Who will regulate the regulator?

Updated July 01, 2019

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Stockbrokers are an endangered species. They are going extinct as an increasing number of brokerage houses put up the shutters.

According to an old-timer, there were about 400 brokers at the time of the stock exchange’s demutualisation two and a half years ago. Almost half of them have now discontinued operations. Around 150 brokers surrendered their Trading Right Entitlement Certificates (TRECs) and are now doing ‘proprietary’ trading. The number of active brokers who still cater to foreign investors, institutions and individuals stands at around 50. A handful of brokers hold an overwhelming share of business.

If the number of brokers is going down, does it mean the allegations levelled by the recently ousted chief executive of the Pakistan Stock Exchange (PSX) about ‘legacy brokers’ are true? Richard Morin recently claimed in a newspaper article that the legacy brokers have long held a stranglehold on the market, have a powerful ally at the Securities and Exchange Commission of Pakistan (SECP) and effectively control the PSX board. He also referred to “a single broker who now calls the shots from his living room”.

Many market men affirm that his assertions make sense. The flamboyant chairman of the SECP Policy Board, Khalid Mirza, had harsh words of criticism for the SECP last week. “The Commission had no mindset to regulate the market properly. Instead of enabling (it), it was disabling the market.”

When asked about his opinion on the PSX, Mr Mirza said the erstwhile Karachi Stock Exchange had deliberately got the other two exchanges in Lahore and Islamabad de-licensed to create a monopoly. He asserted that the capital market could not be developed without competition. “As long as there remains a single stock exchange in Pakistan, there will be no development in the capital market,” he said, adding that most countries developed several markets in order to avoid the exploitation of investors.

“The performance of the Bombay Stock Exchange improved vastly after it faced competition from the National Stock Exchange in India,” Mr Mirza said. The PSX rules are onerous and need to be simplified and rationalised, he added.

Brokerage houses are carrying out downsizing. Job cuts are taking place in non-core departments, such as equity research, finance and operations

A major market participant who did not subscribe to Mr Mirza’s views observed that the principal reason for brokers to opt out of the game of high finance was shrinking brokerage income: the stock market has continued to melt for the third year in a row.

The benchmark index lost a whopping 8,009 points or 19.11 per cent in 2018-19. Brokerage houses are supposed to meet stringent regulatory requirements under the Companies Act, PSX listing regulations and the anti-money laundering laws. Brokerage income evaporated with the reduction in the volume of trade, which is now one-third of what it used to be two years ago.

A broker said that downsizing and cost-cutting were the only way for brokerage houses to keep afloat. Jobs had to be cut in non-revenue-generating departments such as equity research, finance and operations. Revenue comes mainly from core operations of corporate finance and brokerage business.

Following the demutualisation, the Chinese consortium bought 40pc strategic shares in the PSX. The deal was struck about two and a half years ago at the highest bid of Rs28 per share, which cost the consortium Rs8.96 billion. Now trading at Rs12.90 a share, the PSX stock has lost nearly 54pc of its original market value, inflicting a loss of Rs4.83bn on the consortium.

It is intriguing, however, that the Chinese members on the PSX board are not known to have shown a great deal of concern about their loss. All that makes the ground ripe for any big broker to exercise monopoly control.

This brings us back to the controversy surrounding the appointment and resignation of Mr Morin. Any suggestion that he fell short of expectations is somehow considered ‘broker-friendly’. Serious allegations by Mr Morin against stockbrokers and counter-charges by the PSX ought to be thoroughly probed. It must be established if Mr Morin’s simultaneous holding of a key position in a Canadian wealth management company was in breach of his PSX employment contract.

The PSX has condemned Mr Morin’s statement about the nexus among legacy brokers and called it “entirely concocted”. But there are many question marks. One fund manager who asked not to be named raised a pertinent question: “If Mr Morin was guilty of all those charges, then why was he allowed to stealthily leave the country? Did the exchange pay him all his dues and hand over Rs20m for the ‘loss of office’?”

An enquiry to pin the blame is definitely due. But who will conduct an impartial enquiry? The apex and frontline regulators appear guilty of having overlooked Mr Morin’s shortcomings until things turned ugly.

Published in Dawn, The Business and Finance Weekly, July 1st, 2019