Post by Dalinda Maeryn

Karachi Stock Exchange, most traded neighborhood bourse of Pakistan, at present offers equity future items as sole leveraging and hedging tool. In spite of being only leveraged item, the activity in stock and index futures are extremely low. To understand the reasons for low activity and investors’ interest in this market place, we have attempted to discuss with marketplace participants and know the reason for low investor interest in this market place.

To start, Pakistan equity derivatives items were launched on the Karachi Stock Exchange in 2001. Initially, one month deliverable single stock futures had been introduced. Nine years later this industry is nonetheless deemed to be underdeveloped when compared to India. Exchange traded economic derivatives had been introduced in India on the National Stock Exchange and the Bombay Stock Exchange in June 2000. Index futures contracts, based on S&ampP CNX Nifty Index (Nifty) and BSE Sensitive Index (Sensex), had been initially launched. Since then, the turnover of derivative contracts has risen immensely on the India National Stock Exchange.

In most created or developing markets, investors prefer to take positions and derivatives instruments are typically preferred over underlying assets in the spot industry. In Pakistan, this is not the case. In the outgoing calendar year (ie January-December 2010) futures marketplace constituted 3% and 9% in terms of volume and value of the spot marketplace. Nonetheless, throughout the late 2004 and early 2005, the deliverable future contract were choosing up in volume terms. In the course of that period, futures volumes constituted 30 to 40% of the spot market place volumes. But unfortunately due to weak market place infrastructure and danger management measures of that time, the market place could not sustain the outgoing leverage position in the industry, therefore leading to the 2005 March crisis. Following the crisis, a number of threat management measures have been taken to minimize systemic threat.

The National Clearing Company of Pakistan has began releasing information on the futures industry. Accordingly in the calendar year 2010 on an average 174,000 equity derivatives contracts had been traded per month. Institutions have not been heavy users of exchange traded derivatives. In the said period, banks, NBFCs and businesses contributed .7%, 1.6% and 3.2% of the future volumes respectively. People and other investors contributed 94% of the total volumes in exchange traded equity derivatives.

Derivatives users in Pakistan

In Pakistan, many banks, DFIs, mutual funds, non-banking economic institutions trade in the derivatives market place. Even so, the use varies with the nature of the organisation. Mutual funds manage funds of the general public and they perform below the supervision of their respective trustees. Mutual funds, mainly trade in equity derivatives to reap arbitrage opportunities they initial take a long position in the spot industry and then sell in the derivatives marketplace to lock in confirmed earnings. Mutual funds cannot take positions in future trade to produce leverage. Islamic mutual funds are not allowed to purchase or sell in the existing equity derivatives industry. Nevertheless, the Karachi Stock Exchange is operating on the launch of Islamic derivatives.

As far as banks/DFIs are concerned, according to Prudential Regulations for corporate/commercial banking (1.B): “Banks/DFIs may possibly take exposure in future contracts to the extent of 10% of their equity on an aggregate basis. In this connection, the ten% exposure limit for future contracts will contain each, positions taken in future getting and selling.” Despite this regulatory assistance, banks/DFIs participation is extremely low.

In terms of the growth of the derivatives industry, and the range of derivative users, the Pakistan equity derivatives industry has shown subdued efficiency as compared to India. In nearby bourses, retail investors remain the key users followed by private sector institutions and big corporations. State-owned institutions have participated minimally. The assortment of derivative instruments offered for trading is expanding slowly.

There stay main locations of concern for Pakistan exchange traded equity derivatives. Large gaps exist in the range of derivative products that are traded actively. In equity derivatives, only single stock deliverable futures are traded and account for virtually 100% of the total volume in exchange traded derivatives. Trading in Money Settled Futures and Stock Index Futures is practically absent. A lack of industry liquidity might be responsible for inadequate trading in these instruments.

Why do institutions not participate to a greater extent in the derivatives markets?

In Pakistan, some institutions such as banks and mutual funds are only allowed to use derivatives to hedge their existing positions in the spot market place, or to rebalance their existing portfolios. Furthermore, in case of most institutions, internal policies prohibit them from trading in equity derivatives.

The major cause is the lack of information and expertise followed by tight risk management measures mandated by the Securities and Exchange Commission of Pakistan. Also, money margin requirements and Unique Identification Quantity (UIN)-based margin collection are also important concerns for institutions. Previously, the executing broker utilised to deposit margins with the exchange on behalf of his customers.

The broker utilized to act as a collecting agent among the exchange and his client. But in some instances, the broker, to facilitate his critical customers, used to meet regulatory margin needs with out collecting it from the end-user, thus initiating unnecessary risk in the industry.

Since the increased regulatory vigilance and introduction of UIN based margins along with the launch of Institutional Delivery Program (IDS), margins are largely collected directly from the finish user. Consequently, now, even exactly where institutional internal policies allow them to trade in exchange traded derivatives, institutions have reservations in depositing margins with the exchange.

Policy initiatives

Pakistan equity derivatives markets require initiatives by the regulator and the exchange to generate investor awareness about existing merchandise and about how they can use these merchandise to hedge their existing portfolios and to reap advantages from existing marketplace inefficiencies. The exchange ought to launch new programmes to inform and educate brokers, dealers, traders, and market place personnel. In addition, institutions will need to devote more resources to create the business processes and technologies essential for derivatives trading. Moreover, fund managers ought to be motivated to participate much more actively to take benefit of existing industry inefficiencies. The front and back office salary and appraisal must directly be linked to the efficiency and creativity of trading officers. Lack of suitable return reward and appraisal systems usually decrease creativity. Institutions really should attempt to build competent staff at all levels.

Furthermore, market development reforms will aid these markets grow quicker. For example, the development of the shares lending and borrowing marketplace and presence of industry-makers will support boost the liquidity in spot and future markets.

Moreover, state owned institutions like Employee Old Age Benefit Fund and National Investment Trust should be encouraged to participate in the derivatives industry. This will assist boost liquidity.

A managerial structure should be developed in each organisation, which clearly defines roles, responsibilities, and accountability of leading management, front desk and back desk. Each department ought to be given adequate authority. Back workplace staff must be trained and experienced enough to facilitate front desk operations. Also, nearby investor education need to also be focused upon. For this purpose, media coverage, seminars and publications must be created on standard concepts of equity and derivative items ethical standards of transacting in markets on the rights of investors and brokers.

The SECP, in association with the Karachi Stock Exchange board and members, ought to style some mandatory study guidelines for traders, fund managers, settlement officers and other associated parties. This will facilitate blending of professionalism into the capital market place and will eventually increase market depth.

Nevertheless, some efforts have already made in this regard. The SECP, exchanges of Pakistan and other renowned institutions like the CFA Association of Pakistan and Mutual Funds Association of Pakistan have established the Institute of Capital Markets in 2009. ICM has been established as a platform to create human capital, which might be capable to meet the emerging professional expertise wants of capital markets and create standards amongst industry specialists. The institute envisions providing different licensing examinations top to certifications for various segments of the capital markets. However, up-till now, by large no enthusiasm is seen among the audience as the pace of registering is very slow.

About the Author

For much more Info

2 Responses to “Pakistan exchange traded derivatives”

Leave a Reply