IMPLEMENTATION of Unique Identification Number (UIN) system in stock market has begun from August 1, 2006. The system would establish a traceable link between every trade executed on a stock exchange and the person ordering that trade by tagging it with a unique number, which would be CNIC number for Pakistani citizens, company registration number for corporate entities, passport number for foreign individuals etc.

With the help of UIN system, it should be possible for regulators to have real time information about a broker’s proprietary trading, done for each client investor, and for brokers from another exchange, without asking the concerned broker to submit any information from his back office records.

This valuable information could then be used in market surveillance to quickly identify persons suspected of involvement in market abuse. It would also assist in managing settlement risk by providing the basis for reducing netting in brokers’ unsettled positions and identifying reckless speculators who might be taking exposures beyond their financial capacity.

UIN system is a sea change from the present system where exchanges only have trading data for stock brokers with no information about end investors who could be trading though multiple brokers on more than one exchange. At the same time, through intelligent use of information technology, UIN has been brought in a user friendly manner without causing any unnecessary hassle for stock brokers or their clients.

UIN was in the making for some time. It was first conceptualised when investigations into blank selling in 2001 crisis failed due to lack of trade-to-investor audit trail. In 2002, UIN was discussed at different forums but no progress was made. In March 2003, SECP directed the stock exchanges to implement the system but that directive was not implemented. Two years later, in March 2005, SECP issued a new directive, which along with a number of other measures, required implementation of the system by November 2005.

At the behest of SECP, a detailed model for implementing UIN was developed by Central Depository Company (CDC), which, after a public consultation, was approved by SECP. That model had mandatory investor registration, issuance of fresh identification numbers, and different checks and balances to minimise loop holes. Later, during negotiations with stakeholders, the original model was watered down to its present form in which brokers only have to map trading codes to pre-assigned UIN without any registration or verification.

In sum, it is after more than four years from its initial conceptualisation and long drawn negotiations that UIN is undergoing implementation. During this time, more that once it appeared that UIN was about to get derailed but it was probably the public outcry in March 2005 and June 2006 crises that created an enabling environment for its implementation.

The system has the potential to turn the odds against manipulators and reckless speculators who have been thriving on insufficient transparency in trading. It would also have other long term benefits. In future, information provided by the system could help in capital market policy making, product development, and modernisation of system through measures such as straight through processing.

But whether and to what extent UIN would make the desired impact depends on how its initial implementation is followed up. It is critical that decision makers immediately start working on weaknesses in the UIN system to make up for the concessions given on negotiating table.

First, to protect sanctity of UIN data base - the foundation for the whole system - it is essential that ongoing and specific audits be conducted by SECP teams or independent third parties, starting with those UIN holders who are trading large volume. Purpose of these audits is not to build a fool proof system but to save it from becoming a farce. There are strong fears that while genuine UIN might be used for the small fish, sharks would continue to use multiple dummy accounts with different local and foreign brokers to hide their trading. Add to this the problem of identity theft.

By using a photocopy of a CNIC, new trading accounts can be opened, closed, and re-opened without the knowledge of concerned person. To close these back doors, audits of UIN records should ensure that (i) mapped UIN are authentic; (ii) holder of UIN does have a properly documented account with concerned broker; (iii) he placed the orders for trades which were executed using his UIN and, (iv) he made or received payments and deliveries through appropriate depository and bank accounts. There must be strong penal action against material violations of UIN system, otherwise resourceful market players would prefer risking minor penalties rather than disclosing true UIN.

Second, UIN should be considered means to an end – investor protection – and not an end in itself. What has happened so far is the beginning and not the end of UIN implementation. Unless there are effective surveillance and risk management wings which are backed with a clear legal framework and political will to act against abuse, objective of UIN would not be achieved.

At present, these essential elements are largely missing. In spite of role of exchanges as front line regulators, the buck in each market scandal stops at the door of SECP. In view of these ground realities, apex regulator would do well to initiate full scale central surveillance for all three exchanges. This arrangement would also help allay fears about protection of confidentiality of UIN-tagged positions.

Third, regulations and procedures governing UIN should be notified without any further delay. Initiation of UIN without first notifying concerned regulations and modification of UIN model on day to day basis is attracting criticism from market participants. While NCC’s UIN regulations have now been made public, those pertaining to exchanges are still awaited. New notices modifying basic elements of UIN model are still coming out, which points to insufficient home work.

Scope of UIN should be expanded to trading by foreign investors and domestic inter-exchange order flow, but not through ad hoc decisions which are bound to be reviewed again and again. Given the importance and long term nature of UIN initiative, it would be better to institutionalize its implementation. There should be a designated UIN coordinator at the three exchanges, NCC, CDC, and SECP who should meet periodically to provide continuity and consistency in its implementation in the years to come.

Decision makers have got to realise that they must press on with UIN audits, surveillance, updating of legal framework, investigations, and enforcement because in this stock market, the next scandal is never too far away. If future investigations failed to identify the culprits despite UIN system, it would be a great set back. At that time, those advising “go slow on UIN” to appease market participants would duck down and decisions makers would find themselves alone in the firing line.

News media would not bother about finer details of events and it may brand the system as a failure along with those who are steering it. To avoid this undesirable eventuality, decision makers would do well to come up with a clear road map for further implementation of the system so that it can be counted upon to prevent or punish those responsible for market abuse and settlement crises.