VZCZCXRO8644
RR RUEHLH RUEHPW
DE RUEHKP #0361/01 3200433
ZNY CCCCC ZZH
R 160433Z NOV 09
FM AMCONSUL KARACHI
TO RUEHC/SECSTATE WASHDC 1417
INFO RUEHIL/AMEMBASSY ISLAMABAD 0869
RUEHBUL/AMEMBASSY KABUL 0314
RUEHLO/AMEMBASSY LONDON 0359
RUEHNE/AMEMBASSY NEW DELHI 1910
RUEHLH/AMCONSUL LAHORE 2768
RUEHPW/AMCONSUL PESHAWAR 4650
RUEAIIA/CIA WASHINGTON DC
RHMFISS/JOINT STAFF WASHINGTON DC
RHEHAAA/NSC WASHINGTON DC
RUEKJCS/SECDEF WASHINGTON DC
RUMICEA/USCENTCOM INTEL CEN MACDILL AFB FL
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC

C O N F I D E N T I A L SECTION 01 OF 02 KARACHI 000361 
 
SIPDIS 
 
E.O. 12958: DECL: 11/13/2019 
TAGS: EFIN PGOV ECON PK
 
SUBJECT: KARACHI STOCK EXCHANGE - REFORMS, HOPES, CHALLENGES 
 
Classified by: Consul General Stephen G. Fakan, Reasons 1.4 (b)and (d) 
 
¶1. (C) Summary: In the wake of Pakistan's 2008 financial collapse, 
the Karachi Stock Exchange (KSE) is introducing viable leverage 
products and debt liquidity, implementing stringent safeguards 
against market manipulation, and pursuing demutualization - through 
decoupling exchange ownership and trading rights.  KSE and Security 
and Exchange Commission officials told Econ Offs these reforms will 
establish a more stable and modern trading platform, capable of 
attracting both foreign and domestic investment.  Despite these 
officials' optimism, institutional malaise, cronyism, and a lack of 
political will threaten to impede reform efforts.  End summary. 
 
2008 Market Collapse 
-------------------- 
¶2. (U) Pakistan's 2008 economic collapse had a significant impact on 
the Karachi Stock Exchange (KSE), with total market capitalization 
plummeting from a high of $78 billion in 2007 to approximately $33 
billion today.  Daily trading activity also dropped from $500-600 
million to approximately $300 million over the same period.  From 
August to December 2008, the government imposed a floor on KSE to 
prevent further declines.  However, the market has shown recent signs 
of recovery, with increased trading volume and a positive trend in 
portfolio investment.  There are also several initiatives underway 
that have investors and the KSE management optimistic about the 
future of the exchange. 
 
Demutualization is Coming 
------------------------- 
 
¶3. (SBU) On October 13, Adnan Afridi, Managing Director of the KSE, 
told Econ Offs that "demutualization, through decoupling the broker's 
ownership of the exchange from their trading rights, is the key to 
modernizing the capital markets."  (Note:  Demutualization is the 
process by which a customer-owned mutual organization or co-operative 
changes legal form to a joint stock company.  End note.)  Afridi 
believes demutualization will increase both market transparency and 
efficiency, and will inject much needed capital into the KSE. 
 
¶4. (C) The first step, diversification of the KSE Board of Directors, 
was implemented in 2007 to counter claims that the KSE was operating 
as a monopoly and that the 200 brokers, who both own and have 
exclusive trading rights on the exchange, were blatantly manipulating 
the market.  An independent chairman and managing director were 
appointed to guide day-to-day operations of the exchange and 
independent businessmen were given seats on the Board to help balance 
the interests of the brokers.  However, according to Mateenullah 
Khan, Joint Director for the Securities Market Division (South) of 
the Securities & Exchange Commission of Pakistan (SECP), changes to 
the Board have not been fully effective in preventing cronyism and 
manipulation, as many brokers retain close relationships with the 
independent members of the Board and are able to either influence or 
outmaneuver them when disagreements arise. 
 
¶5. (U) On October 11, the National Assembly passed a bill that would 
finish the process of demutualization.  Under the provisions of the 
bill, the 200 brokers who currently own the KSE would sell 40 percent 
of their equity to "strategic international partners" and an 
additional 20 percent to private investors, leaving the brokers with 
a 40 percent ownership stake.  The bill must still pass the Senate 
before it becomes law, and the changes implemented. 
 
Return of Margin Trading 
------------------------ 
 
¶6. (U) Plans developed jointly by the KSE and the SECP in accordance 
with international standards and best practices to re-introduce 
margin trading, suspended in 2008 due to its perceived role in 
contributing to the market crash, are moving ahead. Unlike the Badla 
system (an indigenous "carry-forward" finance system where brokers 
were the sole financers) the new system would standardize broker 
requirements and allow non-broker entities, such as banks, to provide 
leverage financing.  The proposal also includes safeguards such as 
equity requirements, "circuit breakers" (designed to prevent the 
collapse of securities), and an online investor tracking system to 
limit fraud.  The SEC has approved this system which is expected to 
be fully implemented within the next six months. 
 
 
 
KARACHI 00000361  002 OF 002 
 
 
Happier Days Ahead? 
------------------- 
 
¶7. (SBU) Arif Habib, former chairman of the KSE and CEO of one of 
Karachi's largest investment banks, believes Initial Public Offerings 
(IPOs) will play a major role in future market capitalization.  In 
the past, IPOs were not seen as viable because of the loose lending 
standards and low interest rates offered by banks.  However, 
following the 2008 financial crisis, banks have tightened lending 
requirements, reducing the sources of cheap debt, and increasing the 
competitiveness of IPOs.  Habib expects that in FY 2009-2010 there 
will be between 15 to 20 IPOs, compared with zero during the FY 
2008-2009.  (Note: There have been three successful IPOs thus far 
this year, and four more are in process.  End note.)  The KSE is also 
planning an aggressive outreach campaign to the largest 100 companies 
in Pakistan to urge them to use private financing and to convince the 
government to divest more of their 27 percent market share. 
 
¶8. (SBU) On November 2, the KSE launched its Bond Automated Trading 
System (BATS).  This introduced the trading of debt market securities 
to Pakistan's exchanges.  According to Anita Mirza, KSE Head of 
Marketing, the new system is being well received by brokers.  During 
the first day of trading, Rs 40 million ($500,000) of transactions 
for term finance certificates from 24 companies were conducted. 
Mirza described the day as "very successful," and said the value and 
number of transactions, and companies, will increase as the market 
develops. 
 
Comment 
-------- 
 
¶9. (C) Despite optimism regarding these ongoing reforms, many threats 
remain to the long-term viability of Pakistan's financial system. 
While portfolio investment has stabilized, foreign direct investment 
remains well below 2007 levels.  Afridi cited a lack of investor and 
broker knowledge of the current market and proposed enhancements, 
stating that such institutional malaise threatens reform efforts. 
Meanwhile, Khan expressed concern over Pakistan's antiquated legal 
framework and a lack of political will to implement needed reforms. 
Finally, terrorism, with its debilitating impact on the market's 
stability, remains a significant unknown to the future viability of 
the KSE. 
 
FAKAN