End of July 2007 marks the completion of first year of the Unique Identification Number (UIN). system. It is time to assess whether and to what extent regulators have used this tool in achieving its two underlying objectives of protecting investors from market abuse and strengthening management of settlement risk.
Regarding protecting investor—the first objective-- it would not be unfair to say that the ground reality on investor protection ‘before UIN’ is no different from that ‘after UIN’. The UIN system established a real-time traceable link between every trade executed on a stock exchange and the person placing the order for that trade, a major change from the past system where exchanges only had trading data for stock brokers with no information about end investors.
However, it is hard to recount a single instance during the last twelve months where either the stock exchanges, as front line regulators, or the SECP, as apex regulator, used UIN to detect or penalise market abuse, be it blank selling, front running, price manipulation, wash sales, insider trading etc.
Time and again, news media pointed out various cases in which securities had displayed price and turnover movements that merited a probe. At times regulators also publicly announced their intention to investigate some high profile cases (such as Call Mate Telips) where abuse was suspected but nothing ever came out of it. This is quite similar to the situation before UIN when high profile investigations were carried out (such as those in May 2006 regarding blank selling) but were soon forgotten.
On the second objective of UIN – strengthening management of settlement risk – some advancement has been made. Most important is client-level netting (CLN) which was aimed at reducing reckless use of leverage in stock market speculation. The increased margins applicable under CLN are still being phased in and the process should be complete by October 2007. Without the UIN system, it would not have been possible to implement CLN and SECP has done well to use UIN to enforce CLN. However, it is yet to make progress on the issue that securities of clients are not used by brokers to cover their proprietary positions or positions of other clients. Reportedly, SECP is also trying to implement position limits based on UIN to check excessive exposures.
On the whole, UIN remains a tool that has not been fully implemented or used to achieve its objectives. Let’s look at some of the reasons why.
First, carrying out meaningful monitoring, enforcement, and investigation action to detect and punish market abuse requires political resolve at the level of government and the regulators. Unfortunately, it is no surprise that this resolve is missing. SECP has long been unwilling to make any noise on market abuse knowing that it would be made to back down due to pressure from the government.
Market participants are aware that government is very keen to see the KSE-100 index at politically correct levels and they would not miss any opportunity to pass the blame of any downturn in KSE-100, engineered or not, on to the “fear” caused by the SECP actions. Lack of political resolve is the single most important factor that the potential of UIN system in investor protection has not been realised.
Second, other elements required to detect and punish market abuse, such as competent staff, sound regulations and procedures, and surveillance software are either missing or are too weak to do the job. For instance, it has been years that we are hearing that SECP is going to put into place a surveillance system due to failure of stock exchanges to do the same, but nothing has been implemented so far. It is difficult to think of any justification for such a prolonged delay in implementing something which should have been a top priority.
Third, the UIN model that was implemented was a watered down version of original model. It was a mere mapping of client codes and specified UIN with no upfront verification about the authenticity of the data. It was expected that to make up for the lack of checks and balances, systematic audits would be carried out to ensure that (i) mapped UIN are genuine (ii) holder of UIN has a properly documented account with concerned broker (iii) he placed the orders for trades which were executed using his UIN and (iv) he made or received payments and deliveries through appropriate depository and bank accounts which had the same UIN. However, to date, no public announcement has been made by the regulators regarding audits of UIN and doubts have been expressed about the reliability of UIN database.
Fourth, regulations governing UIN have a number of weaknesses, such as the following: (i) they do not require a broker to maintain due mapping for his clients where the broker is executing trades through another broker from another exchange, (ii) they do not give the exchange clear and specific powers to conduct audits into the UIN mappings of its members, and (iii) there is lack of consistency between the definitions of proprietary dealings as used in the NCSS mappings and as specified in the Proprietary Trading Regulations.
That potential of UIN system remains largely unrealised, particularly in the most important area of investor protection, is a loss to the investing public, particularly to the retail investors who are perhaps most vulnerable to abuse.
Regardless of the odds, SECP must focus on things like UIN which are central to investor protection, rather than things like CFS Mk-II, which is just a modified version of the highly controversial ‘badla’ financing. At the end of the day, the criteria by which everyone would judge the performance of SECP would not be the total financing CFS Mk-II made available to speculators but simply whether or not the apex regulator of stock market was able to protect investors from market abuse.
With the landmark judgment of the Supreme Court in the case of Chief Justice Iftikhar Chaudhry, there is finally some hope for rule of law and there is no reason why the rule of law should not come to the stock market for the protection of investors.