Divestment: The road to a new beginning

Divestment of 40% shares of Pakistan Stock Exchange Limited (PSX) has been completed in terms of requirements of Stock Exchanges (Corporatisation, Demutualization and Integration) Act, 2012. Successful sale of PSX's shares to an international consortium is expected to usher a new era of growth and development for the country.
The deal endorses renewed confidence that Pakistan has managed to establish with the international community over past few years. The transaction is not just another routine foreign investment, but evidence that other countries are willing to cement long-standing commitments with Pakistan.
An investment of over PKR 8.9 billion (USD 85 million) by the Chinese consortium in PSX has been made possible due to Pakistan establishing itself as a globally competitive economy with investment potentials. This had much to do with the government's investor friendly policies, strong macro-economic indicators, political stability and improving security situation. The deal shows a marked migration from the period when Pakistan was struggling to attract foreign investment and strategic partners.
Due credit should be given to the Government's focused efforts towards reformation of capital market and the Securities and Exchange Commission of Pakistan (SECP) leading the reforms, to create this enabling environment. Divestment comes at the backdrop of mammoth market reforms that have led to overhaul of our capital market. In the preceding two years, emphasis was on strengthening legal framework, governance, risk management, investor protection and transparency. Major laws such as Securities Act, 2015 and Futures Market Act, 2016 have been enacted and SECP's powers have been enhanced through amendments to the SECP Act, 1997. Subsidiary legislation is being framed to ensure implementation of these laws and prepare market institutions and intermediaries to challenges of a globally integrated investment environment.
New regulations have been introduced with respect to licensing and operations of securities exchanges, clearing company and depository. The broker regime has been revamped with emphasis on investor protection through clear distinction for brokers maintaining client asset custody, enhanced disclosures, client asset segregation, complaint handling procedures and internal control policies.
These reforms were accompanied with major structural and operational improvements. The National Clearing Company of Pakistan Limited (NCCPL) commenced operations as central counterparty that guarantees trading of securities at PSX. Risk management function has been shifted to NCCPL and a Settlement Guarantee Fund has been established for the purpose, which until recently stood at over PKR 2.7 billion. For ensuring investor protection, a centralized Investor Protection Fund of over PKR 2.5 billion is available at PSX for compensating investors in case of broker default. Such initiatives have contributed to improved inevitability conditions and significant improvements to compliance with IOSCO principles. Consequent to this wide-ranging reform agenda, MSCI which is the leading provider of global equity indexes, has announced upgradation of Pakistan from Frontier Markets status to Emerging Markets status. This reclassification strengthened PSX's position globally and paved way for attracting strategic investors.
Perhaps the most crucial reform which set the stage for successful divestment was the integration of the three former stock exchanges under a single, national level exchange banner ie PSX. Integration presented investors with a unified and consolidated capital market structure to invest in and placed PSX in a position to market itself to reputable investors.
From the onset, it was clear that the true purpose of Demutualization ie segregation of majority ownership and trading rights of the stock exchanges, could not be achieved without divestment of shares to strategic investors and institutions. At the time of Demutualization, 60% shares of stock exchange were deposited in blocked CDC account while remaining 40% shares were issued to the shareholders. In terms of the Demutualization Act, 40% of shares lying in blocked account are to be sold to strategic investors and financial institutions while remaining 20% are to be offered to public.
To ensure that 40% shares are divested in a transparent manner, SECP in terms of the Act amended the Stock Exchanges (Corporatisation, Demutualization and Integration) Regulations, 2012. A Divestment Committee was constituted in February 2016 and was tasked to complete the sale of shares in a transparent manner by December 2016. The Committee comprised Chairman and elected PSX directors and market experts who made significant efforts to complete the process timely. The Committee's primary responsibilities included engaging valuer to carry out valuation of PSX, inviting EOIs from potential investors, conducting bidding process and obtaining bids from investors, negotiating a price and finalisation of the sale.
The process aimed to foster good governance, ensure a commercially driven strategy for development of PSX and bring in new technology. The concept of anchor investor was introduced through the Regulations to attract investors who not only acquire shares of PSX but also enter a strategic partnership with PSX for playing major role in its development. While a foreign investor was expected to bring in required expertise, the anchor investor was expected to form consortium with local financial institutions. A foreign anchor investor was thus allowed to acquire up to 30% PSX shares and could go up to 40% shares through the consortium, where each financial institution could hold only upto 5% shares. To ensure that anchor investor's strategic partnership with PSX is long term, the anchor investor has lock-in period of at least 5 years within which it cannot sell its stake in PSX.
The anchor investor is expected to drive PSX in future and play active role in its management. The Chinese Consortium comprises three exchanges which are among largest in the world in terms of market capitalisation and turnover. With diverse product offering, indigenously developed technology and experience with management of successful securities and derivatives exchanges, the potential for contribution towards growth of Pakistani capital market is significant. Further, the Chinese exchanges have a massive investor base (exceeding 168 million investors) which illustrates boundless possibilities for enhancing outreach in Pakistan. Options to establish systems such as China Connect could link securities markets in Pakistan and China, promising opportunities for a gateway to cross border listings.
The Consortium also includes two local partners - Habib Bank Limited and Pak China Investment Company Limited. HBL offers one of the largest branch networks in Pakistan and corporate governance excellence, while Pak China brings local knowledge of and presence in the market particularly in relation to investment in the central depository. The Consortium provides an ideal combination of companies which can significantly contribute towards development of PSX and the market. Besides, this partnership can play pivotal role in CPEC project where local and Chinese companies can approach PSX for meeting their financing needs.
Divestment to strategic investors and financial institutions is expected to result in reducing conflict of interest by limiting influence of brokers in PSX operations. It is expected to strengthen PSX's governance and regulatory structure, enable its increased focus on business operations for enhancing outreach, new product and service development, technological partnerships for upgrading its operations and provision of state of the art trading systems and software with linkages to international markets.
Divestment has equipped brokers with opportunity for capital injection into their businesses to meet enhanced regulatory requirements. Brokers should take this as an opportunity to make requisite investments for any shortfalls in capital, infrastructure, human resource, research and compliance etc. The SECP has already communicated its desire for a brokerage industry comprising professional, well capitalised brokers that emphasise customer protection, transparency and high governance standards. Having played its role as facilitator during divestment, SECP as the market watchdog will be using divestment as a base for instilling a strong enforcement and compliance culture with zero tolerance for regulatory deviations and malpractices.