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Securities Market Division

The regulation of the securities market is the core function of the Commission. The Securities Market Division (SMD) monitors and regulates the securities market through powers vested in the Commission under the Securities and Exchange Ordinance of 1969 and the rules framed thereunder, as well as under The Act. The SMD regulates both the primary and secondary markets including market intermediaries. It also acts as an off-site regulator of the stock exchanges, which includes monitoring their working, particularly with regard to obligations of brokers towards investors, and ensuring smooth functioning of the clearing house and settlement operations. In addition, the Division is entrusted with the task of making appropriate regulatory reforms and proposing measures to deepen the market, restore investor confidence and ensure transparency in stock market operations.

2.1 Overview
The past year witnessed major developments in the capital market as a consequence of various reforms initiated by the Commission to promote investor confidence and strengthen the integrity of the capital market. The measures undertaken by the Commission were aimed at increasing the demand for and supply of capital that would provide the necessary fillip to promote further investments, expand industrial output and generate employment opportunities.

The stock market crisis of May 2000 revealed structural weaknesses in the system that necessitated implementation of immediate corrective measures by the Commission. The move towards implementation of the T+3 settlement system, substantial increase in net capital requirements, stipulation of capital adequacy requirements for brokers and strengthening of margin requirements were measures aimed at improving risk management at the stock exchanges and addressing issues identified during the May 2000 crisis at the exchanges. The appointment of 40 percent independent directors on the Boards of the stock exchanges and action initiated to ensure independence of the CEO of each exchange, are all measures introduced in line with international best practices and will go a long way in ensuring an efficient and transparent capital market in Pakistan

Further, the Commission implemented various regulatory reforms during the course of the year that included the issuance of the Brokers and Agents Registration Rules and the Insider Trading Guidelines. All these reforms have been carried out with a view to protect the rights of small investors and restore confidence in the market.

Institutional investment has been another area of focus recently. A major initiative is underway to develop the mutual funds/pension funds industry to give the market institutional underpinning. Also, regulations have been made more flexible to allow flotation of sector-specific funds to cater to different investor preferences and investment guidelines have been made less restrictive. All this provides wider avenues for investment by these funds.

2.2 Stock Market Review (July 2000 - June 2001)
The stock market was in a bear trap during most of the year under review. Between July and October 2000 the KSE-100 index moved up gradually from 1,520 to a high of 1,605 on October 4, 2000. The marginal improvement in the market was mainly attributable to the successful negotiations/settlement of the Hubco-WAPDA issue and a favorable response from the International Monetary Fund (IMF).

From October 5, 2000, the market slid downwards to reach 1,276 in November 2000, thus recording a fall of 329 points (21 percent). The sharp decline during October-November 2000 was on account of the huge accumulation of positions by some major market participants in shares of Pakistan State Oil (PSO) that were rapidly disposed of when the upward momentum in the market could not be sustained. The bearish tempo deepened further due to dividend announcements by PSO and Pakistan Telecommunication Corporation Limited (PTCL) that were much below market expectations. There was panic in the market and the speculators took advantage of the situation by selling "in blank". As a result, the market moved to the verge of collapse. It was only through the intervention of the Commission that a recurrence of a crisis similar to the one in May 2000 was prevented. The Commission, in November 2000, decided that blank sellers would be required to tender actual delivery of shares by borrowing stock. This regulatory action served to bring some stability in the market and the index gradually moved up to the level of 1,508 by the end of December 2000, remaining above the 1,500 level till January 11, 2001. From January 12, 2001 onward, the market remained bearish, gradually slipping from the 1,500 level to 1,366 on June 29, 2001.

