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SECP- Analysis of Institutions

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A modern and efficient capital market is the backbone of an economy. It plays a crucialrole 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 withoutdeveloping its equity market.

(Rizvi, 2002)

INTRODUCTION

SECP stands for Securities and Exchange Commission of Pakistan. The Securities and ExchangeCommission of Pakistan (SECP) is agovernment agency whose purpose is to develop a modernandefficient corporate sector and a capital market based on soundregulatory principles, in orderto foster economic growth andprosperity in Pakistan.

Why does a Country Need a Security & Exchange Commission?

A well- developed stock market reduces investment risk by offering opportunities for portfoliodiversification. 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 institutionstangled laws, corrupt courts, deeply biased credit systems, and elaboratebusiness registration requirementshurt 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 fromunwritten 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 IndiaCompany was the dominant institution in those days and business in its loan securities used to betransacted towards the close of the 18th century.

Lahore Stock Exchange was formed in 1934 and it had a brief life. It was merged with thePunjab 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 wasclosed during partition of the country and later migrated to Delhi and merged with Delhi StockExchange.

Karachi Stock Exchange was founded in 1947. It is Pakistans largest and oldest Stock

Exchange, with many Pakistani as well as overseas listings.Its current premises are situated onStock Exchange Road, in the heart of Karachis business district.

The Lahore Stock Exchange came into existence in October 1970, under the SEC ordinance of1969, by the Government of Pakistan, in response to the need of the provincial metropolis of theprovince of Punjab.

Islamabad Stock Exchange is also one of the three Stock Exchanges of Pakistan and is located inthe capital. It was incorporated on October 25, 1989, and it became fully operational on August10, 1992.

Corporate Law Authority:

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

It had two (2) wings:

y Monopoly Control WingIt constituted the Monopoly Control Authority (MCA), formed in 971, which isresponsible for the implementation of the rules and regulations to prevent a concentrationof the financial and commercial activity

y Corporate Regulatory WingIt dealt explicitly with the enforcement of the companies law, security and marketregulation, 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 throughthe autonomous Monopoly Control Authority (MCA) was replaced by the Security & ExchangeCommission of Pakistan (SECP) in 1999.

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NeedofSECP Formation

The government of Pakistan and its respective regulatory agencies has been striving hard to tamenegative speculations, restore investors' confidence and stabilize stock market for the last manyyears 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, marketwas indecisive between the spell of greed and gloom, investors were living in the state of despairand the country's financial image had been shattered. The market mechanism has not beenworking under the principle of demand and supply, as well as the economic fundamentals for aslong as can be remembered.

(State Bank Report, 2000)

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

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

y 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.

y 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 Governments

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

- In March 1998, the withdrawal of tax exemption granted to corporate holders ofTerm 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 of1997. However, the figures are deceptive as government issues dominate the corporate bondmarketwith corporate bonds accounting for only 1 percent of GDP. Similarly, the equitymarket became more skewed from 1996-1998, resulting in the top five stocks representing morethan 70 percent of market capitalization by May 1998.

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Nucleartestsof2830 May 1998

Finally, in the outcome of the nuclear tests of 2830 May 1998, foreign currency accounts werefrozen and sanctions were imposed by G-8 countries. As a result,

y

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

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

y The negative market sentiment was reflected in the decline of the key KarachiStock 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 ofCorporate Law Authority in 1997 due to its total failure to manage the stock market and theinvolvement of some of its bosses in financial bungling (ghaplay). Securities and Exchange

Commission of Pakistan (SECP) was established as an independent and powerful regulatorybody to cleanse rotten system, create level-playing field and bring all stakeholders under a newregulatory 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 loanagreement between GoP and Asian Development Bank (ADB) whereby $US 250 million wassanctioned for the development of the capital market in Pakistan.

The establishment of the SECP was an important milestone in the evolution of the regulatoryframework for the capital market in Pakistan.The SECP was set up as an autonomous body for the beneficial regulation of the capital marketssupervision and control of the corporate entities and for the matters connected therewith andincidental 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 harmonyin 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 ofbest governance practices.

