The 8th ACG Cross Training Seminar Merits & De-Merits of Direct & In-Direct Accounts in the Pakistan Capital Market by: Shabnam Fahim Syed Faisal Hashmi Shariq Naseem

Agenda  Pakistan Capital Markets.  Central Depository Company of Pakistan  Merits and Demerits of Direct and Indirect account Method

Pakistani Capital Markets  Market regulators  Stock Exchanges  Instruments Traded  Trading Environment  Clearing and Settlement  Past Brief and Current Situation

Market Regulators  Securities & Exchange Commission of Pakistan (SECP)  Regulating stock exchanges, NBFCs, CDC and Corporate Sector  Functional Responsibility: framing of rules and regulations  Recent developments, REIT, VPS, NBFC rules, debt market  State Bank of Pakistan (SBP)  Regulating banking institutions  Policy measures  Monetary  Credit  Foreign exchange mechanism

Stock Exchanges  Three Stock Exchanges in Pakistan:  The Karachi Stock Exchange  Lahore Stock Exchange  Islamabad Stock Exchange  The Stock Exchanges:  Most active and Liquid- KSE  Self regulatory body

Instruments Traded  Equity  Ordinary Shares  Preference Shares  Bonds  TFCs  Other Debt Instruments- TBs, PIBs  Derivatives  Stock Exchange offers equity futures  Monthly contract- overlap of at least 2 trading days b/w contracts

The Trading Environment  Equities  All Stock exchanges have own trading platforms  Automated Trading System:  Processing based on bids & offers and  Intimation of trades executed  Circuit Breakers- 5%  Bond Market  Primary Market  PIBs Auctioned monthly & TBs fortnightly  TFCs by Pakistani Companies  Secondary Market  PIBs and TBs traded freely  Investors hold TFCs until maturity- low liquidity

Clearing and Settlement  Clearing  Government bonds through SBP  Others through National Clearing Corporation  Scrip less  Settlement System T+3  Payment released-broker ascertains stock transfer- CDC A/c  OTC  No formal organized market  Physical  Less than 1% Settlement

KSE Current Situation  Pakistan Included in MSCI Emerging Market index- May 2005  World Bank-Investment report one of top ten reformer countries  Market capitalization- $ 57 billion with 663 securities (April 17, 06)  4 th year- one of the best performing markets- Business Week- US newspaper, USA today  Past four years compound annual growth rate-56%  KSE100 share index- increased 53.6% July 05 - May rd highest  Capital markets exceptional performance– Reasons  Pakistan Economic Revival- GDP growth onwards  Consistent and transparent economic policies  Successful privatisation process-PTCL/National refinery etc  Impressive Corporate Results  Sound Monetary Polices- SBP, & Capital Market reforms- SECP

… the Country’s only Securities’ Depository CDC...

 Incorporated in 1993  To manage and operate the Central Depository System (CDS)  Live Operations in 1997 Central Depository Company (CDC)

Our services  Depository Services  Trustee and Custodial Services  Registrar & Transfer Agent (in near future)

Legal Framework  Companies Ordinance  Central Depository Company Regulations  Central Depositories Act  Listing Regulations

 Implementation of National Clearing & Settlement System  Launch of trustee and custodial services  Launch of Investor Account Services  Launch of enhanced version of CDS (eCDS)  Induction of Open-end Mutual Funds in CDS  Launch of CDC call centre  CDC Access Achievements

Securities handled through CDS  Ordinary Shares  Preference shares  Term Finance Certificates Certificates of Open-ended mutual Funds  Certificates of Closed-end Funds  Modaraba Certificates

Transactions Supported through CDS  Deposit of Securities  Delivery (Transfer) of Securities  Withdrawal of Securities  Pledge  Corporate Action  Merger / De-merger  Consolidation /Split  Conversion  IPO  Issuance and Redemption of Open End Mutual Fund Units

CDS Elements Issuers Account Holder Participant Pledgee CDS Elements

Account Holders  Account Holders.  Account holders have direct access to the CDS & are allowed to keep their beneficially owned securities in CDS.  Participants  Participants also have direct access to CDS and are allowed to provide custody services to their clients in addition to keeping their beneficially owned securities.

