This is the third report of the Securities and Exchange Commission of Pakistan (the Commission) covering the year July 1, 2001 to June 30, 2002.

During the year under review, the Commission managed the aftermath of the unfortunate events of

September 11, 2001 through carefully devised and timely regulatory interventions. It was also able to consolidate and deepen the reforms introduced in the securities market in previous years as well as pursue several initiatives covering a wide spectrum of the Commission's responsibilities.

As is well known, the Commission has been assiduously tackling the issue of investor confidence. During the preceding year, the Commission took a number of steps designed to engender faith in the integrity of the market and endeavored to improve the governance and risk management aspects of all the three stock exchanges. Consequently both price discovery and trade settlement as well as investor dispute resolution have become visibly efficient, fair and transparent. During the year under review, the focus of attention turned to the other significant area affecting investor confidence, namely, corporate governance. The Commission deemed it to be of utmost importance to redress the disconcerting reality that there was little faith as to whether the listed companies were being managed for the benefit of all stakeholders, including minority shareholders.

The Commission was eventually able to finalize and implement a Code of Corporate Governance (the Code) by making it a part of the listing regulations, which consequently became applicable to all listed companies. Essentially based on the Organization for Economic Cooperation and Development's (OECD) principles of corporate governance, the Code acquired its present shape after extensive consultations with the business community. Despite this, implementation of the Code was resisted by some elements in the private sector and the Commission had to stand firm to ensure that the initiative was not derailed.

Other areas related to corporate governance, like dissemination of adequate and timely information as well as the issue of reliable audits, were also addressed by the Commission. Listed companies were directed to:

The observance of International Accounting Standards (lASs) was enhanced further and by end-June 2002, a total of 38 out of 41 lASs had been adopted. Furthermore, the Commission also directed that an auditor found guilty of professional misconduct would not be allowed to audit the accounts of listed companies for a period up to three years, as may be determined by the Commission.

All these measures appear to have had a salutary impact on the level of investor confidence and we are now witnessing a qualitative change in the market, as reflected by a significant rise in the proportion of "real" investments (as distinct from "squared trades" and "carry-over transactions", i.e. trades carried forward to a subsequent settlement period) from as low as 1 to 2 percent of transactions' volume to over 10 percent. The performance of the market was also ranked as among the best in the world, largely, as a consequence of enhanced investor confidence arising out of the proactive regulatory approach adopted as well as the market's visible under-valuation in relative terms. For a variety of reasons, this has yet to translate into an upsurge in new equity offerings albeit there occurred a large number of corporate debt issues (Term Finance Certificates), mobilizing an aggregate of Rs. 10.13 billion, mainly in order to enhance capacity or re-profile balance sheets.

In addition, the Commission, as a regulator, has been entirely transformed through implementation of a drastic restructuring program that was largely completed during the year under review. The institutional capacity has been greatly strengthened through appropriate re-organization, staffing, training and automation. The Commission new has reasonably well-functioning units that keep the market under surveillance, enforce the laws it administers, closely monitor and try to foster the various specialized institutions it regulates, and keep vigil to ensure that the various activities under the ambit of the Commission are performed effectively and efficiently. While there is considerable ground that is yet to be covered, it is felt that in many respects the Commission is approaching international standards in the discharge of its regulatory responsibilities.

Enforcement of corporate and securities laws (as well as legislation governing institutions within the purview of the Commission) was specifically emphasized during

the year under review. As a result of effective enforcement actions taken by the Commission -vastly exceeding those taken in any previous year -the corporate sector appears to have become much more responsible and disciplined and the quality of corporate disclosure, including financial reporting, has greatly improved. The impact was similar when the Commission tightened its enforcement screws vis-a-vis auditors, stock brokerage houses, modarabas and insurance companies.

It is noteworthy that insurance companies were asked to enter into reinsurance arrangements with reinsures that had a minimum 'A rating and later those companies that were unable to do so, possibly due to reduced global reinsurance capacity, were asked to obtain a satisfactory "claims paying ability" or "financial strength" rating from a recognized rating agency. Insurance companies that could not comply with either requirement were barred from engaging in further insurance business, thereby saving the general public from being offered potentially unworkable insurance policies. It is also a matter of satisfaction that the Commission was able to enforce the minimum capital requirement imposed on leasing companies and that the sector is largely in compliance with this stipulation. Further, in order to clean up its corporate registration records, the Commission launched, and successfully implemented, carefully devised schemes to regularize the default of private and non-listed public companies with respect to their reporting requirements and to facilitate dormant companies exit out of the register of companies.

Further, in line with evolving international practice, the Government decided to consolidate the regulation of all financial institutions, other than commercial banks and Development Finance Institutions, under the regulatory purview of the Commission;

and also to institute the concept of Non-bank Finance Companies (NBFCs)- essentially an umbrella approach whereby the same institution, i.e. an NBFC, can be licensed to engage in one or more financial services provided it meets the prescribed regulatory criteria for each of these services. In response, the Commission geared itself with staffing readjustments in addition to proposing needed legislative changes and preparing a set of comprehensive rules to serve as the basic regulatory framework for NBFCs.

Among a variety of developmental measures taken by the Commission, approval was granted for establishing, under the aegis of the Karachi Stock Exchange, the framework of an over-the-counter, quote-driven market targeting closely held or smaller capitalized companies as well as debt securities. This would appropriately tier the stock market with trading modalities determined to suit each tier. While trading in futures contracts of 13 highly liquid shares commenced in July 2001, towards the end of the year, the Commission approved, in principle, the setting up of an exchange to trade futures contracts in commodities. Also, the Commission was able to see its way around a few impediments and approve the first securitization transaction, which should be a harbinger for others to follow. Overall, the Commission would appear to

have consistently acted in consonance with its declared mission, namely: "to install and sustain a dynamic, modern, and proactive regulatory body that provides impetus for the development of a fair, efficient and transparent capital market and a robust corporate sector".

While a lot has been achieved in the last two and a half years, there is a lot that still needs to be accomplished. Of the three primary drivers of capital market development which constitute the drip feed into the market, i.e. venture capital, securitization and corporate debt, considerable progress has been made with respect to the latter two as a consequence of satisfactory resolution of impeding issues. Only venture capital remains a problem since the tax aspect has not been appropriately addressed so far. The future agenda of the Commission includes continued efforts to:

In carrying out its regulatory functions, including its developmental agenda, the Commission is fully conscious of the need to adhere to international regulatory benchmarks and to remain in harmony with the convergence in regulatory standards that is evolving in International Organization of Securities Commissions (IOSCO). By proceeding thus, the Commission is likely to move rapidly towards realizing the vision it has set for itself "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".