Free and well-developed Equity Market
Equity market is well developed and totally free &
restriction-less for all investor local as well as foreigners. Having fully
automated trading system with separated Central Depository and clearing
company. KSE is FIX Compliant. (Financial Information Exchange Protocol)
State-of-the-art computerized trading system known as Karachi Automated Trading
System (KATS). Internet based routed trading facility. Each and every order/
trade is duly logged & recorded, with pre-trade client-wise margins
verification system effective at order level.
The equity market plays an important role in the economic development of a
country. It helps in the mobilisation of financial resources, both domestic and
foreign. for investment in various sectors of the economy. Moreover, it serves
as an effective medium for exchanging business information among shareholders,
business community, and prospective investors. It is often considered a
barometer that reflects the general investment climate of a country.
In Pakistan, like other developing
economies, the equity market has not played its clue role
because of interventionist economic policies and overreliance on debt
financing. It was not until the mid of 1980s when the importance of an
effective equity market was recognized and steps were
taken to activate the market.
However. the market actually
became active in the beginning of 1991 when it was opened to international
investors. Since then the market
has made considerable progress and improved in size and depth.
PERFORMANCE OF KSE AFTER 2000 AT A GLANCE:
2001 has been quite a
dull year in terms of actual stock market activity in Pakistan. The downward
trend showed the reduction of KSE-100 index. The listed companies were 737
including only three new companies and the market capitalization was Rs.
296.144 billion. During financial year 2002, the KSE had implemented several structural
developments. The KSE-100 index shot up by 2278.54points and market
capitalization also increased up to Rs. 550.55287billion. Only four companies
were listed in Karachi stock market and listed companies reached to 719.The
bullish trend of stock market continued during 2003 and KSE-100index touched the
highest point i.e. 4604.02. The listed companies were 705 in which only 6
companies are new and market capitalization reached up to Rs. 951.55 billion. The
performance of KSE showed improvement in 2004. Seventeen new companies were
listed in stock market and listed companies reached up to 705 and market
capitalization reached up to Rs.1723.454 billion. The continuation of bullish
trend in KSE during 2005 is also observed and KSE-100 index first time cross
10000 points. The KSE-100 index shoots up by 10303.15 points and market
capitalization also accelerated up to Rs. 2467.9 billion. The year 2006
maintained bullish trend momentum and made records in Karachi Stock Market.
KSE-100 index crossed the barrier of 12000 marks and reached 12273.77
points. During 2007 the bullish sentiments in stock market continued. There are
several factors which are speedy privatization process; attracting foreign
investors in prestigious organizations; resolution of IPP(Independent Power
Producer) issue; allowing foreign investors to repatriate their funds without
any restrictions; reduction in the interest rate by commercial banks; recovery
of outstanding/overdue loans; rescheduling of foreign debts and prepayments of
expensive foreign loans. The market capitalization increased up to Rs. 4019
billion and listed companies were 656 including 18 new companies.
Market Indices
KSE 100 INDEX
Karachi Stock
Exchange 100 Index (KSE-100 Index) is a stock
index acting as a benchmark to compare
prices on the Karachi Stock Exchange (KSE) over a period. In determining representative
compaines to compute the index on, companies with the highest market capitalization are selected. However, to ensure full market
representation, the company with the highest market capitalization from each
sector is also included.
The index was
launched in November 1991 with a base of 1,000 points. By 2001, it had grown to
1,770 points. By 2005, it had skyrocketed to 9,989 points. It then reached a
peak of 12,285 in February 2007.[1] KSE-100 index touched the highest ever benchmark of 14,814
points on December 26, 2007, a day before the assassination of former Prime Minister Benazir
Bhutto, when the index nosedived.[2] The index recovered quickly in 2008, reaching new highs
near 15,500[citation needed] in April. However, by November 22, 2008 during the global financial
crisis of 2008 it had fallen to
9,187
KSE 30 INDEX
The Karachi Stock Exchange has launched the KSE-30 Index with base value of 10,000
points, formally implemented from Friday, September 1, 2006. The main feature
of this index that makes it different from other indices are:
KSE-30 index is based
only on the free-float
of shares, rather than on the basis of paid-up capital.
