The function of Pakistan Stock Exchange (PSX) is to manage that investors’ share buy or sell orders are executed on the PSX’s trading system in a timely, efficient and secure manner by brokers, and act as front-line regulator to see that brokers are in compliance with rules and regulations of the Securities and Exchange Commission of Pakistan (SECP) and the PSX.
Clearing its position in a press release here on Saturday, PSX said there have recently been media reports regarding default of stock broker with insinuations that the regulators have not performed their job well. It said there is a well-defined and properly structured regulatory regime under which stock broker (in technical terms, Trading Rights Entitlement Certificate [TREC] holders) have to operate. There are the capital market institutions, i.e. Pakistan Stock Exchange Limited (PSX), National Clearing Company of Pakistan Limited (NCCPL) and the Central Depository Company of Pakistan (CDC), all of which play a role in the smooth functioning of the capital market and facilitating investors therein.
It added that the NCCPL’s function is to ensure that once orders have been executed, then the clearing and settlement proceeds smoothly and no market risk due to non-settlement occurs. The CDC’s function is to act as depository of investors’ shares which have been transferred from the NCCPL into their investment account, or as per their instruction, in their brokers’ sub-account under the investor’s name.
Each of the above three capital market institutions operate under their own rules and regulations covering their specific area of operations and overall; all three institutions fall under the supervision of the SECP. As a result, there is close collaboration between the SECP and PSX/ NCCPL/ CDC not only on regulatory matters but also in the area of capital market development and investor facilitation and protection.
Institutional check and balance system
The capital market institutions and the apex regulator, SECP, have evolved a system of checks and balances to see if brokers are complying with regulations and ensuring safety of investors’ assets. There are periodic audits of brokers as well as spot inspections. If discrepancies between broker record and CDC record are discovered, the CDC sends out notices and letter to investors which have CDC account balance details and asks investors to verify these balances. If the broker is not able to satisfy CDC, a penalty is imposed on the broker with notification to the SECP, PSX and NCCPL. In case of serious non-compliance, the broker can also be suspended as per laid down regulations.
A similar process is followed by PSX and NCCPL as related to non-compliance of brokers and these two institutions’ regulations. At the same time, the SECP also conducts its exercise to check broker compliance and imposes penalties and actions when broker is found to be non-compliant. Despite the above measures, there are cases where investors have lost shares due to some brokers’ illegal behaviour. In some cases, it has also come to light that investors themselves have given loans to brokers and received fixed monthly returns which is a completely illegal activity by both parties under the relevant regulations.
Regulations tightened over time and new initiatives underway
Over time, regulations have continually been made more stringent and regulatory oversight strengthened. In this regard, in September 2015, the SECP took a major initiative to notify Joint Inspection Regulations under which a specific Joint Inspection Team (JIT) was formed. The JIT started operating under the supervision of JIT oversight committee composed of chief regulatory officers of CDC, NCCPL and PSX. Every quarter, based on pre-defined criteria, sixteen to eighteen brokers are randomly selected for inspection with final report of the inspection to be submitted to the JIT committee within 75 days from the start of inspection.
Based on the JIT final report, the committee informs the SECP and asks respective capital market institutions to take regulatory action against the broker if non-compliance is confirmed. It is worth noting that in the recent incidents of some brokers such as MR Securities and AWJ Securities, it was the Joint Inspection Team that found non-compliances of the brokers. No investor complaints had been lodged. These firms had been brokers of the former Lahore and Islamabad stock exchanges and only came into PSX’s ambit after the January 2016 Integration of the exchanges. As such, this was the first direct audit with the PSX involvement.
A System Audit of MR Securities by outside, independent authorised auditor had not highlighted any wrongdoing. Thus the JIT initiative of the SECP actually was effective. Unfortunately, before the full report with evidences could be completed, the broker shut down. The SECP and PSX are now fully focused on recovering the maximum assets of genuine investors and return these to investors as early as possible. Further, specifically as related to the issue of custody of investor assets, the SECP along with CDC, PSX and NCCPL are working on fast-track implementation of two key initiatives:
(i) Standardisation of broker back office system so that all brokers follow clearly specified standardised recording and accounting procedures of their dealing / transactions with investors and same can be audited easily by the Joint Inspection Team (JIT) on regular and spot-check basis.
(ii) Formation of specialised company as subsidiary of the CDC, to be called Professional Clearing Member (PCM) which will take over the responsibility of managing all assets of investors (both money and shares). When implemented, this will allow investors the option to use the PCM rather than have assets in brokers’ sub-account.
Furthermore, in last week a SECP formed committee on Derivatives Trading, has submitted its report to the commission with specific recommendations on launching derivative products and their risk management regime. It is hoped that this will enable the SECP to make appropriate regulatory changes in order for the PSX to launch derivatives trading in Pakistan capital market. This will further improve liquidity and provide investors with greater choices in managing their investment portfolios.
No doubt there is room for improvement in the systems of checks and balances, technology driven control and audit systems that can identify non-compliances early so that regulators can become more proactive.
The Bottom Line: Vigilance
At the heart of it all is safeguarding investor interest. To be successful in this, partnership between capital market institutions and investors is essential. While PSX, CDC and NCCPL will continue to improve their systems regarding market and broker risk management under the guidance of the SECP, investors also need to exercise care. They need to be vigilant and use the facilities discussed above to keep a check that their broker is providing them with correct position of their assets and trading activity. If at any time investors find discrepancies between what the broker statement is showing and what broker is telling them or what the CDC or NCCPL data shows, they must immediately inform the regulators so that timely action can be taken to safeguard their assets.
Again and again, it has been observed that investors simply accept broker’s explanations and do not independently check the facts which are easily available to them. Investors must also be aware that brokers are not allowed to obtain loans from investors in any form and pay fixed return. That is an illegal action. If any broker offers this kind of service, investors must immediately inform the PSX and the SECP, and strong action will be taken against such broker if there is proof.
Finally, investors must be very cautious when broker offers them financing for purchase of shares. They must make sure they understand how it is being done and only accept if it is through the NCCPL’s margin trading system or margin financing system. Anything outside this may carry risks beyond the risk of share price going down.
