Karachi Stock Exchange

Issues & Prospects

Presentation by:

Nadeem Naqvi
Managing Director Karachi Stock Exchange February 15, 2012

www.kse.com.pk

Karachi Stock Exchange (KSE): Profile I

KSE is owned by 200 members
There are 10 directors; 5 elected by members; 5 nominated (including MD) by the Securities & Exchange Commission of Pakistan Active members are approximately 135 at present

Over 600 companies are listed on the Exchange

Market Cap. is currently at US$34bn (US$75bn in Mar 2008)

Value Creation : 2.94x the listed companies

Market Value of paid up capital of

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Karachi Stock Exchange (KSE): Profile II

Benchmark indices
1) KSE-100 Index 2) All Share Index 3) KSE-30 Index 4) KMI-30 Index 5) Oil & Gas Index 6) Banking Index

Strong Systemic Risk Management System

State-of-the-art technology platform

Seamless electronic integration of Trading (KSE), Clearing (NCCPL) and Settlement/Custody (CDCPL) New Product Pipeline: SLB, MTS, ETFs, Sector Indices, Cross Border Index Listings, Options

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Business Functions of the Stock Exchange

PRIMARY MARKET

Mobilise savings into productive investment for economic development

SECONDARY MARKET

Maximise liquidity at the lowest cost per transaction

Pre-trade; trade execution; post trade clearing and settlement of transactions

RISK MANAGEMENT

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Regulatory Functions of the Stock Exchange

Licensing of members / brokers

Listing regulations of companies

Corporate Governance of listed companies Market monitoring & surveillance of trading activity to ensure fair play, efficiency & auditability

Penalty for infractions of regulations

Formal Reporting to SECP

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Asset Class Comparative Performance

KSE -16% 112% 66% 39% 54% 5% 40% -58% 60% 28% Gold 8% 9% 9% 15% 12% 26% 22% 32% 33% 30% DSC 15% 13% 9% 8% 8% 10% 10% 11% 12% 12% PIBs 13% 10% 6% 7% 8% 10% 10% 13% 13% 13% T-bills 11% 6% 2% 2% 7% 8% 7% 11% 13% 13% Deposits* 6% 4% 2% 1% 3% 3% 4% 6% 6% 6%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Average

33%

20%

11%

10%

8%

4%

* Weighted average deposits rate as per SBP data

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Capital raised from the Stock Market

Total amount of equity capital raised by listed companies through issuance of rights shares during the last 10 years (2002-2011) was Rs316bn
Demonstrates the important role that KSE has played in allowing companies to raise long term capital for growth Over PkR122bn was raised by the Government of Pakistan between 2003-2007 from privatization through the stock exchanges Indicates how the Government of Pakistan has been the direct beneficiary of a thriving capital market that allows market driven valuations of state owned companies

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Examples of private sector fund raising

DG Khan Cement Co.
2006 1.7bn 2009 1.0bn 2010 1.2bn 2011 1.5bn

Rs5.4bn in 6 years

Engro Chemical

2006

1.2bn

2007

3.2bn

2008

3.2bn

2009

4.3bn

Rs11.4bn in 4 years

NIB Bank

2006

19.0bn

2007

12.0bn

2011

3.0bn

Rs34.0bn in 6 years

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KSE-100 Index History

KSE-100 Index
16,000

15,676

14,000

12,262
12,000
10,000 8,000 6,000

4,000 2004 2005 2006 2007 2008

4,815
2009 2010 2011 2012

Source: KSE

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Regional Performance - I (June 30, 2011 Dec 31, 2011)

5.0% 0.0%
-1.6% -1.7%

1.9%

-5.0% -10.0% -15.0% -20.0% -25.0%

-3.1%

-9.2% -11.0% -15.2% -17.7% -18.0% -18.7% -20.4%

Singapore

Hong Kong

Pakistan

Philippines

Indonesia

Malaysia

Thailand

Sri Lanka

Source: KSE; Bloomberg

Vietnam

China

India

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Regional Performance - II (Jan 2, 2012 Feb 14, 2012)

16.0% 11.0% 6.0% 1.0% -4.0% -9.0% -14.0% -19.0%
-17.5% 15.5% 13.9% 13.5% 12.9% 9.2% 8.1% 7.9%

