The Need for a comprehensive Global Standard for Financial Markets

The Stock Market Crisis
Pakistan stock exchange has been facing crisis since the last year. The outflow of foreign portfolio investment from the country’s equity market continued as the offshore investors withdrew $36.464 million during the third week January in 2009. The outflow of foreign investment from the country’s equity market started in 2008 due to political uncertainty, weakening economic indicators and the law and order situation in the country. The falling returns in the stock market have also forced many brokers and investment houses to lay off staff.

The Karachi Stock Exchange (KSE) ordered the establishment of a floor to stop its benchmark index from falling any further. It stops share prices from dipping any further and in effect prevents the value of their stock wealth from dipping any further. The Securities and Exchange Commission of Pakistan (SECP), the stock market regulator, was obliged to step in and enforce removal of the floor from December 15th, 2008. This was because of the IMF conditions of a ‘free falling market’ set out in a crucial loan agreement with the IMF. The period the floor was in place was a time of much anxiety for Pakistan’s equity investor community.

Steps to curtail the crisis
The Securities and Exchange Commission of Pakistan (SECP) has attempted to deal with the situation through new ordinances and measures. It amended section 95A of the Companies Ordinance 1984 through Companies (Amendment) Ordinance, 2009 to allow listed companies to buy back their own shares and hold them as treasury shares, which may be re-issued under the regulations being prescribed by the Commission. The amendment states:

‘Power of a company to purchase its own shares. (1) Notwithstanding anything contained in this Ordinance or any other law for the time being in force or the memorandum and articles, a listed company may, subject to the provisions of this section and the regulations prescribed by the Commission in this behalf, purchase its own shares.’

The SECP also wanted to incorporate three new sections in the Modaraba Ordinance, through amendments in Modaraba Ordinance 1980 and addition of new section 41A, for improving regulatory framework of the Modaraba sector, empowering the commission to issue regulations for this sector. Modaraba is a kind of partnership, wherein one party provides finance to the other for the purpose of carrying business.

The international scenario
In 2008, failures of large financial institutions in the United States, due primarily to exposure to securities of packaged sub-prime loans and credit default swaps issued to insure these loans and their issuers, rapidly evolved into a global crisis resulting in a number of bank failures in Europe and sharp reductions in the value of equities (stock) and commodities worldwide. The economic crisis caused countries to temporarily close their markets.

On October 8 2008, the Indonesian stock market halted for two days after a 10% one day drop.
The same day, the Icelandic government shut down the stock market and brought trading in the country’s currency to a halt. Similarly, Kuwait’s and the Russian stock markets were also shut down.

Many of the world’s stock exchanges experienced the worst declines in their history, with drops of around 10% in most indices. To counter the crisis, the Federal Reserve of USA announced a multibillion dollar emergency loan to rescue insurance giant AIG. The Fed continued to take unprecedented actions. After deep rate cuts, the Fed’s key rate now stands practically at zero, effectively retiring it as a tool of monetary policy.

Conclusion
There should be a consistent legal & judicial framework prevalent in all countries to protect the stock markets. The framework should:
1. Limit the number of direct foreign investments flowing into the local stock market
2. Limit the amount of short selling to discourage speculation of stocks
3. Regulate bigger investment companies on their portfolio diversifications & ratings to prevent the market monopolization
4. Regulate the transformation of repayments and installments into marketable securities

The governments around the world should also update their legal frameworks regarding their stock exchanges. The legal infrastructure needs to empower the exchange regulatory bodies by ensuring:
1. Tougher penalties for listed companies to ensure compliance with securities laws
2. Stronger powers to review the information that public companies disclose to investors
3. Greater clarification of offences such as securities fraud and market manipulation
4. Broader rights for investors to sue if companies make misleading or untrue statements or fail to give full and timely information
5. Internationally coherent standards of accounting for companies

What are your thoughts? Please share what you think are the best policies and legal frameworks to put into place to establish a Global Standard for Financial Markets.