Policy liberalization since 1990s has led to rapid growth and expansion in Pakistan's capital market. As a result, regulatory framework could not keep pace with the developments.
It was only in the past few years that the reshaping of legal framework and regulatory system, development of market institutions and infrastructure, and streamlining of policies took place.
The desire for an efficient and fair capital market, and reforms lead the Asian Development Bank (ADB) provide technical assistance in mid-90s. An agenda of reforms covering key aspects was initiated in 1997 under the Capital Market Development Programme.
Its focus included on creating an enabling policy environment, strengthening governance and market institutions and modernizing the market infrastructure. Many reforms implemented in the past few years were part of this programme.
An important milestone was achieved when the Corporate Law Authority was restructured into an autonomous Securities and Exchange Commission of Pakistan (SECP), governed by the Securities and Exchange Commission Act of Pakistan, 1997.
The momentum generated over the past few years in the capital market reforms needs to be further built upon. Perhaps, the singular most important area that needs to be addressed is the structure of the three stock exchanges themselves - Karachi, Lahore, and Islamabad.
The plan of demutualization is in the pipeline and the exchanges, at present, are considering demutualization and analyzing different models and structures.
Demutualization transforms an exchange from an entity owned by its members into a commercial company owned by the shareholders. The Pakistani stock exchanges are mutual associations owned by their members. Generally they have been operated on a non-profit basis, so that any profits are returned to members in the form of lower trading costs or access fees.
In transactions, it is imperative that they are perceived fair, efficient and transparent. This can be achieved if the bourses do not serve interests of their members only, but also of the public. A demutualized exchange generates competitive returns, as well as protects the interests of all its customers and those of the broader investment community.
In another response to technological advances, globalization, potential competition from alternate trading platforms and concern for stock market participants, there is also a need to re-assess the requirements of the country's bourses. Even if one avoids triplication of cost perspective, a strong case can be made for unification/merger of these three exchanges. Talks of it, as yet, are in initial stages. Now, it is up to the SECP to take a pro-active role in these areas and spearhead efforts to modernize the corporate structure.
There is still a preponderance of short term and intra-day trades supported mainly by "badla" financing. Implementation of margin financing and further development of futures/derivative market should help in phasing out the badla/carry-over market. Another step to encourage more settlement based trading can be to further graduate to a T+1 settlement system.
The risk management at the exchanges can be further improved. Presently, all three stock exchanges follow criteria based on the turnover and the EPS for calculating exposure requirements.
The LSE and the ISE have pre-trade verification of members' exposures and the system blocks the orders that drive the members' position beyond the limit imposed by the exchange. The KSE still has a manual-driven system of monitoring exposure requirements and as such there is no pre-trade verification.
In order to further strengthen risk management, the generally followed international practice of calculating exposure requirements on a pre-trade and continuous Value-at-Risk (VAR) basis should be considered.
The reforms and the performance of the market over the past few years has yet to translate into an upsurge in new equity offerings albeit there has been some improvement especially with a few privatization transactions being brought to the market.
In my view, the critical issue facing the stock market in Pakistan is the lack of investor confidence. The preponderance of short-term speculative trades, market manipulation by a few powerful brokers, illiquid secondary market (barring few stocks with large market capitalization) are all factors that project a negative image of the stock exchanges and discourage investors from participating in the market.
The steps outlined above, if implemented, will go a long way in allaying the apprehensions of a common investor and will have a visible impact on the efficiency, fairness and transparency of the market.
(The opinions expressed herein are those of the author and may not necessarily reflect the views of the LSE where he is employed as General Manager.)