Brokers suggest re-introduction of leverage product

The brokers of Karachi Stock Exchange (KSE) have suggested the re-introduction of leverage product and proposed to cap the CFS rate at one month KIBOR plus 10 percent. They were of the view that the current five percent limit of circuit breaker is low and proposed that it should be rationalised for the sake of proper price discovery.
They also proposed to enhance the rollover period of future contracts. These proposals were discussed at an 'unofficial meeting of KSE brokers' held on Thursday June 4, at the exchange. The meeting was chaired by Asad Iqbal, member of Karachi Stock Exchange and was attended by Arif Habib, Zafar Moti, Haji Ghani Haji Usman, Dawood Jan Mohammad, Munir Khanani, Munaf Sattar, Rehan Atique, Sajjad Mankani, G M Malkani, Mohammad Sohail, Amin Yousuf, Naushad Chamdia, Saad Maniar, Siddique Dalal and Farrukh Subzwari.
In the meeting, after a thorough discussion about all the prevailing issues, 21 points were finalised to discuss with all the brokers of the exchange. These proposals were circulated among all the brokers here on Monday for their input.
Asad Iqbal welcomed the participants of the meeting and requested Arif Habib to explain the background and reason for having this meeting. Briefing on the outset of the convened meeting, Arif Habib said that the idea was to develop a consensus, and unified view of the entire broker community and shun the impression that the community had divergent views on the specific need for the leverage product. He further said that because, members in their individual capacity and collectively as a group are engaged in various forms of businesses which include financing, day-trading, lending, retail and institutional trading they always have divergent views as they play a pivotal role in the development and protection of the market as a whole.
He reiterated that the main objective of convening the meeting was to develop a consensus and make a unified recommendation for the consumption of apex regulator. He maintained that while making plea for the re-introduction of leverage product, due care must be exercised and issues in the current model of CFS and DF (deliverable futures) be identified and resolved. At this stage he structured the meeting by requesting all the participants to identify issues one-by-one.
As many as 21 issues were identified by the participants of the meeting that were including, counter party risk management, use of third party shares, selection of shares in CFS and DF, rollover week in DF, broker-client relationship, capital adequacy issues, per part exposure limits, broker to broker business, capping of interest rate, capping of leverage amount, clearing pull up, disclosure of client limits, other derivative products, abrupt changes in the contract, disclosure of concentration, CFS duration, Hammer Price in CFS, Margin Regime, Default client in CIB, Financier Representation and Financier Commitments.
In relation to counter party risk management they discussed that counter party risk concept is already there in CFS and DF and there is no risk to the system. Default cases should be dealt based on UIN. In case of default, financier shall take shares and margins of the finance based on UIN. In case of default by client, member could be suspended. A unanimous decision was made to request KSE Board to settle claims of investors as it was carrying bad name for member community.
Bids would be invited from KSE, NCCPL, CDC, etc for monitoring and surveillance of this system. The selected party should monitor positions at UIN level, and in case margin of failures UIN-part position to the extent of margin requirement may squared off on each margin failure. Broker should not be allowed to pay margins on behalf of a client and a client can pay margin on behalf of another client, subject to legal formulates.
They proposed that once UIN based financing is introduced the problem of Third Party Shares being used or misused of addressed automatically. Regarding the selection criteria in CFS and DF, it was agreed that the existing eligibility criterion is all right.
It was decided that partial rollover is allowed in case of any problem. One third of the amount of the finance would be released and the rest of the one third would be released at the end of second contract and the remaining at the end of third contract.
The committee observed that broker to regulator relationship is governed through specific set of rules, regulations, policies and procedures. Similar set of policies need be devised to strengthen the broker client relationship with proper system and audits.
About the Capital Adequacy Issues, the meeting observed that the Capital Adequacy issues have been addressed in the consultative group and a new version of the Net Capital Balance formulae is being worked upon along with the appointment of a panel of auditors who would be providing the certification. This is under implementation already and once in place most issues regarding Capital Adequacy would be resolved.
The meeting proposed that Per Party exposure limit will be imposed where no one client shall exceed a certain limit of the leveraging facility available to a broker so as to reduce potential of rogue clients causing defaults of brokers.
Regarding broker to broker business the meeting said that LSE and ISE broker's client could work under the existing UIN regulations. It was agreed at the meeting that CFS rate should be capped at one month KIBOR plus 10 percent. About the capping of leverage amount, the meeting proposed given that limits shall be imposed based on a percentage of the free float of a scrip on the total market leverage as well as per broker and per UIN there was no need for a cap on the total leverage.
The forum recorded its concern in relation to pulling/jacking up the market through CFS and decided to seek input from the market to prevent the same. The issue of disclosure of client limits was also discussed and the group was satisfied with the reporting mechanism as it exists including the public disclosure as well as the reporting to the regulator. Regarding introduction of other derivative products, the forum agreed that products should be introduced including options and index futures trading.
The issue of change of contract terms during the life of contract, the participants raised concern over the rampant attitude of the regulators wherein changes were made during the terms of contract. The case wherein DF contracts were rolled over, circuit breaker rules were changed and price floor was imposed. The forum unanimously resolved that regulators be requested to abstain from such actions in the future course of action.
The issue of disclosure of concentrated positions was also discussed and it was agreed to better understand the leverage position, UIN wise and broker wise (top 10) leverage position in CFS and DF should be disclosed on daily bases.
About the CFS contract duration, the forum agreed that the duration of the contract as defined for both deliverable futures and CFS was appropriate and a case could be made for the introduction of multiple contracts such as a 60-day contract in the deliverable futures market. It was informed that there is a process of settlement in case of default, thus there is no need for hammer price.
It was suggested that UIN based progressive regime should be made to cover the risk adequately. Regarding the default client in CIB, it was proposed that the SBP style CIB concept to be introduced and delinquent client on one broker must not be allowed to trade from another house. It was suggested that to raise the same at appropriate level. It was mentioned that this issue had been raised in the board earlier but the feedback from the SBP was not encouraging. This issue would be raised once again and SBP asked to change its rules to allow client defaults towards brokers to be included in the CIB.
The forum observed that financier presence in the decision making process was crucial and they should be consulted at all levels. It was suggested that proper implementation on CFS MK II rules should be made because in the last crisis many financier did not stick to their minimum commitments made. In any future leverage product all such commitments would be enforced as well as appropriate penalties imposed
About the existing circuit breaker, the forum agreed that for the sake of proper price discovery, the current 5 percent limit is low and it should be rationalised. It was decided to circulate these suggestions to the market and take input from market participants so that a consensus is developed for further recommendations.
The brokers were asked to give their comments on these suggestions and proposals till Friday. These proposals would be finalised in the light of in-puts received from all market participants and the final proposals would be sent to the KSE board of directors. The KSE board will send these proposals to the Securities and Exchange Commission of Pakistan for consideration. The meeting also formed a five-member committee of KSE brokers on re-introduction of leverage product. The committee will collect the brokers' suggestions and will finalise these proposals before sending to the KSE board.