WHEN any share market gains more than 70 per cent in value in less than three months, alarm bells of a bloodbath in the making should be going off all over the place. They didn’t. So it came as no surprise when the bloodshed finally began at the Karachi Stock Exchange in Thursday’s show of violence. In four trading sessions between March 21 and March 25, the KSE-100 index sliced off 25 per cent in value. Brokers sat staring at dozens upon dozens of sell orders flashing on their screens as buy columns remained hauntingly vacant.

Investors, carried along on a senseless wave of hype, had gobbled up Oil & Gas Development Company as late as March 21 and at a rate as high as Rs198 gritted their teeth and waited for the chance to book their losses and sell. It never came. The share careened to Rs134 and still there was no way out.

On Thursday, their patience ran thin. When violence began, they too took to the parking lot and then to the management’s offices, breaking lights, throwing things around, trying to get noticed. The KSE now says the five who were arrested have never traded shares. But whoever sent them, if anyone did, it also gave vent to genuine frustration.

Behind the scenes another storm was brewing. Brokers met informally on Wednesday and decided that the settlement of the March futures contracts should not be delayed and instead rollover should be allowed to April by contract ticket. This, they thought, would release funds which would bring more liquidity and buying into the market and also give investors more confidence.

But when the board held an emergent meeting on Thursday morning at 8:30am, they surprised the market with a notice announcing that the settlement of the futures contract would be delayed by one week. Insiders told Dawn that the Securities & Exchange Commission was not in favour of this decision. What followed throughout the day were angry reactions from brokers who claimed they had not been taken into confidence.

A routine board meeting scheduled for Thursday afternoon then got underway with the agenda set aside to focus on the market situation. Nine hours later, a second notice was released just before midnight revoking the decision and reverting to the original settlement schedule for the March futures contract.

Come Friday morning and the market opened five points down, rapidly shed five6 points and then unable to cope with the quantum of sell orders, the system froze for about five minutes only to reopen 300 points in the red with OGDC once again locked at its lower circuit breaker.

Then, during the second trading session on Friday, the KSE announced that the cap on the COT financing rate was raised from 18 per cent to 24 per cent for two weeks.

“The board feels that those switching from futures to T+3 can have two options: either they can go to the broker to broker counter and transfer their position to a strong buyer or if they’re in T+3 they can take advantage of COT,” Moin Fudda, MD, KSE said. “But COT financiers felt 18 per cent was not attractive and so we thought if we increase this to 24 per cent, it will ease the pressure.”

The index closed 349 points down at 7,965 points with the major stocks locked at their lower circuit breakers. But late Friday and early Saturday badla did start trickling in and brokers hoped the leveraged positions would be eased by Monday.

Brokers held a meeting for members at the KSE auditorium on Friday afternoon where they discussed that broker-to-broker transactions were not yielding results and badla will have to come through.

This entire episode raises several questions. First, where were the regulators when the spread between the ready and futures markets had widened to over 70 per cent and volumes in so far slack futures market had surpassed turnover in the ready market?

When OGDC, which accounts for one third of the index, left behind its fair value and was climbing into the clouds without any legs to stand on, why did the KSE not investigate why this mass buying was taking place? Discussion and evaluation at that stage may have prevented the confusion that surrounded the stock market all this week.

Second, when the board decided to delay settlements by one week on Thursday morning, what was the basis for this decision? Did data show any brokers to be in tight positions where they would not be able to make payments?

Moin M Fudda, MD of the KSE says risk management was under control but board members took a view that there could be problems in settlement and he says the KSE chairman proposed the delay in settlement.

“We had a number of people who we thought could face difficulties in meeting their obligations which could create a problem,” he said. In delaying the settlements, the management and board of the KSE violated the sanctity of a contract which has cast serious doubts on the credibility of the KSE in the eyes of investors. And market participants are still unclear as to what led to this decision, aside from some subjective analysis by the board.

Moreover, what changed during the day, except for a backlash from brokers, that led the board to revoke their decision and spread further confusion? “In the evening people thought there is institutional support and if we reverse the decision it could keep the market from falling for five consecutive sessions,” Mr Fudda said. “We felt that if the big brokers feel that way then it is best to reverse the decision although it was painful to do.” Why did the KSE allow the view of big brokers to reverse a decision when nothing had really changed since the decision was taken?

