KARACHI, Sept 10: The pre-trade verification system would be put into place from Monday (Sept 12) at the stock exchanges. That was one of the nine points on which market players and the corporate regulator had inked an agreement in the presence of Prime Minister Shaukat Aziz on August 19.
The system is universally believed to be a step that would strengthen risk management measures, which would eventually contribute to improving the health of the bourses. But the question that boggles many minds is whether the stock exchange has developed or acquired the required technology and software to introduce the system as early as on September 12 and whether all market players have adequate knowledge of how the system would function?
There are indications that the KSE IT team has weakened with the exit of some personnel in the management. If that be so, and if the KSE is ill-prepared to launch the system, it had better be put off to a slightly distant date instead of either bungling up in trying to meet the Sept 12 deadline or ending up putting an old wine in a new bottle, like the ‘CFS’ replacing ‘badla’.
No one had really thought of launching the pre-trade verification system (PTVS) until the crisis of March. Market players who were not and never would be identified engineered the trend to place phenomenally heavy orders in pre-trade, without the intention of executing them. That “locked” shares at the lower limit would not allow shareholders the exit and that trapped small investors who saw their portfolio evaporate into thin air during those 10 days of nightmare. It has not been felt expedient to calculate exactly how many small investors were left with a begging bowl in their hands, for the government and regulators have spitefully termed them “speculators”, who were in the “disgusting” business of ‘satta’.
The absence of pre-trade verifications, nonetheless, reverberated in the task force report on March stock crisis. The learned members of the task force wrote: “Presently, there are no limits on the level of day trading by a broker, due mainly to the lack of pre-trade verification systems and other capital adequacy measures. This weakness, coupled with an almost out of control use of wash trades, facilitated market manipulation.” Then at another place the report recommends: “Until an improved risk management system is introduced, pre-trade verification of KATS (Karachi Automated Trading System) is essential.”
So now, in effect Pakistani equity markets are graduating from post-trade verification to pre-trade verification, which means shifting to an effective risk management measure. In the system now in vogue, both capital adequacy requirements of members and the process of collection and maintaining of their deposits and exposures against losses are carried out on a post-trade basis.
Analysts Hasnain Imam and Noman ul Haq at Arif Habib Securities explain what exactly the pre-trade verification system is about. They note that the objective of PTVS is to ensure that at any point in time, members have timely, relevant and reliable information so as to allow the KSE management to monitor members’ exposure on a real time basis. The system being designed under the supervision of the KSE board for this purpose is known as exposure monitoring system (EMS). The system would accept or reject an order entry in the system on the basis of members’ exposure calculations.
A notice issued by the KSE on August 3 said the following about members’ exposure limits: (I) If at any time during a clearing period the exposure of a member exceeds the limit prescribed for the purpose, such member shall deposit with the Clearing House the amount computed in accordance with the prescribed rates within the time specified by the board which shall not exceed 24 hours in any case. Any short deposit will be called for and any surplus deposit will be released to the concerned member by the exchange; (II) in case a member sustains loss during any particular clearing period, in excess of the limit prescribed for this purpose, such member shall deposit with the Clearing House the amount of such loss within the time specified by the board in the notice but shall not exceed 24 hours in any case. Profit and loss arising due to margin finance transactions shall be treated/ adjusted in the similar manner in which the normal profit and loss on the exchange transactions is treated/adjusted; and (III) no member shall have outstanding transactions in his account of more than the prescribed percentage of the number of the issued shares of particular scrip in a particular clearing period. Deposit may be given either in cash or in the form of readily realizable securities as may be prescribed.
The analysts point out that in the new PTVS, however, the following basic change would take place: The new PTVS would ensure that on a real time basis, members’ capital adequacy requirements are met; deposits against exposure are kept and mark to market is done on a daily basis. The system assesses members’ demand on the basis of their unsettled business, while offsetting deposited cash and securities with the KSE. Now, with a PTVS in place, the member will be required to maintain enough deposits so as to prevent his orders from rejection. It is worth noting that the new PTVS shall allow the members’ ability to trade based only on the valued deposit ranges against the conventional exposure limits.
Important points in regard to the pre-trade verification system have been listed by the analysts as follows: (I) the capital adequacy shall be the first trading parameter that would be checked by the EMS at the order level. The executed/outstanding business of the members shall be the applicable amount in this regard that would be compared with the capital adequacy ceiling; (II) the system shall not book margin calls for squaring up order of filed quantities in the same scrip; and (III) at the order level, the system shall decide whether the relevant queued order will oppose/net-off the executed business in the similar scrip and in case of an affirmative situation, margins shall not be accounted for on such orders to the extent of the opposite side of the business. The system shall also not book contingent orders even on orders to the extent of opposite side of the business.