No official document on the working of stock exchanges in Pakistan is as comprehensive in exposing their flaws, follies and failings as the report of the experts committee on demutualization of the exchanges.

The committee has submitted its report to the Securities and Exchange Commission of Pakistan which after its detailed study and consultations with the office-holders of the three exchanges may initiate remedial action. Whether those steps would come at one go or step by step remains to be seen. So much remains to be done it is more likely to come through phased action.

None of the follies and failings of the exchanges listed by the report in strong language is new. They have been talked about too often before. What the report has now done is to confirm the worst fears in respect of the working of the exchanges and stress the urgency for remedial action.

The report has been prepared after consultations with the varied stake-holders, including issues of shares and the investors through formal meetings and questionnaires.

The Karachi Stock Exchange has to accept much of the responsibility for the erratic ways of other exchanges as it became the model for the Lahore and Islamabad exchanges which in some cases went far ahead of the KSE in its devious ways.

The block-buster report has stunned the leaders of the stock exchanges. And instead of reacting to it in detail they are waiting for SECP's next moves in this regard after scrutinising the report.

For all the space the stock exchanges grab in newspapers daily, and the headlines they make with their indices as they rise or fall, their role in the economy of the country is very small and the investor base is as narrow as around a million.

The report says despite the economic growth in the country companies are not seeking listing on the exchanges and little capital formation is taking place through the stock exchanges, says the report.

"Issuers do not seem to have confidence in the stock exchanges and see minimal value addition in listing. There is limited free float in the market and it is coming under increasing pressure due to disproportionately large growth in mutual funds."

Even the growth in mutual funds has not led to an increase in the number of investors.

The experts noted that the number of share holders in the listed companies has remained stagnant despite the bullish sentiment in the market which carried the KSE index across 5,500 before it came down modestly.

The only measure that is increasing the investor-base is offers for sale of state-owned enterprises to the public at large which in many cases ended up with the large share holders or speculators.

The report does not appear to have made mention of the Term Finance Certificates for a limited period and with a fixed interest rate which have become popular with the companies.

Instead of opting for selling shares through the stock market which is a relatively cumbersome and costly operation. Banks and other investors are ready to buy these TFCs without asking too many questions as the returns from them are fixed, and so is the duration of the instruments.

It is not investment but speculative activity that dominates the trading and liquidity is highly concentrated. The equity market has been distorted by Badla financing. Due to excessive speculation, concentration and Badla financing the market is exceptionally volatile, laments the report.

That keeps the small investor and non-professionals away from the stock market which often appears utterly irrational.

And while the number of issuers and investors is very small the number of intermediaries is disproportionately large. The eligibility criteria for the intermediaries are weak and intermediaries are generally of low quality.

The experts note that an analysis of the problems being faced by the stock exchanges show they are fundamental in nature and the exchanges are fulfilling their economic role and discharging their regulatory functions to a very limited extent."

In spite of the series of reforms relating to governance of the exchanges, professional management has not been allowed to establish itself firmly in the exchanges. There is a general view that the exchanges are being run by brokers in their own interest. "Some of the brokers are very big fish and they dominate the exchanges excessively, particularly in Karachi.

The committee found the very many weaknesses of the exchanges including the vulnerability of the investors to different forms of market abuse, allegations of price manipulation, front-running, insider trading the blank selling. The small investor can get absolutely scorched in such an environment of utterly self- seeking manipulators.

The report says globally stock exchanges have under gone transformation because of advancement in communications technology. Globalization has made it possible for investors and issuers of shares to move to more efficient capital markets even if these are located outside the geographical boundaries of their country But the Karachi, Lahore and Islamabad exchanges do not have the capacity to carry out surveillance and investigation in market abuse. When the abuse gets common and widespread, few of the brokers may want to break the ranks and incur the displeasure of others, far more resourceful and powerful.

The exchanges here are financially weak, and unlike international exchanges they derive most of their income from listed companies rather than trading and other fees on services. Thy do not have the means to finance capital expenditure that is required for development.

The exchanges are unwilling or unable to supervise and discipline members and listed companies. The role of the non- member nominated directors in improving governance has been limited. Surely in such an environment they cannot prevail to the extent they want or the exchanges need.

The exchanges, says the report, are unable to attract and retain professionals. Most of their staff is non-management. Due to inefficient economic and human capital they are unable to grow and develop like international exchanges.

A mutual structure and fragmented market are at the root of the problems, being faced by the stock market. A mutual structure allows control of the exchange by only one stakeholder: the brokers. Fragmentation of the market place added to cost inefficiencies for all stakeholders, says the report

The reforms in the past in the exchanges were brought within the framework of the mutual structure and the fragmented market place. Hence the reforms could not make any substantial impact.

The committee says many of the Asian countries are turning towards de-mutualization of their stock exchanges. Pakistan has hence no option save follow the same route and bring its exchanges on par with international exchanges.

A notable exception in the area of management is the appointment of Moin Fudda, former chief of the Commercial union, as managing director of the Karachi Stock Exchange. But he wants to carry the members of the exchange and the big brokers with him instead of going on a collision course.

Earlier Yasin Lakhani, former chairman of the KSE, tried to bring about several reforms. And he met the resistance from the big fish whose role the experts have lamented and whom they want to discipline.

The next moves of the SECP in this area will be watched with keen interest as those who control the exchanges will not be ready to relax their hold and subject themselves to a healthy and constructive discipline, which can raise the number of equity holders to at least 5 million by the year 2010, if not more.