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SECP and SBP announce Margin Financing rules

ISLAMABAD (July 04 2004): To reduce speculations at stock market by replacing badla trading, the Securities and Exchange Commission of Pakistan (SECP) and State Bank of Pakistan (SBP) have introduced the Margin Financing Rules 2004 and Regulations for Margin Financing by banks and development finance institutions to brokers.

This was announced by SECP Chairman Dr Tariq Hasan in a joint briefing with SBP Governor Dr Ishrat Hussain.

It would make available the financing of stock trading for retail investors, as happened in India, after replacing badla with margin financing.

For six months, badla and margin financing would work parallel and badla would be phased out, as further rules by stock exchanges would be introduced gradually.

Only financial institutions would offer funds for margin financing and no broker can do that.

Banks have also started working to designate branches and develop internal rules for margin financing. A collateral would be required for such loaning.

Dr Ishrat Husain said that for investing $3.2 billion reserves two lead banks and eight banks were selected for which $1.6 billion to HSBC have been released after signing legal arrangements.

These investments would be made in fixed income securities by eight global financial institutions.

He said that from 1999 the Bank has bought $12 billion from open market and interbank and spent $17 billion between 1998-2003 on debt servicing.

He also said that out of total 375 moneychangers 355 have been converted into A and B category exchange companies with Rs 100 million and Rs 20 million capital requirement.

He said that new monetary policy statement would be announced on July 20.

The salient features of the Margin Trading Rules are:

— Margin financing and trading can only be conducted by brokers registered with the SECP having minimum net capital and meeting capital adequacy requirements as fixed by the SECP in consultation with the stock exchanges.

— A broker will enter into a margin agreement with any person who wishes to become his client. The agreement shall contain conditions regarding mortgage, pledge or hypothecation of the securities deposits or bought on behalf of client as well as authorise the broker to dispose of the collateral in a lawful manner to meet the prescribed margin requirements.

— Brokers have been prohibited from extending margin financing facilities to any of their partners, directors, agents, employees etc as well as to any firm where any of their partners is a director, partner, or holds any interest.

— Brokers shall maintain the prescribed margin with the client at all times and give a margin call to the client whenever necessary, due to market fluctuation, the amount of deposited margin falls below the prescribed minimum level. The limit aggregate outstanding balances in the margin accounts maintained by all clients of a broker shall be fixed by the SECP in consultation with the stock exchanges.

— Brokers are required to keep the credit amount of margin accounts in a separate bank account on behalf of his client and also maintain separate central depository accounts for securities deposited/purchased on behalf of his clients.

— Stock exchanges shall frame detailed regulations for brokers, subject to prior approval of the SECP, relating to grant of margin financing and margin trading facilities in relation to any margin account.

Meanwhile, the State Bank on Saturday issued Regulations for financing brokers by banks and development financial institutions (DFIs).

“In order to facilitate the transition from Badla to Margin Financing in Stock Exchanges of Pakistan, encourage active participation of banks / DFIs in this area, unlock investments in equities, enable investors to leverage their stock holdings and to ensure that the relevant activities are undertaken by banks / DFIs in a prudent manner, State Bank of Pakistan is issuing the regulations for financing to brokers by banks / DFIs,” said a release issued by the SBP.

While the banks / DFIs will continue to provide financing against shares to their retail investors under Regulation R-6 of Prudential Regulations for Corporate / Commercial Banking, these regulations will apply for extending financing facilities (including margin financing) to brokers.

Banks/DFIs have been advised to encourage the brokers who are availing margin financing facilities from them to obtain credit rating from a credit rating agency on the approved panel of State Bank of Pakistan.

The State Bank is not making credit rating mandatory, or prescribing any minimum credit rating for the eligibility purposes. The purpose is to emphasise the importance of credit rating and encourage the brokers to provide this important information to the lending bank/DFI for their decision-making.

The margin financing will be provided by banks/DFIs only against approved securities, provided that the approved shares should be in dematerialised form in the Central Depository.

The brokers availing the margin financing from banks/DFIs would be prohibited from lending the funds obtained from banks/DFIs or their own funds, directly or indirectly, to lending bank's/DFI's connected entities, directors or major shareholders and relatives of directors or major shareholders.

