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Eying strategic investor

July 15, 2012


AS the deadline of first week of September for demutualisation of stock exchanges draws nearer, nervous retail stock investors, huddled together in small groups in the corridors of the Karachi Stock Exchange, are seen debating on what was likely to happen.

The words ‘corporatisation, demutualisation and integration’ are difficult to pronounce and more difficult for an ordinary investor to understand. Yet in essence, all it means is the transformation of the stock exchange from a not-for-profit organisation, currently mutually owned (by stock brokers) — to a for-profit company, listed on the stock exchanges and owned by shareholders.

The aims and objects of demutualisation have oft been repeated as to increase transparency and to strike a balance between interests of various stakeholders by segregation of commercial and regulatory functions and separation of trading rights from the rights of ownership. That is visualised to result in removal of conflict of interest of brokers, who now are owners of stock exchange as well as the holders of trading rights.

Although the greatest of all reforms for the capital markets has been on the agenda for several years, nothing came to pass until recently. After approval from the parliament, the President of Pakistan signed the Stock Exchanges (Corporatisation,

Demutualisation and Integration) Act, 2012 on May 8.

The law stipulates that the stock exchanges be demutualised within 119 days of the promulgation in accordance with the timelines specified in the completion of the cycle.

As the statutory status of the KSE would change from company limited by guarantee to company limited by shares, the entire equity of the KSE (as a company) would be vested in the members (brokers). But 40 per cent of those shares would pass on to the members own accounts, while the remaining 60 per cent would be kept in the ‘restricted’ account’ of the members with the Central Depository Company (CDC). A strategic investor would be offered 40 per cent of those shares and the remaining 20 per cent would be floated in the initial public offering (IPO).

Market participants in the knowledge of affairs say that the essential thing is the valuation of the stock market.

The figure is thought to have been worked out but complete secrecy prevails and the paper is securely placed in a sealed cover. The need of keeping the valuation under wraps is to prevent it from falling into the hands of a possible strategic investor.

“The knowledge will make it easier for the buyers of majority shares to make a bid. In case valuation is found to be lower than what has been worked out by him, the strategic investor would surely make a lower bid, which would be a loss to other shareholders,” says a senior member.

Fewer than 50 days remain to the deadline of completion of demutualisation. After that the exchange would have to find a strategic investor within 18 months.

And there are worries. Would the exchange be able to find a buyer of the strategic shares? A market expert said that since the law requires that the buyer must have ‘experience’, the strategic investor has to be some bigger stock exchange of global reach.

The KSE Managing Director Nadeem Naqvi says the potential strategic investor could see value in the exchange. He stresses that the KSE prides itself on many of its assets, which include the modern technology platform; the bourse’s long history of being a premier market; its cordial relationship with the listed companies; its involvement in brokerage business since 1948 and its planned introduction of new products.

Arguing in favour of demutualisation, the KSE MD said it would be a major change on how the exchange is going to be run with a dual organisational structure: one, the commercial operations and two, regulatory functions that would be reported directly to an official board that would be called ‘The regulatory supervisory committee’.

“In this way, conflict of interest between commercial functions and market regulatory functions will be avoided,” Mr Naqvi said.

And what does the stock brokers say? The 200-member strong fraternity is about to see an end to their 60-year control of the market. Yet, there is no sign of the kind of strong resistance seen against even a minor reform, a decade ago.

Veterans can count several reasons for that. A senior broker pointed out that following the unprecedented losses caused by the market meltdown of 2008, which pushed even the most affluent member to the edge of poverty, big brokers had shifted their focus from equity to other businesses. Several have ventured into real estate and some into industry.

But many brokers are also quiet for they are still unclear whether demutualisation would be a boon or a bane for them. The barometer to gauge their reaction is the membership card. “When demutualisation was first announced the price of broker card shot up from Rs45 million to Rs60 million,” says a member, which probably signified their enthusiasm. But now that the date of the big event is approaching, the value of membership card has dropped to Rs52 million.

Another member aired more optimism. He said the card issued to member after demutualisation would be saleable one time. Also ten new cards would be issued by the demutualised exchange.

This senior member was of the opinion that brokers should be happy because instead of the fixed value of the card, realisable only when the card was sold, the members, as shareholders, will now find themselves liquid as they would be the owner of 40 per cent of the paid-up capital of the new company.

Since it would be listed on the exchange, the broker would be able to sell any amount of holding and realise cash that he needs.