Investor base in Pakistan absurdly low

KARACHI: The investor base in Pakistan is absurdly low at about 250,000 investors despite having a population of around 200 million. All regional markets, with even lower population than Pakistan, have investor base exceeding one million investors. This figure appears unrealistic; however, it makes complete sense if we take a look at the past conduct of brokers in this market.

During the last 10 years, not less than 27 brokers have defaulted, resulting in investor claims of more than Rs5 billion. Thousands of investors have lost their entire savings at the hands of these brokers and as a result, today the faith and trust of investors in the capital market is completely shaken. Many investors who have witnessed their relatives, friends and colleagues suffering due to misdeeds of these brokers simply want to stay as far as possible from the stock markets.

The reasons for these events are very clear. There is a group of brokers in the capital markets that wants to deal in public money and keep custody of customer assets, but does all in its power to sabotage any effort to ensure protection of customer assets or bring transparency, since any such reform will be against their vested interests. These brokers have the legacy of generating revenue through malpractices. They want to use customer assets as collateral to borrow funds and use these funds to extend illegal financing to their clients, earning exorbitant interest rates without putting their own assets at risk.

They want to run the practice of so called "dabba" accounts by keeping securities of multiple clients in one account, netting off the CGT but deducting the same from clients, again earning high returns. No industry or business can survive on zero pricing, but many brokers offered zero custody rates to their customers and resisted the introduction of minimum brokerage commission, which itself raises doubts of malpractices and illegal business practices.

There are also other brokers in the market which have long operated as family owned businesses without any corporate governance structure or board oversight, which are considered as fundamental requirements for financial institutions, which deal in public money. Over time, markets have evolved. Defaults and failures of financial institutions have signified the need to instill proper checks and balances and as a result the compliance requirements have increased significantly across the globe. Another key aspect is the AML/CFT threat, which has resulted in more stringent compliance requirements and demands on the financial institutions and intermediaries to graduate accordingly. Another important dimension is the continuous evolvement of capital markets. Technological advances present exciting opportunities but also pose new threats.

In order to be able to respond to all these challenges, brokerage houses which deal in customer assets need to invest significantly in the compliance system, internal controls, appropriate resources, IT infrastructure, etc, to not only meet the more stringent compliance and AML/CFT obligations but also to provide reasonable comfort to investors and regulators that they have the required system to ensure protection of customer assets. However, these brokerage houses simply refuse to change. They avoid reporting requirements, do not hire proper professionals for compliance function, do not want independent directors on their board to improve oversight and do not invest in IT infrastructure to improve efficiency. An interesting point is that these brokerage houses do not want to undergo any kind of rating from a credit rating agency as this will expose the weaknesses in their structure and control systems. They even do not have the proper accounting staff to prepare financial statements in conformity with IFRS. How a set-up with such weak infrastructure and proper staff can hope to survive in today’s environment and demand the right to keep custody of customer assets is beyond comprehension.

Taking cognizance of this fact, SECP has initiated the reform process through broker categorization which aims to ensure that only those brokers which have the sufficient capacity should keep custody of customer assets. Brokers with small capital base who do not wish to enhance their capacity are being given multiple options to transfer their custody to larger brokers with sufficient capacity, professional clearing members or CDC/NCCPL through Direct Settlement System (DSS) or National Custodial Services (NCS).

It is interesting that small brokers have less than 10pc market share in terms of both number of clients and trading volumes. On the other hand, brokers which have more than 90% of market share, have openly appreciated the new regime and termed it as long outstanding reform. Still the efforts from this particular segment continue to stop this process by allegations and media propaganda.