic and foreign resources, and channeling them to the most productive medium and long term uses. Efficient allocation of resources received through this medium is easier.

Stock Exchanges in Pakistan:

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Securities Market Division

Stock Exchange, Depository and Clearing.

Policy and Regulatory

Capital Issues

Brokers’ Registration, Inspection and Investor Complaints

Commodity Exchange

Monitory and Surveillance and Beneficial Ownership


There are three stock exchanges in Pakistani) Karachi Stock Exchange (Guarantee) Ltd.ii) Lahore Stock Exchange (Guarantee) Ltd.iii) Islamabad Stock Exchange (Guarantee) Ltd.

Of these, Exchanges Karachi Stock Exchange dominates the other exchanges in terms of number of listed companies, turnover rate and quantum of Capital raised through floatation of new issues.

Securities & Exchange Commission of Pakistan (SECP) regulates the capital market.

These Stock exchanges form Pakistan equity market.

Their Customers

• Issuers (Listed Companies)

• Brokers and Members

• Investors

What is Stock Market?

A Stock Market is a marketplace that provides opportunities for buying or selling of shares. This is a platform where the buyers and sellers of equity and debt securities of companies, semi-government and governments meet together to trade in securities. A stock market brings together entrepreneurs who wish to raise money through the issue of new securities and individuals and organizations seeking to invest their savings or surplus funds. The stock market thus offers investors liquidity or the ability to convert the investments into cash at short notice thereby encouraging the flow of savings into productive ventures.

Role of a stock exchange :

Stock exchanges have multiple roles in the economy, this may include the following:

Raising capital for businesses

The Stock Exchange provide companies with the facility to raise capital for expansion through selling shares to the investing public.

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Mobilizing savings for investment

When people draw their savings and invest in shares, it leads to a more rational allocation of resources because funds, which could have been consumed, or kept in idle deposits with banks, are mobilized and redirected to promote business activity with benefits for several economic sectors such as agriculture, commerce and industry, resulting in stronger economic growth and higher productivity levels and firms.

Facilitating company growth

Companies view acquisitions as an opportunity to expand product lines, increase distribution channels, hedge against volatility, increase its market share, or acquire other necessary business assets. A takeover bid or a merger agreement through the stock market is one of the simplest and most common ways for a company to grow by acquisition or fusion.

Redistribution of wealth

Stock exchanges do not exist to redistribute wealth. However, both casual and professional stock investors, through dividends and stock price increases that may result in capital gains, will share in the wealth of profitable businesses.

Corporate governance

By having a wide and varied scope of owners, companies generally tend to improve on their management standards and efficiency in order to satisfy the demands of these shareholders and the more stringent rules for public corporations imposed by public stock exchanges and the government. Consequently, it is alleged that public companies (companies that are owned by shareholders who are members of the general public and trade shares on public exchanges) tend to have better management records than privately-held companies (those companies where shares are not publicly traded, often owned by the company founders and/or their families and heirs, or otherwise by a small group of investors). However, some well-documented cases are known where it is alleged that there has been considerable slippage in corporate governance on the part of some public companies. The dot-com bubble in the early 2000s, and the subprime mortgage crisis in 2007-08, are classical examples of corporate mismanagement. Companies like Pets.com (2000), Enron Corporation (2001), One.Tel (2001), Sunbeam (2001), Web van (2001), Adelphia (2002), MCI WorldCom (2002), Parmalat(2003), American International Group (2008), Lehman Brothers (2008), and Satyam Computer Services (2009) were among the most widely scrutinized by the media.

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Creating investment opportunities for small investors

As opposed to other businesses that require huge capital outlay, investing in shares is open to both the large and small stock investors because a person buys the number of shares they can afford. Therefore the Stock Exchange provides the opportunity for small investors to own shares of the same companies as large investors.

Why Do We Need Stock Exchanges?

Companies and investors both need stock exchanges, but for different reasons. For companies, stock exchanges provide a means of raising money to develop and expand their businesses. For investors, stock exchanges provide secure and reliable marketplaces in which they can buy and sell shares.

Ways of becoming a Shareholder

Shares of a company are offered at the stock market at the following stages:

• Initial Public Offering (IPO) When companies offer shares to the general public for the first time, it is known as floatation or an Initial Public Offering (IPO). These can be bought directly from the company with out paying stockbroker’s commission. You might see an advertisement in a newspaper from a company issuing shares or your stockbroker might tell you about a company making an IPO. Simply fill in the share subscription form and deposit the form along with subscription cheque in a branch of the designated bank(s).

• Right Issues Right issues are issued when companies need to raise additional capital to finance their expansion projects or to meet working capital needs, etc. In case of rights issues, the existing investors have the right to subscribe to these new shares in proportion to their respective shareholdings.

• Trading Market The most common way of buying/selling in the stock market is through trading in the secondary market. Through a stockbroker, you can buy shares from existing investors who wish to sell them and vice versa.

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Share dealing: There are various ways of investing in the stock market: you can deal directly in shares, invest through a unit trust or investment trust or let your investment be handled by an advisor.

Who are Stockbrokers?

Stockbrokers are your link to the stock market. Their job is to help you get the best available price when you want to buy or sell your shares, be careful in selecting your broker. Ask references from people who frequently trade at the Stock Exchange and ensure that the stockbrokers/agents that you deal with are duly registered with the SECP.

Benefits for Getting Listed on Stock Exchange:

Improved Debt Capacity: public offering improves company’s balance sheet by increasing equity and reducing debt. In this way, a company may be able to get better debt in future on more favorable terms.

Publicity: IPO is a milestone for any company. If the whole process is successful then it increases company’s value, because IPO provides with free publicity of the company, also many investors, customers, acquisition candidates and strategic partners at established public listed companies would like to deal with listed companies because of a lower default risk.

Additional compensation alternatives for management of the company: a public listed company has many other alternatives like stock options, stock appreciation rights and many other securities, besides offering base salary to the management. In this way, public companies can attract more skilled personals as compared to private companies.

Valuation of companies: public listed companies are usually valued at premium. By public equity marked as compared to private companies because of liquidity and other financing and credibility reasons. Public companies get more attention of business community and financial press as compared to private companies and hence are considered less risky and safer by investors and shareholders.

