KARACHI, June 16: With volumes shrinking (only 64 million shares traded on Tuesday), a desperate search is on for a ready board leverage product. The 80-member meeting at the KSE on Monday shifted through the 21 de-merits of the CFS or ‘badla’ and the brokers are now feverishly looking for a modified-form of CFS.

The Consultative Committee formed by the SECP on the other hand has handed down its model of ‘Margin Financing’ (MF) which could be introduced as leverage product in the market following the ouster of CFS.

Head of Research and Advisory at Crosby Securities Pakistan, Rehan Uddin (also a member of the Consultative Committee) has identified the differences between the MF Model and the CFS MK-II, which should be of investor interest.

(1) In CFS Mk-II lending was provided on undisclosed basis. The financier, wishing to lend in the market, effectively disbursed funds to the CFS Mk-II system, without any knowledge of the counterparty taking up the funds. It means that the lenders did not evaluate the creditworthiness of the financees to whom they were offering funds.

In the absence of a credit screening process, it was very likely that the financiers were in fact providing funds to sub-prime borrowers, whom they would not have entertained at all, had those borrowers approached the financiers directly. In the proposed MF system, lending is on counter-party risk basis, whereby the financier assesses the credit risk of each broker, and lends accordingly.

(2) In case of financee’s default in CFS Mk-II market, the NCCPL settlement system was at risk. NCCPL was responsible for squaring up the financee’s position and paying the amount due to the respective financiers. In the proposed MF system, defaults are managed by the financier outside the settlement system of NCCPL.

(3) Risk Management of the financee shall be carried out by the financier in the MF system, giving them control over the quantum and form of margins from the financees. In CFS Mk-II, risk management of the financees was carried out by the stock exchanges and NCCPL.

(4) The margining regime of CFS Mk-II was designed to protect the settlement system, since lending was purely on undisclosed basis. In the proposed MF system, the margining regime is flexible enough to allow the financiers to protect their interests, while ensuring the protection of the settlement system at the same time.

(5) The list of securities eligible for the CFS Mk-II market was pre-defined. In the proposed MF system, the financier decides which securities to finance.

(6) Length of contract was 22 working days in the CFS Mk-II Market, which has created problems in the past for the financees. In the proposed MF system, the individual contract will have no pre-defined maturity.

(7) Upon execution of CFS MK-II Contract, 100 per cent settlement obligation shifted to financier. The proposed MF system allows the financier to partially finance the purchase, thereby ensuring some equity participation by the financee himself.

(8) The efficiency of CFS Mk-II encouraged reckless speculation by the financees. The margining and the netting regime facilitated the financees. In the proposed MF system, where operational efficiency has been given due importance on one hand, the financier has been empowered to define rules of the lending. This will ensure that the financiers have the capacity to limit reckless speculative positions being taken by the financees, by managing the margin requirements, along with party-wise and scrip-wise exposures.

(9) By the introduction of the proposed MF system, information relating to entire credit given to the brokerage houses may be available to the investors. This information was not available earlier.

(10) There were no position limits on the financiers in CFS Mk-II market. The proposed MF system imposes position limits on the financiers as well, in order to limit excessive funding in a particular scrip.
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