[dropcap]P[/dropcap]akistan Stock Exchange took quick hit within a short span of time and just in one year, the reform of the country’s capital market recording positive impact both in the regional and international equity business.
The recent agreement with Chinese companies to invest in the capital market and in the past the renewal of status expansion and merging country’s three exchanges into one – Pakistan Stock Exchange – made this Exchange highly attractive. The market capitalization of the PSX is around $90 billion now, although only about a quarter of that is freely tradable. In December, the average daily value of trades stood at about $200 million, doubling from December 2015, but some way below pre-2008 crisis levels, when daily trades reached $400-$500 million.
The PSX saw its benchmark index increased by 60 percent over the past year, making it one of world’s top performing indexes. Pakistan was the world’s fifth highest-returning stock market in 2016, but that growth was driven by local investors, with the bourse eager to attract more foreign inflows.
Pakistan Stock Exchange was created in January 2016, following the merger of the Islamabad, Karachi and Lahore exchanges. Soon after, Pakistan’s bourse was boosted, when the country’s stock market was reclassified to be included in the MSCI’s emerging market index category. Pakistan was dropped from the MSCI Emerging Markets Index when it imposed a floor on the market during the financial crisis in 2008, effectively trapping local and foreign investors for several months. In January 2015, at the start of the corporatization, Pakistan decided that the exchanges would offer no higher than 40 percent of their shares to international investors, no less than 20 percent to the public and the remaining to qualified domestic financial institutions.
PARTNERSHIP WITH CHINA
A delegation from the Chinese-led consortium formally signed documents for the takeover of PSX with Pakistan’s Finance Minister Ishaq Dar, who said the Chinese bourses could help develop the latest technology and trading systems.
Over the past few years officials have been enacting market reforms to regain the trust of investors, including demutualising Pakistan’s bourses to weaken the influence of stockbrokers and deepen the investor base.
The acquisition marks the first time that Chinese exchanges have bought stakes in a foreign bourse. It’s envisioned that the deal will further strengthen economic and financial cooperation between China and Pakistan. The deal is also likely to boost Pakistan’s market with the introduction of Chinese capital, technology, experience and financial products.
The Pakistan Stock Exchange (PSX) sold 40 percent strategic shares on to a Chinese Consortium that made the highest bid of Rs28 per share for 320 million shares on offer. The value of the transaction is calculated to be Rs8.96 billion ($85 million).
The Chinese Consortium comprises three Chinese exchanges — China Financial Futures Exchange Company Limited (lead bidder), Shanghai Stock Exchange and Shenzhen Stock Exchange. Two local financial institutions like Pak-China Investment Company Limited and Habib Bank Limited had 5 percent each. 20 percent shares will be offered to public through IPO. This is the first such sale of strategic interest in a bourse in the regional markets. At least 17 parties had submitted expressions of interest (EoIs) at the preliminary stage. According to the sources, six bidders were in the final run, which included a consortium of Markhor and NASDEQ, but it withdrew before the closing time.
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With 40 percent of the PSX equity already vested with the 200-strong stock broker community, the remaining 20 percent would be offered in an initial public offering (IPO) to the general public. This divestment brings about an excellent partnership for development of the capital market in Pakistan. The arrival of Chinese investors will be positive step in developing economic and social development in the region. The sell-off would result in substantial liquidity generation among stock brokers that was expected to result in their higher capital sufficiency.
The 20 percent shares to be offered to the public would raise another Rs4.5 billion. According to people familiar with the affairs, the entire proceeds from the sale of shares would be distributed among the 200 stock brokers in a certain determined ratio.Most brokers and market participants were of the opinion that the sale of controlling stock was justly priced. The market participants were of the opinion that divestment would add value to and help in index trading, new product and possibly cross-border listings. The foreign investor will be anticipated to bring in large investment, experience, technological assistance and new products.
FUTURE PLANS
Pakistan’s soaring stock exchange will introduce derivatives trading from the middle of 2017. The introduction of derivatives, as well as plans for listing of infrastructure bonds, will boost liquidity in the market and lure foreign investors.
Pakistan’s economy has greatly recovered in recent years, with improving security across the country fuelling economic growth. The feeling was further encouraged by China’s plans to invest $57 billion in a network of roads, railways and energy infrastructure across Pakistan. The introduction of derivatives would help drive profits. Derivatives would bring in more liquidity in the market which is good for exchange business because trading activity generates trading fees.
The PSX stake acquisition will enhance understanding of the Belt and Road initiative among countries along the route, as financial cooperation is indispensable to the initiative. Considering the divergence in social systems, culture and language among the route’s countries, closer financial ties would clear up misunderstandings of the project.
The government would launch infrastructure bonds on the bourse to help fund huge projects and reduce delays, at the same time as allowing companies to fund capital expenditure more cheaply.
Pakistan hopes that the Chinese bourses will boost Pakistan’s small corporate debt market, which has struggled to gain purchase as Pakistani companies continue to turn to banks for loans.
The deal will stabilize and develop financial markets along the route. China could draw on the experience of its two stock connect schemes that link Hong Kong to Shanghai and Shenzhen and replicate the model to enable closer equity market ties between China and Pakistan.
The deal could change the way funds are collected across borders and lure in more capital for projects along the initiative. Infrastructure projects alone along the route are estimated to require hundreds of billions of dollars.
After Chinese capital is introduced to Pakistan’s bourse, the market will be more internationalized and capital that flows to the country will likely to benefit the local economy and enterprises.
More Chinese-funded financial institutions will enter the market, stock transactions will be boosted and the government’s stamp tax will rise. Listings and transaction cost will also multiply.
If only Pakistan’s government and large firms reap the gains, small firms will fall the prey to stock market internationalization. This is certainly not what Pakistan’s government we are looking for, and such a result would not be desirable.
Regulations, corporate governance and investors’ opinions on value differ considerably between the two markets. The countries also differ in terms of improving investors’ knowledge, allowing their stock markets to develop, achieving rational valuations and attracting professional investors.
China needs to align domestic and Pakistani investors in concept and culture while not transferring problems of the A-share market to Pakistan. Despite these challenges, Chinese investment in Pakistan’s stock market will serve as a model for financial cooperation between China and other countries.