They Go Scott Free Again

They are more than two hundred in number.  Many of them are winners. They were provided with an opportunity by a few to make windfalls and they did so smartly. Others are the losers. They are ditched by a few as well. And they are still licking their wounds.

Shaukat Tareen, Razi-ur-Rehman, Zafar A. Khan, Adnan Afridi, Sohail Diyala, eight plus four stock brokers and dozens of investors topped the list. They all are not names in Bridget Jone’s Diary but bleep equity market meltdown in 2008.

The PPP-led coalition government was in its first year of the rule. Karachi Stock Exchange was Asia’s only rising stock market. The bourse was shining on strong fundamentals and technical reasons. It claimed several reasons for its bullish streak, including recent political stability. Looking at a turbulent 2007, the benchmark KSE-100 Index appeared as a car without breaks.

Analysts were unanimous in seeing political stability and prospects of overall improvement in law and order in the country as two chief driving factors for the index. To them the recent formation of coalition governments at both federal and provincial levels following the February 18 general elections, hailed as free and fair, signals for future political stability in the country.

All hell broke loose. When stock market saw foreign investors queued up on selling windows dumping blue-chips and bellwethers. At that time benchmark KSE-100 index was hovering over Wuthering heights.

Those a few sitting at the helms of affairs did only one thing. They froze the market. Investors got panicked both the foreigners as well as locals including stock brokers, punters and jobbers. The sufferers blame the then finance minister Shaukat Tareen for creating an artificial vacuum by freezing the market.

Background interviews suggest many stock brokers and white nights ran pillar to post for unfreezing the market but to no avail. They were against such a freeze. They believed the market had the capacity to absorb sell-out shock being spewed out by the foreign investors.

The then chairman, Securities and Exchange Commission of Pakistan (SECP) Razi-ur-Rehman was also against freezing the stock market. Whispers were in the air that Finance Minister Shaukat Tareen was handling the affairs all alone.

The securities regulator chief kept his lips zipped. He played no active or pro-active role as securities watchdog. The burly finance minister ‘a former banker with an international repute’ had been given an open court to do experiments in the name of market protection at his freewill. SECP’s commissioner securities market Sohail Diyala too proved docile in front of his bigwigs.

Interestingly, decision to freeze the stock market had proper endorsement by board of directors from the KSE led by the independent chairman Zafar A. Khan, the former chairman of PTCL. They argued if the market had not been frozen the market would have not been able to withstand the hammering of foreign selling.

A prolonged debate ensued. Finally the freeze was lifted with a stricter ‘upper and lower lock’ combination. But the damage was done. The stock market floored in just two consecutive trading sessions. The swarm of sellers was so huge that market suffered gate crashing quit.

Then the game began. Of course, insider trade was done. Only an honest forensic probe can prove this. Those who knew what would have been the next bought blue-chips at throwaway prices. Share of National Bank of Pakistan were available at rupees thirty a piece at that time. Likewise, natural resources’ exploring giant such as OGDCL was trading below rupees 70 a scrip.

A lot of hue and cry was made. A bailout package was drafted. NIT market support fund was formed. The stock market was resurrected. It sprang to new heights. The bigwigs remained indulged in their follies. This time they raised ‘upper lock’ to ten per cent. Those who had their hands on blue-chip shares at cheapest rate sold out their holdings during the bull-run. Rich became richer and richer became richest overnight.

The life seemed easier. A sigh of relief was about to be whistled out when a bigger hell broke loose. The Sub Prime Scam hit the global market. It engulfed entire America. It swept Europe. It submerged Far Eastern economies. The bubble burst plunged Middle East and enveloped entire Asia. Pakistan too faced the music. The stock market was flattened again.

The rise and fall had its own fallout. Some twelve stock brokers defaulted. Their clients moved the courts for payments. National Accountability Bureau is now pursuing criminal proceedings against four of the stock brokers. The NAB is now fluttering its wings to perch on initiating attachment of moveable and immoveable assets of the four stock brokers to clear the dues.

This tarnished image of the stock market globally. International rating agencies dragged down the KSE to negative list. Morgan and Stanley expunged Karachi Stock Exchange from its ’emerging market index’. Till now, the KSE has not been able to revive its privilege with MSCI.

The stock market has been in existence for over six decades. Yet if one gauges the number of investors in the market by the number of Unique Identification Numbers’   in Central Depository Company, there are around 270,000 UINs. Of that more than half are inactive.

If it is compared this with around 30 million bank deposit holders in the country, the stock market has not been successful to attract a substantial investor base. One of the reasons is that the risk (standard deviation) of the Pakistani stock market at 25% is much higher relative to other stock markets in the region.

Thus, investors have found stock market investment very risky and have shied away from it. This has partially to do with the high economic, political and security risk factors in the country. However, excessive leveraging and the mind set of investors to take short-term speculative positions rather than long-term investment positions are other factors that have made our market more risky than others. Also, stock investing has been limited to a few large investors and has not spread among millions of small investors, as is the case in other emerging markets.

In 2005, the stock market crashed. Three years later it happened again. This is so because corporations have been historically family-controlled, especially those in the textile, automotive, tobacco, and agricultural sectors. Today, the majority of corporations remain under family control.

There are three main types of listed corporations: multinational, family-controlled, and state-owned enterprises such as PIA. A majority of listed corporations are family-controlled via pyramid structures and cross-shareholdings.

Pakistan’s equity culture is still developing. The lack of focus on an equity culture in the 1980s, the high returns on government bonds and easy access to bank loans in the 1990s all discouraged an equity culture in Pakistan. Debt financing is still prevalent, which hinders further development of an equity culture.

The equity market is relatively shallow and is oriented
mostly towards a handful of major companies. According to ICAP, Pakistan’s equity market was 40 per cent of its GDP in 2005.

V Current reforms on the government’s agenda are the demutualisation of the stock exchanges and the creation of over-the-counter markets, both of which will help increase the depth of the market.

However, equity financing is still not a priority because of a lack of competition in various industries. Family-controlled companies are often satisfied with their position in the market and prefer not to risk weakening family control by selling shares to minority investors.

Besides, the ‘comply or explain’ regime in place does not give the securities regulator an active monitoring role ‘listed companies just need their statement of compliance signed by a verified accountant. Accordingly, many companies think of the code as simply requiring a rubber stamp, not any serious compliance.

A more active monitoring system, balanced between too much interference and no monitoring, would help ensure greater compliance with the code of corporate governance. A major complaint is that the stock exchanges themselves do not completely follow the code.

The legal system provides little effective recourse for any shareholder, let alone the minority shareholder whose rights have been violated. The court system is overburdened, plagued with delays and suffers from a general lack of experience with corporate matters. However, reforms have been introduced to improve the ability of the court system to handle such matters. The High Courts are required to have a companies’ judge to handle corporate matters.

Although steps are being taken to create a more accommodating legal system, the largely lethargic system does not present a positive outlook for minority investors in the short to medium term.

A submissive legal framework, lack of state-of-the-art forensic probe and absence of highly trained detectives to delve in any misdeed, the insider trading, abuse of power, stock manipulations, and instances of gains through flawed regulatory system will continue to haunt corporate sector particularly stock market.