KARACHI, Feb 23: As the regulators push ahead with the second-generation reforms, stock broking business is bound to come under pressure. Like the banking sector, the result has to be ‘the survival of the fittest’.

Most small brokers with fewer clients and small volumes are terrified with the impending elimination of client-level netting system (CLN), which the Securities and Exchange Commission of Pakistan (SECP) looks determined to put into effect on the T+3 (ready market) from March 4 and on contracts for futures deliverable market from April 1. The step is to be taken under the capital market reforms.

The measure of survival would be the capital adequacy and liquidity. Small brokers who would fall short of the two would have few options: Merge with larger brokerage houses; inject more liquidity to be able to meet exposure requirements and capital adequacy into the business or pack up and leave.

The membership of the Karachi Stock Exchange is limited to 200 seats, of which 160 are active brokers. Those in the knowledge of affairs estimate that around 80 per cent of the 160 are either small or medium-sized brokers.

The axe of the elimination of client-level netting that would increase margins at broker level was to fall from December 30, 2006; extended to February 1, 2007 and then to March 4, as the bourse pleaded that the necessary IT hardware for installation of the system was incomplete.

The chief regulator says there would be no further extension.

Only five trading sessions away, the brokers are either unaware of how the system would actually work or they feign ignorance. Three meetings between the broker community and the management last week ended in fiasco. But the management says the system is now ready, though even the big brokers express some reservations.

“The system has to be rationalised”, says one of the top five brokers who asked not to be named. He thought that the measure was important for the market and it should be implemented. He, nonetheless, said there was flaw in the Risk Management System (RMS) unveiled on December 5.

Regarding the CLN, he said there was misunderstanding of the risks by the regulators. The big players said that it was suggested that each and every transaction has to be scrutinised on its own for the risk involved.

“There is an anomaly in the system, which places say even 200 per cent margin on transaction with no risk and zero per cent on a riskier trade”. He believed that though mock sessions were being held, the Regulators had thought it fit to learn by trial and error.

Overall, the brokers’ margin obligations would increase by 20 per cent, said he, though for big players additional burden would be as small as 2 to 5 per cent.

But another market watcher disagreed that such a line could be drawn between those with big business and the smaller ones. The impact, he thought, would vary but cannot currently be quantified.

An owner of a smaller stock brokerage house who frowned on the new measure said that such reforms were fit to be implemented in bourses where there were futures market and derivatives. He believed that if netting was eliminated on cross settlements, the burden would be unbearable for brokers.In a way it is good that the market participants’ attention has now turned away to CLN, from the skirmishes between the nominated chairman/SECP and the KSE MD, about which lot of dirty linen has already been washed in public.