The other indices in Karachi Stock Exchange represents total return of the market. That is, when a
company announces a dividend, the other indices at KSE are not reduced/adjusted
for that amount of dividend (whether cash or bonus).Whereas, KSE-30 Index is
adjusted for dividends and right shares.
At the end of 13
July, 2007, KSE-30 Index reached its highest ever level of 17,162.45.
KSE ALL SHARE
INDEX
In 1995, the need was
felt for an all share index to reconfirm the KSE-100 and also to provide the
basis of index trading in future. By August 29, 1995 the KSE-All Share Index
was constructed which became operative on September 18, 1995.
KMI INDEX
KSE Meezan Index
(KMI-30) comprises thirty companies which qualify by the KMI Shariah screening
criteria. The index was introduced on the Karachi Stock Exchange in September 2008 and the base period for this Islamic
index is June 30, 2008.
The index is
calculated using "free float market capitalization". At any point in
time, the level of the index reflects the free float market value of selected
Shariah-complaint shares in comparison with the base period. KMI-30 is
rebalanced semi-annually.
The guidance is taken
from qualified and well reputed Shariah experts while Shariah complaint of
stocks is done.
Demutualization Overview
Demutualization is the process
of converting a non-profit, mutually owned organization to a for-profit entity
owned by the shareholders. Securities and Exchange Commission of Pakistan has
also been pursuing the process of demutualization of stock exchanges since 2002.
The process involves not only
Corporatization, (which is conversion of a stock exchange limited by guarantee
into an entity limited by shares) but also it segregates ownership and trading
rights. Demutualization brings balance among interest of different stakeholders
in the corporate and governance structure of a stock exchange.
WHY – Demutualization is a well
established global trend and has been adopted by many recognized stock
exchanges around the globe. To bring about an improvement in the governance
structure and to make the stock exchanges more competitive.
WHEN – Several detailed sessions
and meetings were held with the stakeholders (including the management, board
and demutualization committees of the stock exchanges). ISLAMABAD, March 27: The Stock Exchanges (Corporatization,
Demutualization and Integration) Law got approved in a joint session of
the Parliament. This landmark achievement was long awaited since the
passing of the bill by the National Assembly in October 2009.
The SECP has approved various
documents submitted
by the stock exchanges under the Stock Exchanges (Corporatization,
Demutualization and Integration) Act, 2012. And on 7th May 2012 the Parliament’s Act received the assent
of the President. “An Act to provide
for the corporatization, demutualization integration of stock exchanges in
Pakistan for the development of the Capital Markets of the Country”
Introduction
Ø
Capital
market plays a vital role in channeling savings into investments leading in
increased income, employment, and output. Being a developing country, Pakistan
needs a securities exchange that enjoys the confidence of domestic and foreign
investors and able to mobilize both domestic and foreign capital for economic
growth.
Ø
Globally,
stock exchanges have undergone transformation. Advancement in communication
technology and globalization have made it possible for investors and issuers to
move to more efficient capital markets, even if these are location outside
geographical boundaries of their country.
Ø
The
committee was constituted by the SECP to make a comprehensive plan for
demutualization and give recommendations on integration or transformation of
KSE, LSE and ISE.
Ø
In
order to cover its terms of reference, the Committee conducted a consultative
process in which it sought views or core stakeholders – investors, issuers and
members of exchanges – through meetings and questionnaire
Problems Faced by the Stock Exchanges
Ø
Despite
economic growth in the country, companies are not seeking listing at the
exchanges and little capital formation is taking place through stock exchanges.
Issuers do not appear to have confidence in stock exchanges and see minimal
value addition in listing. There is limited free float in the market and it is
coming under increasing pressure due to a disproportionately large growth in
mutual funds and commodity market.
