22 October 2004	Friday	07 Ramazan 1425

ISLAMABAD, Oct 21: A report prepared by an Expert Committee has found dozens of loopholes in all the three stock exchanges working including the vulnerability of investors to different forms of market abuse , allegations of price manipulation, front running, insider trading and blank selling.

The report of the Expert Committee on Demutualization and Integration/Transformation, which was recently submitted to the Securities and Exchange Commission of Pakistan (SECP), has found a number of loopholes in existing stock exchanges infrastructure.

The report was prepared after consultations with the core stakeholders - investors, issuers and members of exchanges - through meetings and questionnaires.

Globally, the report says, stock exchanges have undergone transformation, because 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 located outside geographic boundaries of their country.

However, the Karachi, Lahore and Islamabad stock exchanges do not have the capacity to carry out surveillance and investigation in the market abuse. The exchanges, it says, 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.

Despite economic growth in the country, companies are not seeking listing at the exchanges and little capital formation is taking place through stock exchanges, the committee has found.

"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 disproportionately large growth in mutual funds," says the report.

Investor base, it reveals, is small. Percentage of adult population that owns share is less than one per cent. 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 investor base are offers for sale of state owned enterprises," the report observes.

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," the report reveals.

The exchanges, it says, are unable to attract and retain professionals. Most of their staff is non-management. Due to insufficient economic and human capital, they are unable to grow and develop like international exchanges.

"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," the report observes.

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, it says.

According to the report, analysis of the problems being faced by stock exchanges show that these are fundamental in nature and exchanges are fulfilling their economic role and discharging regulatory responsibilities to a very limited extent.

"A mutual structure and fragmented market are at the heart of problems being faced by the stock market. A mutual structure allows control of exchange by only one stakeholder i.e. brokers. It has also deprived the exchanges of economic and human capital that they need for further development. Fragmentation of market place has added to cost inefficiencies for all stakeholders," it says.

The reforms in the past were brought within the framework of mutual structure and fragmented market place. That's why, the reforms have not been able to make substantial impact, the committee has found.

Many of the Asian countries, the report says, are turning towards demutualization of their stock exchanges. Pakistan, it says, has no other option but to do so in a bid to bring its exchanges on a par with international standards.