StructureofSECP:

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

y Security & Exchange Policy Board

y Security & Exchange Commission

Securityand Exchange Policy Board:

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

In addition, it is responsible for advising the Government on matters falling within the purviewof the Act and other corporate laws and to express its opinion on policy matters referred to it bythe 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 privatesector.

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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Securityand Exchange Commission:

The commission has full financial, administrative and operational autonomy and comprised offive 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 thefive commissioners, three, including the chairman, are from the private sector and two would befrom government.

The work of the Commission has been distributed amongst its six (6) divisions, each of which isheaded 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 isheaded 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 needsand scenarios. It also undertakes strict monitoring and vigilance of the corporate sector with aview to promoting transparency, accountability and good corporate governance practices,thereby protecting the interests of investors.

Organizational Division

CompanyLaw

Division

SecurityMarket

Division

SpecializedCompany

Division

Finance&

Company

Division

HR &Training

Division

InsuranceDivision

IS & ITDivisio

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The CLD operates with the following departments.

Registration Department:

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

The Registration Department comprises the following Wings:

y Registration and Licensing

y Investigation and Compliance

y 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:

y Enforcement I

y Enforcement II

y Enforcement III

Insurance Division:

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

y Non-Life Insurance

Company Law Division

Registration Department Enforcement Department

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y Life Insurance

Finance& Admin Division:

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

This division has been organized into the following departments:

y Finance & Accounts Department

y Administration Department

Human Resource & Training Division:

The Human Resource & Training Division is headed by Mansur Ahsan, Executive Director. It isresponsible for various activities that include manpower planning, recruitment, selection andcapacity building of the SECPs employees.

This division has been organized into the following departments:

y Human Resource Department

y 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 specializedcompanies (except insurance companies). Its functions include licensing, monitoring, regulatorycompliance and enforcement of all applicable laws.

PensionWing: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 PensionSystem, on a longer term, it would devise a regulatory framework for existing occupationalsaving schemes.

Non-Banking Finance Companies Department

The Non-Banking Finance Companies Department (NBFCD) is headed by Executive DirectorMr.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 financeservices, discounting services, housing finance services, venture capital investment, assetmanagement services or investment advisory services), mutual funds, venture capital funds,modaraba management companies and modarabas.

The NBFCD consists of the following Wings:

y NBFC-I

y NBFC-II

y Modaraba

y Monitoring and Inspection

SecuritiesMarket Division:

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

The SMD regulates the primary and secondary markets as well as market intermediaries throughregistration, surveillance, investigation, enforcement and rule making, with the objective ofprotecting investor interest. The SMD also processes and grants approvals to prospectuses forpublic offering of both debt and equity securities. In addition, it is entrusted with instituting

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appropriate regulatory reforms to develop and promote the market, engender investor confidenceand 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:

y Stock Exchanges, Depository and Clearing,

y Policy and Regulation

y Monitoring and Surveillance and Beneficial Ownership

y Capital Issues

y Brokers Registration, Inspection and Investor Complaints

y Commodity Exchange

STOCK MARKET

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

StockExchangesin Pakistan:

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

Securities Market Division

Stock

Exchange,

Depository

and

Clearing.

Policy and

Regulatory

Capital

Issues

Brokers

Registration,

Inspection and

Investor

Complaints

Commodity

Exchange

Monitory

and

Surveillanc

e and

Beneficial

Ownership

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

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

Whatis StockMarket?

A Stock Market is a marketplace that provides opportunities for buying or selling of shares. Thisis 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 togetherentrepreneurs who wish to raise money through the issue of new securities and individuals andorganizations seeking to invest their savings or surplus funds. The stock market thus offersinvestors liquidity or the ability to convert the investments into cash at short notice therebyencouraging the flow of savings into productive ventures.

Roleofastockexchange:

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

Raisingcapitalfor businesses

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

Mobilizingsavingsforinvestment

When people draw their savings and invest in shares, it leads to a more rational allocation ofresources because funds, which could have been consumed, or kept in idle deposits with banks,

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are mobilized and redirected to promote business activity with benefits for several economicsectors such as agriculture, commerce and industry, resulting in stronger economic growth andhigher productivity levels and firms.