Ø
Investor
base is small. Percentage of adult population that owns shares is less than 1%.
Growth in mutual funds has not led to increase in the number of investors. The
number of shareholders in listed companies has practically remained stagnant
despite the bullish sentiment in the market. The only measure that is expanding
investors base are offers for sale of state owned enterprises.
Ø
In
spite of a series of reforms relating to governance, professional management
has not been allowed to establish firmly in the exchanges. There is a general
view that exchanges are being run by brokers in their own interest. Exchanges
are unwilling or unable to supervise and discipline members and listed
companies. The role of non-member nominated directors in improving governance
is rather mixed. Although they have helped in improving the standard of
governance but not to the desirable extent.
Ø
Due
to existence of three exchanges, liquidity and price discovery are fragmented
and costs escalate for all stakeholders. There is virtually no competition
among exchanges and KSE is the dominant exchange in all market segments.
Ø
Investors
are vulnerable to different forms of market abuse. Market remains rife with
allegations of price manipulation, front running, insider trading and blank
selling. Exchanges do not have the capacity to carry out surveillance and
investigation in market abuse.
Ø
The
management of settlement risk is weak and needs improvement.
Ø
Exchanges
are financially weak. Unlike international exchanges, they derive most of their
income from listed companies rather than trading charges and other fees on
services. They do not have the means to finance capital expenditure that is
required for development.
Ø
Exchanges
are also unable to attract and retain professionals. Most of the staff is
non-management. Due to insufficient economic and human capital, they are unable
to grow and develop like international exchanges.
Ø
Speculative
activity dominates the trading and liquidity is highly concentrated. The equity
market has been distorted by Badla
financing. Due to excessive speculation, concentration, and Badla financing, the market is
exceptionally volatile.
Ø
While
the number of issuers and investors is very small, the number of intermediaries
is disproportionately large. The eligibility criteria for intermediaries are
weak and intermediation is generally of low quality.
Ø
Analysis
of the problems being faced by stock exchanges shows that these are fundamental
in nature and exchanges are fulfilling their economic role and discharging
regulatory responsibilities to a very limited extent.
Demutualization of Stock Exchanges
Ø
Demutualization
can improve governance structures at the exchanges, provide access to economic
and human capital, generate commercial pressures for growth and development,
allow entry of new and better intermediaries, unlock value of membership cards
for members, provide domestic and international recognition, give opportunity
for making equity cemented international alliances, and help change the
perception and image of an exchange.
Ø
International
and in particular Asian experience of demutualization has demonstrated that
after demutualization, the market capitalization, turnover, and products and
services offered by exchanges have greatly increased to the benefit of all
stakeholders. Brokers have benefited from demutualization through higher
commission earned on increased trading volumes, and by capital gains on the
shares, which they received on demutualization.
Ø
The
core concern about demutualization is that it causes conflicts of interest
between the regulatory and commercial role of a stock exchange. A number of
measures can be taken to address this conflict including separation of some
regulatory functions within or from the exchange and greater transparency into
how a demutualized exchange is run.
Ø
The
committee is of the view that Demutualization can help solve problems of the
stock exchanges. However, demutualization should be seen as a means to an end
and not an end itself. It would need to be carefully structured to achieve the
desired results.
Integration of Stock Exchanges
Ø
There
are a number of factors favoring integration, such as geographically neutral
custody and settlement and the ability to provide remote trading terminals.
Ø
There
could be various scenarios in which demutualization and integration take place.
The scenario is which the interest of all stakeholders is best served is the
one in which all three exchanges both demutualize and fully integrate.
Ø
Integration
of stock exchanges can bring cost efficiency for all stakeholders, improve
liquidity and price discovery, increase the pool of economic and human capital,
offer synergies in risk management and surveillance, reduce complexity in operations, lead to focused supervision by
SECP, and provide domestic and international recognition.