Acquisitions: public companies may acquire other companies by stocks as compared to cash or debt. So, they can cash for other operating activities, if a company’s stock has a higher multiple of earnings then cost of the acquisition may get reduced.

Cash Proceeds: A public company gets a lot of cash proceeds because of public offerings so company may use that cash for operating activates, future expansion or for strategic transactions like acquisition.

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Capital Access: Public company may get more cash from public equity and debt capital markets at lower cost as compared to private companies which borrow at higher cost from traditional financing sources.

Liquidity: public offering provides liquidity options to the stock holders of the company. Stock holders have the liberty to sell their stocks to public equity markets subject to the minimum period of stock ownership.

The Roles of Securities and Exchange Commission of Pakistan

The Securities and Exchange Commission of Pakistan (SEC) is an autonomous statutory body that is entrusted with the integrated administration and regulation of the capital markets, corporate sector and financial (non-banking) sectors in Pakistan. SECP’s regulatory ambit extends to the Insurance sector, NBFIs and to the significant components of capital markets such as Stock Exchanges, Commodity exchange, CDC, NCCPL, beside the vast and growing corporate sector. The Policy making for each of these areas also falls under SECP’s purview that entails not only the revision of existing laws and regulations to bring them in line with best practices but also the promulgation of new laws etc. The field is really vast and challenging.The mandate entrusted upon the Commission has made SECP the catalyst to evolve the capital markets of the country as progressive, transparent and efficient markets, employing best practices and safeguarding the interests of the investors at large.As the regulator of an emerging market the SECP’s regulatory philosophy is based on the principle of developmental regulation. SECP, therefore, laid considerable emphasis on market development while administering and enforcing various corporate and securities laws. SECP’s regulations are based on:

• Consultative rule making• Facilitating implementation• Stringent enforcement

Now we will take just an overview of the role, the SECP plays in the capital markets of Pakistan. We will focus on the recent developments made by the SECP but first we will discuss the traditional role of the Securities and Exchange Commission of Pakistan.

1. Regulating the issue of Securities

The Securities and Exchange Commission of Pakistan is the regulatory authority in Pakistan and responsible for making the various rules regarding the Capital Markets.

2. Regulating the business in Stock Exchange and Other securities markets

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The SECP not only regulate the business of Stock Exchanges but also regulate the business of other securities markets. For example; the SECP is now specially promoting the insurance sector and formulating the various rules to protect the policy holders.

3. Monitoring the Capital Markets

SECP also monitor the capital markets working in Pakistan. By monitoring the markets the SECP enables itself to

recognize various changes and problems which may occur. gather the information about the reasons of the fluctuations in the markets, detect the flaws in the policies, identifying the unfair capital market practices

The Securities Market Division of the Securities & Exchange Commission of Pakistan (SECP) has detected 22 cases of violation of laws, including insider trading and imposed penalties on the stock exchange members and other market stakeholders. During the last one year, the Securities Market Division had detected 22 cases of insider trading, price

manipulation, short- and blank-selling, wash trades, broker misconduct and non-compliance of the listing regulations.

44 members of the Karachi Stock Exchange and six members of the Lahore Stock Exchange were issued warning letters for possible violations. Two banks were also

issued warning letters for non-compliance of the securities laws. In addition, a stock exchange was also penalized for violation of the Securities & Exchange Ordinance, 1969.

(Daily Times, Tuesday, 20th April, 2010)

4. Registering

The SECP also register and regulate the working of stock brokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deeds, registrars to an issue, underwriters, portfolio managers, investment advisors and such other intermediaries who may be associated with the securities markets in any manner.

SECP also propose regulations for the registration and regulating the working of collective investment schemes, including unit trust schemes.

SECP promotes and regulates self-regulatory organizations including securities industry and related organizations such as stock exchanges and associations of mutual funds, leasing companies and other NBFIs.

SECP also regulate substantial acquisition of shares and the merger and take-over of the companies.

5. Prohibiting Fraudulent and Unfair Trade Practices

Prohibiting the fraudulent and all unfair trade practices relating to the securities markets is the core function of the SECP.

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The SECP has formulated various rules to protect the investors and companies against the fraudulent and unfair trade practices.

According to the Section 29(1) of The SECP Act, 1997, “the Commission may conduct the investigations in respect of any matter that is offence under this Act.

6. Promoting Investor’s Education and Training

For helping the capital markets of our country the SECP has designed numerous programs to educate the investors. The basic purpose of these

programs is to make the investors able to understand the nature of capital market. The SECP is also training the intermediaries of the securities markets. This will leads to

the better understanding between the SECP policies, investors, and the Capital Market.

7. Calling for Information and Undertaking Inspection

As we discussed above that the SECP can conduct investigation in respect of any matter that is offence under the SECP Act, 1997. The SECP can also call for the information and undertake the inspections, conduct inquiries and audits of the Stock Exchanges and intermediaries and self-regulatory organizations in the securities market. For example; through the inspection of the matters the SECP can solve the problems of the capital market with having the clearer picture of the matter and as well as the market. By conducting the audit of the Stock Exchanges the SECP enables itself to get the real position of its capital market and comes to know that the either the Stock Exchanges are following the rules or not.

The commission suspended the registration of five members of the Karachi bourse on June 26, 2009 due to unresolved investors' complaints. Subsequently, to ascertain the quantum of these

complaints and other related issues, the commission initiated an inquiry against these brokerage houses under Section 21 of the Securities & Exchange Ordinance, 1969

(Daily Times, 20th April, 2010)

8. Suggesting Reforms of Law

It’s an important role performed by the SECP. SECP consider and suggest the reforms of law relating to the companies and bodies corporate, securities markets, including changes to the constitution, rules and regulations of companies and bodies corporate, Stock Exchanges or clearing houses.

9. Encouraging the Development

We discussed in previous section that in 90s, we were working with poorly regulated, inefficient, and nontransparent capital markets. The SECP performed its role as the greatest encourager of the development of the not only the capital markets but also for the other related markets. The SECP did all this by making the rules and regulations relating to the markets. SECP has formed a

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research wing for identifying the areas of improvement to make those areas better. The research wing of the SECP can conduct research in any of the matters relating to markets.