Facilitatingcompanygrowth

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

Redistributionofwealth

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

Corporategovernance

By having a wide and varied scope of owners, companies generally tend to improve on theirmanagement 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 andthe government. Consequently, it is alleged that public companies (companies that are owned byshareholders who are members of the general public and trade shares on public exchanges) tendto have better management records than privately-held companies (those companies whereshares are not publicly traded, often owned by the company founders and/or their families andheirs, or otherwise by a small group of investors). However, some well-documented cases areknown where it is alleged that there has been considerable slippage in corporate governance onthe part of some public companies. The dot-com bubble in the early 2000s, and the subprimemortgage crisis in 2007-08, are classical examples of corporate mismanagement. Companieslike 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 themost widely scrutinized by the media.

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Creating investment opportunities for smallinvestors

As opposed to other businesses that require huge capital outlay, investing in shares is open toboth the large and small stock investors because a person buys the number of shares they canafford. 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. Forinvestors, stock exchanges provide secure and reliable marketplaces in which they can buy andsell shares.

Waysofbecominga 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 outpaying stockbrokers commission. You might see an advertisement in a newspaper from acompany 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 ina branch of the designated bank(s).

Right IssuesRight 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 existinginvestors have the right to subscribe to these new shares in proportion to their respectiveshareholdings.

Trading MarketThe most common way of buying/selling in the stock market is through trading in thesecondary market. Through a stockbroker, you can buy shares from existing investors who wishto sell them and vice versa.

Sharedealing:There are various ways of investing in the stock market: you can deal directly inshares, invest through a unit trust or investment trust or let your investment be handled by anadvisor.

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Who are Stockbrokers?

Stockbrokers are your link to the stock market. Their job is to help you get the best availableprice 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 thestockbrokers/agents that you deal with are duly registered with the SECP.

Benefitsfor Getting Listedon StockExchange:

y Improved Debt Capacity: public offering improves companys balance sheet byincreasing equity and reducing debt. In this way, a company may be able to get betterdebt in future on more favorable terms.

y Publicity: IPO is a milestone for any company. If the whole process is successful then itincreases companys value, because IPO provides with free publicity of the company,also many investors, customers, acquisition candidates and strategic partners atestablished public listed companies would like to deal with listed companies because of alower default risk.

y Additionalcompensationalternativesformanagementofthecompany: a publiclisted company has many other alternatives like stock options, stock appreciation rightsand 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.

y Valuationofcompanies: public listed companies are usually valued at premium. Bypublic equity marked as compared to private companies because of liquidity and otherfinancing and credibility reasons. Public companies get more attention of businesscommunity and financial press as compared to private companies and hence areconsidered less risky and safer by investors and shareholders.

y Acquisitions: public companies may acquire other companies by stocks as compared tocash or debt. So, they can cash for other operating activities, if a companys stock has ahigher multiple of earnings then cost of the acquisition may get reduced.

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

y CapitalAccess: Public company may get more cash from public equity and debt capitalmarkets at lower cost as compared to private companies which borrow at higher costfrom traditional financing sources.

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y 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 theminimum period of stock ownership.

The RolesofSecuritiesand Exchange Commissionof

Pakistan

The Securities and Exchange Commission of Pakistan (SEC) is an autonomous statutory bodythat is entrusted with the integrated administration and regulation of the capital markets,corporate sector and financial (non-banking) sectors in Pakistan. SECPs regulatory ambitextends to the Insurance sector, NBFIs and to the significant components of capital markets suchas Stock Exchanges, Commodity exchange, CDC, NCCPL, beside the vast and growingcorporate sector. The Policy making for each of these areas also falls under SECPs purview that

entails not only the revision of existing laws and regulations to bring them in line with bestpractices 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 capitalmarkets of the country as progressive, transparent and efficient markets, employing bestpractices and safeguarding the interests of the investors at large.As the regulator of an emerging market the SECPs regulatory philosophy is based on theprinciple of developmental regulation. SECP, therefore, laid considerable emphasis on marketdevelopment while administering and enforcing various corporate and securities laws. SECPsregulations 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 thetraditional role of the Securities and Exchange Commission of Pakistan.

