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REGULATION OF SECURITIES MARKET

Regulation of the Securities Market is the core function of the Commission. The Securities Division (SD) of the Commission monitors and regulates the securities market through powers vested in the Commission under the Securities and Exchange Ordinance of 1969 and the rules framed thereunder, as well as under the Act. SD regulates both the primary and secondary markets as well as market intermediaries. Since stock exchanges are working as self-regulatory organizations, SD essentially performs functions of an offsite regulator. It also takes initiatives for development of securities market. Regulatory functions include monitoring the working of the stock exchanges particularly with regard to the obligations of the brokers towards investors and ensuring smooth functioning of the clearing house and settlement operations. As regards the primary market, it clears offering documents both for equity and debt issues within the framework of the Companies Ordinance 1984. On behalf of the Commission, SD exercises surveillance of the market, initiates enquiries and undertakes inspection and audit of stock exchanges and intermediaries. It also monitors the performance of Central Depository Company (CDC). Its developmental role requires SD to formulate proposals for amendment of laws governing the securities market and the introduction of new financial products and instruments.

SECURITIES MARKET IN PAKISTAN
At present, three stock exchanges are functioning in Pakistan, namely Karachi Stock Exchange (KSE), Lahore Stock Exchange (LSE) and Islamabad Stock Exchange (ISE). Some key statistics about the stock exchanges are given below:-

Trading on all the three stock exchanges is fully automated. The three stock exchanges are also linked to the Central Depository System (CDS) of the CDC which has been operational since September, 1997. All major listed companies have joined the CDS. As on 30th June 2000, 329 companies had joined the CDS, representing 30% of total listed capital. About 97% of trades settled by the stock exchanges are now handled through CDS. Automation of the trading system and operationalization of CDS have enhanced the efficiency of the capital market and has made it more transparent and safer for investors.

PRIMARY MARKET

Primary Market - Equity
The period under review was not very encouraging for new issues. In view of slow economic activity, political uncertainty, high rates of return on Government saving schemes and depressed market conditions where shares of existing companies were available at grossly discounted value with dividend yield of up to 20%, it was extremely difficult for new companies to raise capital from the public. As a result, no company could offer shares for public subscription in 1999. However, in the year 2000 three companies made a public offering, details of which are given in the table below:

Rs. in Million

*    Offered at premium of Rs.5 per Share.
** Offered at premium of Rs.1.50 per share.
It would be observed that only 3 companies could offer their shares to general public over a period of 18 months, of which two were over subscribed and one namely, Al-Meezan Investment Bank was heavily under subscribed.

Primary Market  -  Fixed Income Securities
The corporate debt market in Pakistan is in its infancy. There are several reasons for the slow development of the debt market. Easy availability of funds from banks and development finance institutions (DFIs) to the industrial and commercial sector, encouraged companies to meet their short term and long term capital requirements through the banking sector. The other major impediments towards the development of fixed income securities were high rate of return on national saving schemes and the procedure for offering of securities to general public which was cumbersome, costly and time consuming. However, during the period under review, important policy changes promoted fixed income securities market. Lowering of return on national saving schemes, limited availability of long term funds with DFIs, and simplification of procedure for issue of fixed income securities in the recent past have enabled companies to raise funds from the stock market through issuance of Term Finance Certificates (TFCs), redeemable capital instrument provided under the Companies Ordinance, 1984.  During the period under review, six companies issued TFCs through public floatation as per details given in the Table.

Rs. in million

* Green show option was exercised
The government is also keen that the corporate sector should not rely exclusively on banks or DFIs for meeting their financing needs. In order to encourage the corporate sector to meet their financing needs from the capital market, the Government has allowed tax exemption to individuals and companies on their investment in listed companies.  The Commission also constituted a committee under the chairmanship of Mr. M. Khalil Mian, Chairman, Pakistan Credit Rating Agency (PACRA), in 1999 to review the policy framework for TFCs. Based on the recommendations of the Committee, a number of important steps have been taken for the promotion of TFCs market which include permission to companies to issue abridged prospectus, reduction in listing charges and other related charges by the exchanges and the CDC. All these steps should promote the development of a vibrant fixed income securities market in Pakistan.

STOCK MARKET REVIEW
(January 1999  – June 2000)
During the period under review, the market showed considerable volatility. The year started on a bearish note as the KSE-100 Index drifted downward from 952 on 2nd January, 1999 to as low as 852 on 8th February, 1999 and remained between 861 to 938 during the rest of February 1999. The market started picking up in the month of March 1999, owing to the news of a possible resolution of the Power Projects’ issue and reduction in interest rates. As a result, the KSE-100 index improved to 1,057 by end of March 1999. The market became bullish in April/May, 1999 with the signing of Stand Still Agreement with Hubco and unification of the exchange rate. The KSE-100 Index moved sharply up from 993 on 12th April, 1999 to 1,417 on 24th May, 1999. The impressive growth of 43% during April – May 1999 can be attributed to reduction in interest rates, stability in rupee – dollar parity, de-dollarisation of the economy and optimism about resolution of the Hubco issue. However, the bullish tempo of the market was short lived as the market was soon caught in the bear trap due to flaring up of situation in Kashmir. As a result, the index dropped from 1417 on 24th May, 1999 to a low of 1027 on 23rd June, 1999 and was 1055 by 30th June, 1999.

