DIVESTMENT OF 40% STRATEGIC STAKE IN PSX
This article appeared in Special Editions of The Dawn, the News,
Business Recorder and Pakistan Observer on Share Purchase
Agreement of PSX with Chinese Consortium.
January 20, 2017
The bidding for PSXs 40% equity stake by local and
international investors took place on December 22,
2016. Based on the results of the bidding process, the
Chinese Consortium submitted the highest bid @ Rs. 28
per share and as a result is acquiring the 40% equity
stake in PSX. The said Consortium comprises of three
Chinese exchanges, i.e. China Financial Futures Exchange
Company Limited, Shanghai Stock Exchange, Shenzhen
Stock Exchange and two local financial institutions, i.e.
Pak China Investment Company Limited and Habib Bank
Limited. This landmark achievement would not have
been possible without the laudable efforts of the
Government of Pakistan that enabled economic and
political stability in the country to attract foreign capital
for the said divestment process. Equally important, the
Securities and Exchange Commission of Pakistan (SECP),
under the able leadership of Chairman Zafar Hijazi,
played a pivotal role by providing appropriate
regulations which served as an impetus in attracting
foreign strategic investors. Improved stock market
performance and changes in the operations and
structure of the Exchange over the last few years was
also a strong reason for the success of the said
divestment.
Roadmap and the Process of Divestment
The roadmap for divestment of the 40% strategic stake
in the Pakistan Stock Exchange was provided by the
Stock Exchanges (Corporatization, Demutualization and
Integration) Act, 2012. The purpose of the said Act was
to set the foundation for improved governance,
transparency and operational efficiency of the stock
exchanges in order to serve investors better and protect
their interest while enabling businesses to source long
term funding for growth from the capital market and
thus foster higher economic growth in the country.
Subsequent to demutualization and corporatisation, a
Memorandum of Understanding (MoU) was signed
between the Demutualization Committees of ISE, KSE
and LSE in 2015 to integrate the operations of LSE and
ISE into KSE and rename KSE as Pakistan Stock Exchange
Limited (PSX). The SECP approved the integration plan
which was also approved by Competition Commission of
Pakistan (CCP). Operations of the three stock exchanges
of Pakistan were integrated into Pakistan Stock
Exchange Limited (PSX) on January 11, 2016.
The SECP subsequently constituted Divestment
Committee (Committee) with mandate to oversee and
complete the process of divestment of up to 40% equity
stake of PSX to local and/or international investors. The
Committee invited Expression of Interest (EOI) and
seventeen EOIs were received by PSX. The Committee
reviewed and forwarded the EOIs along with its
comments to the SECP.
Purpose and Impact of Divestment
Although the former Karachi Stock Exchange was
incorporated in 1949 and later the Lahore and
Islamabad Exchanges also came into being, the investor
participation in the capital market of Pakistan remained
low. For example, the investor base of Pakistan remains
at 0.2% of the population versus just under 2.0% in India
and over 8.0% in Malaysia. Similarly, the market
capitalization to GDP ratio in Pakistan is 30% versus
nearly 80% in Thailand and over 40% in Indonesia
indicating that the local corporate sector was still not
using the capital market for its funding needs as much as
companies in other jurisdictions. The debt side of the
market remains very nascent even now. Further, while
the liquidity of the market has improved recently with
Average Daily Value Traded reaching over US$200
million in December 2016 as against less than US$100
million in December 2015, given that Pakistan market is
still largely a cash market, the room for significant
growth in liquidity is large if appropriate products
including derivatives are introduced within a proper risk
management regime.
There were several objectives for initiating the
divestment process for the 40% equity stake of PSX.
First, the narrow investor base of the stock market
needed to be significantly expanded. A strategic investor
with experience of operating in larger markets would be
able to provide direction and lead in this endeavor.
Second, market liquidity had to be enhanced. The
strategic investor was expected to fast track the roll out
of various products including derivatives that would
enable greater liquidity generation. Next, by joining
hands with international partners, Pakistan market
would move towards greater integration with global
capital markets thus improving both international
investor base as well as opening up opportunities for
domestic companies to source capital from other
markets. Finally, it was felt that there was a need to
further upgrade the technology platform of PSX in line
with advances in trading and related technologies in
other jurisdictions.
Potential Investors Perspective
While the above reasons prompted the selling
shareholders to initiate the divestment process with
encouragement from the Apex regulator, it is
worthwhile considering why a strategic investor would
be interested in investing in PSX. Given the catchup
potential with regional markets there is no doubt the
upside to market liquidity, investor base and listed
capital is huge with the right mix of product suite,
marketing initiatives and international participation.
Organizational streamlining and realignment also
provide near term opportunities for raising efficiency,
customer reach and increase in revenues of the
Exchange.
In a study by Ernst & Young a while ago covering
emerging markets, it was shown that when a countrys
per capita GDP reached around US$2,000 one of the
fastest growing segment of the economy for the next
decade was the financial services sector. Given that
Pakistans per capita GDP is near US$1,700 and in PPP
terms has already crossed well over US$2,000 the
tipping point for accelerated growth of financial sector,
including the capital market, has arrived.
Thus, timing wise this is indeed an opportune moment to
invest in PSX which effectively represents the capital
market of the country. Beyond the broader dynamics
noted above, the CPEC (China Pakistan Economic Corridor)
initiative is a very specific factor that is expected to
positively impact the capital market both directly and
indirectly. For the first time, due to the CPEC initiative, per
capita investment in Pakistans economy will rise sharply in
the next several years. Both public sector and private
sector investment activity has picked up very sharply in
FY16 versus last few years and this is expected to rise
further in FY17 and FY18. There is expectation that not just
equity cash calls from the capital market will rise
significantly but debt side of the market is also likely to get
a boost from infrastructure bonds. Therefore, from the
strategic investors perspective investment into PSX is
indeed an attractive proposition.
The PSXs KSE-100 Index increased by 40% from in 2016,
making Pakistan the best performing market in Asia and
is among the top few markets in the world to have
shown a return of 30% or higher in US dollar terms in
2016. Going forward, a key development in CY2017 will
be the formal inclusion of the Pakistan market in MSCIs
emerging market index by June, 2017. As this occurs and
there is likely to be increased allocation to the Pakistan
market by passive investors (Index funds) which would
translate into new portfolio investment inflows into PSX.
In conclusion, the divestment of the strategic stake in
PSX is a milestone development for the Pakistan capital
market and heralds a new era of development and
growth of this important plank of the countrys financial
sector. At the same time, this transaction demonstrates
the increasingly close economic and financial
relationship between Pakistan & China.