Ø
If
KSE, LSE and ISE integrate, the CDC and NCC shall become subsidiaries of the
integrated exchange. This would further enhance cost efficiencies and help in
having a single business strategy and coordinated developments. Due to
integration, NCEL shall also become a subsidiary of the integrated exchange.
Ø
The
core concern about integration is that it would eliminate possibility of
inter-exchange competition. A balanced board of directors, inter-broker
competition, close supervision by SECP, and encouragement of ECN, where brokers
would be able to electronically match orders within the brokerage house, and
possibility of licensing another stock exchange in the future, if necessary,
would address concerns relating to lack of inter-exchange competition.
Ø
The
Committee is of the view that integration can address solve the problems of
stock exchanges. However, like demutualization, integration should be seen as a
means to an end and not an end itself.
Ø
A
number of key issues in demutualization and integration would have to be
address for their successful implementation.
Ø
These
issues include who should take decision to demutualize and integrate the stock
exchanges, compensation to members, composition of the future board of
directors, moratorium period on grant of
new trading rights, self listing of an integrated and demutualized exchange.
The Committee has discussed each of these issues in the light of responses of
different stakeholders and international precedents.
Model 1: Fully Integrated Demutualized Exchange
(FIDE)
Ø
The
Committee recommends that KSE, LSE, and ISE should form a FIDE. With the
integration of the exchanges, NCC, CDC, and NCEL shall become subsidiaries of
FIDE.
Ø
Demutualization
and integration should be effected under special legislation and the two should
take place simultaneously. The decision for both demutualization and
integration should be taken by SECP, as the two processes have implications on
the interest of investors.
Ø
The
process of simultaneous demutualization and integration requires that as a
first step, a new demutualized company be incorporated and licensed as an
exchange (NewSE). Finanacial institutions should be given 60% shares in the
NewSE against cast. Members of the exchanges should be given 40% shares against
consideration other than cash for the transfer of assets of KSE, LSE, and ISE
to the NewSE. KSE, LSE, and ISE should cease to exist and the NewSE becomes
FIDE. Financial institutions and members should disinvest 20% of their holdings
in favor of general public and FIDE should get self-listed.
Ø
All
existing members of KSE, LSE and ISE should be given trading right in FIDE,
subject to fulfilling the legal and other requirements. Those who own more than
one membership card should be given a single trading right. However, their
compensation should be according to the number of memberships held. Since each
member shall be given a trading right in the new integrated and demutualized
exchange, compensation to members is not for the trading rights but for the
perceived ownership rights in the exchange.
Ø
A
moratorium on grant of new trading rights should be placed for one year after
demutualization and integration.
Ø
No
one person should be allowed to hold, directly or indirectly, more than 5% of holding shares without prior approval of
SECP. A person holding trading rights in FIDE should not be allowed to exercise
voting rights, directly or indirectly, of more than 1% of total voting rights
in a general meeting.
Ø
Employment
in FIDE should generally be on a strict basis of merit. However, as between
applications for positions at FIDE who are assessed as equally capable of performing
the role, preference could be given to existing staff at KSE, LSE, and ISE.
FIDE should appropriately compensate the employees that might be made
redundant.
Model 2: National Exchange (NE)
Ø
An
alternative model is being recommended. If sufficient progress is not made
towards demutualization and integration within one year, the NewSE, sponsored
by financial institutions, should become National Exchange (NE) whether or not
KSE or LSE or ISE merge into it.
Requirements
a)
Members
– 200
b)
These
200 members become company(s) themselves and their shares are floated
c)
3
stock exchanges (6.4 shares each) – Depends on the operation
• Not More than 40% strategic
buyer (foreign or any other) – till 2014
• Not Less than 20% float in
market (20 or more)
• Remaining to be held by the
Broker(s)
Critical Success Factors
Ø
The
success of demutualization and integration shall depend on some critical
factors. These are commitment by the SECP, commitment by the Government of
Pakistan, participation and sense of ownership by financial institutions as
shareholders and brokers in the new setup, fair compensation to the members of
KSE, LSE, and ISE, quality of the first board of directors of FIDE or NE, and
quality of the first CEO and key management personnel.
