ON APRIL 30 last year, in an article published in Dawn, “Prospects of Internet-trading in Pakistan” I had challenged the idea of introducing web-based trading in Pakistan at that point in time given the state of development of the country’s stockmarkets.
This current article is a review of where things stand presently, in the US, Asia and Pakistan in particular, and whether the probability of success of introducing such a product has changed. Simply put, does the current “bull run” justify such a platform?
Asia’s situation: Since December 2001, Hong Kong’s leading on-line securities brokers with both global and blue-chip local brand names have with shut-down their Hong Kong stock brokerage businesses, slashed staff or both. The majority of trading (approximately 60 per cent or so) in Hong Kong is still done over the phone with brokers. The relative dearth of inter-net use in Hong Kong is certainly true with stock trading. In a survey by the Hong Kong Securities and Futures Commission (SFC) in October 2001, only 10 per cent of 1,000 respondents said they traded stocks on-line. The US on-line trader, Charles Schwab, is discontinuing its Hong Kong trading in January as part of an international strategy to focus on the most promising areas.
Not quite different: TD Waterhouse, the second-largest discount brokerage firm in North America, has said that its customers averaged trades that were 43 per cent lower from a year earlier. With the investment banking business undergoing the steepest decline since the 1970s, all major brokerages are cutting back and laying off staff.
Take the case of Merrill Lynch. The world’s largest retail brokerage firm is under more pressure than most to shave costs because its profit has grown more slowly than that of its competitors, and its international brokerage business is losing money. Merrill began reducing its staff last year, lowering total employment to a current level of about 66,000. But in the wake of September’s attacks and economic retreat, the firm launched a major review of all of its operations in order to slash nearly US$2 billion a year from about $20 billion in annual expenses.
This trend is likely to continue into the second quarter of 2002. A retrenchment in the brokerage industry, accompanied by firms pulling out of the business, is by no means unusual. One of the big challenges of the brokerage industry is to deal with the cyclical nature of the business as it goes from boom to bust, with violent swings in earnings and market activity.
Merrill and HSBC have a joint venture offering of an internet-based trading platform. While both firms initially said they would invest as much as $1 billion in the new unit, the decline in trading has quickly dampened expansion plans. In August, plans to move into Germany and Japan were put on hold, and then in October about one-quarter of the 600 British employees were let go. Most online brokers acknowledge that among many firms, including Merrill Lynch HSBC, are struggling financially at the moment because of market conditions. However, they feel that the long-term potential for the business continues to be promising. Critics have their doubts.
American example: An individual equipped with a computer and modem can gain access to an astonishing array of stock price information by tapping into a single inter-net site via the net. Web-based or on-line-trading allows a computer-user to buy and sell securities through web. The concept was first developed, tested and introduced in the United States where, until a few months ago, a significant percentage of all stock market trades took place through the Internet.
In America, on-line brokering is a volume business that had matured during the long bull market that reached its peak in March last year. There were three major reasons behind the widespread use of inter-net in the US for trading in the stock market. The first was the increased level of investor education and awareness regarding investment options and the investment decision-making process. The growth of on-line brokering had been led by the migration of existing investors from other channels. Discount brokers, such as Charles Schwab and Waterhouse had several years of experience drumming up business, and employees’ 401(K) pension plans encouraged individuals to manage their investments more actively.
Secondly, the “Great Bull Run” that started in 1991 combined with the mania for inter-net stocks and dotcoms had created an atmosphere where it had become a way of life to invest in the stock market. The surge in technology and Internet shares in the second half of 1999 up to March 2000 pushed up on-line trading volumes even further. Things are rather grim now. “On-line trading by individuals has ground almost to a halt. Who wants to turn on the computer, says Richard Strauss at Goldman Sachs, when looking at your portfolio makes you feel sick?” (The Economist, October 27th, 2001)
Lastly, the high level of inter-net penetration had resulted in cost savings, convenience as well as ease for existing and potential investors. According to estimates, 52 per cent of all American house-holds have access to the net. Naturally, with such a high level of penetration, investing on-line was much easier for the investing public. Of course, with the recent downward trend witnessed across global stock markets, especially the US, things are rather different now.
