The Karachi Stock Exchange ranked among the best performing markets in 2012. While celebrating the good times that are rolling, stakeholders, however, ought to keep an eye on the fault lines which, if not taken care of, carry potential risks and perils.

The crises in 2005 and 2008 caused a quake across one of those great fault lines: the ‘badla’ debacle. The scraping of ‘badla’ has taken care of the leverage financing.

Another major development over the past couple of years is the loss of foreign investors’ power to set the market direction. The market is no longer at the mercy of overseas investors, for the local individuals and institutions are able to quickly absorb any major offloading by foreigners. Yet, there are other disconcerting fault lines.

Flawed index: In the benchmark KSE-100 share index, as few stocks as can be counted on finger tips of one hand can turn the tide one way or the other. Prominent are the oil and gas exploration companies (E&P stocks), which have the greatest weightage in the index.

If the index is flawed, one should scarcely be amazed by the deafening silence of the monitors. If the stock markets are regarded ‘barometers of the economy’ the phenomenal rise in index is wrongly thought to reflect economic progress. The introduction of KSE-30 index on market capitalization basis, failed to grab investors’ attention. It is scarcely mentioned when the market goes up or down.

Lack of depth: The market lacks depth. With more de-listings and next to no new listings, the number of stock market quoted companies is decreasing instead of increasing. Until autumn, more than half the company stocks were sitting idle with no trading the year round. Smaller and dormant scrips on the textile and cement sectors have started to come into focus.

Retail investors and punters have made good money in trading in ‘penny’ stocks, but they could lose where they throw discretion to the wind and jump into worthless or junk scrips. The privatisation process stands stalled for the past four years when part of state-held stocks in big ticket companies — Habib Bank, PSO, the SSGC, PPL — could be made through Initial Public Offerings (IPOs).

Number of investors: In a population of 180 million people fewer than five hundred thousand are in business of shares. And even lesser number represents those deep pocket high-net worth individuals who lick all the cream and honey. It results in unequal distribution of wealth as the fortunes made in stocks are not widely shared. The market does not have larger number of local long-term investors.

In the declining interest rate scenario, it would be easier to shepherd people with money to the stock market for bigger returns, from lower returns provided by the risk free fixed investments.

Reforms: Progress has been made in the demutalisation process. But in the matter of introduction and acceptance of new products (options and derivatives), margin financing and others the progress is all but slow. The regulators introduced several products in the recent years, but the lack of activity testifies to a lack of interest of investor.

Fair trading: It has to be conceded that the regulators have come down with a heavy hand on some of the unfair trade practices, such as insider trading, front running, wash trades and others. Yet leakages need to be plugged where ‘material information’ reaches some bigger investors before the general investing public. The rise in price of a company stock just before the announcement of a major event raises suspicion of leakage of ‘material information’.

Small investors: Many stocks are currently priced at considerably higher than ‘fair’ price. Small investors who continue to hold them, could burn their fingers. It would be cruel to dismiss small investors and day-traders as ‘satta wallas’ because speculation — in measured quantity — is the spice of stock trading. They give the markets the high volumes. Efforts at investor education need to be stepped up. Small shareholders ought also to be empowered by strong representations on the corporate boards.

Corporate debt market: The size of the listed corporate debt market at less than one per cent of GDP pales in the face of the performance in most countries, where the government —as the largest issuer of debt securities — provides the volume required for a liquid secondary market. It has been quite a while now that the two main regulators of the corporate and the banking sectors, SECP and SBP, had decided to join hands to promote development of debt market. Unlike most developed markets where the size of bond markets is five and even 10 times the equity market, the Pakistani bond market is much too shallow.

The KSE had decided a couple of year ago to set up a trading platform and system for government securities — Treasury bills and Pakistan Investment Bonds , through the bourse. However, the already present Over-the-Counter market at the KSE which invested in government securities was used mainly by banks, financial institutions and some wealthy individuals, but lacked larger individual participation. It was a sign that the new platform may not be of much use.