2. Securities Market Division

• 2.1 Overview
• 2.2 Stock Market Review - July 2001 to June 2002
• 2.3 Developments in the Capital Market
• 2.4 Monitoring and Surveillance
• 2.5 Investor Complaints
• 2.6 Beneficial Ownership
• 2.7 Issue of Capital
• 2.8 Review of Prospectuses and Supporting Documents
• 2.9 Inspection of Books and Records of Members

The regulation of securities market is a core function of the Commission. The Securities Market Division (SMD) monitors and regulates the securities market in pursuance of powers vested in the Commission under the Securities and Exchange Ordinance, 1969 and the rules framed there  under as well as the Act. The SMD regulates both the primary and secondary markets, including market intermediaries, along with off-site regulation and monitoring of the stock exchanges. Regulatory reforms and monitoring measures are undertaken by the SMD to deepen the market, engender investor confidence, ensure transparency, improve risk management and enhance governance at the stock exchanges.

During the year under review, major developments took place in the capital market as a result of far reaching reforms implemented by the Commission. Although the Karachi Stock Exchange 100 Shares Index (KSE-100 index) ranged between 1,075 and 1,930, systemic risk was largely contained due to effective risk management measures introduced at the stock exchanges. The lowest levels witnessed during the year followed the events of September 11,2001. The market again experienced a sharp decline between May 18 and May 20,2002, when it lost 252 points owing to tension at Pakistan's border with India. The volatility of the market also exposed certain shortcomings in the Carry-over Trade (COT) system, which prompted both over-trading by weak holders as well as sudden withdrawal of funds by COT financiers. To ameliorate the situation, the Commission introduced several remedial measures during the year that helped in strengthening regulation of the COT market.

The Commission permitted the formation of a quote-driven, Over-the-Counter (OTC) market for listing of smaller enterprises and debt securities. It also allowed establishment ofthe National Commodity Exchange Limited (NCEL), which will allow trading in futures contracts in commodities. These initiatives will widen the scope of activities in the capital market and encourage investment by facilitating investors with varying risk profiles to enter the market.

Other significant reforms during the financial year 2002 include introduction of a two-tier arbitration procedure at the stock exchanges for settlement of claims and disputes;

registration of brokers and agents; and issuance of regulations for short selling whereby short selling in ready marketwill be permitted and regulated in accordance with well-established norms.

The primary market continued to remain dull. There were only three Initial Public Offerings (IPOs) and three offers for sale during the year. Of these six issues, five remained under-subscribed. Only the offer for sale of 10 percent shares of National Bank of Pakistan elicited substantial interest of investors and was, as a result, over-

subscribed. The debt market, however, remained buoyant with 17 new offerings during the year compared to 10 in the preceding year.

The KSE-100 index opened at 1,366 in July 2001 and closed at 1,770 in June 2002, indicating a 30 percent gain. The overall market sentiment was bullish though there was a high degree of volatility.

During July and August 2001, the market remained rather depressed, witnessing low trading as evidenced by average daily turnover of 62.5 million shares. The index fell from 1,337 to 1,258, thereby losing almost 6 percent (80 points) during the two months.

In September 2002, the market was gripped by a bearish spell as a fall out ofthe tragic events of September 11, 2001 in the USA-in fact, there was panic in capital markets all over the world and Pakistan's market was no exception. The stock exchanges remained closed for three days in order to reassess the situation, prevent any runaway sentiment from damaging the market and determine measures to further strengthen the risk management system. The stock exchanges were re-opened with the introduction of new circuit breakers to check market volatility. The KSE-100 index dropped from 1,256 on September 11, 2001 to 1,133 by the end ofthe month. The sharp decline of about 10 percent in the index was clearly in response to the events of September 11 as well as settlement problems arising out of the over-exposure of Crescent Investment Bank, a major market player, to COT financing.

From October 2001 onwards, the market started picking up and the KSE-100 index recorded an impressive increase of 33 percent during the month - after touching its lowest level of 1,075 points on October 2,2001, it rose to 1,425 on October 29,2001. The improvement in market sentiment during the month of October was attributable to a variety of factors such as resolution of over-exposure of Crescent Investment Bank and positive indications about financial assistance to Pakistan, including expectations of a debt write-off and reduction in interest rates.

This upward swing of the market was, however, arrested in November and December 2001, owing to increase in cross-border tension and apprehensions regarding an all-out war between India and Pakistan. As a result, the KSE-100 index dropped from 1,425 on October 29, 2001 to 1,269 on December 28, 2001, representing a decline of 11 percent.

