Lack of competence

The corporate earnings generally are showing a healthy 20 percent rise with banking sector and oil and gas companies outshining the rest in FY 06. However, these stellar performances are not reflected in the stock market movement which remains confined in a small range and in fact is edging downward in small spurts.
The draining of liquidity from the market is commonly claimed to be the reason for good scrips trading at below valuation levels. The government also appears to be worried and the Finance Ministry bosses are trying to get the two regulators - SECP & SBP - to solve the riddle with the help of brokerage firms and banks.
Investor's selling from the effects of the March blow-out are not just worried but are also hurting as their portfolio holdings dwindle. And, also lower volumes make it more difficult for them to exit the market. The government is rightly concerned at the state of affairs. Its shares constitute 47 percent of the market capitalisation of Rs 222 billion and a further exit of retail investors from the market will adversely impact its privatisation programme.
Eighteen months ago, the two apex regulators had jointly agreed to phase out 'Badla' or Carry-Over Transaction and replace it with margin financing. It was a critical element in the market reforms because a number of times systemic accidents suffered by the market were attributed to few Badla providers enjoying oligopolistic powers.
Since Badla providers also act as brokers they know speculative positions as well as the strength of these positions and are, therefore, able to exploit this to their advantage. In the past these brokers were sole financiers in Badla. However, in last few years financial institutions too became providers of funds in COT.
The Badla rate is a combination of equity and financing risk and was a cause of excessive uncertainty and volatility. As this had systemic implications, the SECP in 2001 took a number of steps to defang this home-grown financial instrument. As part of market reforms, the SECP quite rightly decided to push for well established pre-transaction margin financing directly from banks or through brokerage firms and develop a futures market in both indices and individual stocks.
The objectives of the apex regulator are sound and need full support from all and sundry. However, the implementation has run into a dangerous collision course.
This was bound to happen because the two financial instruments ie COT and margin financing sought from banks are by their very nature quite different and as such not interchangeable. Therefore, there is a clear mismatch between phase-out of COT and phasing - in of margin financing.
In COT the lenders are high net individuals - and development financial institutions besides some banks, while in margin financing it is banks alone. Secondly, COT is 'blind-lending' ie against scrips alone irrespective of the borrowers and the risk is calculated purely against the scrip.
While in margin financing the credit rating of brokers, as well as the borrowing record of their clients, are taken into consideration besides the scrip therefore the rate for covering the risk is bound to be higher.
The roadmap provided by Tarin Committee to overcome the liquidity obstacles and ultimately make the CDC - as the lender of lot resort is pragmatic and provides an independent view. If the SECP objective of cutting down the market manipulative forces to size is to succeed, which inter alia requires that the influence of a handful of powerful brokers be checked then other institutional players will have to emerge as active participants with independent views in the market.
At present, all banks, DFIs, insurance companies and government-owned pension funds look towards these very brokers for their investment decisions. This leads to a herd mentality. Unless, they have human and technological resources to analyse and take independent decisions for execution of orders, there is very little the SECP can do to break the hold of the big brokerage groups. You can take the horse to water but cannot make him drink it.