Account Categories  Main Account – Transitory Account  House Account – Account Holder’s own account  Sub Account – Client Account  IAS Account – Client Account

Account Holder Central Depository System (CDS) Account Holder Main A/C House A/C Main A/C House A/C Sub-A/C Investor A/C. Participants Account Structure

Admission Criteria Direct Account Member Stock Exchanges Financial Institutions Qualified investors that meet:  Technical requirements  Business Integrity requirements  Capacity requirements  having Data Processing & Operational Capabilities Indirect Account Any person or corporate entity.

Merits & De-Merits of Direct & In-Direct Accounts

Benchmarking  Forthcoming slides would provide you the behavior of Direct & In- direct Accounts, taking different important parameters of Capital Markets as the Yardstick.  We would analyze the merits & de-merits of both the type of accounts, by placing each of them individually, in different dynamic Capital Market motions.  This exercise would allow us to determine the effectiveness of each type of account in a more practical & realistic milieu.

Cost Direct Definitely DAs cost more than IDAs. A significant difference is of “Security Deposit” which is a refundable amount and required at the time of joining the CDC as a DA. Another additional cost is pertaining to the “CDS Connection Fee”. In-Direct Comparably IDAs do prove cost- effective than their adversary, however we might find cases where Custodians charge and an additional cost as “processing and/or convenience charges”.

Efficiency Direct Capital Markets, anywhere in the world, are dynamic & momentary in nature. DAs always prove more fruitful in such dynamic environments as you have more control and less dependency. Capital Markets, anywhere in the world, are dynamic & momentary in nature. DAs always prove more fruitful in such dynamic environments as you have more control and less dependency. In-Direct In the dynamic Capital Markets, dependency Is always treated as a Shortcoming. No matter how efficient your Custodian is, you remain dependent on them and dependency is not advisable.

Confidentiality Direct Letting your cards known to others is treated as a Cardinal Sin in Capital Markets. DAs always protect your confidentiality and ensure that your portfolio remains known to you ONLY. In-Direct Adding a third party in sharing your confidential information would always add risk.

Clearing. Direct DAs allows investors to reach the 1st layer of Clearing & settlement in some cases like via IDS. In such cases sometimes you may also get the chance of dealing with the Virgin Transactions. In-Direct Clearing through IDAs always keep you on the backseat. You may not be able to avail the advantages of reaching the 1 st layer of clearing & Settlement

Settlement Direct Where reaching to the 1 st level of Clearing & settlement can be fruitful in many ways like getting access to the virgin transactions, sometimes (specially in cases of Failed settlement from one of the involved parties) you may place yourself in a very Risky situation. In-Direct IDAs always remain away from settlement cycle means also remains away from the risk & rewards associated to it.

Compliance & Audit Direct DAs are subject to number of regulatory requirements. It also requires compliance to number of regulatory frameworks including CDC Regulations. DAs are also exposed to the CDC Participant Audit requirements. In-Direct IDAs only involve minimal level of Regulatory and compliance related requirements.

Risk Management & Security Direct DAs are always more secure and Risk mitigating in nature. Having your securities under your own control is always advisable. In-Direct IDAs are more prone to risk then their counterparts.

Information Direct In CDC, DAs have an edge mainly due to two reasons:  Access to complete set of CDS reports. CDS reports.  Integration process. In-Direct Although IDAs do not have the access to the two main sources of information which DAs have, but having an IDA with “Global Custodian” may also be very informative.

Global Operations Direct Investors having Global Operations may find it difficult to maintain Direct Depository Account in every location they operate. In-Direct IDA’s in this case have a clear edge over their rival, specially in case of “Global Custodians”, you only have to deal with a single party for your complete Global Operations.

Maintenance & Convenience Direct DAs are definitely convenient in cases where you have huge Operations and you do not want to involve in lot of paper transactions In-Direct IDA’s are more convenient for smaller investors. However, they also prove very convenient in cases like “Global Operations” and cases where the investor need to maintain numerous accounts.

Registration Direct There are minimal chances of Registration risk in DAs as even in cases of leaving securities in main account do not have any Registration threat. In-Direct IDA’s do have a imminent registration threat, leaving shares in Main account of Custodian, because of any reason, may create a serious Registration threat.

Entitlements Direct Dealing with entitlements and other corporate actions is safer with DAs. You remain on the top as far as the announcements are concern. In-Direct In IDAs, you add an additional leg to your entitlement cycle which is not advisable.

Value Added Services Direct IDA’s are only exposed to the value added services extended by the depository itself. In-Direct IDA’s have an edge specially in cases where your account is with a “Global Custodian” like Cash Management, proxy services, etc.

Thank You!