6.6% 3.4% 2.3%

Singapore

Hong Kong

Philippines

Vietnam

Pakistan

India

Indonesia

Malaysia

Thailand

Source: KSE; Bloomberg

Sri Lanka

China

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Market Cap to GDP Unrealized Potential

50% 46.4%

45%
40% 35% 30% 24.9% 15.6% 9.9% 16.1% 31.6%

36.5%

33.7%

25%
20% 15% 10%

18.3% 18.2%

16.5%

5%
FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12
Source: KSE; Economic Survey FY11 *As at Mid Feb 2012

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Average Daily Turnover (Shares mn)

(Shr mn)

400 350 300

344

365

257

258

250

200
150 100 50
133

171 121 79 94*

CY04

CY05

CY06

CY07

CY08

CY09

CY10

CY11

* CY12: Jan todate

Source: KSE

CY12

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12,000

16,000

4,000

8,000

KSE-100 Index

03-Mar-08 17-Mar-08

31-Mar-08 14-Apr-08 28-Apr-08 12-May-08 26-May-08 09-Jun-08

23-Jun-08 07-Jul-08 21-Jul-08 04-Aug-08 18-Aug-08 01-Sep-08

Market All Time High at 15,676 (Apr 18,08)

Imposition of Floor at 9145 (Aug 27, 08)

15-Sep-08 29-Sep-08 13-Oct-08 27-Oct-08 10-Nov-08 24-Nov-08

08-Dec-08 22-Dec-08 05-Jan-09 19-Jan-09 02-Feb-09 16-Feb-09

KSE-100 Crisis Period Performance

Market Bottom at 4815 (Jan 26, 09)

02-Mar-09 16-Mar-09

Source: KSE

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30-Mar-09

Key Causes of 2008 Market Crisis

High leveraging, a phenomenon in most global markets since mid-2000s
Sell-off by foreign funds in tandem with global market sell-off in the summer of 2008 Investor defaults leading to brokerage houses receivables build up and pledging of clients shares to banks SBPs sudden change in regulation regarding banks exposure quantum to equities/broker loans Margin calls by banks & associated forced sell-off of securities collateral, accentuating downward pressure on market Regulatory panic via artificial floor imposition & no arrangements for short-term liquidity for Pakistan market in contrast to full liquidity support by regulators in other markets

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Capital Market Contribution to Taxation

KSE Collected Taxes worth PkR17bn between FY05 FY11
(PkRbn)

5.0
4.2

4.7 3.6
2.8

4.0 3.0 2.0

1.0 FY05 FY06 FY07 FY08

0.6

0.5

0.4

FY09

FY10

FY11
Source: KSE

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Declining Volumes Impact Broker Performance

Brokerage Commission
6.1

PkRbn

7.0 6.0 5.0 4.0

PkRbn

Total Income
8.4

PkRbn

Net Profit
2.2

9.0 8.0 7.0

2.5 2.0 1.5 1.0

5.7

1.4

6.0
5.0
3.0 2.0 1.0 2008 2009 2010 2011
2.4 2.3 1.7

0.5 0.0 -0.5

4.0 3.0 2.0 2008

3.9 3.2

-1.0 -1.5 -2.0 -2.5

-2.2 -1.3

2009

2010

2011

2008

2009

2010

2011

Source: KSE; Based on a sample of 50 active brokerage houses

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KSE: 5-Year Financial Performance

Operating Revenue
PkRmn 1,397 PkRmn

Operating Profit
PkRmn
868

Net Profit
800 700
603 508 772

1,400

1,000

1,200
1,000 800 600
771
668 701

800
600 400 200
320 303 458

600 500
243
198

400 300 200

314

400
200 -

(200) (400)
(295) (314)

100
0

68

50

2006 2007 2008 2009 2010 2011

2006 2007 2008 2009 2010 2011

2006 2007 2008 2009 2010 2011

Source: KSE

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Lessons from past crises

INVESTOR PROTECTION
Brokers quality & capability Strong financial penalty & regulatory coordination Preemptive risk management regime Power to the Investors Investor Protection Fund

SYSTEMIC RISK MITIGATION

Market Liquidity Robust margining regime Trade settlement guarantee Clearing House Protection Fund

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Investor Protection a Key Point of Focus