Margin Financing shall be provided by banks/DFIs from designated branches only.

The details of the existing designated branches will be provided to Banking Inspection Department of State Bank of Pakistan within fifteen days of the issuance of this circular and the details of branches designated after the issuance of this circular will be provided within fifteen days of the designation of the branch for the purpose of extending margin financing.

Before undertaking margin financing, the banks/DFIs will prepare comprehensive policies and procedures for the purpose.

The policies in this respect will be duly approved by the Board of Directors, if not already covered appropriately in the current credit policy.

The banks/DFIs will obtain legal opinions to ensure that the manner in which they are accepting shares (especially those of the clients/customers of the broker) as collateral is legally sound, the documentation (including the authority/consent of the clients/customers of the broker in case their shares are being pledged) is sufficient to create an effective pledge over the collateral and they are fulfilling all the legal requirements appropriately. In this context, Pakistan Banks Association may encourage banks/DFIs to prepare uniform legal documents for the purposes of extending margin financing to brokers.

Banks/DFIs will put in place an effective system for monitoring margins and their exposures on the shares of various companies and brokers, keeping in view the quantum of their margin financing.

Banks/DFIs would review, on an ongoing basis, their exposure in margin financing with a view to assess the risks due to volatility in assets prices.

The bank/DFI should be mindful of their exposure towards stock markets and should make necessary arrangements to monitor their exposure on continuous basis.

In this regard, Risk Management Guidelines, issued by State Bank of Pakistan, may be meticulously followed.

The banks/DFIs will maintain at least minimum margins as prescribed by State Bank of Pakistan from time to time. Banks/DFIs may, however, set higher margin, if they so desire.

Banks/DFIs will monitor the margin on at least daily basis and will take appropriate steps for top-up and sell-out on the basis of their approved policy in this respect and agreements with their customers (brokers).

For the purpose of this regulation, value of the shares held as collateral shall be based on the last closing price of the share on the preceding market day.

The financing to brokers against their receivable will, however, be subject to a minimum margin of 30 percent. Such receivables should appropriately be assigned to the lending bank/DFI and should be verified from the respective clients of the brokers.

Banks/DFIs must make efforts to avoid concentration of margin financing to a few brokers. In this respect, they may prescribe internal limit for margin financing to a single broker.

It is expected that the margin financing would be spread out by a bank/DFI amongst a reasonable number of brokers.

A bank/DFI shall not extend financing to any broker in excess of its per party limit under Regulation R-1 of Prudential Regulations for Corporate and Commercial Banking. The total margin financing portfolio, at any given point in time, should not exceed the equity of the bank/DFI.

The total financing, including margin financing, availed by a broker from the financial institutions should not exceed the limits prescribed in Regulation R-5 of Prudential Regulations for Corporate and Commercial Banking.

Banks are cautioned that they should keep in mind and ensure compliance at all times with the requirement of subsection (2) of Section 23 of the Banking Companies Ordinance, 1962, which is reproduced here for reference purposes:

“Save as provided in subsection (1), no banking company shall hold shares in any company whether as pledgee, mortgagee or absolute owner, of an amount exceeding thirty percent of the paid-up share capital of that company or thirty percent of its own paid up share capital and reserves, whichever is less”.

DFIs have also been advised to ensure compliance with this requirement.

The financing extended to the directors or major shareholders of a broker shall be considered a part of the overall financing allowed to the broker for the purposes of these regulations.

The limits mentioned above are overall financing limits and total financing facilities to brokers (eg working capital financing, financing against receivables of brokers, financing to brokers for their proprietary trading, or any other financing to brokers by whatever name called) should not exceed the limits prescribed above. Further, for the purposes of monitoring and better controls, banks will keep separate records of the following facilities:

— Financing against the shares of clients of brokers.

— Financing against own shares of brokers.

— Financing against receivables of brokers.

— Working capital finance against any other security.

— Any other financing facility to brokers.

The areas not covered under these regulations will be governed by Prudential Regulations for Corporate and Commercial Banking.

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