All claims are paid from liquidating assets of the broker. If that is not enough, a fund is utilised up to an aggregate amount of Rs75m.
The past few months have been tumultuous for Pakistan’s capital markets. While the benchmark index of the Karachi Stock Exchange (KSE) has gone up over 15% since February 15, 2013, several scandals involving brokerage house defaults and insider trading have surfaced during the same period.
The latest brokerage house to bite the dust is ZHV Securities. According to a KSE notice issued on May 14, the KSE board of directors has forfeited the Trading Right Entitlement Certificate (TREC) of ZHV Securities because of the brokerage house’s “inability to resolve admitted investors’ complaints/claims arising out of trades/transactions, registered with the KSE, due to financial precariousness.”
In a default case like this, creditors are exposed to the risk of losing their money, even though the KSE management has explicitly said in its notice that the forfeiture will not affect the rights of the company’s creditors. According to the KSE, ZHV Securities remains responsible for discharging all its financial obligations.
Under existing investor protection rules, in the case of default all claims are paid from the sale proceeds of assets of the broker under control of the exchange. Those claims that remain unsatisfied after the sale are then paid from the Investor Protection Fund up to an aggregate amount of Rs75 million.
“Before KSE’s demutualisation, the defaulter’s seat would be sold to raise money to meet its financial obligations. But now there is no seat, and all the exchange has got is the broker’s TRE certificate and shares in the KSE,” KSE Managing Director Nadeem Naqvi said while speaking to The Express Tribune.
As per existing regulations, each broker is required to maintain a minimum base capital of roughly Rs31 million, which is the estimated value of a TREC, and its shareholding in the exchange. This is a notional value that the Securities and Exchange Commission of Pakistan (SECP) and the KSE board came up with, and is based on the book value of KSE shares post-demutualisation.
Hence, if claims exceed the amount of minimum base capital and broker’s assets, the KSE is expected to meet the gap through the Investor Protection Fund. However, the problem is that the Investor Protection Fund, which used to have Rs1 billion before the 2008 crisis, has now shrunk to approximately Rs500 million. This leaves the exchange with only two options, says Naqvi: the KSE can either increase the allocation of a percentage of the trading fee – commonly known as ‘Laga’ – to generate more money for the fund, or it can reduce the maximum contribution of the fund from Rs75 million to Rs25 million per default case.
Naqvi believes going for the first option will scare away investors and clients, as dwindling volumes on the bourse have already hurt the earnings of a majority of brokers in recent years. “The brokerage fee is charged on volumes. Brokers’ earnings are extremely low, as most of them are barely surviving despite a rising KSE-100 Index,” he said.
As for the second option, Naqvi says the KSE board already recommended it in October last year but the SECP has yet to approve it.
National Investor Protection Fund
Naqvi says the best solution to ensure investor protection in the long run is the creation of a separate national investor protection fund. “I think this fund should be of substantial size, preferably about Rs5 billion, in which all exchanges, the SECP and the Asian Development Bank should contribute,” he said. He added that the fund should operate along the lines of a typical deposit protection scheme, through which small investors of up to Rs100,000 should be protected. He said the KSE already has Rs500 million, adding that its size can be increased to Rs900 million with the help of the two other exchanges.
“The rest of the contributions should be made by the government and international financial institutions like the ADB. Investor protection is essential for capital markets. We cannot leave small investors on their own in case a broker defaults,” he said.
Published in The Express Tribune, May 19th, 2013.
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