1. RegulatingtheissueofSecurities

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

2. Regulatingthe businessin StockExchangeandOthersecuritiesmarkets

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

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3. MonitoringtheCapitalMarkets

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

y

recognize various changes and problems which may occur.y gather the information about the reasons of the fluctuations in the markets,

y detect the flaws in the policies,

y 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 imposedpenalties 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, pricemanipulation, 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 StockExchange were issued warning letters for possible violations. Two banks were alsoissued 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

y The SECP also register and regulate the working of stock brokers, sub-brokers, sharetransfer agents, bankers to an issue, trustees of trust deeds, registrars to an issue,

underwriters, portfolio managers, investment advisors and such other intermediaries whomay be associated with the securities markets in any manner.

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

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

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

5. Prohibiting Fraudulentand Unfair Trade Practices

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

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

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

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6. Promoting Investors Educationand Training

For helping the capital markets of our country the SECP has

y

designed numerous programs to educate the investors. The basic purpose of theseprograms is to make the investors able to understand the nature of capital market.

y The SECP is also training the intermediaries of the securities markets. This will leads tothe better understanding between the SECP policies, investors, and the Capital Market.

7. Callingfor Informationand Undertaking Inspection

As we discussed above that the SECP can conduct investigation in respect of any matter that isoffence under the SECP Act, 1997. The SECP can also call for the information and undertake theinspections, conduct inquiries and audits of the Stock Exchanges and intermediaries and self-

regulatory organizations in the securities market. For example; through the inspection of thematters the SECP can solve the problems of the capital market with having the clearer picture ofthe matter and as well as the market. By conducting the audit of the Stock Exchanges the SECPenables itself to get the real position of its capital market and comes to know that the either theStock 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 thesecomplaints 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 ReformsofLaw

Its an important role performed by the SECP. SECP consider and suggest the reforms of lawrelating to the companies and bodies corporate, securities markets, including changes to theconstitution, rules and regulations of companies and bodies corporate, Stock Exchanges orclearing houses.

9. Encouragingthe 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 ofthe development of the not only the capital markets but also for the other related markets. TheSECP did all this by making the rules and regulations relating to the markets. SECP has formed aresearch wing for identifying the areas of improvement to make those areas better. The researchwing of the SECP can conduct research in any of the matters relating to markets.

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10.Regulatingthe Insurance Business

The SECP is ensuring and monitoring compliance by insurers, insurance surveyors and insuranceintermediaries of all laws, rules and regulations pertaining to insurance for the time being inforce. SECP is also regulating professional organizations connected with the insurance business

and encouraging the organized development of the insurance market in Pakistan.

11.Maintainingthe Investorsconfidence

SECP plays an important role in maintaining the confidence of the holders of the insurancepolicies by protecting the interests of the policy holders and beneficiaries of insurance policies inall matters, including assignment of insurance policies, nominations by policy holders, insurableinterest, and surrender value of policies of life insurance, and other terms and conditions ofcontracts of insurance.

12.DisclosureofInformationtothe Public

To protect the interests and rights of the investors, the SECP has formed various rules andregulations. On the identification of the SECP various sections of the Companies Ordinance,1984, has been changed. For example, its necessary for the companies listed at any stockexchange 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 toprovide the best information to the public and reducing the chances of fraud.

13.SettlementofDisputes

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

CapitalMarket Reforms by SECP

Capital Market in Pakistan has experienced many ups & down in the past, due to politicalsituations of country accompanied with simultaneous changes in policy relating to CapitalMarket. The equity market of the country had to survive in an atmosphere of absoluteuncertainty. It had become very common to change the policies of the previous government bythe sitting government. Sometime it affected the inflow of foreign resources in the equity marketwith the lapse of time.

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Capital Markets in early sixties and seventies were on its peak as a great number of companies ofdifferent sectors floated/offered their shares to public for subscription which were in generalheavily oversubscribed. In fact general public was then more inclined to invest their funds inequity market. Small investors then used to invest their funds in equity market as the returnoffered 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 declinedtremendously as also the shares offered to the public remain unsubscribed or are not fullysubscribed.

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 wasformed as a regulatory body to build up healthy capital Market in Pakistan. Following are thereforms 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; marketdevelopment; and investor protection and investor education have been implemented. Theseprovided due impetus to development of existing buoyant and broad-based capital market in thecountry.