There ensued a sustained bull rally from January 2002 onwards when the KSE-100 index moved from 1,322 on January 1, 2002 to as high as 1,930 on March 14, 2002. The market then underwent a few corrections and consolidation, with the index ranging between 1,904 and 1,817 during the period from March 15 to May 9, 2002. Thereafter, the market turned bearish during the remaining part of May 2002, with the index ranging between 1,817 and 1,527 - closing at 1,663attheend ofthe month.

During June 2002, the market remained mostly bullish as the KSE-100 index moved up from 1,648 on June 3, 2002 to as high as 1,791 on June 10, 2002 and was 1,770 atthe end of June 2002.

The bullish tendency in the market could be attributed to a numberof factors, including improvement in Pakistan's international relations in the post September 11 scenario, rescheduling of international debts, removal of economic sanctions, decline in interest rates, low level of inflation, trade concessions, economic assistance extended by a number of countries, cooperation with international donor agencies, large foreign exchange reserves and a relatively stable exchange rate. The KSE-100 index reached the level of 1,931 on March 14, 2002 and the KSE was ranked by several international economic commentators as one ofthe best performing markets in the world.

The carry-over market movement closely paralleled that of the ready market. Betweet September 2001 and June 2002, the daily traded value in COT averaged Rs. 3.5 billion with a low of Rs. 0.03 billion on July 13,2001 and a high ofRs. 11.5 billion on February 8, 2002.

The newly formed futures contracts market also registered substantial growth. The average daily turnover in futures increased from less than Rs. 0.5 billion in September, 2001 to more than Rs. 1 billion in June 2002. Average traded value of futures, as a percentage of traded value in the ready market, also increased from about 30 percent to 45 percent during the same period.

Market volatility during the year remained higher compared to the previous year. During financial year 2002, volatility of the KSE-100 index atcbsing level, as measured by standard deviation, was 256 points whereas it was 90 points in the preceding year. Despite the increased volatility, serious systemic risk issues did notarise owing to effective risk management measures that lent an element of stability during periods of market turbulence.

Liquidity of the market improved considerably during the year. The average daily turnover of the three stock exchanges for the year 2002 was recorded at 154 million shares as compared to 134 million shares during the previous year.

The KSE continued to have more than 75 percent share of the total turnover of all the three stock exchanges. However, the share of the Lahore Stock Exchange (LSE) increased from 11 percent to 19 percent during the year. Along with turnover, the traded value at the LSE also increased from Rs. 346 million to Rs. 391 million, representing an increase of 13 percent during the year.

However, despite the improved liquidity, the market continues to lack depth as turnover and market capitalization remain concentrated in the top 15 scrips.

Several measures were taken by the Commission during the year to further enhance market efficiency and investor confidence. The important initiatives in this regard are highlighted below.

In an effortto regulate short selling in the ready market and to bring it in line with international best practice, the Commission approved the Regulations for Short Selling under Ready Market, 2002 in February 2002. Introduction of these Regulations is a significant step towards minimizing market manipulation and ensuring a healthier and more transparent capital market.

In September 2001 and May 2002, the market witnessed abnormal price fluctuations due to the September 11 events and growing cross-border tension between India and Pakistan, respectively. On both occasions, the risk management measures, earlier introduced by the Commission, worked effectively. However, certain weaknesses were observed in the COT system. These weaknesses were discussed at length with various stakeholders including brokers, investors and stock exchanges' management and also deliberated in meetings of the Stock Exchanges Coordination Committee and the Consultative Group for the Capital Market. Based on these deliberations, the stock exchanges were advised to make the following changes in the COT system:

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

The Investor Protection Fund (IPF) and Clearing House Protection Fund (CHPF) have been set up to ensure effective risk management in the secondary market and to protect investors' interest in case of default by members of the exchanges. The Commission observed that the funds were not fully funded by the exchanges and directed them to ensure that the IPF and CHPF become fully funded by June 30, 2007. The requirement has been phased-in so that by June 30, 2002, the exchanges would have to fund at least 50 percent of the actual contributions made towards IPF and CHPF. Thereafter, the funding requirements would increase gradually so that by June 30, 2007, both funds would be fully funded.

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. Section 5A of the Securities and Exchange Ordinance, 1969 provides that 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. The statistics with respect to registrations granted up to June 30, 2002 are presented in the table below.

TABLE Registration of Brokers and Agents

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.

Recently, the Commission, under the Securities and Exchange Ordinance, 1969, directed the stock exchanges to further improve governance and advised them to reconstitute their Board of directors as under:

It is expected that the Boards thus reconstituted and streamlined will not only function better but will also be able to look after the interests of all stakeholders more effectively.

