SECP raises CFS limits for bourses

ISLAMABAD (November 03 2006): After a detailed meeting with the stock exchanges management, the Securities and Exchange Commission of Pakistan (SECP) on Thursday enhanced the CFS limit to Rs 55 billion for Karachi Stock Exchange (KSE), Rs 10 billion for Lahore Stock Exchange (LSE) and Rs 5 billion for the Islamabad Stock Exchange (ISE) from November 6.

It also delayed implementation of value at risk (VAR) management system till December 4. It was also due to come into effect from November 6. The SECP and stock exchanges management also reached an amicable solution to VAR management system and institutional margining. The SECP team was headed by its chairman, Raziur Rehman Khan. He was assisted by securities market division commissioner Rashid I. Malik.

The KSE, LSE and ISE delegations were represented by their management. The KSE team comprised of Yaqoob Mammon, Haji Ghani Usman, Daud Jhon Mohammad, Abid Ali Habib, Faizyab, Yasin Lakhani, Munir Ladha and Siddique Dalal.

Sources said the SECP announced that the existing timeline for abolition of in-house badla and its conversion to CFS to be completed by November 30, as already notified, and the shares shall be transferred to CDC blocked account of the members.

Exchanges would come up with a mechanism for it by November 10. As a result of the conversion of in-house badla to CFS and the consequential impact on the capital adequacy of members, it was agreed any excess limit shall be brought within approved limits by November 30 by each respective members.

The mock trial runs in respect of (i) separation of CFS and ready market; (ii) introduction of CFS market margins; (ii) new netting regime for all the markets; (iv) removal of across settlement netting from the ready market; (v) new VAR-based margins and haircut regime; and (vi) introduction of special margins for CFS and deliverable futures shell start at the earliest and continue by November 30. In case of any problems/observations, exchanges shall inform back to the commission latest by November 25.

The SECP proposed, and is working with mutual funds and banks/financial institutions, to exempt the ready market trade on behalf of banks/mutual funds/financial institutions from payment of margins provided that financial institutions meet certain conditions. Furthermore, with regard to trades by financial institutions on CFS/futures market, margins shall be paid directly by institutions to exchanges, if any.

In any case, the entire new risk management system, as directed by the commission, shall be implemented with effect from December 4. The meeting decided that 100 percent VAR-based margins applicable on illiquid scrips as determined by the commission would be reduced to 60 percent and implemented from December 4, 2006.

The maximum cap on CFS financing rate to be 10 percent plus one month Kibor. The rate will be determined on the last Friday/working day of the month and will be applicable from the next trading day.

All scrips that meet with the following criteria will be eligible for CFS: companies that have average daily impact cost of less than one percent based on previous three months daily impact cost and on an order size of Rs500,000; companies should have traded on more than 90 percent of the trading days during last three months; companies with free-float of more than 20 percent of issued capital or 45 million free-float shares and mutual funds units/securities are not eligible for CFS financing.

In consultation with exchanges, the SECP also decided that the deposit against 50 percent exposure in cash for the deliverable futures contract to be implemented with effect from November 2006 futures contract. Exchanges agreed to pay appropriate return to members against the deposited cash margins after deducting one percent service charges. No further extension shall be sought by exchanges for the implementation of the proposed risk management measures.

During the meeting, the SECP informed exchanges that the commission wishes to emphasise that the reform process is not being derailed or rolled back. All major risk management measures, which were being proposed from early 2006, have now been adopted unanimously by stock exchanges.

The implementation has been slightly delayed in order to smoothen the transition and to take all market participants along. It is pertinent to point out that excessive netting, which distorted market exposure, has now been abolished completely under the new regime. Client level netting would be abolished from February 1, 2006.

VAR-based margining system has been introduced, which has been under discussion since early 2005. In-house badla has been the bane of a transparent and orderly market and this has been abolished. Margin financing is being promoted, rather than curtailed, as in-house badla is no longer possible and market participants would be forced to go margin-financing route.
<br> The meeting was told the SECP believes that various funding mechanisms should be made available to the market place and the market should decide and adopt the best option available to it.

Furthermore, special margin (old COT II) has been reinstated not only in CFS market but for the futures market as well. COT II was abolished arbitrarily by the KSE in June 2005. This is an important instrument for the market to correct itself from unidirectional movements. The most significant reform from the market's point of view is that the UIN has been successfully implemented, which is an important measure to ensure transparency and good governance in the market place.

The KSE 30 Free-Float Index has also been introduced to provide a more realistic benchmark to the market. Furthermore, cash settled future product has been developed and provided to the KSE on August 24, 2006. It shall hopefully be implemented by the KSE management shortly. The National Commodity Exchange is now in the final stages of going live.

According to the SECP, members of the three stock exchanges had requested the SECP chairman to meet with them to listen to their concerns and provide guidance on various perceived difficulties emanating from the new risk management measures being introduced at the exchanges from November 6, 2006.

The major concern highlighted by members was that they were given a presentation by the KSE management on the implications of the new regime on October 31, 2006 and in their view further time was needed by them to fully understand the mechanism/modalities of the new risk management measures.

The SECP chairman, at the onset, pointed out to participants that these measures were discussed in detail with exchanges at various forums since February 2006 and matters pertaining to these measures were circulated to members from time to time.

On June 18, 2006, a complete detailed paper on the proposed risk management measures was presented to stock exchanges and conveyed to all members. Thereafter, a series of meetings were held with each of the three stock exchanges, ie, directors, members and management of the three stock exchanges.

On August 30, 2006, a revised paper was again issued incorporating all suggestions, recommendations and feedback from the market. On September 13, 2006, a final paper after detailed discussion was issued.

In this way, the SECP made abundantly sure that its proposals were transmitted to members and to exchanges completely and proposals modified to take into account market realities.

It is, therefore, surprising for the commission to hear newspaper reports and electronic media programmes complaining about lack of co-ordination and information and for not providing sufficient time to market participants to understand and react to new proposals to enable them to adopt the same with ease.

Furthermore, he emphasised that the last meeting with the KSE management was held on September 29, 2006 in which the final version of the new risk management framework were agreed upon.

In short, exchanges as well as members should have been fully conversant with the new regime to be introduced well in advance of the implementation date. However, since it became apparent that members were still not fully aware of the new system and the KSE management had not conducted mock trials of the new system, the SECP deferred the new system to December 4, 2006.

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