Ø
The
passing of this law is a significant accomplishment which will bring the
Pakistani capital market on par with other international jurisdictions like
India, Malaysia, Singapore, USA, UK, Australia, Hong Kong, Turkey etc. However,
it’s in its implementation stage right now. Demutualization will in turn
enhance governance and transparency at the stock exchanges and will attract
strategic investors which will not only provide equity and technical expertise
but will also result in increased visibility of these exchanges on international
capital market forums.
Recent
Happening/Events
Capital Gain Tax (CGT)
In Pakistan,
securities trading remained exempt from CGT for 36 years till June 30, 2010. In
2010, after the imposition of CGT, investors were required to file the income
tax returns along with declaring the source/evidence of investments for which
they did not have the documented details. New CGT ordinance has been adopted
since April 2012. The tax rate for CGT will be 8 percent and 10 percent for
investment holding up to six months and 12 months respectively till June 30,
2014. NCCPL will be depositing the tax with the FBR on an annual basis. In
addition, no question relating to the source/nature of money will be asked by
the tax authorities if the money remains invested in the stock market for a
period of 45 days (till June 30, 2012) and 120 days (till June 30, 2014) before
and after the promulgation of CGT Ordinance
Broker
A stockbroker is an individual/institution who is
especially trained and certified to participate in the securities market
on behalf of clients and gets a commission/brokerage when the deal is executed.
Why Brokers
Stock exchanges are like clubs and they have members
(i.e. brokers– only people who honor trades are joined as members).Now brokers
need to fulfill certain criteria in order to become member of stock
exchange. Broker can be banks, financial institutions, independent brokers
etc.
Technical Analysis
A method of evaluating securities by analyzing statistics generated by market
activity, such as past prices and volume.
Fundamental Analysis
A method of evaluating a security that entails attempting to measure its
intrinsic value by examining related economic, financial and other qualitative
and quantitative factors.
Traditional Services
·
Obtaining
information about the financial
circumstances of customers and companies.
·
Analyzing
market trends.
·
Advising
on and participating in negotiations .
·
Recording
and transmitting buy and sell orders .
Online
Services
·
Trading
terminals are available for the user convenience.
·
Online
decision making services without the assistance of the broker.
·
Cost
saving benefit for online clients.
·
However
corporate sector prefer to use traditional as compared to online brokerage.
Broker
Client Relationship
Fiduciary
relationship
A broker has a "fiduciary" relationship with their client.
This means the broker has a legal obligation to make a full and accurate
disclosure of the broker's own interest in the transaction.
Conflicts
of interest
The primary responsibility of a broker is to advise clients and act on
their behalf in the purchase and sale of shares, so obviously they cannot trade
in competition with those interests.
Similarly, a broker must tell a client of any information that might
suggest the transaction is not in their interests. They must also have a
reasonable basis for recommending the stock.
Problem
faced by Equity Market
Ø There
is a common view that exchanges are being run by brokers in their own interest.
Exchanges are unwilling or unable to supervise and discipline members and
listed companies.
Ø Despite
economic growth in the country, companies are not seeking listing at the
exchanges and little capital formation is taking place through stock exchanges.
Issuers do not appear to have confidence in stock exchanges and see minimal
value addition in listing. There is limited free float in the market and it is
coming under increasing pressure due to a disproportionately large growth in
mutual funds.
Ø Exchanges
do not have the capacity to carry out surveillance and investigation in market
abuse. Market remains ordinary with allegations of price manipulation, front
running, insider trading and blank selling.
Ø Exchanges
are also unable to attract and retain professionals. Most of the staff is
non-management. Due to insufficient economic and human capital, they are unable
to grow and develop like international exchanges
Ø Lack of the technical skills and knowledge
of investors, brokers and research market analyst.