Riskmanagement Reforms

Reforms, particularly focused to strengthen riskmanagementin the capital market include:

Rationalizationofthecarry-overtrade (COT)system

Badla is a kind of interest and unofficial way of lending money to encourage the peopleto buy shares on borrowed money for a very short period of time and just pay only interest pluscommission rather than entangling their total capital. As the banks encourage the businessmen toexpand their business through borrowed money in the same way, the brokers encourage the

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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 havenothing to do with it, but in badla transaction the buyer gets nothing except a memo ofconfirmation. In bank borrowing, the borrower obtains money physically and pays principal plusprincipal 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 byinvolving too little amount. In actual buying the transactions is one time and ownership of sharesis transferred from seller to buyer permanently while in badla transaction only the value of theshares is changed and ownership is shifted to buyer in token. In short, shares trading under badlatransactions are an artificial way of business means, aiming at luring the innocent people andminting money from them. As a very small amount of money enters the market under badlawhile heavy numbers of shares are traded- this is the reason that it causes negative impact on themarket instead of bringing any significant and positive effects.

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

COT should be for a minimum period of 10 days with the financee having the option torelease 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 afinancial institution.

Inductionofthe T+3 systems

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

In the past, the stock exchanges in Pakistan had been following fixed trading settlementsystem. The trading was carried out for fixed period normally from Friday to Friday to be settledthe following Wednesday. The Exchanges clearing house thus carried the settlement risk forabout ten days. At times the period was even longer than ten days due to holidays or some otherreason. It was particularly high in case of our stock exchanges, which were relatively illiquid andcould be manipulated easily. In the past, many defaults by members occurred due to overexposure 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

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it became a market where people could buy shares with no money and sell without possessingany shares.

The T+3 system is aimed at capping systematic risk and improves efficiency of thesettlement 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 inimproving 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 downsubstantially.

It helps generate liquidity as the buyer will receive the shares and the seller will receivethe cash earlier i.e. on the third day of trade whereas presently both buyer and seller willreceive 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 theworld.

The implementation of T+3 first resulted in reduced turnovers at the stock exchanges andpeople misinterpreted it with faults in the system itself and its inability to complement Pakistansequity market structure. However, the low turnovers were due to the lack of understanding, lackof practice, natural resistance to unknown and parallel availability of the old system. There weresome minor dislocation in the trading system, but it is now back to be normal since the investorshave fully realized its benefits.

Implementationofthecapitaladequacylimitson brokerexposure

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

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

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

working capital.

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

Fraud Investigation Unit:

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Fraud Investigation Unit (FIU) has been recently established within the SECP and is responsiblefor deterring and combating financial crimes in the corporate sector. The focus of the unit is toidentify and investigate financial crimes, including financial crimes risk assessment and itsmanagement, and support in providing assurance for corporate governance and creation ofdeterrence.

Corporate Governance Reforms

Independentmanagement has been appointed at the stock exchanges to run the dailyoperations. The structure of boards of directors of stock exchanges has been changed throughnomination of non-member directors, one of whom must also be the chairman of the board.

Pursuant to the introductionofthe CodeofCorporate Governance in March 2002, theSECP has taken several measures to increase the level of transparency and disclosure incorporate 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 listedcompanies.

Transparency Reforms

For the purpose of enhancing Transparencyin the capital market SECP has implemented thefollowing:

Banned In-House Badla: COT

Establishingacodeofconduct underthe brokers Registration Rules (regulationof

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 brokeragehouses/brokers is being established. The regulation framed comprehensively, lists outdocuments/records, which the brokerage house/brokers would be obligated to present forinspection to a person authorized by the Commission for the said purpose. The basic aim of theseregulations 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 toestablish 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, unlessregistered with the Commission. The registration of brokers and agents under the Brokers andAgents Registration Rules 2001 started on November 1, 2001. These regulations enable direct

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controlling of brokerage activities. It allows smooth operation of stock market and serves as atool for investor protection.

Registration of brokers and agents has had a positive impact on stock market dealings owing tothe 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.

