Making sense of Pakistan’s stock market mess

By

Muhammad Rabnawaz Awan

The Karachi stock exchange has been generating significant returns for the last three years, but has lost its charm in 2015. A year that began with so much promise has not resulted in the same and the unusual volatility has taken hold of Pakistan’s capital market.

According to Bloomberg, a reliable global financial news service, the KSE benchmark index has generated a mere 2% return in 2015. After the worst quarter in four years, most financial analysts believe the stock market would slide further down and traders would continue panic selling as the ghost of 2008 still haunts the market.

No one can forecast the future of the stock market, but understanding where the regulator and investors went wrong teaches a valuable lesson for how we should move forward. When we study the market chaos, just about every financial analyst and academic agrees that oppressive regulations, regulatory burdens, and litigation risks undermine the success of bourses.

The stock market turmoil has become a concern for thinking-nationals who fear it could further destabilize Pakistan’s feeble economy and would prove a body blow to a government which is trying to promote Karachi as an economic hub in the region. However, little evidence suggests that the stock market lay anywhere near the center of legislators’ concerns, during either the boom or the crash as they think it neither contributed much to economic growth while it was rising, nor threatened the economy when it collapsed. Thus, it was left on the sole discretion of the regulator to tame the market.

The turmoil of the past three months has spread doubts about whether the markets regulator has either the inclination or the skill to come out of the share fluctuation debacle. A large part of the problem is that the Securities and Exchange Commission, the regulatory body entrusted with the mission of promoting the strong appearance of the capital markets in the country, succeeding in its mission of “making headlines,” but failing in its mission to protect capital markets. The SECP’s most perverse incentive perhaps is to promote the notion that the capital markets are in crisis and this way it wants to be viewed as superior substitutes for the particular sort of crisis. A close look at Commission’s approach to dealing with the corporate wrong doing suggests that it largely believes in enhancing enforcement as the big-wigs think activities of the enforcement department legitimize the Commission’s existence. The more robust approach to enforcement might be “a huge step in the right direction,” but it is not enough to regulate the market successfully. Roger Steare, a British ethicist and corporate philosopher, would be worth quoting here. In his excellent book ‘Ethicability’, while criticizing the role of regulator in compliance and enforcement, he writes: I don’t believe the regulator should be enforcing culture because it’s a contradiction in terms: if you enforce culture, you get a police state with compliance on the surface and subversion underneath.”

In order to justify a crackdown against Stockbrokers, the equity market regulator claims to be trying to benefit small investors, but seemingly it has no comprehensible policy of small investors’ role in the capital market. For one thing, if small investors are going to participate in stock markets, then they are going to lose money and the SECP appears to think that risk is unacceptable, even in the cost of hurting brokerage houses that are nationally known and admired.

In the past few months, the heavy regulatory burden on those brokerage houses and companies whose misfortune it is to be publicly listed on the stock exchanges proves that the SECP is pursuing a policy that is consistent with its self-interest but clearly suboptimal from a market perspective. Thus resentment of market participants heightened by comments about their misconduct has adversely affected the Bull Run.

One of the most troubling aspects that promote negative sentiments in the bourses is that the SECP, in the recent past, has been unable to resist the urge to stoke pre-investigation publicity. When the regulators publicize their cases, there is a fine line between informing the public and playing into the desire to extract publicity. This is especially the case with white-collar crime investigations in which pre-investigation publicity may convict a defendant in the public’s eye long before the case gets to trial. The Commission now routinely issues press releases when it starts investigating a case. These press releases haze the distinction between allegation and fact. In addition, the SECP allows its enforcement officers not only to ghostwrite the official press release but also to insert gratuitous quotations that exaggerate the formal accusations with more colorful words and phrases like “tricks,” “calculated fraud” and “reaping substantial profits.”

The releases also begin with ambiguous phrases like “according to the Commission’s order.” Some releases—including one in April 29 announcing an inquiry against directors of ACE Securities—claim that an SECP investigation has already “found” wrongdoing, though official facts are supposed to be “found” only after a subsequent inquiry.

The need is thus that the SECP should avoid prejudgment of cases and it should find strict neutrality in both fact and appearance. The Commission should also tone down some of the language used in press releases when announcing a case. By failing to do so, it risks having ruined the equity business in the country.

Muhammad Rabnawaz Awan

The writer is a business and economic columnist. He has been part of the SECP media team for over six years.