But has the KSE’s own business and profitability grown at the same level as market capitalisation? Has its image as a fair and transparent institution in the eyes of investors improved? Now, as the bourse nears its integration and de-mutualisation, the opportunity is ripe for the KSE’s new management to take the business to a higher level that is scaleable, profitable and diversified. Time has come for the KSE to re-position itself and restructure its business model for the next phase of its growth.
The stock exchanges across the globe have either changed or are changing their traditional business models. Until a few years ago, most of them were organised as “mutuals” or co-operatives of members. After a listing of 22 exchanges on the lines of London, New York, Toronto and Singapore bourses, a new structure has evolved to facilitates greater volume of business, operational efficiencies, transparency and the transition to new electronic trading platforms.
Under the new business model, exchanges have gone public and have listed themselves at the stock market. This model is not without its weakness. Demutualisation has created a conflict of interest between market participants (brokers, as well as investors) and the operators of the exchange who attempt to maximise returns to shareholders.
The KSE is a regulated entity, overseen by the Securities and Exchange Commission of Pakistan (SECP). Globally, regulatory rules are far from uniform across different jurisdictions, and the involvement and goals of regulators also differ. However, in most cases, regulators have the function of market oversight, with the objective of providing a framework of rules or laws, and the power to enforce or even prosecute for the orderly functioning of financial markets (e.g., ensuring fairness among market participants). Furthermore, in particular for cash markets with some degrees of retail involvement, there is an additional objective of protecting the consumer, the small investor.
During the past few years, the KSE has provided a convenient locus for the regulator to carry out its duties and responsibilities. At times, there has been a difference of opinion between the KSE and the SECP; the two have often taken different views about how to enforce these objectives of transparency, fairness and disclosure and to what extent these measures may have an impact on the day-to-day business of the exchange.
To be fair, the KSE has provided a conducive and well-structured environment for equity trading, although it may not always be perceived as being completely transparent or fair. Improvement has occurred in trading policies, disclosure and risk management systems, though many opine that it could have occurred sooner and it was “too little, too late”.
Over the years, the KSE has deployed substantial resources towards development of IT infrastructure, trading platform and risk management system. From a social responsibility perspective, the KSE has performed a valuable marketing and education service at the product level which has complemented the marketing efforts of broker-dealers and investment banks.
A business analysis reveals that there are 22 listed global exchanges. Of these nine are in North America, seven in Europe and six in Asia. Exchanges are scaleable businesses and the majority of the cost base tends to be largely fixed. The exchange business is characterised by dominant market positions, solid financials, strong cash generation and above-average earnings growth.
On a global average, the exchange business has a return on equity of over 24 per cent. The 22 listed exchanges have witnessed a revenue growth of over 17 per cent in the past five years while costs have increased by a shade over eight per cent.
Comparing its performance in 2005 and 2006, KSE’s revenue has been growing at half the global rate, despite being in an emerging market with strong trading volumes; its increase in costs has been at almost twice the rate of global exchanges. The financials stress upon the need for a strategy where the KSE strongly improves its margins and enhances corporate profitability and other key performance indicators.
For the KSE, revenue diversification will become increasingly important if it wants to be a major player in the region and it appears that the exchange is well-placed to develop an “integrated” offering for less traditional market opportunities. Going forward, the KSE must target revenue diversification through aggressive product development, strategic stakes in regional exchanges with strong product portfolios and acquisition of fast growing niche exchanges or trading platforms that trade products with little or no correlation to the existing portfolio (e.g. energy, commodities, weather, etc.).
The KSE will need to identify and implement sources of incremental revenue, like sale of real time data. Its product portfolio needs to be enhanced to include derivatives, exchange traded funds, an Islamic Securities platform and real estate investment trusts. The bourse will need to focus on rapid development of algorithmic-trading technology and enhancement of its current trading platform to allow efficient trading opportunities to institutions looking to transact quickly across a basket of stocks (for instance, programme traders and hedge funds).
For the KSE, structural drivers for volume growth are in place in the form of a robust economy, a growing capital market and increased demand for capital from new issuers and listed companies. Turnover velocity (measured as the turnover value divided by cash market capitalisation) is expected to continue to grow and converge to the regional average. However, continued strong volume growth may come in conjunction with higher fee attrition than currently anticipated as the regulator and participants put pressure on pricing.
There is a tremendous potential in the KSE in terms of growth, revenue diversification and income generation through new, innovative products. Such a strategy will lead to strong profitability and a dominant role in the Asia-Pacific region.