Overall, the KSE-100 index dropped by 10 percent during the period July 2000 to June 2001 - from 1,520 on July 3, 2000 to 1,366 on June 29, 2001. The bearish trend in the market could be attributed to several factors such as depreciation of the Pak rupee against the US dollar, continued selling by foreign investors (mainly Morgan Stanley Pakistan Fund and Templeton), the Prudential Group crisis, fear of National Accountability Bureau/Federal Investigation Agency investigations into the affairs of a few brokerage houses and the lack of support from institutional investors. The pressure on the market from these factors was compounded by the fact that all market participants (whether jobbers, speculators or institutions) were holding positions dependent on short term financing and had no substantive capacity to absorb the foreign selling. It was largely due to these reasons that the market failed to respond to a range of incentives conducive to stock market development announced in the June 2000 budget.

2.3 Stock Exchange Wing
2.3.1 Reforms in the Stock Market
The May 2000 crisis highlighted fundamental weaknesses in the stock exchanges, including poor governance, weak risk management as well as lack of market integrity and transparency. The Commission accordingly took a number of important steps in line with a comprehensive reform program to restore investor confidence and to achieve a fair, transparent and efficient stock market. In order to achieve these objectives, the Stock Exchange Wing of the SMD implemented the following measures:?
i) Improvements in Governance
The following measures have been implemented:

1. The Commission is to nominate 40 percent independent directors on the Board of each stock exchange after due consultation. In 2001, seven non-broker directors were nominated on the Boards of the Karachi Stock Exchange (KSE) and the Lahore Stock Exchange (LSE) and five directors on the Board of the Islamabad Stock Exchange (ISE).

2. Independent, professional management has been ensured on the exchanges by requiring the Managing Director/CEO of each stock exchange to be appointed and removed with the approval of the Commission. Independent CEOs have already been appointed at the KSE and the LSE with prior approval of the Commission.

3. The directors of each exchange have been directed not to delegate operational powers to any person other than the Managing Director.

4. The number of broker-directors in the Central Depository Company (CDC) has been reduced from five to three (out of a total of nine).

5. The Chairman of the CDC is to be a non-broker.

6. The Board of Directors of the CDC are required not to delegate operational authority to anyone except the CEO.

7. The Commission has nominated a director on the Board of the CDC.

1. Risk Management Measures
The following actions were taken and necessary directives issued:

1. The requirement for net capital balance to be maintained by a stock broker has been enhanced by 10 times to Rs. 2.5 million for KSE brokers, Rs. 1.5 million for LSE brokers and Rs. 0.75 million for ISE brokers.

2. A measure of capital adequacy for stock brokers has been stipulated. The exposure of a broker must not exceed 25 times the net capital employed.

3. Margin requirements have been strengthened; notably the brokers' ability to trade up to Rs. 50 million without margin was abolished and all exposure of brokers is now subject to margin.

4. The undisclosed market system whereby the identities of the buyers and sellers are not revealed, in accordance with international practice, has been introduced. This has helped check manipulation and front running to a certain extent.

5. The internationally accepted T+3 settlement system has been introduced and successfully implemented at the three stock exchanges.

6. Blank selling has been prohibited.

2.3.2 Regulatory Actions
In order to strengthen the regulatory framework of the capital market and to facilitate the implementation of the Commission's reform agenda, a number of rules and regulations were issued which included:

1. Members, Agents and Traders (Eligibility Standards) Rules, 2001 - to prescribe minimum standards for market intermediaries.

2. Stock Exchange Members (Inspection of Books and Record) Rules, 2001 - to enhance monitoring of brokers and agents and strengthen the Commission's surveillance capabilities.

3. Public Companies (Employees Stock Option Scheme) Rules, 2001 - to motivate and facilitate employees in acquiring a stake in their company's share capital.

4. Insider Trading Guidelines, 2001 - to protect small investors from the use of privileged information by insiders.

5. Amendments in the Securities and Exchange Rules, 1971 (Net Capital Balance Requirement) - to define "net capital" in line with internationally accepted practice and ensure adequate risk management at the exchanges.

6. Share Transfer Agents, Underwriters, Balloters and Consultants to the Issue Rules, 2001 - to specify and streamline the eligibility criteria for share transfer agents, underwriters, balloters and consultants to the issue.

