The Securities (Leveraged and Pledging) Rules have significantly impacted the Pakistani capital markets, albeit not in a positive way.
These rules allow stock exchanges, central depositary companies and clearing companies to act as authorised intermediaries for leverage products, such as margin trading and margin financing system. This article recommends removing these frontline regulators from the list of authorised intermediaries and letting a consortium of banks operate these products.
These rules have been perceived as a window of opportunity for continuing Badla with new variants, names, or brands. Badla, which refers to margin financing or margin trading, has been discontinued globally after introducing derivatives such as options and cash-settled futures.
This shift away from Badla has proven to be beneficial for other markets, as seen in the case of India, where the introduction of options and cash-settled futures led to the rerating of the Indian capital market and turned it into the largest derivatives equity-trading market in the world.
The market operates on leverage and often goes through boom-bust cycles detached from the fundamentals, technical aspects, or economic performance
In contrast, the Pakistani stock market has experienced a weakening trend. It is considered one of the least participative markets globally, with a significant portion of its turnover coming from stocks on the Margin Trading System (MTS).
The market operates on leverage and often goes through boom-bust cycles detached from the fundamentals, technical aspects, or economic performance.
However, the Pakistan Stock Exchange (PSX) has recently implemented a new trading system, eliminating the previous hindrance to launching option contracts on individual securities and indices.
To address the shortcomings of the Pakistani capital market, several proposed measures could be implemented. First, it is recommended that frontline regulators distance themselves from managing the MTS. This move would align with global practices, as no developed market has margin trading and financing products under the direct control of frontline regulators.
Instead, the Ministry of Finance should take the necessary steps to establish a separate derivative exchange, as originally intended in the act.
Furthermore, regulators should consider revising authorised intermediaries to strengthen the stock market. Allowing a consortium of conventional and Islamic banks to act as authorised intermediaries while removing frontline regulators such as stock exchanges, central depositaries (CDCs), and clearing companies from the list would be a step in the right direction.
In addition, the PSX should consider reducing the non-refundable fee for online-only brokerage or making it refundable. Doing so would encourage individual investors to participate, leading to increased market liquidity.
The Securities (Leveraged and Pledging) Rules have also created an uneven playing field in the Pakistani capital markets. Leveraged buyers have a disproportionate impact compared to genuine buyers, with a four-to-one ratio. This situation limits the influence of genuine buyers and sellers in the market, given that 60 per cent of trading is linked to leverage and the possibility of netting in rupee terms.
Moreover, the restriction on leveraged shares pledged was lifted in 2019, contradicting the commitment made after the 2008 crash. Rule 3(2) of the Leverage Market Rules, which allows stock exchanges, central depositories, and clearing companies to act as authorised intermediaries, has been criticised as an anti-market and anti-level playing field.
In conclusion, the Securities (Leveraged and Pledging) Rules have had a detrimental impact on the Pakistani capital markets, leading to market concentration, limited vibrancy, and an uneven playing field. To strengthen the stock market and promote inclusivity, it is crucial to consider closing the MTS market, revising authorised intermediaries, and encouraging online-only brokerage.
By addressing these issues, a healthier and more inclusive Pakistani stock market can be fostered, benefiting all market participants.
The author is the CEO of the Securities Exchange Management Suite and a former general manager of the Pakistan Stock Exchange.
Published in Dawn, The Business and Finance Weekly, July 3rd, 2023