Board members appeared on television to say there is no panic is laughable. To say the board meeting on Thursday morning happened in a hurry and so inadequate information was available is even worse. The KSE management has full access to the positions of every brokerage house to determine settlement problems in the making. Board members saying the notice did not cause panic because panic was already there is pathetic. Do board members still need to learn that settlement problems case far deeper panic than just a falling market?

Third, since the Thursday morning notice of the KSE said the board had unanimously decided to delay the settlement by a week, why did brokers then spend the rest of the day deepening the uncertainty with their angry comments against the regulators? After all, five brokers elected by the general body sit on the board.

Fourth, what role did the badla brokers play? If they were not willing to finance the market at 18 per cent despite the so-called crisis on the logic that badla in Lahore was running at 100 per cent, then why did they come in at 24 per cent?

Is it not the job of the apex regulator to ensure that regulations at all three stock exchanges are uniform? Moreover, why were all manner of figures being tossed around about the total leveraged position?

Fifth, did any real and meaningful discussion take place on the real problem of small investors being stuck with stocks they no longer want to hold? That, after all, is the crux of the problem. Take this example. Investor A is a weakholder who bought OGDC at say Rs190. He cannot get COT financing to rollover his position (or, as of Friday, he can pay 24 per cent for it since 18 per cent was not attractive enough for the badla brokers) and he has been topping up his margins with his broker every day as the market has fallen. At Rs171, he decides to sell and book his losses. He asks his broker to sell but the broker responds that there are no buyers. OGDC falls further. At the end of the day, the weak holder has to top up his margins again to the 25 per cent level. The next day he tries to sell again but cannot. The same is repeated session after session. The scrip locks in the first few minutes of trade at its lower circuit breaker and he can’t sell. The broker keeps collecting margins. The stock is now at Rs143.

Now, the settlement date is Wednesday. As of Friday, the broker tells his client to deposit the entire amount. He can’t. The broker seizes the margin and takes the position in his name. The broker earns good. The client is left with not even the shirt on his back. No broker defaults, the board and the management look good. And the small investor is left unprotected.

The KSE MD said in addition to COT (at the new higher rate) and broker to broker transactions, margin financing will also become available in those locked scrips which do not come under COT.

He also said a few institutions with substantial sums have assured to pick up delivery. Fudda also said the possibility of removing the circuit breakers was discussed but ultimately rejected by the board. “It was feared that if certain stocks drop substantially, it could have a trigger effect and cause a big dip,” said Fudda. This view holds that the circuit breakers allow the exchange to collect margins from brokers at the end of every trading session with the knowledge that the fall will not be greater than five per cent.

Without the caps, the market will go into free fall quickening the default of some brokers and resulting in failed settlements. But another view holds that the market would have gone into freefall but at a certain level-somewhere below 8,000 points—buyers would have returned. That way, at least a real market would be operating—one of buyers and sellers—which as of this week has ceased to function.

Moreover, even at the cost of a couple of broker defaults, the market would find its natural level without artificial support. Other suggestions have also made the rounds. One is to let the market trade naturally and if it rises or falls 25 per cent, then halt trading and force settlement.

Another is to convert the futures market—which functions as a forward delivery market-into a genuine futures market without deliveries. Simultaneously, switch from a flat margin system to a system where margins requirements rise as the prices rise. And a third suggestion from the banking community was to establish a counter where weak holders could sell OGDC at a price fixed by the exchange and the major brokers agree to come in as buyers.

The last question is where has the Securities & Exchange Commission been throughout this mess? Why was the KSE allowed to violate the sanctity of contract with no evidence of settlement problems in hand? And then, why was the decision allowed to be revoked without any explanation?

Fudda said: “I would not say the SECP approved both decisions but they were in the loop and kept in the picture.” But as small investors sit on stock they can no longer afford to hold and yet have no option to sell, what has the SECP done to protect their interests? Is it truly sufficient for SECP officials to hold a news conference at the weekend saying things will be looked into?