Replacementofthe BlankSelling bygenerallyacceptedandcarefullyregulated 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 doesnt own to buyer in interception of decrease in share price. Theseshares are owned by PARTY-B. When prices fall down SELLER buys from PARTY-B, returnsshare and margin to PARTY-A.

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

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

SELLER

PARTY-A

BUYER

PARTY - BSELLER buys when

share prices are

low

Shares sold in

behalf of

SELLER

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The distinctions among a sale, a short sale, and a blank sale are made by the Regulationsgoverning short selling in the ready market that were implemented in 2002. Under theseregulations, a sale is not subject to any special restrictions if (i) it is backed by ownership ofshares or (ii) a buy transaction before a sell transaction. It becomes a short sale if you didnt ownthe shares or hadnt first executed a buy transaction but had arranged for borrowing the shares

before you sold them.It becomes a blank sale if you hadnt even borrowed the shares sold, i.e.you just sold in thin air.

Lets take a simple example. On Monday, you sell the 500 shares of Hubco you own. You cantender delivery on Thursday, under the T+3 system and receive payment. Else you can squareyour position by buying 500 shares of Hubco later in the day. You are betting on the prices goingdown. Youd receive the profits on squaring if the price indeed fell. If you werent lucky and theprice rose youd have to pay the losses.

If you didnt have the 500 Hubco shares, but you first executed a buy transaction of 500 shares,youd still be fine because you had a claim on what you sold. You might have bought the sharesfractions 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 andsold at another trying to arbitrage away the price differential. As long as the sale transaction isnot before the buy transaction, it is legal and does not attract any special restrictions.

If you didnt have the 500 Hubco shares, but you had first borrowed them before selling them,youd be making a short sale. If you didnt 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 buyback 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 doesnthave but he might have to deliver.

(ii) Blank seller steals away money from other investors by manipulating the prices. Byputting in blank sales and creating selling pressure, the seller tries to mislead othersinto thinking that the prices are falling due to genuine selling so that others also startselling. Once the price drop is artificially magnified and accelerated, the blank sellersquares 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 doesnt have theshares. If contrary to his expectations, market moves against a blank seller, he wouldhave to square at substantial losses that he might not be able to bear. Moreover, if heis unable to offset his position, delivering shares that he never had can become verydifficult.

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sources. CNS is understood to mean a system in which the clearing members would have theoption of carrying over their positions to the next settlement day as opposed to the presentsystem 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 ofdelivery or payment except of a mark to market charge.

In CNS, clearing members are required to settle only with the clearinghouse rather thanthe counter party, which would minimize the risk of default. Other settlement options underNCSS 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. Effectiveinformation systems were installed within the SECP.

NCSS has provided much required stability to the market by capping the systemic risk toa great extent. With the launch of the System, the capital market has gotten to work understandard 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 fortrades on their respective exchanges. Other features of the NCSS include a mark-to-marketmechanism, formal stock lending and position financing.

DemutualizationofStockExchanges

The most important and debating step taken by the Securities and Exchange Commission ofPakistan (SECP) was the Demutualization of the three stock exchanges. It is important thatmore than 85 percent of worlds leading stock exchanges have already been demutualized.

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

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

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PERFORMANCE OF SECP

Over 4-5 years SECPs vision is to get more companies listed

(Says, Former Member of Policy Board)

SECPs focus is on quantity of companies rather than developing an efficient, transparent andprogressive Capital Market.

0

100

200

300

400

500

600

700

800

900

FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08

Total No. Of Public Listed Companies

Total No. Of Public Listed Companies

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Number OfNew Listed Companieson KSE

StockMarket Liquidity:

Graph show the market liquidity (Turnover Ratio) at Karachi Stock Exchange during the years2003 to 2008. The analysis shows a continuous decline in the market liquidity within the studyperiod has occurred at KSE. The market liquidity has declined from 4 to 3.42 in the year 2004and it further declined to 3.11 in the year 2005. The market liquidity went down to its bottomfrom 1.35 to 0.25 from the year 2007 to 2008.

