The Pakistan stock market generally comes under selling pressure in the last week of every month. It is the roll-over week when the future contracts are to be settled or rolled over to the next month. The investors’ anxiety and uncertainty stem from the nail-biting wait to see if the task is successfully accomplished.

Many investors have been complaining that the 30-day contract maturity is a spoiler for the market, asking for the introduction of longer-term maturity contracts so that they are spared the agony that they face on the fourth week of each month.

A query was put to the Securities and Exchange Commission of Pakistan (SECP) regarding the progress on the proposed longer-term future contracts. A spokesperson for the apex regulator responded: “A proposal to introduce 60 days’ and 90 days’ future contracts has been submitted and is under review of the SECP which entails analysing all relevant factors and ensuring effective risk management.”

Earlier on Oct 19, 2020, the Pakistan Stock Exchange (PSX) released a notice “for solicitation of public comments” regarding the “proposed amendments to regulations in relation to future market of PSX”.

‘Margin trading and deliverable contracts were typical instruments of pump-and-dump’

The exchange stated that “in light of international best practices and recommendations of the SECP-constituted committee on enhancing liquidity,” the PSX proposed to carry out following key changes in the futures market: (a) introduction of the 90-day contract maturity instead of the 30-day contract maturity in the deliverable future contract (DFC) market, (b) removal of the mandatory roll-over period and (c) changes in the criteria for the selection of securities eligible for trading in DFC and cash-settled futures (CSF) contract markets. The last day for the submission of public comments was Oct 26, 2020.

Sani-e-Mehmood Khan, former general manager of the PSX and a capital market expert, vehemently disagreed with the proposed amendments to futures market regulations. He said they would further tarnish the name of Pakistan’s capital markets. He pointed out that the existing deliverable futures were monthly forward contracts and that those contracts were very much similar to margin trading contracts which contain an “option” at the end of the buyer to release and settle the contract before maturity.

Moreover, Mr Khan said margin trading and deliverable contracts were typical instruments of pump-and-dump. Regularising the three-months term could simply be understood as creating an alcove, which would be three times bigger than the existing pump-and-dump alcove.

The former PSX official observed that he was sanguine that the exchange was aware of the situation that in certain stocks the turnover-to-leverage ratio was over a staggering 80 per cent (on Oct 25, 2020). He said a cautious review of the situation would help dispel the impressions that “it is a deliberate attempt to regularise the activity of pump-and-dump in our market”.

To give weight to his argument, he quoted several scrips and their leverage percentages (at that time). SNGPL had ready volume of 9.3 million shares while leverage was Rs7.8m. This makes 84.3pc leverage. NBP’s ready volume of 8m shares was against the leverage of Rs5.5m, producing 67.5pc leverage. POL’s ready volume of 0.13m was against the leverage of Rs87,000 (66.95pc).

Regarding the current situation, Mr Khan said last week the combined leverage — i.e. margin trading, margin finance and open interest — was Rs55bn. He said that the interest rate, which was normally charged around 9.5pc, had gone up to 22-23pc in some highly overvalued scrips. But he conceded that the percentage depended on the risk taker. When the seller is taking risk of the price of security going steeply down, he would charge a higher rate.

Khalid Mirza, former chairman of the SECP, said he had to clarify to some investors that the futures market, which he had started back in 2002, was not un-Islamic. He contended that the deliverable futures were actually standard forwards. Mr Mirza said he was perfectly comfortable with the launch of 60-day or 90-day contract maturity provided the appropriate level of margin was charged.

“The exchange must insist on cash settlement and if you have a deliverable contract, it should have a separate counter,” he affirmed. The former chairman of the apex regulatory body argued that even the Rs55bn open interest (mentioned above) was not a matter of concern if there was margin at the right level.

The minimum margin rate should be managed. “Where there is sufficient margin, there is no risk to the market since the purchaser has a cushion and in case the seller doesn’t buy, he can sell the security in the market,” he said.

Khurram Schehzad, CEO of Alpha Beta Core, also thought that the greater number of products, 30-day, 60-day and 120-day contract maturity was healthy for the market. It would open up choices for investors. He said that futures and options help in risk management, provide depth and liquidity to the market and enable investors to take a long-term view.

He said that if the forward contracts were not settled and rolled over, they created excess volatility in the market. “Cash-settled futures as a separate counter do exist and are useful, but they are not widely used,” he said.

Published in Dawn, The Business and Finance Weekly, , March 1st, 2021