10. Regulating the Insurance Business

The SECP is ensuring and monitoring compliance by insurers, insurance surveyors and insurance intermediaries of all laws, rules and regulations pertaining to insurance for the time being in force. SECP is also regulating professional organizations connected with the insurance business and encouraging the organized development of the insurance market in Pakistan.

11. Maintaining the Investor’s confidence

SECP plays an important role in maintaining the confidence of the holders of the insurance policies by protecting the interests of the policy holders and beneficiaries of insurance policies in all matters, including assignment of insurance policies, nominations by policy holders, insurable interest, and surrender value of policies of life insurance, and other terms and conditions of contracts of insurance.

12. Disclosure of Information to the Public

To protect the interests and rights of the investors, the SECP has formed various rules and regulations. On the identification of the SECP various sections of the Companies Ordinance, 1984, has been changed. For example, it’s necessary for the companies listed at any stock exchange in Pakistan to issue the opinion of a qualified auditor along with the financial reports. It is also necessary to disclose all necessary matters in the financial statements and reports to provide the best information to the public and reducing the chances of fraud.

13. Settlement of Disputes

SECP also performs its role as the authority to resolve the potential disputes between the parties I.e. investors and companies. SECP is not only solving these matters but also is trying to improve existing methods and advise new opinions for the expeditious settlement of claims and disputes between the parties.

Capital Market Reforms by SECP

Capital Market in Pakistan has experienced many ups & down in the past, due to political situations of country accompanied with simultaneous changes in policy relating to Capital Market. The equity market of the country had to survive in an atmosphere of absolute uncertainty. It had become very common to change the policies of the previous government by

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the sitting government. Sometime it affected the inflow of foreign resources in the equity market with the lapse of time.

Capital Markets in early sixties and seventies were on its peak as a great number of companies of different sectors floated/offered their shares to public for subscription which were in general heavily oversubscribed. In fact general public was then more inclined to invest their funds in equity market. Small investors then used to invest their funds in equity market as the return offered in the shape of Dividend on such shares was sufficient to satisfy them. Presently the situation is quite reverse. The number of companies floating their shares has declined tremendously as also the shares offered to the public remain unsubscribed or are not fully subscribed.

PERFORMANCE OF KSE IN THE PRE- REFORM ERA(Amount in Billions of Rs)

Source: State Bank Annual Report, 2002

Governments have been ineffective in addressing weaknesses of the capital markets. SECP was formed as a regulatory body to build up healthy capital Market in Pakistan. Following are the reforms and activities SECP did in order to:

“Develop a fair, efficient and transparent regulatory framework, aimed at fostering growth of a robust corporate sector and broad based capital market in Pakistan.”

Substantive reforms in the areas of risk management; governance and transparency; market development; and investor protection and investor education have been implemented. These provided due impetus to development of existing buoyant and broad-based capital market in the country.

Risk management Reforms

Reforms, particularly focused to strengthen risk management in the capital market include:

Rationalization of the carry-over trade (COT) system

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Badla is a kind of interest and unofficial way of lending money to encourage the people to buy shares on borrowed money for a very short period of time and just pay only interest plus commission rather than entangling their total capital. As the banks encourage the businessmen to expand their business through borrowed money in the same way, the brokers encourage the jobbers to play in the market by borrowed money. But in the business transaction the assets purchased by borrowed money remain in the possessions of the borrower and the banks have nothing to do with it, but in badla transaction the buyer gets nothing except a memo of confirmation. In bank borrowing, the borrower obtains money physically and pays principal plus principal interest while in badla transaction; the buyer pays difference of his purchase price and market price plus commission.

The most negative aspect of badla trading is that one can buy huge quantity of shares by involving too little amount. In actual buying the transactions is one time and ownership of shares is transferred from seller to buyer permanently while in badla transaction only the value of the shares is changed and ownership is shifted to buyer in token. In short, shares trading under badla transactions are an artificial way of business means, aiming at luring the innocent people and minting money from them. As a very small amount of money enters the market under badla while heavy numbers of shares are traded- this is the reason that it causes negative impact on the market instead of bringing any significant and positive effects.

To restructure the situation, the Commission introduced several remedial measures in 2002 that helped in strengthening regulation of the COT market and the stock exchanges were advised to make the following changes in the COT system:

COT should be for a minimum period of 10 days with the financee having the option to release it after one day

COT should only be allowed in specified liquid shares

Higher margins should be mandated for COT

COT shares should be kept with the CDC or with the clearinghouse of the stock exchange and should be pledged in the name of the financier, if the financier were a bank or a financial institution.

Induction of the T+3 systems

In order to reduce systematic risk in the stock market, the “Group of 30” recommendation called for the utilization of rolling settlement on a minimum of T+3 basis (trading date plus three days). In T+3 settlement system, the purchase and sale transaction must be delivered and settled on the third day following the date of trade.

In the past, the stock exchanges in Pakistan had been following fixed trading settlement system. The trading was carried out for fixed period normally from Friday to Friday to be settled the following Wednesday. The Exchanges clearing house thus carried the settlement risk for about ten days. At times the period was even longer than ten days due to holidays or some other

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reason. It was particularly high in case of our stock exchanges, which were relatively illiquid and could be manipulated easily. In the past, many defaults by members occurred due to over exposure of members on account of this longer clearing cycle. The weekly settlement system, together with Badla and open window led to huge turnover and mindless speculation. Due to this it became a market where people could buy shares with no money and sell without possessing any shares.

The T+3 system is aimed at capping systematic risk and improves efficiency of the settlement process. It has been introduced in order to bring down speculative and overtrading beyond the financial capacity of the brokers thereby risking the investors’ hard earned money.

Benefits: Implementation of T+3 is a significant achievement, which has gone a long way in improving the markets’ efficiency and transparency. The main benefits of T+3 system are:

It reduces risk as the time between execution of trade and settlement of trade is cut down substantially.

It helps generate liquidity as the buyer will receive the shares and the seller will receive the cash earlier i.e. on the third day of trade whereas presently both buyer and seller will receive shares or cash whatever the case maybe, on the 10th day.

It particularly provides comfort to foreign institutional investors as T+3 settlement system is internationally known and is in line with other major stock exchanges of the world.