During the period, July to September 1999, the market moved both ways depending on political developments.  It recovered from 1,066 on 1st July, 1999 to 1,292 on 20th August, 1999.  It again dropped to 1,147 on 7th September, 1999 but improved to 1,210 on September 27th 1999 before closing at 1,199 on 30th September 1999.  The October – December, 1999 period was eventful for the market. The market initially reacted negatively to the removal of PML Government on 12th October, 1999 and as a result, the index dropped from 1,257 on 12th October 1999 to 1,164 on 14th October 1999. It remained below 1,200 for the rest of October. However, the market recovered in November, and consolidated at 1,247 by 30th November 1999. In the month of December, the market became bullish as KSE-100 index moved sharply up from 1,255 on 1st December 1999 to 1,441 on 18th December 1999 and was firm at 1,409 on 30th December 1999.

The bullish tempo of the market continued in the new year. The reports of bumper wheat crop, de-regulation of gas sector companies and setting up of Natural Gas Deregulatory Authority, further reduction in interest rates by 2%, good half yearly results of PTCL, and more importantly, permission to scheduled banks to remit sale proceeds to foreign portfolio investors without the approval of State Bank of Pakistan were major reasons for the upward surge in the market. The index, which was 1,457 at the beginning of January 2000 moved consistently up and rose to 1,773 by January end. The month of February was an extension of bullish tempo as the KSE-100 index for the first time after many years breached the 1,800 level, 1,900 level and 2,000 level. The index, which was 1,457 at the beginning of year 2000, reached as high as 2,013 on 23 February 2000. Thus in less than two months, the market jumped by 38%. In the next few days, profit taking brought some correction in the market, which arrested the rising trend to some extent. The index was 1,931 by the end of February 2000. In the month of March 2000, encouraged by good corporate announcements, expectations of abnormally high profits of the textile sector and aggressive buying by some big operators fuelled the bullish tempo again.  As a result the KSE-100, which was 1,874 on 1st March 2000 sharply escalated to attain its highest level at 2,054 on 22nd March 2000. However, high prices attracted heavy profit selling and the market lost 123 points in just two days pushing down the index at 1,931. Thereafter the market again picked up to close at 2000 on 31st March 2000. The highest turnover in a single day of 536 million shares was recorded on 21st March 2000.

In April 2000, the market moved both ways with bulls trying to keep the market up.  While doing so, they targeted in particular a few selected scripts and pushed their share prices upward.  They were eager to keep the market tempo rising and at times they were successful in doing so. The bears anticipating that a bullish trend on borrowed capital cannot be sustained for a longer period continued to put pressure on the market. The jobbers and shrewed operators took full advantage of the tug of war between bull and bears and resorted to heavy buying/selling to take advantage of the situation. The index, which was 1998 on 3rd April 2000, dropped to 1928 on 10th April 2000. It again jumped to 2034 on 19th April 2000 and later on managed to close at 1901 on 28th April 2000 indicating beginning of bearishness in the market after a long bull run.

Bearish signs were  obvious right from the beginning of  May 2000.  There were reports that some big operators who had built huge positions on borrowed capital in certain scripts were finding it difficult to raise funds from the market. The cost of funds for financing shares (Badla Rate) which was as low as 12% to 14% p.a. for most part of year 2000 went as high as 40% to 50% p.a. for certain scripts. Owing to nervousness and high Badla rate, the KSE-100 Index which was 1921 on 1st May, 2000 dropped sharply and went to a low of 1552 as on 18th May, 2000. By 26th May, 2000 there were clear indications that all was not well at the major exchanges and the long boom period was heading towards a bust - there were reports of dis-honouring of commitments by one broker of KSE and few brokers of the LSE.  On 1st June 2000, the KSE declared one of its brokers as a defaulter while the LSE suspended a few of its members who failed to honour their commitments to the Clearing House. The market was hit by one of the worst crisis, which adversely affected market sentiment. As a result, the Index, which was 1921 on 1st May, 2000 sharply dropped to 1399 on 9th June, 2000 i.e. a fall of 27%. Even good corporate announcements along with reports of abnormally high profits by the dormant textile sector and further reduction in the interest rates/national savings rates failed to reverse the negative trend. The market remained depressed for the first half of June 2000 when KSE-100 index remained below 1500 but by the end of June 2000 the market was beginning to consolidate above 1500 level and was 1521 by 30th June, 2000.

The period under review was characterised by high turnover. The average daily turnover which was 77 million in 1998, moved sharply up to 128 million in 1999 and further to 247 million for 2000 (upto 30th June). Similarly the average daily value traded also rose from Rs.1.8 billion in 1998 to Rs.4.4 billion in 1999 and further to Rs.9.5 billion during January – June 2000.

CAPITAL MARKET POLICY REFORMS
A number of steps were taken towards the development of the capital market during the period under review. These included:

Based on the recommendations of the Committee appointed by the Commission on securitization, Companies (Asset Backed Securitization) Rules, 1999 were notified on 14th December 1999. The rules provide for eligibility of registration of special purpose vehicle and parameters of securitization of assets.

