KSE may introduce MTS from February

After a gap of 21 months, Pakistan capital market is expected to have a new leverage product, namely 'Margin Trading System' (MTS) most likely from early next month. In the absence of any leverage support, market activity had touched its historic lows as volumes averaged at $71 million in the year 2009-10 compared to historical averages at $249 million during 2000-08.
Analysts believe that the participation of local retail investors is expected to increase after the launching of the MTS, and trading activities at the local bourse are expected to increase significantly. The much-improved and transparent leverage product, MTS, would provide additional impetus at the KSE bourse, while supporting better activity, coupled with much-needed price discoveries giving investors a way to re-rate stocks suiting more to their risk-return profiles, they added.
Khurram Schehzad, Head of Research at Invest Capital and Securities, said that Pakistan's capital markets, especially the KSE, survived on cash only for the last 21 months. The leverage product has always been a next-door friend (or a foe, at times) to the KSE, right from the early days of its inception to its recent forms ie Badla, CFS (Continuous Funding/Financing System), CFS MKII and now the Margin Trading System (MTS).
However, concerted efforts have once again produced results over the last six months where the product is expected to be formally launched from February, 2011, he said, adding that initially a smooth approval of the product had hit snags following the protestation from the KSE chairman, which came only after the product had been approved by the KSE board (his concerns revolved around risk management and anti-money-laundering).
Khurram said that after having been approved by the SECP, the talk-of-the-town leverage product, MTS (Margin Trading System), has now steered through the final stages, as the Federal Ministry of Law has endorsed the much-needed product. This has turned up as an additional excitement for investors, "in fact one of the major ones at the KSE". However, official launch of MTS should be taken into account realistically with its exact modalities, especially the additional risk mitigating measures, if any, to be incorporated by the SECP at the final stage.
He said that like many other emerging/frontier markets, leverage seems to always excite investors at Pakistan bourses as well. It gets further traction to enthuse investors in the presence of the recently imposed capital gains tax in Pakistan markets where revealing investor's wealth has been considered an issue (favouring more speculative activity). More so, due to the cost of leverage having been made adjustable to CGT liability as per the draft rules capital gains tax.
According to him, the leverage product is usually designed on borrowing-then-invest philosophy, enforcing natural upward bias for the market. In addition, leverage also supports the severe liquidity and low volumes issues facing the bourses over the last few years. As a result of better activity, market/stock price distortions should also adjust to their fundamental levels more quickly (promoting price discovery) while providing an ease with respect to entry and exit. This improves confidence of the foreign investors as well despite law and order and other broader economic issues facing the country.
However, he said, high cash margins, coupled with high interest rates, would limit product's attraction for many an investor in the market. About the financier, Khurram said that while clearing differences between bourse and the regulator followed by approvals and the launch of the product are the most crucial stages, financier's response is equally important to make it a winning combination at the bourses. It is pertinent to recall that the concept paper indicates a cap rate of 1M KIBOR+8 percent (~21 pefrcent rate where interest rates are expected to go further up) while it seeks to provide a tax advantage by taxing the financier's income (from this head) at 10 percent against the corporate tax rate at 35 percent. However, general risk aversion shown by the financial institutions (especially banks) so far suggests that the product may not pace up, at least initially.
The concept paper of the said leverage product makes it resemble the previously prevalent CFS MK II until 2008. Nevertheless, the new margin trading system includes improved risk measures alongside latest changes from the CDC on investor's sub-account level. The product is also believed to entail more transparency with names of top 15 financers and financees to be disclosed on daily basis. If applied in its true spirit, the much-improved and transparent leverage product, MTS, would provide additional impetus at the KSE bourse while supporting better activity coupled with much-needed price discoveries giving investors a way to re-rate stocks suiting more to their risk-return profiles.
Hasnain Asghar Ali at Aziz Fidahusein Co said that there is likelihood of improvement in stock valuations after introduction of ready board leverage, as it will certainly increase the trading capacity of the local participants. While high quantum activity by offshore participants is likely to be an add-on, gloomy economic and financial horizon along with volatile political and law and order fronts would, however, keep nervousness visible. Nevertheless, selective and calculative activity in fundamentally strong speculative and liquid stocks will prove prudent.
He said that with the rising stock prices, anticipation of high payouts and earnings is duly on the rise, either through core business or with the support of technical entries. It is, therefore recommended to trade on conservative estimates, since apart from selective sectors, majority stocks and sectors are likely to disappoint the local bourse mainly on payout front due to over-optimistic earning bells in the arena. However, leverage impact in some might allow the stocks to justify the current rates. Official announcement of launching of leverage product for ready board along with sensitive properties is likely to dominate the proceedings. Delay might, however, keep rumour-mongering on higher side, thus keeping the upcoming sessions quite volatile.