Impact of Meltdown on the Capital Markets

Kamran Y. Mirza Chairman Karachi Stock Exchange

KSE vs. Other Regional Markets

Country Index January December 2007 Return 96.70% 47.10% 40.20% 9.80% 3.80% -11.10% January December 2008 Return -65.4% -52.4% -58.3% -40.5% -52.4% -42.1% January August 18 2009 Return 59.87% 55.85% 36.32% 22.44% 5.60% 16.09%

China India Pakistan United States United Kingdom Japan

Shanghai Sensex 30 KSE 100 Nadaq Composite FTSE 100 Nikkei 225

Source: KSE Research

From being one of the best performing markets in 2007, KSE became one of the worst performing markets in 2008
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Key Reasons Behind Market Decline

Long Period of Political Uncertainty Elections/change in Government Fear amongst investors of policy changes that could impact viability of listed companies (media speculation has contributed to these fears) Key decisions with respect to economy were not taken (e.g. removal of subsidies, reduction in govt. borrowing, etc.) Macro economic Imbalances Excessive government borrowing from State Bank of Pakistan due to over spending on subsidies Sharp decline in Forex Reserves Sharp Fall in value of Currency Sharp increase in interest rates

Market fall was not engineered; rather it reflected a severe loss of investor confidence due to decline in economic indicators
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Situation at the KSE

Clearing house margins fully collected at all times However, weakness seen in margin collection at client level by brokers Significant accounts receivable at brokerage houses Collateral collected in the form of securities as opposed to cash Margin calls from KSE & Banks led to continuous selling from leveraged holders of equities Weaker Rupee and poor economic performance resulted in an outflow of approximately US$ 363.62 million from the capital market during July 2008 to February 2009 Sharp decline in volumes was witnessed in 2008 (Avg. daily 146.55 million) vs. 2007 (Avg. daily 268.23 million)

In a low volume market, margin selling leads to sharp fall in market reinforcing the bearish sentiment.

Imposition of Floor
With the Floor in place, the market was restricted for nearly 4 months.

Regulators were faced with unique circumstances and took administrative measures to achieve soft landing.

Had such action not been taken: The rise in systematic risk pertaining to the capital markets would have resonated throughout the financial system. Continuous selling by Foreign Investors would have led to a further decline in foreign reserves

Intervention
Globally, Governments intervened in their economy/ capital markets by taking stakes in troubled companies/financial institutions and providing loans on preferential terms to others. These interventions were taken as Governments and Regulators were faced with unique circumstances with long term consequences to the economy.

In Pakistan, action by the Government and Regulators intervened in the following ways:

Government Post Floor a Rs. 20 billion NIT managed fund was introduced to provide support to the capital market and allow investors to exit their positions by taking positions in 8 scrips with considerable government holdings.

Intervention
Regulators (KSE and SECP): Lower bound circuit breakers revised to 1% from 5% in June for 15 days. Short selling and blank sales banned for July & August 2008 Futures contracts Two special clearing sessions led to settlement of approximately Rs. 10 billion of leveraged positions Floor place on closing prices of scrips as of August 27, 2008

Objective of each intervention was to allow for an orderly decline in the market without causing systemic failure/panic
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Impact of Floor
CFS MK-II has been discontinued; Deliverable Futures Contracts have been reintroduced into the market Collateral is being collected in the form of cash However, volumes have not been sufficiently generated; A new leverage product will have to be introduced to generate volumes Post floor, the following has been witnessed: 2009 volumes (Avg. daily 177.99 million) are above 2008 volumes (Avg. daily 146.55 million) but still significantly lower than 2007 (Avg. daily 268.23 million) While volumes have reduced, volatility has also reduced Banks are lending less in the equity market and have become more risk averse In addition, banks are not actively participating in the equity markets as they used to Investor confidence still low due to strained economic conditions
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Key Lessons for Stakeholders

Regulators: The quality of collateral matters cash is the best form of collateral. Regulators need to come up with framework so that value of both on and off balance sheet transactions are known Changes need to be introduced to protect investors shares in brokers subaccounts

Investors: Investors should seek adequate investment advice in order to make rational and financially sound investment decisions Public/Media: Media needs to play a responsible role in educating public about the capital markets