THE Securities and Exchange Commission of Pakistan (SECP) was all set to launch margin financing in the stock exchanges before the end of August, 2009, after the final approval of its concept paper. This has not happened so far.

A SECP notification said the proposed financing mechanism has been devised in line with international best practices and keeping in view the local market needs. This is expected to provide the needed liquidity to stimulate trading activity. The proposed product will enable retail investors to access financing against shares.

In case of margin financing, according to the proposal, only financial institutions would offer funds and no broker can do that. A comprehensive disclosure framework would be developed to provide information to investors/regulators in a fair and transparent manner.

Analysts' estimate that around 80 per cent of the total trade in the Karachi Stock Exchange is short-term and speculative in nature and driven by borrowed money, mainly provided by brokers and individuals.

Pakistan is among the few markets with 'Badla' financing in place which has restricted the role of the banks to a great extent. India phased out 'Badla' in 2001. Industry participants say that the transition to margin financing is likely to be the most difficult for small brokers with no history in dealing with banks and financial institutions, unlike the big players who have a clearer credit history and credit standing.

A CEO of one of the major brokerage houses opined that 'the current system is indifferent to small or big brokers. In margin financing you cannot force banks to lend every one.' Authorities say, only 2—3 per cent of daily trade is actually settled in full while the rest is financed through 'Badla' and can be rolled over as long as the investors pay the daily fee.

The regulators have been trying for some time to replace the 'Badla' financing with margin financing. The State Bank set up in April, 2005 a committee that recommended that Rs2 billion should be available in margin financing for the market before replacing the Rs12 billion 'Badla' financing. However, by July 2005 only Rs200 million was available for margin financing.

The move to replace Badla by margin financing is designed to curb the growing speculation in the local stock markets. But the transition is not likely to be without volatility in the short- term.

The concept paper of SECP was forwarded to stock exchanges for consideration. While the move was well received by investors, there is still resistance to it from the influential lobbies in the stock exchanges. The KSE Trading Affairs Committee unanimously rejected the concept paper and proposed instead the old Continuous Funding System (CFS) or in other words the Badla with 21 amendments. Many members of the KSE hold Badla financing responsible for all the mess in the stock market which made it possible for the big fishes to eat up billions of rupees of small investors. Informed sources say, there are disputes worth Rs4-5 billion still pending between brokers and their clients in the Badla financing. Above all, Badla financing dealt a severe blow to the stock market whose market capitalisation plunged to $23 billion from $76 billion in the last market crash triggered by Badla and CFS.

Of course, this does not mean that at present banks have no role in the trading of stocks. Banks are making investment in the shares as well as providing loans to investors and brokers against the collateral of shares.

In the year 2000, bank investment in shares was Rs14.7 billion or 4.35 per cent of their total investment of Rs338.7 billion. This increased to Rs106.5 billion or 8.83 per cent of the total investment of Rs1204.5 billion in 2007. Similarly, the advances against the shares were Rs98 billion or 4.1 per cent of the total advances in 2000 and Rs98.9 billion or 3.5 per cent in 2007.

The key market players have always approached banks for rescue in times of crisis. This also happened at the time of recent market crisis when the banks had halted the CFS lending owing to concerns over the default of brokers.

SECP has made it clear that it had given enough time to market players to adapt the new system. However, only time would tell that how the bargaining among the different stakeholders conclude and what comes out of it in the end.