The implementation of T+3 first resulted in reduced turnovers at the stock exchanges and people misinterpreted it with faults in the system itself and its inability to complement Pakistan’s equity market structure. However, the low turnovers were due to the lack of understanding, lack of practice, natural resistance to unknown and parallel availability of the old system. There were some minor dislocation in the trading system, but it is now back to be normal since the investors have fully realized its benefits.

Implementation of the capital adequacy limits on broker exposure

Capital adequacy: A measure of the financial strength of a bank or securities firm, usually expressed as a ratio of its capital to its assets.

The SECP has implemented capital adequacy for stockbrokers. Previously, the KSE allowed brokers to carry an exposure of Rs 50 million free of cost. The SECP has come out quite vocally against this and now there is no deposit-free exposure limit and exposure up to Rs 50 million will require a 5 per cent deposit. These deposits are accepted in either cash or securities, as is the current practice.

The member would be required to maintain a capital adequacy ratio, which is 25 times of the net working capital.

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Minimum capital standards are thus a vital tool to reducing systemic risk. They play a central role in how SECP supervises financial institutions. But capital requirements have so far tended to be simple mechanical rules rather than applications of sophisticated risk-adjusted models.

Fraud Investigation Unit:

Fraud Investigation Unit (FIU) has been recently established within the SECP and is responsible for deterring and combating financial crimes in the corporate sector. The focus of the unit is to identify and investigate financial crimes, including financial crimes risk assessment and its management, and support in providing assurance for corporate governance and creation of deterrence.

Corporate Governance Reforms

• Independent management has been appointed at the stock exchanges to run the daily operations. The structure of boards of directors of stock exchanges has been changed through nomination of non-member directors, one of whom must also be the chairman of the board.

• Pursuant to the introduction of the Code of Corporate Governance in March 2002, the SECP has taken several measures to increase the level of transparency and disclosure in corporate reporting. Several amendments were made to the Companies Ordinance, 1984 so as to make key provisions of the Code applicable to all companies including public sector listed companies.

Transparency Reforms

For the purpose of enhancing Transparency in the capital market SECP has implemented the following:

Banned In-House Badla: COT

Establishing a code of conduct under the brokers Registration Rules (regulation of brokers)

In order to bring transparency in the business of stock market, brokerage houses and members (broker/dealer) a proper system of inspection of books and records of such brokerage houses/brokers is being established. The regulation framed comprehensively, lists out documents/records, which the brokerage house/brokers would be obligated to present for inspection to a person authorized by the Commission for the said purpose. The basic aim of these

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regulations is to ensure fair dealing, proper documentation etc. Failure to comply with the regulations would entail penal action.

The Commission promulgated the Brokers and Agents Registration Rules in May 2001 to establish a direct regulatory nexus with brokers and agents for protection of investors’ interest. No person can act as a broker or agent to deal with transactions in the securities market, unless registered with the Commission. The registration of brokers and agents under the Brokers and Agents Registration Rules 2001 started on November 1, 2001. These regulations enable direct controlling of brokerage activities. It allows smooth operation of stock market and serves as a tool for investor protection.

Registration of brokers and agents has had a positive impact on stock market dealings owing to the enhanced level of awareness created amongst brokers and agents regarding the level of integrity and care required of them in the conduct of their business.

Replacement of the “Blank Selling” by generally accepted and carefully regulated “Short Selling”

Blank selling and short selling are two ways of profiting from a falling stock market. Essentially, the seller first sells the securities and then buys them back at a lower price, netting the difference.

Short Selling: Seller does not own shares. It is a leveraged sale. It is non-Islamic.

Seller “sells” share he doesn’t own to buyer in interception of decrease in share price. These shares are owned by PARTY-B. When prices fall down SELLER buys from PARTY-B, returns share and margin to PARTY-A.

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SELLER

PARTY-A

BUYER

PARTY - BSELLER buys when share prices are low

Shares sold in behalf of SELLER


For instance, if you sell 500 shares of Hubco at Rs 32 and buy them back at Rs 30, you would have earned Rs 2/share.

While this may appear an interesting and harmless way of profiting, blank and short selling have often been held partially responsible for many a stock market crisis internationally. Blank selling is prohibited in every stock market while short selling is usually tightly regulated.

The distinctions among a sale, a short sale, and a blank sale are made by the “Regulations governing short selling in the ready market” that were implemented in 2002. Under these regulations, a sale is not subject to any special restrictions if (i) it is backed by ownership of shares or (ii) a buy transaction before a sell transaction. It becomes a short sale if you didn’t own the shares or hadn’t first executed a buy transaction but had arranged for borrowing the shares before you sold them. It becomes a blank sale if you hadn’t even borrowed the shares sold, i.e. you just sold in thin air.

Let’s take a simple example. On Monday, you sell the 500 shares of Hubco you own. You can tender delivery on Thursday, under the T+3 system and receive payment. Else you can square your position by buying 500 shares of Hubco later in the day. You are betting on the prices going down. You’d receive the profits on squaring if the price indeed fell. If you weren’t lucky and the price rose you’d have to pay the losses.

If you didn’t have the 500 Hubco shares, but you first executed a buy transaction of 500 shares, you’d still be fine because you had a claim on what you sold. You might have bought the shares fractions of a second earlier or even simultaneously; you might be carrying over your buy position using the Carry Over Financing; or you might have bought at one stock exchange and sold at another trying to arbitrage away the price differential. As long as the sale transaction is not before the buy transaction, it is legal and does not attract any special restrictions.

If you didn’t have the 500 Hubco shares, but you had first borrowed them before selling them, you’d be making a “short sale.” If you didn’t even borrow the shares, you sold blank. Practically, a blank seller squares his trade the same day while a short seller may tender delivery and buy back the shares later.

Under the regulations, blank selling is prohibited. Short sale is permissible.

Rationale for prohibiting blank:

(i) It is wrong in principle because one cannot be allowed to sell something he doesn’t have but he might have to deliver.

(ii) Blank seller steals away money from other investors by manipulating the prices. By putting in blank sales and creating selling pressure, the seller tries to mislead others into thinking that the prices are falling due to genuine selling so that others also start selling. Once the price drop is artificially magnified and accelerated, the blank seller squares himself at a profit.

