ISLAMABAD, Sept 7: Pakistan's move to replace 'badla' based equity financing with globally accepted margin financing will bring the country's stock markets in line with international standards , but the transition is not likely to be without volatility in the short-term, analysts say.

The Securities and Exchange Commission of Pakistan (SECP) announced over the weekend its plan to introduce margin financing in place of badla or carry-forward financing to curb growing speculation in local stock markets.

The state regulator's move to replace badla financing was not well-received by investors. Reflecting the bearish tone in markets on Monday, the Karachi Stock Exchange 100-share index fell 2.5 per cent, or 131 points, to an intraday and two-month low of 5,185 points in afternoon trading. The key index fell below key support levels of 5,290 and 5,200 on Monday, before closing 2.3 per cent lower at 5,195.50.

Analysts say the index may go below 5,000 in the near term as investors come to grips with the new system. "The new system will bring about a change in the culture of our markets, and this change may bring in some turmoil in the beginning," said Mohammed Sohail, research head at Investcap Securities.

According to analysts' estimates, around 80 per cent of total trades at the Karachi Stock Exchange is short-term and speculative in nature, and driven by borrowed money mainly provided by brokers and individuals.

However, market regulator SECP said it had given enough time to market players to adapt to the new system. "The gradual phase-out enables brokers to acquaint themselves with the new system and educate their investors," said Tariq Hassan, chairman of the SECP.

In the first phase beginning October, margin financing will be introduced for 50 out of 663 currently active listed companies. The whole process should be completed by June 2005. Pakistan is among the few emerging markets in the world with badla trading in place. India phased out badla in 2001.

Industry participants say the transition to margin financing is likely to be the most difficult for small brokers with no history in dealing with banks and financial institutions, unlike the big players who have a clearer credit history and credit standing.

"The current system is indifferent to small or big brokers. But in margin financing you can't force banks to lend to everyone," said Nasim Baig, CEO of Arif Habib Investments. In badla or carry-forward financing, traders and investors can roll over their costs by paying a daily settlement fee. Roughly half of the daily badla financing is provided by banks through big brokers, while the rest is private money from individuals and other brokers.

The authorities say only two to three per cent of daily trade is actually settled in full while the rest is financed through badla and can be rolled over as long as investors pay the daily fee.

Money flows will be tighter in the case of margin financing, which will involve banks and other financial institutions. In the case of banks, for example, investors will be required to deposit 20 per cent of the amount they want to trade, in the form of cash or approved securities that include shares of listed companies.

The regulator's move to replace badla with margin financing is part of plans that include the demutualization of stock exchanges - or conversion from member-owned to shareholder-owned entities - and developing the country's futures market.

The SECP plans to increase the number of shares traded in the country's sluggish futures market to 30 from 14 currently. Phasing out badla may well give the futures market a boost, industry participants say, noting that like badla, settlement for futures trades is not immediate and can be done up to one month after the trade.

"My feeling is that a lot of speculative trade will move to the futures market once margin financing is fully implemented," said Mr Baig. "I think whatever may come, we need these reforms to make our market more vibrant," said the SECP chairman. -Dow Jones Newswires