Let’s not be scathing, let’s not criticise for kicks; putting it simply, the SECP has got it right this time round. The recent amendments made to the Securities (Leveraged Markets and Pledging) Rules, 2011, are welcomed respite for capital market participants at a time where all-round dullness seems to dominate. The actions of the regulator insofar as providing an investor friendly platform to boost capital market activity needs to lauded in this case. The key word here is ‘investor friendly’ and the changes in regulations surely fit the adage well. This was the primary intention behind the introduction of Margin Trading products when re-introduced into the market in 2009. However, for one reason or another, the product failed to spur activity and lacked attractiveness. The changes supplement the affordability of the product and provide it with better appeal for investors now.
Let’s take stock of what the key amendments encompass: (I) At present, borrowers who wish to take up leveraged positions through availing margin financing facilities are required to deposit and maintain a minimum of 25 per cent ‘cash only’ margin. This was posing to be a dampener for stock market activity as the requirement is surely pocket heavy. SECP has offered relaxation by likely reducing the cash requirement (amount though still not disclosed) and also has indicated that a part of the margin can be furnished by certain selected shares as a pledge too. In simple terms, it now costs less money upfront to take up a leveraged position in stocks. (II) Individuals have also been allowed to act as financiers for Margin Trading as opposed to the current situation of only institutions providing financing for the purchase of shares.
It is exactly the purchase of shares, in turn daily turnover, which facilities like Margin Financing encourage. Designed on a ‘borrow and buy’ principle, leverage stimulates market activity and should help investors engage more in transactions boosting average daily volumes. The last few years have seen participants struggle with a bout of illiquidity that has hurt business prospects for brokers, in addition to compromising on price discovery for investors. It should also assist in building market depth and attracting more people to the local bourse – both local and foreign alike. But is margin financing the magic wand which waves the troubles goodbye or do other factors also come into play?
Insofar as providing the favourable conditions for trading activity are concerned, the SECP has been spot on in the aforementioned amendments. However, another issue that the regulator needs to address is that of Capital Gains Tax (CGT). The tax has delivered benefit to neither the government, nor the payer – well it shouldn’t for the latter anyway. Most of the concern over this topic hinges around the information heavy needs of filling and dubious collection mechanism. Reforming it in another way and automating collections would serve purpose here. Then the general sense of risk aversion in a weak economic environment is another hindrance. While not much can be done about that from the regulatory front, raising public awareness of the attractive valuations available at the local bourse (5.7x for 2012E earnings) should aide in attracting investment. Nevertheless, let’s not get greedy and focus on one step at a time.
Coming back to Margin Financing, it is pertinent to mention one key point that should not be left untouched here. Recalling that excessive leverage was a key factor behind the 2008 stock market crisis, one must be aware of the dark side attached. Like all borrowing principles, borrowing magnifies the quantum of gain or loss given a particular movement in the underlying price of a stock. Lower initial margin requirements can also aide in speculation, precisely the problem that surfaced three years ago. However, this recklessness can be tackled through robust risk management frameworks and formation of a ‘fit and proper’ criterion. A balanced stance needs to be achieved between relaxations and tightening; where tilting towards either extreme undermines the regulator’s standing. The move explained above is a move towards such a balanced position and is certainly a good grounding for revival.
The writer is a financial
analyst and freelance journalist