How those big stock brokers are breaking the market

LAHORE: The reservations expressed by Richard Morin, the former chief executive of Pakistan Stock Exchange (PSX), about efforts underway to ensure the dominance of large brokers are substantiated by the fact that rules are being imposed that would eliminate 40-50 brokers at the start of next fiscal.

It is pertinent to note that when capital market was demutualised in 2015 about 400 brokerage firms were registered in the capital market. The number has since been reduced to around 240-250 firms. This has naturally reduced competition and was not in line with global experience where demutualisation results in mushroom growth of brokers.

The demutualised exchanges are technically very sound and technology ensures that none of the broker crosses the limits based on his paid-up capital. The moment any broker tries to cross that limit the system refuses to accept orders.

This way, trading is secure with a broker with a paid-up capital of Rs5 million or Rs500 million. The trading limit of each broker is to the extent of ten times its paid-up capital. With such technology in hand, the demutualised stock exchanges try to register as many brokers as possible. They register brokers under different categories based on the type of trading they want to do and the capital they have at their disposal.

It is unfortunate that this universal practice was not followed in Pakistan. All the brokers are given licence in one category only with a minimum capital requirement (the larger brokers of course register with very high paid-up capital because they have to trade in billions).

The Securities and Exchange Commission of Pakistan (SECP) has enhanced the minimum paid-up capital requirement to Rs35 million to be complied by June 30, 2019. The capital market over a period of 18 months has crashed from 52,000 points level to around 35,000 points, causing huge losses to small brokers (the big brokers’ cartel remains untouched because they are the ones that manipulate the market). Under these circumstances it would not be possible for small brokers to enhance their paid-up capital.

A study by The News revealed that if the minimum capital requirement condition is not withdrawn about 60-80 brokerage firms would lose the licence to trade. Of these about 35 firms will be from Lahore, 25 from Islamabad, and 20 from Karachi.

This will reduce the number of brokerage houses from present 240 (130 in Karachi, 70 in Lahore, and 40 in Islamabad) to 160. This will further strengthen the hold of large brokers on the capital market and the general investors would be at higher risk of manipulation.

Pakistan could have emulated the brokerage registration procedure followed by India that is a fast growing capital market being ranked 11th largest in the world. The comparison of Indian capital market with that of Pakistan would reveal the reason for low growth of capital market in Pakistan.

Let us start with common known facts. India has a population of 1,270 million, which is six times larger than Pakistan. Its gross domestic product (GDP) of $2.7 trillion is 19 times higher than Pakistan’s $282 billion. India’s equity market capitalisation of $2.27 trillion is 52 times larger than the PSX’s $43 billion. There are 13,000 registered brokers and 33,000 sub-brokers in India, while in Pakistan there are only 240 registered brokers and a few sub brokers. The investors registered with central depository company in India are 20 million, which is hundred times higher compared to hardly 200,000 in Pakistan.

In India the brokers are granted license in six categories and the paid-up capital is according to the category. In trading member category only, the registered individual is allowed to trade and deposit and the paid-up capital is Rs1 million (Rs2 million Pak rupees). The next is self-clearing member and in this category the trader is not allowed to settle the account of any other person. The deposit fee again is Rs1 million. This way there are six categories of brokers and the maximum deposit or paid up capital is Rs3 million. In Pakistan there is only one category and the paid-up capital is being enhanced to Rs35 million.

This enhancement of paid-up capital has got nothing to do with safeguarding the investors’ interests. Each broker is allowed to trade up to 10 times his/her paid-up capital. The software in the capital market system ensures that no one crosses this limit. If a broker with a low paid-up capital defaults the loss to investors would be less, but if the paid-up capital is high, the loss would be higher. So it’s time things changed for the better and there’s nothing wrong in taking a leaf out of someone’s book, if it helps.