Stockmarket Liquidity

8/11/2019 Stockmarket Liquidity

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The age old saying, "every dog has his day" is meant to conveythe truism that all arguments can find support at some pointin time. In the context of Pakistan's stock market, two distinctarguments are vying for public attention today. One school of thought is looking at the collapse in share traded volumes by8 times relative to 3-4 years ago as evidence that Capital Gains

Tax (CGT) has scared away retail investors. This group issupposedly supported by brokers whose earnings are dependenton commissions generated from trading volume. Collapse involume means collapse in income, hence the fixation of blameon the tax regime. The crisis facing the stock brokerage industrycan be gauged by the fact that over the last one year out of approximately 2,500 KATS terminals available to members of the KSE, around 1,000 have been disconnected due to lack of business.

The other school of thought is joyously announcing that collapse

in trading volume is a sure sign that speculation has stoppedand, in fact, the Capital Gain Tax should not be viewed simplyas a revenue generating mechanism but rather, as a consciouspolicy decision to promote long-term investment and curbspeculation. This view Is supposed to be supported by anti-broker lobby within political and bureaucratic circles.

Which view is correct? And why should anyone other thanimmediate parties - investors, brokers and finance/tax officials- be concerned about this issue of liquidity? In this article weattempt to break a few myths and conventional wisdom

regarding market liquidity and speculation and highlight someactions that we believe can be beneficial to promote the primaryobjective of the stock market. This is to facilitate efficientsourcing and allocation of capital to productive sectors of Pakistan's economy on the one hand, and to provide a repositoryof an attractive asset class for savers & investors on the otherhand.

Let us focus on the issue of liquidity and speculation as thatcurrently appears to be the central theme related to the stockmarket. Assume for a minute you are in a world where there

is no speculation, all investors are able to understand how listedcompanies are likely to perform and can freely make the choiceof investing in the shares of various listed companies. In this

world different investors are unlikely to have widely differingviews about a company's future prospects. So if a company isexpected to perform well everyone will want to buy it's shares.But in this case, who will sell? Who is the seller? Conversely, if everyone expects a company's performance to be poor, everyonewill want to sell it's shares. If so, who will buy it? Where is the

buyer?

Luckily, we do not live in such as idealized world. In the realworld, investors are of varying skills and views. Thus, an investorwho has greater insight into a company, its industry dynamics,regulatory framework, etc. can make a more accurate estimateof future performance than an investor who has done a naiveanalysis. Therefore, at any given point in time, there will besellers for a particular stock and there will be buyers. The morepeople that participate in the market, the more buyers andsellers there will be and thus the more liquid the market will be.

Now, also in the real world, there are different types of investors.Some invest for the long term because it has been shown thanover long periods, equity investments generally provide greaterprotection against loss of purchasing power due to inflationthan many other liquid financial investments. The emphasis ison "liquid". One can perhaps get better return from real estate,but it is not liquid. You can not quickly dispose off real-estateif you need urgent liquidity. Even with bank fixed-deposits ornational saving schemes, early withdrawal attracts considerablepenalty which can sharply reduce your return on investment.

Equities can be more liquid depending on the shares you investin. When you want to sell, you would like to sell your shares asnear the current market price as you can get. This means thereneeds to be a ready buyer for those shares - some one whofeels that the share price has the potential of going up afteryou have sold it and he/she has bought it. He or She is willingto take that risk. It is that risk taker who is providing the liquidity.The larger such participants in the market, the more liquid themarket is. .

Now this risk taker may or may not be a long-term investor. It

is entirely possible, in fact more often then not, it is usually thecase that the risk taker has a much shorter investment horizon.If you, the initial investor, are selling not because you think the

The Karachi Stock Exchange(Guarantee) Limited

STOCK MARKET LIQUIDITY -"EVERY DOG HAS HIS DAY"

by Nadeem Naqvi , Managing Director, KSEThis article was printed in The News - July 12, 2011





measures have been enacted by the SECP and implementedby the stock exchanges.

As a result today, with implementation of the AutomatedSecurities Settlement System at CDC, the National ClearingCompany (NCCPL) deposits shares directly into investor sub-account instead of first transferring shares into broker's mainaccount. In fact, in the next phase a project is under studywhereby brokers should have no control over investors' sharesor investors' funds. They should simply perform the brokeragefunction of research and order execution. Another system nowimplemented is to prohibit trading by employees of brokeragehouses through other brokerage houses by linking all CDS

accounts with respective Unique Identification Numbers (UIN's)in the NCCPL UIN database.

In order to help improve liquidity in the market, a very tightlycontrolled Margin Trading System (MTS) was introduced anddealing requirements in the deliverable futures market (DFM)were made ultra stringent. After observing that over regulatedrequirement led to these products being a non-starter, a morebalanced approach is being considered by the Exchange whilekeeping systemic risk management framework intact. This is anevolving situation and will require reality checks at each step.

The Exchange is finalizing, under SECP guidance, proceduresfor delisting companies that have been on the defaulters counterfor a long time. As the Exchange does not have legal powersto take action against these companies, it is working out a planof action with the SECP so that the SECP can initiate legalproceedings against such defaulter companies, their directorsand office bears to provide relief to investors. .

The Exchange is also working hard to find ways to help incompensating investors who lodged complaints with theExchange against defaulted or expelled brokers. Under Pakistanlaw and due to certain court rulings there have been problemsin providing early compensation by way of sale of forfeitedmembership and through the Investor Protection Fund. However,the Exchange is working with its legal advisors and in conjunctionwith the SECP to overcome these legal hurdles and start whateverpayouts are possible as early as practicable. Unfortunately, asis often the case in this country, many fictitious claims have alsobeen received. The Exchange has obtained the services of reputable independent auditors to verify all claims so thatgenuine investors who lost money are able to be compensated

as much as possible.

Based on the above developments, I would like to say thattoday's risk management system at KSE, CDC and NCCPL is

much more stringent and security of investors' assets issignificantly better than previously. I have personally informedmembers of the brokers community that the frontline regulatorfunction of the Exchange has, as its prime responsibility, theprotection of investors, providing a level playing field to big &small investors and strive to deter wrong doing. In the last case,the Exchange's future operating philosophy will be that thereis zero tolerance for bad apples in the brokerage industry, if this industry is to survive and serve investors.

A final thought for investors: As the title of this article says,

"Every dog has his day," we are at that point in the economiccycle where fixed income investments are preferred due to highrisk free rate (on government bonds). But this too shall pass.Interest rates cannot stay high indefinitely, industrial & consumerdemand cannot remain suppressed for long. As the cycle turns,equities will outperform again. Actually, Pakistan is ahead of the Asian region where monetary tightening is at early stageswhile in Pakistan we may see monetary easing as early as thefirst quarter of calendar year 2012. Those who have the financialrisk taking capacity and are able to spend time and energydoing proper research, have the opportunity to go against the

crowd and invest in high quality, proven performance recordcompanies, to obtain higher potential returns over time ascompared to fixed income securities. But remember, withpotential for higher return comes higher risk - please do notfall victim to greed, do not take more risk than you can bear,aim for reasonable return and once you achieve it, sell andrelax.

Stock Market Liquidity 03

Disclaimer: Investing in stocks & shares carries various risks, including lossof the principal amount. Investors are advised to conduct this own researchbefore investing or take advice from professional investment advisors.

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Stockmarket Liquidity