Straight Through Processing (STP) for Improving Market Liquidity

Presentation for the 10th ACG Cross Training Seminar at Bali - Indonesia Straight Through Processing (STP) for Improving Market Liquidity By Ali Abbas Zaidi Faisal Parekh Abdul Rasool Hooda 10th ACG Cross Training Seminar

Agenda • Pakistan Economic Fundamentals & Capital Market • Central Depository Company of Pakistan Limited • Straight Through Processing (STP) for Improving Market Liquidity 10th ACG Cross Training Seminar

PAKISTANAn emerging economy……. A view of Pakistan’s miracle mile - Karachi’s Financial district 10th ACG Cross Training Seminar

Pakistan - Economic Fundamentals The Economic Turnaround Economic growth has accelerated to 7%YoY average over FY03-06 • Robust consumer spending, rising investment and accelerating exports creating sustainable growth • Emerging middle class and favorable demographics • Improved sovereign risk ratings Geopolitical challenges managed for sustained economic growth Proactive policy environment keeps challenges neutral for economic growth story. • Command structures of militant elements defused • Major gains made in Pakistan-India peace process. • Musharraf’s rule has created unprecedented domestic political stability Market at a discount due to perceived risk Attractive entry level for investors • Growing themes for investors are private equity and public equity • Portfolio investors are well placed to enter the listed equity space after an extended period of market consolidation and attractive valuations • Several structural and cyclical themes are noteworthy for investors 10th ACG Cross Training Seminar

Economic Fundamentals - Driving Market Performance Sustainable Economic Growth Generated through strong domestic demand Real GDP Growth (%) GDP Per Capita* (USD) US$ 1,000 crossed Source: Economic Survey 2004-05, 2005-06, 2006- 07 Source: Economic Survey 2004-05, 2005-06, 2006-07 * At current dollar prices • Real GDP has grown at an average 7.5% between FY04 - FY07 and remains on a sustainable and accelerated trajectory • FY07 nominal GDP is USD146.5bn with USD925 GDP/capita • Per capita income projected to cross USD1,000 in FY08 - and USD2,000 by FY14 10th ACG Cross Training Seminar

Economic Fundamentals - Driving Market Performance The Economic Turnaround Stable Exchange Rate & Healthy FX Reserves FX Reserves (US$ mn) US$/PKR Source: Economic Survey 2005-06 Source: SBP Website • Strong capital inflows stabilizing currency financing continuing trade deficit • FY07 expected current account deficit /GDP is 4.5%-5.0%. Capital account surplus/GDP may exceed though. • Significant FX reserves cushion against US$/PKR volatility 10th ACG Cross Training Seminar

Pakistan’s Equity Market Stellar performance set to continue… 10th ACG Cross Training Seminar

Pakistan – Showcasing Stock Market Currently three Stock Exchanges in Pakistan at Karachi, Lahore and Islamabad • Karachi Stock Exchange (KSE) is the main bourse with 654 listed companies as of Apr 30, 2008. • KSE started operations in 1947 but came into limelight in early 1990s due to financial sector liberalization. • KSE has 200 fixed members. Around 163 are active. Out of 200 , 173 are corporate and rest work as sole proprietor. Only 10 are listed. • Around 30 brokers have proper research department with on average 3 analysts. • Financial institutions (Mutual Funds, Commercial Banks, DFIs, etc), foreign fund managers & high net-worth individuals are main players in the market. • Process of demutualization of Karachi Stock Exchange (KSE) has began. 10th ACG Cross Training Seminar

KSE100 Index – Walking the trendlines The KSE 100 Index has witnessed a compounded annual growth rate of 34% over the past 10 years KSE 100 is a capital weighted index consisting of 100 companies representing 85% of the total market capitalization of the Exchange. 10th ACG Cross Training Seminar

Regional Market - Index Growth Comparison for 2007 10th ACG Cross Training Seminar

CDC –The only Securities Depository of the Country 10th ACG Cross Training Seminar

About Us! Central Depository Company of Pakistan Limited (CDC) was incorporated in January 1993 as an unlisted limited liability company to manage and operate the Central Depository System (CDS) and started its Live Operations in September 1997. The equity partners include all there stock exchanges and reputable commercial banks and other financial institutions 10th ACG Cross Training Seminar

About our Business • Depository Services: responsible to operate and maintain Central Depository System (CDS) • Investor Account Services: Allows retail investors to open and maintain securities accounts directly with CDC. • Trustee & Custodial Services (T&C): provide services to open end and closed end funds. Emerged as largest T&C service provider in the private sector in a short span of time. • Securities Registrar Services: carry out all statutory compliance of Issuers towards their shareholders including maintenance of statutory registers and matters relating to transfers & corporate actions under service contract 10th ACG Cross Training Seminar