Debt
vs Equity
Debt vs. equity financing is one of the
most important decisions facing managers who need capital to fund their
business operations. Debt and equity are the two main sources of capital
available to businesses, and each offers both advantages and disadvantages.
Debt
Financing
Debt
financing takes the form of loans that must be repaid over time, usually with
interest. Businesses can borrow money over the short term or long term. The
main sources of debt financing are banks and government agencies, and Business.
Debt financing offers businesses a tax advantage, because the interest paid on
loans is generally deductible. Borrowing also limits the business's future
obligation of repayment of the loan, because the lender does not receive an
ownership share in the business.
However,
debt financing also has its disadvantages. New businesses sometimes find it
difficult to make regular loan payments when they have irregular cash flow. In
this way, debt financing can leave businesses weak to economic downturns or
interest rate hikes. Carrying too much debt is a problem because it increases
the perceived risk associated with businesses, making them unattractive to
investors and thus reducing their ability to raise additional capital in the
future.
Equity Financing
Equity
financing takes the form of money obtained from investors in exchange for an
ownership share in the business. The main advantage to equity financing is that
the business is not obligated to repay the money. Instead, the investors hope
to reclaim their investment out of future profits. The involvement of
high-profile investors may also help increase the credibility of a new
business.
The main disadvantage to equity
financing is that the investors become part-owners of the business, and thus
gain a say in business decisions. "Equity investors are looking for a
partner as well as an investment, or else they would be lender. As ownership
interests become diluted, managers face a possible loss of autonomy or control.
In addition, an excessive reliance on equity financing may indicate that a
business is not using its capital in the most productive manner.
Both
debt and equity financing are important ways for businesses to obtain capital
to fund their operations. Deciding which to use or emphasize, depends on the
long-term goals of the business and the amount of control managers wish to
maintain. Ideally, experts suggest that businesses use both debt and equity
financing in a commercially acceptable ratio.
Some
experts recommend that companies rely more heavily on equity financing during
the early stages of their existence, because such businesses may find it
difficult to service debt until they achieve reliable cash flow. But start-up
companies may have trouble attracting venture capital until they demonstrate
strong profit potential. In any case, all businesses require sufficient capital
in order to succeed. The most prudent course of action is to obtain capital
from a variety of sources, using both debt and equity, and hire professional
accountants and attorneys to assist with financial decisions.
Recent Happening
Capital Gain Tax (CGT)
In Pakistan, securities trading remained exempt from CGT for 36 years
till June 30, 2010. In 2010, after the imposition of CGT, investors were
required to file the income tax returns along with declaring the
source/evidence of investments for which they did not have the documented
details. New CGT ordinance has been adopted since April 2012. The tax rate for
CGT will be 8 percent and 10 percent for investment holding up to six months
and 12 months respectively till June 30, 2014. NCCPL will be depositing the tax
with the FBR on an annual basis. In addition, no question relating to the
source/nature of money will be asked by the tax authorities if the money
remains invested in the stock market for a period of 45 days (till June 30,
2012) and 120 days (till June 30, 2014) before and after the promulgation of
CGT Ordinance
Suggestions And Steps for Attracting Investment
Some suggestions/steps
are
Enhancing the
technical skills of investors, brokers and research analyst
Ø Karachi
Stock Exchange had a meeting with Morgan Stanley Capital International (MSCI),
a leading provider of market indices across the world, at MSCI office in
London.
Ø KSE
highlighted the change in monetary policy stance, centralization of Capital
Gains Tax at National Clearing Company of Pakistan and implementation of KYC
and anti money laundering regulations in the stock brokerage industry
Ø As
the inflation-driven monetary policy stance of the State Bank appears to be
more predictable in the months ahead, the market observers foresee a positive
domino affect on the share market that, they believe, would keep attracting
more investors with the benchmark KSE 100-share index poised to hit new highs.
Ø Integration
of Stock Exchanges can lead to cost efficiency for all stake holders, offer
better risk management, focused supervision by SECP and provide international
recognition
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