In order to ensure expeditious resolution of investors' complaints, the Commission has approved a two-tier arbitration procedure for the KSE. Under the new procedure, all claims and disputes of more than Rs. 0.5 million, which are not amicably settled otherwise, should be referred to an Advisory and Arbitration Committee (AAC) for resolution or decision. The Committee consists of three members, namely, one member director, one non-member director and the Managing Director. A claim or dispute could be referred by the AAC to a panel of arbitrators. However, claims and disputes of up to Rs. 0.5 million would be resolved or decided by the Managing Director of the exchange. It is expected that introduction of the new arbitration procedure will have a positive impact on engendering investor confidence.

Derivative products give depth to the capital market, providing investors with basic hedging instruments and investment alternatives. The Commission approved the regulations governing futures contracts trading on June 9,2001. Trading in futures contracts made its debut at the KSE on July 5, 2001. Currently, 13 scrips are being traded at both the KSE and the LSE. Stocks are selected for futures trading primarily on the basis of their liquidity.

Regulations for futures contracts have been approved for the Islamabad Stock Exchange (ISE) and trading is expected to commence shortly.

The Commission is currently working closely with the stock exchanges for development of a wider range of derivative products, such as options, index futures, swaps, etc.

In order to regulate futures trading in provisionally listed securities, i.e. securities that have applied for listing but have not yet been listed, it was considered essential to frame new regulations. Consequently, in February 2002, the Commission approved the Regulations for Futures Trading in Provisionally Listed Companies, 2002 for the KSE.

A quote-driven OTC market, essentially for small-cap stocks and debt securities, provides investors with an alternative, convenient and efficient avenue to make investments. Moreover, promoters can set up new projects or expand their operating activities by raising finance in a cost-effective manner in the OTC market where regulatory requirements are less stringent than in case of regular listing. An OTC market provides several benefits to investors and issuers that include the following:

The proposed minimum capital requirement for a company to be listed on the OTC market is Rs. 10 million as compared to Rs. 50 million for the regular market. The minimum public offering will be Rs. 5 million or 25 percent of the capital, whichever is higher.

In May 2002, the Commission approved, in principle, the concept of an OTC market and the stock exchanges are currently in the process of drafting the necessary regulations.

The Commission has approved the establishment of NCEL for trading in futures contracts in commodities. The NCEL will be the first demutualized

exchange and will be sponsored by the KSE, LSE, ISE and other premier institutions of the country. Itwill be the first exchange of its kind in Pakistan and will consolidate commodity futures trading at the national level. The introduction of futures contracts in commodities will offer the investors basic hedging instruments, enabling them to lock-in costs, and will also provide the necessary stimulus to boost investment. The NCEL is expected to be fully operational by the end of December 2002. The rules and regulations governing the futures contracts are currently under preparation by the NCEL.

The National Clearing and Settlement System (NCSS) commenced operations on December 24, 2001. Companies are being inducted in the NCSS in a phased manner. By September 30, 2002, the total number of companies inducted into the system was 150.

Various efforts are underway to educate investors about the significant aspects of investing in securities. The Commission has published a series of Investor Guides to educate existing and potential investors about the investment risks and rewards, the importance and significance of financial planning and, most importantly, the rights and responsibilities of investors and the recourse available to them. The preparation of the Investor Guide series is a part of the Commission's investor awareness program. Information asymmetries provide undue advantages to certain market participants in case of market failure. The Commission, therefore, aims to achieve maximum dissemi nation/disclosure of information to all investors.

The Commission, in February 2002, formed a Consultative Group for the Capital Market. The Group acts as a think-tank for the Commission through regular and wide ranging deliberations on policies and issues currently impacting the capital market. The Consultative Group is headed by the Chairman of the Commission and includes leading experts and practitioners drawn from the capital market along with senior officials of the Commission.

In response to technological advances, globalization, growing competition and, more significantly, concern for investors' interests, stock exchanges worldwide are embarking upon a process of demutualization. Out of the 52 exchanges, represented at the 2001 meeting ofthe International Federation ofthe Stock Exchanges (FIBV), 32 had demutualized while 20 had approved plans for demutualization.

Demutualization transforms an exchange from an entity owned by its members into a commercial, shareholder-owned company. A demutualized stock exchange has a

clear commitment to generate competitive returns for its shareholders as well as to protect the interests of all its customers and those of the broader investor community. Mr. Alan Cameron, former Chairman of the Australian Securities and Investment Commission, conducted a seminar on "Demutualization of Stock Exchanges" in Islamabad in April 2002, which was attended by capital market experts, representatives of the three stock exchanges as well as officials of the Commission. He outlined the reasons, importance and likely benefits of demutualization and informed that all members of the FIBV had either completed, or were in the process of, demutualization.