(iii) Blank seller exposes himself and the market to an increased risk of defaults. Unlike a genuine seller, blank seller faces substantial price risk because he doesn’t have the

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shares. If contrary to his expectations, market moves against a blank seller, he would have to square at substantial losses that he might not be able to bear. Moreover, if he is unable to offset his position, delivering shares that he never had can become very difficult.

(iv) Blank selling artificially raises the volatility in the market and hurts its perception as a fair place. Bad perception scares away investors, thus narrowing the investor base and hurting the process of capital formation.

Listed companies are required to circulate quarterly accounts to shareholders.

Market Development Reforms

Formation of the Central Depository Company

The establishment of the Central Depository Company (CDC) was also a milestone in the corporate history of Pakistan aiming to create transparency in trading, eliminate the trading of fake shares and facilitate electronic transfer

An electronic book entry transfer of securities known as the Central Depository System has completely replaced the older system of physical transfer of shares. Investor account services have been introduced in order to facilitate individual investors to maintain their accounts directly with the CDC. Although for the investors, the opening of account with CDC entails more transaction costs in addition to the brokerage commissions, but it adds more security to the investor’s money. Investors are therefore encouraged to open their accounts with the CDC while they actively trade in shares through the brokers.

Implementation of the automated national clearing and 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 150 scrips have been added to the NCSS. This project has been prepared with the assistance of the ADB.

It is an electronic system developed to replace the individual clearing houses operated in each of Pakistan's three Stock Exchanges by a single entity. The consolidated and geographically neutral Clearing House is located at Karachi, with sub - offices at Lahore and Islamabad. None of the regional markets, including India have such an advanced system of clearing and settlement.

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The system is based on rolling system on T+3 based on Continuous Net Settlement (CNS). By adopting the above system design the ratio of trade with settlement has improved and in turn speculative trade is expected to reduce. Under the NCSS, Continuous Net Settlement (CNS) is the main settlement option available to settle trades/transactions received from different sources. CNS is understood to mean a system in which the clearing members would have the option of carrying over their positions to the next settlement day as opposed to the present system in which settlement of trades has to be done at the designated settlement day. Previously, if clearing members were short of funds or securities, they had to resort to borrowing. With CNS, clearing members have the option of carrying over their positions to the next settlement day (subject to allocation, if any), thereby rolling over their position without the constraint of delivery or payment except of a mark to market charge.

In CNS, clearing members are required to settle only with the clearinghouse rather than the counter party, which would minimize the risk of default. Other settlement options under NCSS include: Balance Order Settlement (BO) and Trade for Trade Settlement.

The platform for the NCSS was created in full consultation with market participants, investors and brokers, and adjustments were made to the system as called for. Effective information systems were installed within the SECP.

NCSS has provided much required stability to the market by capping the systemic risk to a great extent. With the launch of the System, the capital market has gotten to work under standard rules and regulations and it has also made intra-stock exchange settlements possible. Previously, all three stock exchanges of Pakistan operate their individual clearing houses for trades on their respective exchanges. Other features of the NCSS include a mark-to-market mechanism, formal stock lending and position financing.

Demutualization of Stock Exchanges

The most important and debating step taken by the Securities and Exchange Commission of Pakistan (SECP) was the ‘Demutualization’ of the three stock exchanges. It is important that more than 85 percent of world’s leading stock exchanges have already been ‘demutualized’.

Under this system the stock exchanges will be converted into profit making organizations and the members of the stock exchanges will be receiving dividend from the stock exchange income. In this case the members will have to loose their rights of brokerage business. The brokers will be different from the members of the stock exchange. By implementation of this system, the transparency and independency will be ensured. At present members of the stock exchanges do the business of brokerage, which leads to clash of interests and the stock exchange as a rule making, and execution body cannot work as an independent and transparent institution.

There are two main forces driving stock exchanges to demutualize: 1) increased global competition and 2) advances in technology

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PERFORMANCE OF SECP

“Over 4-5 years SECP’s vision is to get more companies listed”

(Says, Former Member of Policy Board)

SECP’s focus is on quantity of companies rather than developing an efficient, transparent and progressive Capital Market.

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Number Of New Listed Companies on KSE

Stock Market Liquidity:

Graph show the market liquidity (Turnover Ratio) at Karachi Stock Exchange during the years 2003 to 2008. The analysis shows a continuous decline in the market liquidity within the study period has occurred at KSE. The market liquidity has declined from 4 to 3.42 in the year 2004 and it further declined to 3.11 in the year 2005. The market liquidity went down to its bottom from 1.35 to 0.25 from the year 2007 to 2008.

Turnover ratio

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The Stock Market Concentration at KSE:

The stock market concentration can be measured by analysis of the share of market capitalization by large firms stocks in total market capitalization at a stock exchange. These large firms make a group and are seen as the leading 3 to 5 firms in the market (Maunder-et al. 1991). High concentration may adversely affect the liquidity as there are common results in the studies of co-relationship between concentration and liquidity.

Analysis and Results:

The Capital Formation at Karachi Stock Exchanges is divided into two categories viz. The Equity and the Debt Instrument (Bonds/Debentures). The Equity is a big and major source of capitalization, which has been started, with very first day of operation of the stock exchange in 1948 and the debt instrument is very latest mode of finance, which was introduced in the year 1995. As it is discussed above that the investments in debt instrument at KSE is insignificant, so here; the analysis is only based on the data of equity investment at KSE during the study period. The Market Concentration at KSE is witnessed in the Table

MARKET CONCENTARTION IN KSE (%)

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The market concentration is found in the leading 5 groups of companies which are:

1. Cotton and Textile,

2. Chemical & pharmaceuticals,

3. Fuel and Energy,

4. Transport & Communication and,

5. Banks and other financial Institutions.

Reasons why do Companies not get listed?

Disclosure of Financial results: Public companies have to disclose their financial results, management compensations and transactions between company and management or principal shareholders to SECP periodically. In addition to this, public companies have to disclose any kind of positive or negative developments through press releases. In this way, public companies lose their confidentiality and any weak decision is subject to criticism by its competitors.

Outside pressure: Public companies have to make their revenues look good in short term because of expectation of public shareholders. This pressure adversely affects company’s long term goals.