Turnoverratio

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The StockMarket Concentrationat KSE:

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

Analysisand Results:

The Capital Formation at Karachi Stock Exchanges is divided into two categories viz. The Equity and theDebt Instrument (Bonds/Debentures). The Equity is a big and major source of capitalization, which hasbeen started, with very first day of operation of the stock exchange in 1948 and the debt instrument isvery latest mode of finance, which was introduced in the year 1995. As it is discussed above that theinvestments 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 theTable

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MARKET CONCENTARTION IN KSE (%)

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.

Reasonswhydo Companiesnotgetlisted?

y DisclosureofFinancialresults: Public companies have to disclose their financialresults, management compensations and transactions between company and managementor principal shareholders to SECP periodically. In addition to this, public companies haveto disclose any kind of positive or negative developments through press releases. In thisway, public companies lose their confidentiality and any weak decision is subject tocriticism by its competitors.

y Outsidepressure: Public companies have to make their revenues look good in shortterm because of expectation of public shareholders. This pressure adversely affectscompanys long term goals.

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

y Ongoingextraexpenses: there are numerous expenses which specifically apply topublic companies like printing and distribution expense of annual reports and proxystatements, fees of lawyers, accountants and transfer agents, besides that, public companyhas a potential liability for misstatement and omissions in public disclosures.

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

y Needmoreemployees: companies need more skilled personnel for dealing thisinvestors, business journalists, securities analysts, and SECP officers. So, this is anotherextra cost which companies have to bear.

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y Dividends: public limited companies, power of management and initial investors getdecreased 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 ofthe company. So, extra time, money and effort are required for execution of any kind of

transaction requiring the permission of shareholders.

y Shareholders as owners of company

y Price Earningmultiple: The most common measure of how expensive a stock is. TheP/E ratio is equal to a stock's market capitalization divided by its after-tax earnings over a12-month period, usually the trailing period but occasionally the current or forwardperiod. The value is the same whether the calculation is done for the whole company oron a per-share basis. The higher the P/E ratio, the more the market is willing to pay foreach dollar of annual earnings.

EarningsMultiple: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 17UK 14.4

KSE 11.48

Telenor and Mobilink doesnt get listed on KSE, according to PE Ratio its better for them to getlisted on Indian stock exchange or any other Stock Exchange for capital generation, they wouldbe able to raise the same amount of capital by floating less number of shares.

Delistingofcompaniesfrom StockExchange:

More than 75 companies were de-listed from the Karachi Stock Exchange during the last fiveyears. 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 theemphasizingondividendpayments 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 modernizetheir 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 inharmonized way to develop the stock market as deterministic and reflector of the economy. ThePlanning authorities should identify the priority sectors with the help of information and trendsprovided by the Ministry of Commerce and Ministry ofIndustries, while, the Securities and

Exchange Commission and the State Bank of Pakistan should develop the strategies to promotethe investment in those priority sectors through debts and equity financing by institutional andindividual investor.

ReasonsforDelisting

S. No ReasonsforDelisting 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

AnalysisofSECPs Ineffectivenessinregulatingstockmarket

y

Lackofgoodgovernance

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

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

Governments economic managers, some of whom are perceived to be quite close to bigstock brokers, used to proudly claim that KSE was best performing market of the worldand a rising KSE-100 was barometer of Pakistans economy. They did not care that KSEsbest performance was merely based on percentage increase in KSE-100 and this index andthis market have very limited economic relevance and hardly any link with life of a commonman.

y Deviationfrom SEC Act 1997

Despite SECPs autonomy under the SEC Act 1997, federal government exercises directpowers over this regulatory body, which include

- Power to appoint its chairman, other commissioners and chairman ofSECPs policy board.

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

y InterferenceofGOP

Taking advantage of governments political stakes in stock market, some powerful stock brokershave turned KSE-100 into a negotiating tool. All they have to do to block and even malign SECPis to cause a downfall in the index.

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

y SECP hasnot beenabletoprotectshareholdersrightsandinterests

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 Courtif it fails to ensure justice to them.

(Dawn News, Tuesday, 30 March 2010)

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y SECP isitselfresponsibleforcrises

There is much that SECP could have done, but did not do, to improve its governance and lay asustainable foundation for regulation. Reality is that core elements of good governance havebeen 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 tooversee its performance and make policies regarding SECP. Conventionally, SECPschairman has also been the chairman of policy board. Clearly, this sort of overseeing doesnot help. Composition of policy board is specified in SECP Act. It has no representation frominvesting 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 forthemselves. Members of policy board from private sector are also chosen so that they wouldlook good on paper and be toothless in practice.