The three stock exchanges in Pakistan are, at present, considering demutualization and are engaged in analyzing different models/structures of demutualized exchanges.

The Market Monitoring and Surveillance Wing (MSW) was set up within the Commission in October 2000 to fadlitate initiatives in risk management. The MSW has two specific functions: (i) monitoring of systemic risk at the exchanges; and (ii) surveillance to detect general or specific instances of market abuse. The MSW monitors the market by using on-line data available on the websites of the exchanges. It takes cognizance of price and turnover aberrations to determine possible market malpractices, such as blank selling, insider trading, etc.

The MSW issues a comprehensive market report at the end of every day, which focuses on the latest market information and risk parameters. In view of the importance of risk management in the COT market, a daily report specific to the COT market is also prepared and distributed within the Commission.

The MSW steered the investigation committee formed to determine violations of the Commission's restraint order with respect to blank selling on September 12, 2001. The committee pointed out various weaknesses within the prevalent system at the stock exchanges that made it difficult to check the violations and highlighted the need for forming specific regulations governing blank and short selling. These regulations were subsequently framed with the assistance of the MSW and have been in force since March 2002.

In May 2002, when the market witnessed a sharp decline, the MSW played a key role in collection and analysis of the COT market data. Based on the conclusions drawn in that study, a number of important risk management practices have been proposed by the Commission for the COT market.

The MSW is also spearheading the establishment of surveillance wings at the stock exchanges so that they can work closely with the Commission to enhance the effectiveness of monitoring and surveillance exercises.

In orderto enhance its monitoring and surveillance capacity, the MSW is in the process of developing the Market Surveillance Software (MSS). The project has been assigned to a leading IT firm and will be fully operational by the end of December 2002. This software will not only enhance the ability of the MSWto procure near real-time information from all the three exchanges but will also generate alerts whenever an unusual trading pattern is detected. The MSS will also be used by the surveillance wings at the three exchanges, which will work in close coordination with the MSW.

The Investor Complaints Wing within the SMD has emerged as an efficient and effective instrument for the protection of investors' interests, in particular, those of small investors. The Wing has successfully brought about quantitative as well as qualitative improvements to redress investor grievances, which are partly reflected in the statistics presented below.

B"ABLE3 Investor Complaint Statistics (July 1,2001-June 30, 2002)

As a result of expeditious resolution of investors' complaints, there is greater awareness amongst investors and brokers regarding their rights and obligations as well as enhanced confidence in the enforcement of these rights and obligations. This is a significant achievement of the Investor Complaints Wing. By gradually channeling investors' complaints to the relevant stock exchanges and monitoring the resolution of these complaints, the Wing is also attempting to develop the institutional capacity of the stock exchanges to handle and resolve the complaints. As a result of these efforts, the stock exchanges have started addressing investors' complaints in a more effective manner. Further, as a priority, the Wing seeks to eliminate basic anomalies within the systems, procedures and relevant regulations of the stock exchanges to achieve more efficient redressal of investors' complaints.

In order to protect the interests of minority shareholders and to discourage the management of listed companies from making windfall gains on the basis of privileged inside information, every director, chief executive, management agent and person holding 10 percent or more shares in a listed company is required to file certain prescribed returns for beneficial ownership. Also, any gains made by beneficial owners in transactions completed (purchase and sale or sale and purchase) within a six-month period are to be reported to the issuer and the Commission and tendered as stipulated in the law. During the year under review, the Commission finalized five
cases of tender able gain, aggregating Rs. 9.5 million, out of which Rs. 6.6 million have been tendered to the Commission while two beneficial owners have filed appeals before the Appellate Bench of the Commission.

During the year, Rule 16 of the Companies (General Provisions and Forms) Rules, 1985 was amended in order to exclude acquisition of right shares from the determination of tender able gain.

The Capital Issues Wing of the SMD deals with approval of prospectuses for public offer of securities. Under the Companies Ordinance, 1984, the prospectus of any company inviting public subscription for its securities is required to be approved by the Commission prior to its issue, circulation and publication. The Wing also deals with cases relating to further issue of capital and inter-corporate financing.

During the year under review, there were six public equity offerings as compared to two in the preceding year. In addition, there were 17 offerings of debt instruments in the form of Term Finance Certificates (TFCs) as compared to 10 in the preceding year, which is a clear illustration of growing investor interest in TFCs.