Going Public cost: it includes underwriting costs, registration fee, fees of initial accountants and other miscellaneous expenses. For example, “A company raising $ 50 million on NASDAQ should expect to pay over $ 5 million in fees.” Usually companies need five to six months for the whole initial public offering procedure, so the management salaries for the time period are also the part of going public cost.

Ongoing extra expenses: there are numerous expenses which specifically apply to public companies like printing and distribution expense of annual reports and proxy statements, fees of lawyers, accountants and transfer agents, besides that, public company has a potential liability for misstatement and omissions in public disclosures.

Planning: IPO provides lot of cash inflow which is good, but managing and proper utilization of cash is very important. For this, company should have a proper plan of growth and investment in the future; otherwise it can quickly loose this benefit.

Need more employees: companies need more skilled personnel for dealing this investors, business journalists, securities analysts, and SECP officers. So, this is another extra cost which companies have to bear.

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Dividends: public limited companies, power of management and initial investors get decreased because of the diluting effect. On the contrary, power of shareholders increase. That is why; there is a need of special approval of shareholder for any major decision of the company. So, extra time, money and effort are required for execution of any kind of transaction requiring the permission of shareholders.

Shareholders as owners of company

Price Earning multiple: The most common measure of how expensive a stock is. The P/E ratio is equal to a stock's market capitalization divided by its after-tax earnings over a 12-month period, usually the trailing period but occasionally the current or forward period. The value is the same whether the calculation is done for the whole company or on a per-share basis. The higher the P/E ratio, the more the market is willing to pay for each dollar of annual earnings.

Earnings Multiple: Significantly lower than world stock markets

Exchanges P/E Ratio

American 45.4

Shanghai 33.3

Tokyo 32.8

Malaysia 24.2

India 21.69

Singapore 19.4

UAE 17

UK 14.4

KSE 11.48

Telenor and Mobilink doesn’t get listed on KSE, according to PE Ratio its better for them to get listed on Indian stock exchange or any other Stock Exchange for capital generation, they would be able to raise the same amount of capital by floating less number of shares.

Delisting of companies from Stock Exchange:

More than 75 companies were de-listed from the Karachi Stock Exchange during the last five years. Majority of the companies opted to the option of de-listing on voluntary basis.

A major cause of this voluntary de-listing of the companies was the emphasizing on dividend payments by the Ministry of Finance and the Securities and Exchange Commission of Pakistan (SECP), while the companies had required the funds for re-investment to expand and modernize their equipment to compete in the free trade regime. In fact, the Securities and Exchange

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Commission of Pakistan (SECP), Ministries of Finance, Economic Affairs, Commerce, Industries, Investment and Privatization, and the State Bank of Pakistan should work in harmonized way to develop the stock market as deterministic and reflector of the economy. The Planning authorities should identify the priority sectors with the help of information and trends provided by the Ministry of Commerce and Ministry of Industries, while, the Securities and Exchange Commission and the State Bank of Pakistan should develop the strategies to promote the investment in those priority sectors through debts and equity financing by institutional and individual investor.

Reasons for Delisting

S. No Reasons for Delisting 2006 2007

1 Voluntary Delisting after Buy-Back of Shares 3 4

2 Delisting due to winding up of Company by Shareholders 2 1

3 Delisting due to Merger 12 2

PROBLEMS IN SECP

Analysis of SECP’s Ineffectiveness in regulating stock market

Lack of good governance

It shows that there is one weakness in the system - lack of good governance in federal government and at SECP. Reality is that core elements of good governance have been largely missing in workings of SECP.

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Problems of governance in government are too obvious to be stated. The reasons this government, like some of its predecessors, became so involved in stock market is that it could not resist the excitement to use KSE-100 index as “evidence” of its economic success.

Government’s economic managers, some of whom are perceived to be quite close to big stock brokers, used to proudly claim that KSE was “best performing market of the world” and a rising KSE-100 was barometer of Pakistan’s economy. They did not care that KSE’s “best performance” was merely based on percentage increase in KSE-100 and this index and this market have very limited economic relevance and hardly any link with life of a common man.

Deviation from SEC Act 1997

Despite SECP’s “autonomy” under the SEC Act 1997, federal government exercises direct powers over this regulatory body, which include

- Power to appoint its chairman, other commissioners and chairman of

SECP’s policy board.

Chairman of SECP wanted to be chairman of policy board, but rule is: No person from SECP (insider) can head Policy board.

Interference of GOP

Taking advantage of government’s political stakes in stock market, some powerful stock brokers have turned KSE-100 into a negotiating tool. All they have to do to block and even malign SECP is to cause a downfall in the index.

They know that soon government machinery would be set into motion to bring KSE-100 back to a politically correct level. Following March crisis, interference of the country’s economic managers into affairs of SECP is said to be on the rise, at times verging on micro management. Thus primary responsibility of SECP’s ineffectiveness in doing its job lies with the government

SECP has not been able to protect shareholders rights and interests

Thousands of investors, suffering losses of more than Rs 800 billion in the stock market, over the last five years, have approached the policy board of the Securities and Exchange Commission of Pakistan (SECP) and threatened to take the matter to the Supreme Court

if it fails to ensure justice to them.(Dawn News, Tuesday, 30 March 2010)

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SECP is itself responsible for crises

There is much that SECP could have done, but did not do, to improve its governance and lay a sustainable foundation for regulation. Reality is that core elements of good governance have been largely missing in workings of SECP. Missing elements take account of:

1. Accountability

First of these elements is accountability. It is the policy board of SECP that is supposed to oversee its performance and make policies regarding SECP. Conventionally, SECP’s chairman has also been the chairman of policy board. Clearly, this sort of overseeing does not help. Composition of policy board is specified in SECP Act. It has no representation from investing public, which provides SECP with its reason for existence. Majority of its members are ex- officio, coming from other bureaucracies, most of which have very little to show for themselves. Members of policy board from private sector are also chosen so that they would look good on paper and be toothless in practice.

Thus, its not a surprise that SECP’s policy board has not made any perceptible effort to fulfill its purpose and its composition suggests that it is also unlikely to do so in future. Due to lack of accountability by the policy board, SECP chairman is considered all powerful in internal matters. This has resulted in highly controversial decisions, some of which led to court cases and caused great damage to SECP.