These factors combined with extensive economic documentation, effective tax system, vigilant regulation and efficient infrastructure have altered investor psychology and thus, the mindset of the average American stock market investor. Internet trading has brought about a clear shift in individual investor behaviour.
Pakistan’s case: In Pakistan, there are three major obstacles in the way of successful on-line trading. These are a low level of investment awareness of the individual investor, small degree of Internet penetration and dislike for documentation owing to the “phenomenon” of the underground economy. In addition, there are issues of technological infrastructure and bandwidth.
The level of investor awareness regarding investment opportunities is very limited. There are a handful of sophisticated stock market investors, if any. Investors need input and advice from stockbrokers to make investment decisions; this is quite different from the proverbial “tip” that one gets from one’s broker. Many individual investors have an acute aversion to risk, which suggests that a big chunk of savings is invested in fixed-income but relatively safer deposits. In the absence of direct communication with brokers, what will the investor base investment decisions upon? Moreover, regulation has failed to keep pace with change, let alone technological change. How will the law protect investors? Has the Securities and Exchange Commission of Pakistan (SECP) framed draft rules, or is it in the process of developing any guidelines for safeguarding the interest of the investor for on-line trading?
Secondly, the low degree of Internet penetration, approximately 1.5 million users, limits the scope of the on-line product. The profile of these Internet-users is unknown. An educated guess would point in the direction of not many among these to be market speculators or investors.
A major stumbling block will be averseness to documentation in our society. Because the quantum of the black economy is approximately 70 per cent of Pakistan’s GDP, meaningful progress is not possible without accommodating it. Cash is a preferred mode of conducting transactions and business for many. Unlike trading off-line, i.e., directly through a broker via phone or personal visit, on-line investment will leave an audit trail of the entire trading process. Cheques will need to be exchanged. This will be discomforting for quite a few. Many investors will not be comfortable with the thought of disclosing their sources of wealth, which will be used to fund transactions, or speculate.
Another aspect is that of regulation. Obvious concerns are regulation of commerce on the Internet, web-based trades and available avenues for re-dress for the investor. The settlement system would also need to be integrated with this mode of trading. America’s market watchdog, the Securities and Exchange Commission (SEC) set up an “Office of Internet Enforcement” over two years ago. Examples of misuse include attempts to raise money for bogus companies, “scalping” and “pumping and dumping”. However, at the same time, the Internet has made the SEC’s job much easier, notably in tracing evidence due to the presence of audit trails.
Reluctance to change: Investors change their habits very slowly, even when they are offered what appears to be a compelling deal. Thanks to the impact of technology, stock brokering seems sure to change in some ways. Thanks to people and their persistent habits, it is hard to predict the timing of technology’s impact. With a low degree of investor awareness and Internet-penetration rate, phobia for documentation and lack of reliable technological infrastructure, the Internet-trading equation does not balance right now. Pakistan’s stock market is still in its initial stages of development. Ranked by market capitalization, the Karachi Stock Exchange is the smallest of Asia’s major markets while trading volumes are confined to a handful of stocks. Perhaps the introduction of on-line trading may be premature.
One thing is certain. For inter-net trading to be successful, a prolonged bull-run is essential. Otherwise, the retail investor’s interest is not stimulated. In August last year, there was a lot of euphoria about Internet Trading in Pakistan and its potential contribution to the development of the country’s capital market. With all this hype around it, what is the utility of online-trading for the investor in a stock market like Pakistan? Is it really worth the investment in technological systems and infrastructure support in a country where there are other, more pressing issues, like corporate governance, exchange regulation (a faked announcement of Hubco-lenders approval in November last year a case in point), fair disclosure and accounting standards confronting the capital market?
Any further delay or failure to address these outstanding issues is likely to stall the growth of the country’s stockmarket. Once the euphoria of the current bull run wears out, the ground realities will once again resurface. For meaningful long-term development of Pakistan’s stock market, these issues need to be taken care of. Or we will continue to lag behind among the emerging markets.
ON APRIL 30 last year, in an article published in Dawn, “Prospects of Internet-trading in Pakistan” I had challenged the idea of introducing web-based trading in Pakistan at that point in time given the state of development of the country’s stockmarkets.