The table below provides a comparison of share capital and TFC offerings during the year.

During the financial year 2002, there were three offerings of fresh equity capital. The total amount offered to the general public was Rs. 944.5 million whereas the amount of capital listed on the stock exchanges stood at Rs. 2,807.6 million. The relevant details of the three offerings are given below.

Further, during the year, there were three secondary offerings of shares (disinvestments) involving shares aggregating Rs. 341.5 million in value based on the offer prices. The total capital listed on the stock exchanges was to the tune of Rs. 4,530.7 million. Details of the secondary offerings are presented in Table 6.

Companies can raise further capital by way of pre-emptive rights and/or bonus issue of shares withoutthe approval of the Commission. In certain exceptional circumstances, listed companies may also be allowed to raise capital without the offer of right shares. In this regard, the Commission received 11 applications, of which seven were approved during the year.

Companies may issue shares at a discount to face value, if so approved by the Commission. During the year, seven listed companies were allowed to issue shares at varying discounts to the respective face values of their shares.

Under Section 90 of the Companies Ordinance, 1984, read with Companies Share Capital (Variation in Rights and Privileges) Rules, 2000, companies can issue more than one kind of share capital. During the year under review, three companies, namely, Security Leasing Corporation Limited, Fauji Cement Company Limited and Natover Lease and Refinance Limited were allowed to issue preference shares.

The law restricts companies to invest in their associated companies/undertakings up to 30 percent of their paid-up capital and free reserves. However, in certain exceptional cases, this limit can be relaxed. In this regard, the commission received 12 cases for relaxation, ofwhich eightwere approved.

The year under review was the best so far in respect of raising funds through debt instruments in the form ofTFCs. The TFCs are gaining popularity among investors due to a number of factors, like (i) attractive rate of return and safety of principal amount invested; (ii) substantial decline in returns offered by the National Savings Schemes (NSS); and (iii) restrictions imposed on institutional investors for investing in NSS.

During the year, approval was granted to 17 companies to issue TFCs involving an aggregate amount of Rs. 12.9 billion. Of this amount, Rs. 10.1 billion (inclusive of green shoe option) has already been raised: Rs. 7.4 billion through private placement and Rs. 2.8 billion from the general public. The balance will be raised through floatation of subsequent tranches ofTFCs. While TFCs are mostly offered on the basis of floating returns with a specific floor and ceiling, Sitara Chemical Industries Limited issued a debt instrument on a profit and loss sharing basis.

Table 7 summarizes the relevant details of the 17 debt issues offered for public subscription during the year under review.

"The green shoe option was not exercised. "The company was allowed to retain the entire over-subscribed amount.

During the year under review, the Capital Issues Wing initiated a review of prospectuses and supporting documents with a view to improve the quality of disclosure and rationalize the contents of these documents. After due consultation with the stake holders, the Commission issued guidelines to help the issuers in providing complete disclosure of all material information to investors. The guidelines, inter alia, stipulate the following:

(i) language of the prospectus should be simple, clear and concise;

(ii) all foreseeable risk factors and management's perception of these factors should be adequately disclosed;

(iii) the primary purpose of the issue should be explained in appropriate detail and the use of subscription proceeds should be specified;

(iv) the disclosure of dividend policy should be meaningful;

(v) all material information, such as changes in key personnel, statement of capital structure before and after the issue and material expenses of the issue, should be disclosed; and (vi) the prospectus should not be used as a marketing tool and printing of photographs and fancy formatting should be avoided.

Further, to facilitate investors and broaden the scope and readability of prospectuses, the Commission has, through these guidelines, encouraged the publication of prospectuses in Urdu as well as in English languages. In addition to the guidelines, a complete checklist of the documents required to be submitted along with the application for approval of prospectus has also been issued and posted on the Commission's website.

Rule5 (2) of the Securities and Exchange Rules, 1971, read with Section 6(i)ofthe Securities and Exchange Ordinance, 1969, requires every stock exchange and every director, officer, and member of the stock exchange to prepare and maintain books and accounts, which shall be subject to inspection by any person authorized by the Commission. On April 26,2001, the Commission issued the Stock Exchange Members (Inspection of Books and Record) Rules, 2001. These Rules provide for maintenance of certain books and records by members of the stock exchanges in addition to the records required to be maintained by them under the Securities and Exchange Rules, 1971. The Commission is currently seeking to build its capacity to effectively and efficiently undertake inspection of books in addition to conducting audit of members.