CDS Account Structure Central Depository System (CDS) Issuers / Registrars Account Holders Pledgees Account Holders Participants Investor Account Services CFS Participants Main Account Main A/c Corp Investor A/c CFSH Account House Account House A/c Indv Investor A/c CFS Sub Account Sub Account Cash Account 10th ACG Cross Training Seminar

Types of Accounts in CDS CDC provides following types of accounts to facilitate custody and settlement of securities: • Main Account: This account is used as a transit account where securities moved from one account to another are routed through this account • House Account: This account is meant for keeping securities beneficially owned by the Participant • Sub-Account: Multiple Sub-Accounts are opened and maintained by the Participants to record title to securities owned by his clients commonly known as Sub-Account Holders • Investor Account: CDC provides service where retail level investors can have direct custody account with CDC for maintaining their investment portfolios 10th ACG Cross Training Seminar

About our Legal Framework • Central Depositories Companies (Establishment and Regulation) Rules, 1996 • Central Depositories Act, 1997 (XIX of 1997) • CDC Regulations • The Companies Ordinance, 1984 (XLVII of 1984) • Listing Regulations of Stock Exchanges • Zakat & Ushr Ordinance, 1980 (XVIII of 1980) • NBFC Rules and Regulations 10th ACG Cross Training Seminar

About some of our Achievements • 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 (i.e IVR & Web services) • SMS (Short messaging services) • Registrar / Transfer Agent Services 10th ACG Cross Training Seminar

Operational Highlights contd.. *as at April 30, 2008 10th ACG Cross Training Seminar

Operational Highlights *as at April 30, 2008 10th ACG Cross Training Seminar

About our future plans • 100% Dematerialization of Pakistani Capital Market • Trusteeship for REITS • Back Office Accounting Functions for Mutual Funds • Web-based Transactions • Investment Road Shows (Local & International) 10th ACG Cross Training Seminar

Straight through Processing(STP) What is STP? Straight-through Processing (“STP”) is a mechanism that automates the end-to-end processing of transactions of the financial instruments in a manner where no physical activity is involvement during the progression of a transaction. STP can be defined as electronically capturing and processing of transactions in one pass, from the point of initiation of a deal to the final settlement. STP is the name given to the automation of all processes related to the trade lifecycle of financial securities, including equities, fixed income, and derivatives. 10th ACG Cross Training Seminar

Advantages of STP • STP ensures accuracy speed & secured connectivity at all stages of the transactions using the efficient IT systems. • STP enables the entire process for capital market and payment transaction to be conducted electronically without the need for re-keying or manual intervention. • STP minimizes settlement risks as clearing & settlement occurs simultaneously. • STP also helps in reducing the systemic & operations risks to improve certainty of settlement & reduces operations costs. 10th ACG Cross Training Seminar

Type of Markets Following type of markets exists to cater various securities transactions: • Ready Market • Spot Market • Deliverable Futures Contracts Market • Continuous Funding System Market 10th ACG Cross Training Seminar

Infrastructure Institutions Following are the infrastructure institutions of the Pakistani Capital Market: • Stock Exchanges (Karachi-Lahore-Islamabad) • Clearing Company (geographically neutral) • Settling Banks • Central Depository Company (geographically neutral) 10th ACG Cross Training Seminar

Integration of Institutions Investor The market participants & institutions involved in the securities transactions are integrated in the manner to achieve STP Stock Broker Central Depository System Automated Trading System Clearing & Settlement System Settling Bank 10th ACG Cross Training Seminar

STP of Ready Market (T+2) In Pakistani capital market, STP is implemented to a great extent, however, there is still room for further improvement. Step by step activities performed during progression of a trading cycle is mention as under: • Buyers and Sellers of the securities are required to transact through intermediaries i.e. Stock Brokers or their authorized agents. Both buyers and sellers are required to open Sub-Accounts with the Stock Broker or an Investor Account directly with the Central Depository Company. • Investors are also required to possess a Unique Identification Number (UIN) issued by the Clearing Company before entering into stock trading. UIN is recorded at the time of placing of order by the Stock Broker with the Stock Exchange which is passed on to the Clearing Company. • Orders can be placed either through online trading portal (provided by some of the prominent brokerage houses) or through conventional mode of trading, e.g. via telephone calls, personal visit, text messaging (using cell phones) or emails to the Stock Brokers or their authorized agents. • In case of online trading, orders placed by the clients are received and stored in the online trading portal of the Stock Broker and directly transmitted to the automated trading system of the Stock Exchange, hence, no manual intervention is required for execution of trade orders. contd.. 10th ACG Cross Training Seminar

