Leverage at your own risk

Whether its the football World Cup or investor weariness, the bottom line is that equity markets have largely remained volatile. Sentiments are difficult to assess at the local bourse at a time when turnover is weak.
Investors and brokers alike have decried the lack of liquidity in the capital market for long now. Since 2008, the word "margin" has been all but barred from KSE. It seems a return is imminent, now that a committee of stakeholder has been constituted to recommend policy to SECP.
"The committee will meet next week and formulate its recommendations for SECP, margin financing should be up and running in about a month", Arif Habib, a leading stock broker who is in the committee constituted by the regulator, told BR Research.
And if one leverage product wasn enough to cheer up the market, KSE has proposed the introduction of margin trading as well.
Aren both the same thing, one might ask?
"No! While margin financing is a product whereby banks provide leverage to investors, margin trading is the leverage, a broker might provide to its clients", said an operations manager at a fund management company in Pakistan.
To be sure, the proposed margin financing will allow banks to lend to investors based on their financial health. Commercial banks have well defined due diligence and risk assessment criterion. Credit risk of the counterparty will be pivotal in such a transaction.
On the other hand, in margin trading, the risk is on the performance of the scrip. Its a form of in-house financing, where the broker might allow clients leverage on its own, in a view to earn greater commission for greater capital gains.
But, what goes up certainly comes down as well. While leverage offers the possibility of magnifying returns, downside risks may also be severe. In margin trading, more than margin financing, all the risk is borne by the client. The broker acts only as the financing agent, assuming zero risk.
Brokers surveyed by BR Research are looking to leverage products, as turnover volumes will increase as a result. And the market has supposedly priced-in the possible counter balancing affect of capital gains tax.
Parameters restricting the allowance for margin trading must be clearly defined and strictly enforced if the market regulator wants to safeguard against another stock market crisis.