IN order to address the twin problems of low liquidity and high volatility at the Pakistan Stock Exchange, the regulator announced a raft of regulatory reforms it plans to introduce.

With one eye on the MSCI, which many hope would favourably decide to reclassify the PSX back to the ‘Emerging Market’ (EM) from the ‘Frontier Market’ (FM) segment, the regulators are striving to put up on display a bold new face of the local equity market.

The PSX is set to introduce three proposals that would go a long way in changing the way trading takes place at the stock market. Those include gradual enhancement of existing ‘circuit breakers’; introduction of ‘Index-Based Market Halts’ and raising the minimum ‘free-float’ of shares.

Taking the last as the first measure, the listed companies have been provided a three-year period to enhance their free-float to 25pc where the paid-up capital of the company amounts to Rs5 million or more. For corporates that fail to comply, the front line regulator proposes to shift them from the ‘main counter’ to ‘less liquid securities’ counter’.

A senior market participant explained that free-float means all outstanding shares excluding government shareholding directors/sponsors shares, shares in physical form, shares of associated companies, employees share scheme, treasury stocks and any other category barred from selling shares.

“Close to one-third of the currently 561 listed companies maintain free-float at less than 25pc”, says an analyst at brokerage Topline Securities. The enhanced free-float would help in price discovery; reduce the menace of manipulation and improve trading volumes.

Raza Jafri, head of research at brokerage Intermarket Securities pointed out that the volumes were on the wane.

“Daily market volumes have averaged 138m shares in the CY16 to-date, which is 44pc lower than the average of 247m shares seen in CY15 and at present they are the lowest since average of 79m shares trading witnessed in CY11”, says Raza. Low volumes lead to weak market performance.

Regarding the ‘circuit breakers’, those are currently maintained at 5pc. A share during trading is prevented from going up or down by 5pc over the previous day’s closing price, on any particular day. The circuit breakers are now proposed to be gradually enhanced to 7.5pc and then to 10pc.

The ‘index-based market halts’ is quite a new concept for the local stock market and would seek to halt trading for a short time in case the index rises or falls by say 10pc. Apart from the above reform measures, the National Clearing Company of Pakistan Limited (NCCPL) has also modified the Margin Finance System (MFS) which is also aimed at improving liquidity and facilitate trading by market participants.

Former KSE chairman Arif Habib says that the proposed new measures are ‘positive’ for the market. Yet the bourse is in need of leverage products. He observed that market participants had suggested a few other proposals for improving in margin trading system which ought to be incorporated for the benefit of investors.

Another senior broker elaborated that recommendations were made to the regulators to consider unfreezing collateral in MFS and potentially allow individuals to become financiers as well.

Relating to the hike in free-float, market participants said such restrictions were not Pakistan-specific, such as those seen on Wall Street and Dalal Street.

Yet several experts suspected that all companies may not be willing to raise their free-float to 25pc since no penalty had been prescribed. They would rather opt to be shifted to the ‘less liquid securities counter’ from the ‘main counter’ than relinquish their tight holding.

Khurram Schehzad, Chief Commercial Officer (CCO) at JS Global Capital responding to queries said the market size had vastly increased over the last several years, which warranted enhancing circuit breakers so as to attract bigger investment and larger investor participation.

Instead of fixing the free-float to 25pc in absolute terms, he said those should be based on historical trading value. “Some kind of benchmark should be worked out such as to link the free-float with the free float market cap or one-year traded daily volume”. Khurram observed that tax incentives should be given on derivative products which the PSX intends to introduce in the market.

Zubair Ghulam Hussain, head of equities at Foundation Securities said widening of circuit breakers would help improve market depth whereas simultaneous introduction of index-based halt would restrict volatility. The regulators were prompted to suggest changes as the average trading value during the current calendar year to-date had recorded steep drop to Rs7.5bn, from Rs11.3bn the previous year.

Generally, the investors were excited about the concept of both index-based halts and the enhancement in circuit breakers to 10pc from 5pc. The index-based halts would provide a ‘cooling period’ of say 30 minutes during which the trading would be brought to a halt so as to offer the opportunity for settlement and re-consider the exposure limits of investors. It would also help restore sanity at the market in times of panic or ‘irrational exuberance’.

Although no time period has been stipulated within which the new measures would be put in place, but it may be quicker, considering the potential market growth in the foreseeable future. More so, the MSCI KSE-100 index’s marches back to the emerging market segment.

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