STP of Ready Market (T+2) • Once trade is executed, the online system automatically sends the confirmation to the client, provided that the order was a ‘market price order’ where no limit of price was quoted by the client. In case of a ‘limit order’, client is informed after trade is executed upon matching price is fetched. In this case client has to contact the Broker/agent for a confirmation. Most of the broker provides timely SMS facility to ensure execution of trade. • All outstanding trades are settled through an automated Clearing Company where trade feeds are automatically transmitted from the trading systems of Stock Exchanges to the Clearing System of Clearing Company. • Upon receipt of trade feeds, Clearing System prepares balance order after netting all trades showing net delivery obligation of the Selling Broker. Such balance order report is prepared and transmitted by the Clearing Company through the automated feature, which reflects on the screen of Stock Broker on the Settlement Date. • On or before the Settlement Date, the Selling Broker manuallyplaces the securities in his Main Account from his House Account / Sub-Account (client account). Such securities are automatically picked by the Clearing System of the Clearing Company and delivered to the Buying Broker in blocked form. This activity can also be done anytime prior to settlement date using Future-Dated Intra-Account Delivery. contd.. 10th ACG Cross Training Seminar

STP of Ready Market (T+2) • Simultaneously, the Settling Bank, after confirming as to the availability of sufficient funds in Buying Broker’s bank account manuallymarks (by ticking the online report reflected on its screen) the report, which results in automatic unblocking of securities delivered in the Main Account of the Buying Broker. • Once securities are unblocked as a consequence of action performed by the Settling Bank, the Buying Broker manually moves the securities from his Main Account to his House Account or, as the case may be, the respective Sub-Accounts of his clients. With this, the trading and settlement completes. • In case of delivery default on the part of the Selling Broker on the Settlement Date, the Clearing System initiates the default proceedings as per their rules and regulations and squares-up the trade. • In case of money default, the Clearing System, on the electronic instruction of the Settling Bank, retrieves the securities delivered in to the Main Account of the Buying Broker in blocked form into its retrieval account for further processing as per procedures. • Institutions are required to become an Account Holder of and an Associate Clearing Member of Clearing Company. contd.. 10th ACG Cross Training Seminar

STP of Ready Market (T+2) • In case of an institutional trading, the only change is that the risk management is done directly with such institution, whereby at the time of trading, the Stock Broker specifies that trading is done on behalf of an institution. Based on such information, the trade feed send by the Stock Exchange to the Clearing Company are tagged specifying the details of such institution. The Clearing Company then obtains affirmation from such institution and securities are then directly delivered to such institution subject to payment. The whole process is done without any manual intervention. • As per this STP model, there are manual interventions at three stages as mentioned above 10th ACG Cross Training Seminar

STP of Deliverable Future Market Contracts In the deliverable futures contract, the settlement is made after 30 days (every Friday of last week of the month), the securities are traded in the forward market and after the script is live on ready market the securities are settled accordingly. However, marked to market profit/loss is calculated on daily basis. 10th ACG Cross Training Seminar

STP of Continuous Funding System Market • In this market, the settlement cycle is 22 business days. Securities purchased by an investor are delivered to the authorized financier. Upon payment along with agreed mark-up, such securities are delivered to the investor or the investor may sale the said securities in the ready market resulting in the closure of CFS contract. • In case the investor is interested in extending financing period, it can be rolled over after the expiry of 22nd business day for another 22 business days. • However, any corporate action accrued during the intervening period are automatically passed on the respective investor. 10th ACG Cross Training Seminar

Flow of Settlement of Trade (T+2) ACTIVITIES Buying Investor BuyingBroker SellingBroker Selling Investor Stock Exchange Trade Execution on Automated Trading System Trade Execution on Automated Trading System Automated Trading System daily generates a report at close of trading hours of executed trades which is sent to the Clearing House each trading day Automated Trading System daily generates a report at close of trading hours of executed trades which is sent to the Clearing House each trading day Clearing Company(Netting of trades) Manual Intervention by moving securities from Main A/c to client account after settlement Manual Intervention by moving securities from Client Account to Main A/c for settlement purpose Receiving & Payment Orders Receiving & Payment Orders Delivering & Payment Orders Securities delivered Buying Broker Selling Broker (Securities in CDS in book-entry form) Clearing Company Securities delivery Securities delivery Funds payment Funds payment Issue Cheques / notify of receipt Issue Cheques / notify of receipt Release Payment Release Payment Manual Intervention by manually marking the securities confirming the availability of sufficient balance Buying Investor Selling Investor Settling Bank 10th ACG Cross Training Seminar

STP Development - A Look Ahead… • As per the current system design, all securities are routed through the Main Account while delivering one account to another. Due to such setup, true STP is not achieved. • In order to bring in more efficiency and transparency in the securities transactions, it would be appropriate to change the present model such that securities are directly transferred from one account to another. • Such model would greatly facilitate settlement of securities where UIN would play major role in identifying the buyer and seller. The system would have all the information regarding buyer and seller, based on which securities would be collected from the seller’s account and directly delivered to the buyer’s account without any manual intervention. 10th ACG Cross Training Seminar

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Straight Through Processing (STP) for Improving Market Liquidity