7. The Companies Share Capital (Variation in Rights and Privileges) Rules, 2000 - to specify rules for issue of different classes of shares.

8. Brokers Agents Registration Rules - to establish a direct regulatory nexus with brokers and agents to ensure investor protection.

In addition, the Listed Companies (Substantial Acquisition of Shares and Takeover) Ordinance, 2000 has been approved by the Cabinet in principle. Once finalized and promulgated, this would facilitate take over bids and protect the rights of minority shareholders.

2.3.3 Developments in the Market
1. Establishment of Futures Contracts Market
A market in futures contracts has been introduced in July 2001. A beginning was made by granting approval to the KSE to commence trading in standard futures contracts in certain shares. The emergence of a market in futures contracts would not only deepen the capital market in Pakistan but also provide investors with basic hedging instruments and investment alternatives.

2. National Clearing and Settlement System
Another development during the year has been the incorporation of the National Clearing Company of Pakistan Limited. The company was incorporated on July 3, 2001. The software of the National Clearing and Settlement System (NCSS) is ready and is being tested. The regulations of NCSS have been finalized and the company is expected to start operations shortly.

2.4 Market Monitoring and Surveillance
Since its establishment in October 2000, the Market Monitoring and Surveillance Wing (MMS) has filled an important regulatory gap in the SMD. The mandate of MMS is to closely track and monitor the market with a view to identifying possible instances of market manipulation and abuse for further investigation and necessary action.

Consisting of a team of six executives, headed by a Joint Director, MMS is entrusted with the responsibility of monitoring different sectors of the market on a real-time basis as well as monitoring developments in these sectors outside the ambit of the market itself. MMS takes note of unusual or abnormal price or volume movements and other developments/variations in market behavior which indicate that an abuse of the market may have occurred.

At present, MMS relies on its constant, real time, watch-and-observe activity as well as such intelligence as it is able to gather from formal and informal sources. This will soon be supplemented by an analysis of real-time trading data through a software program linked to automated trading systems of the stocks exchanges (via a server), which is being designed to evaluate trading data against specified benchmarks. The system would automatically generate "alerts" when any unusual activity or price movement is detected and would obviate the possibility of omitting any action that might have remained otherwise unnoticed.

MMS is the Commission's "eyes and ears" focused on the stock market. It is, in particular, expected to look out for suspected instances of insider trading and market manipulation such as dissemination of false information, cornering and abuse of the trading process to give a fake or misleading appearance in relation to the price of a security and/or its activity.

MMS's activities also include the preparation of intra-day, daily and monthly internal reports; company and sector specific research; analyzing trading data; and collating data for its information database. Further, since its inception, the Wing has been involved in a number of special assignments. Its analysis of trading data led to the Commission's Restraining Order on Blank Selling in November 2000. It has also been deeply involved in analyzing trading data of various brokers involved in the May 2000 crisis.

In connection with MMS, it is noteworthy that the Commission is endeavoring to get each stock exchange, as a frontline regulator, to significantly strengthen its monitoring capacity. MMS would then be essentially supplementing the surveillance carried out by the stock exchanges and in close coordination with them. With this system in place, it would be possible for the securities markets to operate in a fair, efficient and transparent manner.

2.5 Investor Complaints
Quick redressal of investor complaints and grievances is an important instrument in restoring investor confidence, thus an Investor Complaints Wing has been set up in the SMD. The complaints are either handled directly by the Commission itself or, if deemed appropriate, passed on to the concerned stock exchange with the Commission taking steps to ensure that these receive proper attention. Following is a statistical overview of this Wing's activities, albeit the data does not capture qualitative improvements in the disposal of complaints which has helped in preventing further abuses in the market.