With effect from 30th June 1999, the restriction on companies to issue different kinds of securities was removed and now companies can issue shares of different kinds and classes. Companies Share Capital (Variation in Right and Privileges) Rules 2000 were issued for public opinion.

The Committee constituted by the Commission on Substantial Acquisition and Take Over Law finalised its recommendations and the Commission, after making necessary amendments, submitted the final draft to the Government.

The Commission has framed draft regulations with respect to Employees Stock Option Schemes, which will soon be released for public opinion.

MEASURES TO STRENGTHEN RISK MANAGEMENT
Risk management and market surveillance system of the KSE and LSE were tested during the crisis of May 2000. It was observed that there were several weaknesses and gaps in the existing system which need to be improved significantly in order to restore investor confidence.

Soon after the crisis, the Commission took up the question of strengthening risk management with the managements of all three stock exchanges and the following decisions were taken:

The present exemption in exposure up to Rs.50 million available to brokers will cease effective from 1st October, 2000 and brokers will be required to deposit 5% on exposure up to Rs.50 million.

The requirement of net capital balance for members has been increased from 0.25 million to Rs.2.50 million for exchanges having trading volume of more than 7.5 billion shares in a calendar year and to Rs.0.75 million for exchanges having trading volume of lower than 7.5 billion shares per annum. Members shall be required to file net capital balance certificates with the respective stock exchanges every quarter and with the Commission every year duly certified by a practicing Chartered Accountant. This will be implemented from 1st December, 2000.

The definition of net capital is being redefined to make it more realistic.
Capital adequacy of brokers has been prescribed for the first time.  Stock exchange members will only be allowed to trade up to 25 times their net capital balance. This will be effective from 1st December, 2000.

The existing system of 5 days trading cycle with settlement on the 10th day puts the clearing house of the exchange at high risk. In order to minimise risk, stock exchanges have been asked to switch over to the internationally accepted T+3 settlement system. The exchanges are also in the process of setting up the National Clearing and Settlement System. The introduction of T+3 Continuous Net settlement (CNS) facility would reduce risk substantially.

The exchanges have also been asked to develop regulations for short selling with facilities for lending and borrowing of securities.

FUTURE ROAD MAP FOR THE DEVELOPMENT OF CAPITAL MARKET
The Commission has developed the following road map for enhancing the efficiency of Capital Market in Pakistan.
Setting up of National Clearing & Settlement System  (NCSS)

With the technical assistance of ADB, the Commission is co-ordinating with the three exchanges for setting up of NCSS. The System will be based on rolling settlement on T+3 based on Continuous Net Settlement (CNS). The consultants have finalised the system design and the NCSS is expected to be operational in 2001.

Standardisation of Rules & Regulation of the Exchanges
A Task Force consisting of the officials of the Commission and the three stock exchanges has been set up to standardise the rules and regulations of the exchanges. The task force has been asked to complete the assignment by 31st December, 2000.

Adoption of Code of Ethics For Members of the Stock Exchanges
The Commission in consultation with the three stock exchanges will ensure adoption of a code of ethics for brokers.

System Audit for Brokerage Houses during 2000
The Commission intends to get system audit of at least 10 brokerage houses from KSE, LSE & ISE done during 2000.

Linkage of Stock Exchange with Remote Areas
The Commission has been emphasising upon the stock exchanges to develop infrastructure to provide access to remote areas. This would enable the public to trade outside the premises of the exchange both within the city as well as in different cities.

Internet Routed Trading
The Commission has advised all stock exchanges to develop the necessary infrastructure so as to introduce Internet routed trading in the market. The Commission is also preparing a regulatory framework for e-trading.

Education of Investors
The Commission intends to hold seminars in different cities to create public awareness regarding the capital market. It also intends to publish various brochures for the education of investors.

Setting up Monitoring and Surveillance Wing
The Commission is establishing a Monitoring and Surveillance Wing which will be manned by adequately qualified and trained professionals. The Surveillance Wing of the Commission will have terminals linked to stock exchanges to be able to effectively monitor the price movement. The Commission has also advised KSE to beef up its existing Surveillance Wing and have asked the other two stock exchanges to set up Surveillance Wings.  With the setting up of an effective surveillance system both in the Commission and at the exchanges together with better coordination between the Commission and exchanges will help monitor the behaviour of the exchanges in an effective manner.

INVESTORS’ COMPLAINTS
In order to address investors’ complaints in an effective manner, a special unit called Investors Complaints Cell (the Cell) was established in the office of the Chairman. Prompt and proactive role of the Cell towards resolution of investors’ complaints has not only provided comfort to the investors but has also generated awareness among stock exchanges, brokers and companies to respond urgently to investor complaints. The Commission, however, feels that the arrangements in place for redressal of investor grievances need to be strengthened.  The table below shows the status of complaints received and disposed of during the period under review:

STATUS OF COMPLAINTS RECEIVED AND DISPOSED OF FROM JANUARY 1999 TO JUNE 2000

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