It was well within the domain of SECP to recommend to federal government to let an individual, other than its chairman, chair its policy board and take its first step towards internal accountability – something it still hasn’t done.

2. Transparency

Second element of good governance that SECP is yet to espouse is transparency. It is an irony that SECP, which is champion of transparency in corporate sector, has never published its financial accounts in its annual report. Nothing can justify such lack of elementary transparency.

SECP’s annual reports tend to give a highly exaggerated account of SECP’s performance. If one were to believe even some of the regulatory achievements of its Securities Market Division, nothing like March 2005 and June 2006 crises could ever have happened.

These reports quite needlessly glorify SECP’s chairmen by publishing their photos on the cover. SECP’s website is also full of meaningless information about its vision, mission, strategy etc focusing more on SECP rather than the needs of investing public. It was always SECP’s own

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decision to make fair and full disclosure of its financials and regulatory performance to the public - a decision it is yet to take.

No internal audits

3. Delegation coupled with meritocracy

Third missing element of good governance at SECP is delegation coupled with meritocracy. Technically, executive directors should be running its different divisions but due to SEC Act and SECP’s internal dynamics, chairmen and those commissioners, whom the chairman likes, run the show with minimal delegation across the organization.

Thus there has been inevitable friction between commissioners and executive directors, in which the commissioners have prevailed. There has been substantial turnover in executive directors and SECP has found it increasingly difficult to replace them.

Weaknesses of SECP

The retarded growth of Capital Market in the Past has been due to a variety of factors, of which the following are significant:

Public companies and public sector enterprises were not encouraged to list on the stock exchange because government interest rate and credit allocation policies distorted the price structure of equity finance relative to loans from financial institutions and other sources. This stimulated excessive reliance on debt financing and led to high debt-equity ratios.

Public companies received funding directly from the government either through appropriations from the national budget or at relative low interest rates from state-controlled financial institutions.

The majority of private sector firms have tended to be relatively small and consequently their needs have tended to be modest, mainly confined to meeting working capital requirements. The firms have been able to generate the required finances from personal loans and their own contributions and related earnings as well as short term loan facilities from commercial banks.

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There is a strong concern among private company owners regarding to dilution of ownership and control of their firms. Most owners wish to keep the benefits of their entrepreneurship and control over the future of their enterprises within a limited circle of relatives and friends. Even when a company is listed on the stock exchange, most of the shares are not available for public trading.

A number of companies are reluctant to disclose information about their financial status. The disclosure requirement has been instituted to protect the interests of investors.

However, since most of the private companies do not have to submit externally audited fin statements, they are better able to evade taxes in some way.

As a result of factors such as after-tax returns, risk and liquidity, other instruments offered higher yields and less risk than securities.

Investors have generally felt that the market can be engineered for anyone but the largest investors. There is trading on the basis of privileged info involving considerable unacceptable risk for the small investors.

Institutional investors such as investment companies, modarbas, unit trusts, pension funds and insurance co have played a little role in the development of share market.

There is lack of appropriate financial information regarding the stock market. Of al the markets, the stock market is the most diff to comprehend.

Debt market calls for restructuring

Difficulty in Financing for corporations:a) Fiscal slippages

b) Delay behind the latest IMF money

c) Delay behind other pending funds

The bottom-line is that debt market is the missing element in Pakistan’s capital markets, and that there is a need for a substantial (considerable) rise in corporate financing via issuance of commercial papers and bonds - something which can help accelerate economic growth of the country.

According to a research made by Business Recorder, Financing for corporations in Pakistan is becoming increasingly difficult. Fiscal slippages, the delay behind the latest IMF money and

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other pending funds, are also crowding out (forcing out) corporations from bank financing. In such a scenario, the development of debt markets in Pakistan may provide a new avenue for companies to quench (satisfy) their monetary thirst

National vs. international

Corporate bond market - $3-4 billion Stock market - around $30 billion

Difficult for companies to finance their expansion

Pakistani corporate bond market is under $3-4 billion, which is negligible compared to the size of its stock market of around $30 billion. This comes in stark contrast to global standards, where bond markets are several times larger than the stock markets.

This has made it difficult for companies to finance their expansion, whereas internationally, large corporations rely on the strength of their balance sheets to issue commercial papers and bonds. These papers are then bought primarily by mutual and pension funds as investment instruments.

In Pakistan, however, even AA-rated companies have to go to banks for their financing needs, which crowds out the small and medium size businesses from bank credit.

Obstacles in Bond growth

1. A big impediment in the growth of the bond and commercial paper market is that the SECP takes months to grant approval for their issuance, whereas taking a loan from a bank is much quicker. Even in cases of launching mutual funds, sometimes it takes six months to launch a vanilla product due to bureaucratic hurdles at the SECP.

Since the bond/TFC gets a rating before the firm applies to the SECP for listing purposes, the regulator should take days instead of months to approve the issuance of such securities. As a consequence, companies have resorted to issuing privately placed TFCs; however, since these are not listed they don add to the development of bond market.

2. Fail in Execution of BATS: Another problem is that, although there is a bond trading system in place, BATS, at Karachi Stock Exchange, it has not yet been made a mandatory channel for bond trading.

Unless the SECP issues instructions that all bond trades have to take place through BATS, there will be problems in terms of price discovery, transparency, liquidity, efficiency and documentation.

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3. High rates on National Savings Scheme: The third impediment is that the government continues to offer very high rates on National Savings Scheme, which is crowding out the private sector and encouraging investors to lend to the government rather than the private sector. This creates hurdles in private sector capital formation.

RECOMMENDATIONS

Although, a lot has been achieved during the last 4-5 years, however there is a lot, which still needs to be accomplished. Market forces demand a more vigorous financial market in the country. Some measures that can be taken to improve the functioning of capital markets in Pakistan are:

Efforts must be made to increase the depth and breadth of the market by limiting family ownership and encouraging new industries.

To improve financial reporting and disclosure, more vigorous regulations are required. The accounting profession should try to improve its self-regulation, internal Audits committee should be made strong.