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

It was well within the domain of SECP to recommend to federal government to let anindividual, other than its chairman, chair its policy board and take its first step towardsinternal accountability something it still hasnt done.

2. Transparency

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

SECPs annual reports tend to give a highly exaggerated account of SECPs performance.I

f onewere 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 SECPs chairmen by publishing their photos on the cover.SECPs website is also full of meaningless information about its vision, mission, strategy etcfocusing more on SECP rather than the needs of investing public. It was always SECPs own

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decision to make fair and full disclosure of its financials and regulatory performance to thepublic - 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 andSECPs internal dynamics, chairmen and those commissioners, whom the chairman likes, run theshow with minimal delegation across the organization.

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

WeaknessesofSECP

The retarded growth of Capital Market in the Pasthas been due to a variety of factors, of whichthe following are significant:

y Public companies and public sector enterprises were not encouraged to list on the stockexchange because government interest rate and credit allocation policies distorted theprice structure of equity finance relative to loans from financial institutions and othersources. This stimulated excessive reliance on debt financing and led to high debt-equityratios.

y Public companies received funding directly from the government either throughappropriations from the national budget or at relative low interest rates from state-

controlled financial institutions.

y The majority of private sector firms have tended to be relatively small and consequentlytheir needs have tended to be modest, mainly confined to meeting working capitalrequirements. The firms have been able to generate the required finances from personalloans and their own contributions and related earnings as well as short term loan facilitiesfrom commercial banks.

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

y 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.

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

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

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

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

y There is lack of appropriate financial information regarding the stock market. Of al the

markets, the stock market is the most diff to comprehend.

Debtmarketcallsforrestructuring

y Difficultyin Financingforcorporations:a) Fiscal slippagesb) Delay behind the latest IMF moneyc) Delay behind other pending funds

The bottom-line is that debt market is the missing element in Pakistans capital markets, and thatthere is a need for a substantial (considerable) rise in corporate financing via issuance ofcommercial papers and bonds - something which can help accelerate economic growth of thecountry.

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 andother pending funds, are also crowding out (forcing out) corporations from bank financing. In

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such a scenario, the development of debt markets in Pakistan may provide a new avenue forcompanies to quench (satisfy) their monetary thirst

Nationalvs.international

y Corporate bond market - $3-4 billion

y Stock market - around $30 billion

y Difficult for companies to finance their expansion

Pakistani corporate bond market is under $3-4 billion, which is negligible compared to thesize of its stock market of around $30 billion. This comes in stark contrast to globalstandards, 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 andbonds. These papers are then bought primarily by mutual and pension funds as investmentinstruments.

In Pakistan, however, even AA-rated companies have to go to banks for their financingneeds, 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 theSECP takes months to grant approval for their issuance, whereas taking a loan from abank is much quicker. Even in cases of launching mutual funds, sometimes it takes sixmonths 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 suchsecurities. 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 tradingsystem 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 throughBATS, 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 governmentcontinues to offer very high rates on National Savings Scheme, which is crowding out theprivate sector and encouraging investors to lend to the government rather than the privatesector. 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, whichstill needs to be accomplished. Market forces demand a more vigorous financial market in thecountry. Some measures that can be taken to improve the functioning of capital markets inPakistan are:

Efforts must be made to increase the depth and breadth of the market by limiting familyownership 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 Auditscommittee should be made strong.

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

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lesson to be learned is that independence, competent people and effective corporate governanceare critical to the success of policy and institutional reform, and sharply focused technicalassistance 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 thecontrol 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 theMinistry 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 andWorld Bank loans for the GoP.

The SECP will be subject to unwarranted political and bureaucratic pressures which will bealmost impossible to withstand and will consequently affect the performance of its duties andfunctions 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 shouldand 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, itshould 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 and3. Strengthening SECPs internal controls, and4. Stop interfering in SECPs 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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10.http://www.brecorder.com/index.php?show=&&id=495901&currMIndex=01&currPageNo=1&q

uery=&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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