While enhancement in post event investor compensation has occurred, more work is required on the prevention side
Strengthening of brokers financial, professional and risk management capability is one area of priority Regular reporting of brokers payables & receivables is another area to be focused upon to preempt problems turning into crisis Brokers sales personnel training emphasising financial planning and longer term investment rather than just trading Technology driven separation and management of custody accounts can significantly reduce risk of comingling

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Empowering Investors to Protect Themselves

Strengthened regulatory regime, driven by technology
Universal Identification Number (UIN) for each individual investor Auto tagging of CDC Sub A/C with UIN & KATS Code
CDC

KSE

CDC

Investor UIN

KATS KATS Code Code

No comingling of investors funds with broker's funds (separate bank accounts) SMS & email alert service on any share movement / transaction in UIN from CDC & NCC

NCC

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Managing Operational Risk: Key Measures

Information Security
No removable storage devices in KSE employee computers All personal e-mail/media sites blocked Information flow matrix strictly enforced Security cameras at sensitive locations

Risk Management Gateway to Members

Client Level Margining Client shares by the broker can not be utilized for his own business or trades of other clients New Margining Regime Concentration margins at all leveraged & futures markets; liquidity margin in the ready market over and above existing VAR margins

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New Initiatives to Broaden Investor Base

Launch of vision 2014: 500,000 investor base by Dec 2014 versus approx. 250,000 at present
Comprehensive, time bound action plan to generate investor awareness by joint forum of all capital market institutions, SECP and the reactivated Institute of Capital Market New regulations by SECP to encourage individual investor participation New product rollouts including sector indices, Options, ETFs, market-maker regulations, cross-listing of Regional Index derivatives Initiation of personal financial planning / wealth management training program for brokers and mutual funds sales personnel

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New Initiatives to Increase Listed Companies

Launch of IPO Initiative by the three exchanges under umbrella of South Asian Federation of Exchanges (SAFE)
Cooption of investment banks, DFIs, investment banking divisions of large banks & top-tier brokers to market the IPO concept to privately held businesses Detailed review of listing regulations in order to reduce paperwork/application process timeline for listing, under guidance of SECP

Initiative for launching a dedicated SME Exchange

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KYC & CDD Initiative

Changes in Exchanges regulations mandating brokers to follow international KYC and Customer Due Diligence (CDD) guidelines by Anti Money Laundering Task Force as per international compliance standards
Rollout of Broker education programme regarding anti money laundering laws & regulations, KYC and CDD

Mandatory creation of compliance function by all brokers

Assisting brokers in defining internal KYC guideline and implementing KYC and CDD activities on an ongoing basis Stronger system audit regime to monitor KYC Compliance

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Structural Issues Hampering Market Growth

Corporate Tax Structure Anomaly Partnership/Proprietorship Tax rate of 20-25% versus corporatized business tax rate of 35%. This is a huge disincentive to listing on the stock market
Lack of liquidity Banking sector nearly absent from capital market financing; partially due to stringent regulations and partially due to crowding out by Govt. borrowing Capital Gains Tax Conundrum Poorly designed and inappropriately timed imposition of new CGT regime. Perception of unfair treatment for equity investors (c.f. investment in govt. securities; no tax on agricultural sector; non implementation of RGST on trade services). Further, perceived fear of harassment by taxofficials of individuals has driven out retail investors from the market

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Structural Issues Hampering Market Growth

Absence of Market Makers Till date, absence of market makers has been a key cost of low or nil liquidity in the derivatives market. This is changing
Lack of Incentives for Debt Market SBP still to focus on developing a robust domestic secondary market for Govt. debt at retail level. As that happens the stock market and brokers can became a strong retail distribution network for the Govt. and help reduce cost Problem facing NRPs Cumbersome SCRA regulations a major disincentive for Non-ResidentPakistanis (NRPs) to invest in the domestic equity market Lack of international marketing No systematic, institutionalized effort to expose Pakistans capital market to global investors and the Pakistani Diaspora

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Sustainability of an Exchange
Information Technology Quality of Human Resources

THE VALUE PROPOSITION

Access to Customers

Products & Services

Rules & Regulations Risk Mgmt. Regime Licensing of Brokers Capital Resources Supportive Govt. Policy

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THANK YOU

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