One way to ensure impartiality and remove conflict of interest of the auditor is to allow companies to engage auditors on a non- renewable fixed term contract.

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To curb speculation and carry over trading, the Futures market needs to be strengthened. Instead of ‘badla’ financing, the commercial banks need to be encouraged to extend financing facility to traders.

Better regulation of insider trading is essential. The directors and senior executives should be required to disclose their sales and purchases on a regular basis.

Given the technical nature of issues involved in the insurance and pension industry, absence of organized education and training facilities must be addressed as a matter of priority.

To create flow of real capital, primary markets need to be developed. SECP should devote part of its expertise and attention to the creation of enabling environment for development of the primary market.

Outside directors on the stock market boards need to be those who have no conflict of interest, and also possess requisite knowledge. Nominations from research and academic circles could be one of the solutions.

Investors should make thorough investigations about the companies before they buy their shares. They should not get carried away by the market manipulators. Investing in blue chips is much easy but at the same time they should expand or keep their investment portfolio diversified.

Measures to popularize the stock market through effective marketing efforts.

The capital market reforms should not be implemented and left to rotate in the economy themselves. The responsible organizations should very closely monitor them especially any anti reforms measure should be taken care of. Also as there are still some reforms pending or are in the process of implementation, maybe a wider outcome will be observed later once all the reforms are made functional in the economy. Presently it is better to clean up the mess and develop a real market that would function as financial intermediaries in its true sense. The main

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lesson to be learned is that independence, competent people and effective corporate governance are critical to the success of policy and institutional reform, and sharply focused technical assistance projects have a better chance of success.

SECP faces curbs on its independence

In a major development, the government is contemplating to bring Securities and Exchange Commission of Pakistan an independent corporate and capital market regulator under the control of finance ministry and withdraw job protection to its chairman and commissioners

through an amendment in the law.

(Dawn News, 12th May, 2010)

If this happens it would downgrade SECP into a department of GoP and in particular the Ministry of Finance. We seem to be going back in history and trying to re establish the CLA. Incidentally, creation of an independent SECP has always been a conditionality of ADB and World Bank loans for the GoP.

The SECP will be subject to unwarranted political and bureaucratic pressures which will be almost impossible to withstand and will consequently affect the performance of its duties and functions namely enforcing laws fairly, fiercely and independently.

Recommendations For GoP:

Being a regulatory body, SECP is an extreme case of a knowledge based organization. It should and could have hired and retained the best of minds, which it did not.

If government is sincere in making SECP an independent and effective securities regulator, it should prove it through its actions. The least it can do is to

1. Liquidate its political stakes in stock market, 2. Amend SEC Act reducing its direct powers over SECP and

3. Strengthening SECP’s internal controls, and

4. Stop interfering in SECP’s affairs though any indirect means such as giving statements about stock market issues.

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REFERENCES

1. www. secp .gov.pk/

2. http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/the-newspaper/ business/finance-ministry-to-rule-over-regulator-secp-faces-curbs-on-its-independence-940

3. http://www.dailytimes.com.pk/default.asp?page=2010%5C04%5C20%5Cstory_20-4- 2010_pg5_17

4. http://www.accountancy.com.pk/newsgen.asp?newsid=1847

5. http://www.akdtrade.com/investors_guide.asp

6. http://www.secp.gov.pk/ChairmanSpeeches/PDF/150404_KSE.pdf

7. http://www.universitip.com/term-papers/prospects-and-benefits-of-demutualization-of- stock-exchanges-in-pakistan-898599279.html

8. http://www.pakistaneconomist.com/issue2002/issue16/f&m3.htm

9. http://www.dawn.com/2006/07/10/nat1.htm

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http://www.pakistaneconomist.com/issue2002/issue16/f&m3.htm

http://www.universitip.com/term-papers/prospects-and-benefits-of-demutualization-of-stock-exchanges-in-pakistan-898599279.html

http://www.universitip.com/term-papers/prospects-and-benefits-of-demutualization-of-stock-exchanges-in-pakistan-898599279.html

http://www.secp.gov.pk/ChairmanSpeeches/PDF/150404_KSE.pdf

http://www.akdtrade.com/investors_guide.asp

http://www.accountancy.com.pk/newsgen.asp?newsid=1847

http://www.dailytimes.com.pk/default.asp?page=2010%5C04%5C20%5Cstory_20-4-2010_pg5_17

http://www.dailytimes.com.pk/default.asp?page=2010%5C04%5C20%5Cstory_20-4-2010_pg5_17

http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/the-newspaper/business/finance-ministry-to-rule-over-regulator-secp-faces-curbs-on-its-independence-940



http://www.secp.gov.pk/


10. http://www.brecorder.com/index.php? show=&&id=495901&currMIndex=01&currPageNo=1&query=&search=1&term=2004-10-01|2006-12-31&supDate=

11. http://www.dawn.com/2003/02/24/ebr11.htm

12. http://www.adb.org/documents/books/rising_to_the_challenge/india/india-cap.pdf

13. http://www.dawn.com/2006/07/24/ebr1.htm

14. www. sbp .org.pk/ reports / annual /arFY03/qtr-index-eng.htm

15. SECP - Annual Report 2007, 2008, 2009.

16. Dawn News, Economic & Business Review- March, April, May 2010 Issues.

17. Daily Times- March, April, May 2010 Issues.

18. Pakistan & Gulf Economist: Reforms In The Capital Market, Rizvi, Shamim Ahmed (2003).

19. http://www.livetradeonline.com/252growth.htm

20. http://www.insipub.com/ajbas/2009/2344-2349.pdf

21. Bashir Ahmed Khan, Former member of SECP- Policy Board.

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http://www.insipub.com/ajbas/2009/2344-2349.pdf

http://www.livetradeonline.com/252growth.htm

http://www.sbp.org.pk/reports/annual/arFY03/qtr-index-eng.htm

http://www.dawn.com/2006/07/24/ebr1.htm

http://www.adb.org/documents/books/rising_to_the_challenge/india/india-cap.pdf

http://www.dawn.com/2003/02/24/ebr11.htm

http://www.brecorder.com/index.php?show=&&id=495901&currMIndex=01&currPageNo=1&query=&search=1&term=2004-10-01%7C2006-12-31&supDate=



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