Table 1 - Investor Complaint Statistics

It is clear from the above that the Commission's vigilance and vigor has resulted in a significantly higher rate of complaints' disposal. There is an increasing confidence in the investor community that their genuine complaints will be addressed in a fair and effective manner. The Investor Complaints Wing is a pillar for investor protection, which the Commission plans to strengthen appropriately in due course.

2.6 Beneficial Ownership
In order to protect the interests of small shareholders and to discourage managements of companies from making windfall gains on the basis of privileged inside information, each director, chief executive, management agent, etc. and holder of more than 10 percent share capital of a company is required to file certain prescribed returns of beneficial ownership. Also, any gain made by a beneficial owner of more than 10 percent equity capital through transactions completed within six months must be reported to the company and the regulators, and tendered as stipulated by law. During the period under review, the Commission was able to finalize cases of tenderable gains aggregating Rs. 2.1 million.

During the period under review, a proposal to amend the relevant rules, in order to exclude the acquisition of right shares from the determination of tenderable gains, was finalized and sent to the Government for necessary clearance and notification.

2.7 Issue Of Capital
The prospectus of any public offer of securities is required to be approved by the Commission prior to its issue, circulation and publication. Due to a variety of reasons (including political uncertainty, rupee devaluation, lack of foreign portfolio investment, etc.), there were only two public equity offerings during the year under review. However, there were 10 offerings of debt capital, i.e. Term Finance Certificates (TFCs), that highlights growing investor interest in these securities.

Table 2 ahead provides a comparison of share capital and TFC offerings during the year.

Table 2 - Share Capital and TFC Offerings
(Rs. in million)

2.7.1 Share Capital
During the year under review, there was no offering of fresh equity capital. However, four secondary offerings of shares were considered, of which two offerings were finalized involving shares aggregating Rs. 212.50 million in value based on the offer prices achieved. The total capital listed on the stock exchange was Rs. 1.985 billion. The other two offerings considered, but not implemented, pertained to Government of Pakistan (GOP) holdings in two listed companies being offered for sale by the Privatization Commission.

Relevant particulars of the two secondary offerings of equity capital that were actually completed during the year under review are as follows:

Table 3 - Secondary Offerings of Equity Capital
(Rs. in million)

Particulars of the two privatization offerings that were not completed are given below:

Table 4 Privatization Offerings

2.7.2 Further Issue of Share Capital
Companies can issue further capital by way of pre-emptive rights and/or bonus issues of shares without the approval of the Commission. However, in certain exceptional circumstances listed companies may be allowed to further raise their capital without the issue of right shares. In this regard, five applications were received, of which four were approved.

During the year, it was observed that some companies had not complied with the requirements of the Companies (Issue of Capital) Rules, 1996 while issuing bonus and right shares. The total number of companies that had issued bonus and right shares was 69 and 35 respectively. 19 companies issuing right shares and four companies making bonus allotments were asked to explain their failure to comply with the disclosure requirements prescribed under the Rules.

2.7.3 Issue of Shares at Discount
Listed companies may issue shares at a discount if so approved by the Commission. During the year, two companies were allowed to issue shares at 60 percent and 30 percent discount, respectively.

2.7.4 Debt Capital
The year under review was the best so far in respect of raising of debt capital by companies. Approvals were granted to 10 debt issues involving an aggregate of Rs. 8.9 billion. Of this amount, Rs. 5.489 billion (inclusive of green shoe option) has already been raised; Rs. 4.295 billion placed privately and Rs. 1.194 billion through public offering. Three companies will raise the remaining Rs. 3.475 billion in subsequent tranches.

Investor interest in TFCs is, among other reasons, attributable to: (i) attractive returns offered to TFC holders as compared to similar savings schemes of public and private institutions; (ii) a substantial fall in returns under various National Savings Schemes; and (iii) restrictions placed on institutional investors from investing in National Savings Schemes.

Table 5 below summarizes the 10 debt issues during the year under review.

Table 5 Debt Issues
(Rs. in million)

Note: All issues except Nishat Mills Ltd. have been oversubscribed

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