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KARACHI STOCK EXCHANGE ROLE OF CAPITAL MARKET IN ECONOMIC DEVELOPMENT A Presentation by: by: Nadeem Naqvi Managing Director Karachi Stock Exchange October 01, 2014 www.kse.com.pk Why the Capital Market – Background (I) Bulk of commercial bank deposits are for less than one-year maturity As a result, they can engage in only a limited amount of maturity transformation, i.e. borrow short-term and lend long-term In era gone by, long-term financing for industry used to come from public sector development finance institutions (DFI’s) such as NDFC, PICIC, IDBP, Bankers Equity who received long term funding from multi-lateral agencies and lent long term to industry Poor governance & losses led to closure of these DFI’s Despite their operating weakness these DFI’s did play an important role in the industrial development of Pakistan from 1960’s to early 1980’s KARACHI STOCK E XCHANGE 01 Why the Capital Market – Background (II) It was hoped that a new set of DFI’s could fill the void, so we had government-to-government joint venture Investment Companies such as Pak-Kuwait Investment Company, Saudi-Pak, Pak-Brunei, Pak-Iran, PakChina, Pak-Oman Unfortunately, with a few exceptions, the JV Investment Companies did not fill the void of providing significant long term project finance Globally also, infrastructure and long-term finance has moved from national DFI’s to capital markets in the last two decades In Pakistan, absence of a liquid private sector debt market has meant that there are limited sources available for both the public & private sectors to access long term capital needed for sustainable economic growth KARACHI STOCK E XCHANGE 02 Role of the Capital Market in Pakistan Despite the above noted limitations, Pakistan’s Capital Market has played an important role in enabling the public and private sectors to access long term funding In the last 10 years, the total amount of equity capital and debt raised has been nearly PkR 1,000billion Out of this, over PkR 170billion was raised by the Government of Pakistan via privatization through public offerings If the debt capital market is seriously developed there is no reason why an enormous amount of savings (both domestic and international) can not be tapped for infrastructure and industrial development by the public and private sectors KARACHI STOCK E XCHANGE 03 Capital Market & Economic Growth Linked Development of Capital Market has been found to be closely linked to the stage of economic development CATEGORY FRONTIER ECONOMIES TRANSITIONAL ECONOMIES PER CAPITA GDP Less than US$ 2000 US$ 2,000 to US$ 8,000 EXAMPLES (2011) Financial Markets Development • Nigeria - $1,500 • Increasing monetization of economy • Vietnam - $1,400 • Growing demand for financial services & products • Egypt - $2,780 • When GDP per capita reaches $2,000 30% of population typically has bank accounts • Indonesia - $3,500 • Colombia - $7,100 • Unofficial economy shrinks as SME’s need greater financing from the formal sector • Role of capital market grows • S. Africa - $ 8,070 EMERGING MIDDLE INCOME ECONOMIES Source: E&Y US$ 8,000 to US$ 20,000 • Malaysia - $ 9,980 • Pension Funds / Insurance Companies become important institutional investors • Mexico - $ 10,050 • Consumer credit gross • Turkey - $ 10,520 • Businesses become larger needing greater amount of long term funding from capital markets. Debt market becomes increasingly important KARACHI STOCK E XCHANGE 04 Pakistan Stock Market Performance KSE-100 Index increased by 20% from Jan-April 2014. KSE100 Index constitutes about 80% of total market capitalization KSE-100 Index increased by 49% in CY2012 and 49% in CY2013 Pakistan market has been top five best performing stock markets in the world for last three years Market Capitalization in US$ terms has reached US$71billion Despite the above, Market Cap/GDP Ratio is just only 30% at present compared to 46% in April 2008, the previous market peak KARACHI STOCK E XCHANGE 05 KSE-100 Index: Scaling New Heights 32,000 Mkt Cap/GDP = 46% Mkt Cap/GDP = 27% 30,000 28,000 26,000 24,000 22,000 Previous High Index Apr 18, 2008 15,676 20,000 18,000 16,000 14,000 Market Floor Oct 9, 2008 12,000 9,181 All Time High Index Jul 24, 2014 30,475 10,000 Market Low Jan 26, 2009 8,000 6,000 25-Sep-14 16-Jun-14 05-Feb-14 27-Sep-13 19-May-13 08-Jan-13 30-Aug-12 21-Apr-12 12-Dec-11 03-Aug-11 25-Mar-11 14-Nov-10 06-Jul-10 17-Oct-09 08-Jun-09 28-Jan-09 19-Sep-08 11-May-08 01-Jan-08 25-Feb-10 4,815 4,000 KARACHI STOCK E XCHANGE 06 Major World Indices Performance (July 2013 to June 2014) 45.0% 41.2% 40.0% 35.0% 31.4% 31.0% 30.0% 25.0% 20.2% 12.1% 11.7% 11.5% 10.0% 6.2% 5.9% 5.0% China Philippines Malaysia Hong Kong MSCI EM Brazil Vietnam India Pakistan 0.0% MSCI FM 3.5% 2.3% 1.2% Indonesia 15.0% Thailand 20.0% KARACHI STOCK E XCHANGE 07 Historical Asset Class Returns in Pakistan *10-Year average annual return for asset classes Ban k D epo sits 4.5% Govt. T-B il ls 10.6% Govt. PI Bs 11.3% Defen ce Savi ng s C erts 11.0% Gol d KSE-100 In dex 12.7% 26.1% *CY2004 - CY2013 KARACHI STOCK E XCHANGE 08 Foreign Portfolio Investment has driven Market Foreign Portfolio Investment inflow was US$676mn during FY14 vs. US$569mn FY13 Average Daily Value Traded was PkR9.4bn between Jan to June 2014 while for whole of 2013 it was PkR7.6bn and in 2012 it was PkR4.7bn In 2008 the estimated leveraged position in the market was between PkR70bn and PkR80bn. At present, within Margin Trading System the leverage is around PkR5.0bn while it is estimated that leveraging via banking system is around PkR10bn KARACHI STOCK E XCHANGE 09 Foreign Portfolio Investment Net Flows (US$ mn) 400 341 350 300 233 250 200 150 92 100 65 50 81 70 36 16 (46) (48) (100) 4QFY14 3QFY14 4QFY13 3QFY13 2QFY13 1QFY13 4QFY12 3QFY12 2QFY12 1QFY12 (150) 2QFY14 -94 (111) 1QFY14 (50) KARACHI STOCK E XCHANGE 10 Market Capitalization to GDP Ratio 50.0% 46.3% 45.0% 40.0% 36.7% 35.0% 36.9% 31.8% 30.0% 27.0% 25.2% 23.0% 25.0% 20.0% 16.7% 18.5% 18.2% 17.0% 15.0% 10.0% FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 KARACHI STOCK E XCHANGE 11 Percentage of Companies Paying Dividend 45% 44% 44% 43% 42% 42% 41% 40% 39% 39% 2010 2011 39% 38% 37% 36% 2012 2013 KARACHI STOCK E XCHANGE 12 Current Dynamics of KSE KSE was Demutualized on August 23, 2012 and turned into a company limited by shares with an equity base of nearly $80 million The Board of Directors of KSE now has 6 public interest directors nominated by the SECP including the Chairman, 4 representatives of previous members of the Exchange and the MD Within 24 months of Demutualization 40% stake with management control has to be sold to strategic investor, 40% will be retained by exmembers/now shareholders and 20% will be offer to the general public via IPO and the shares of the Exchange will be listed on itself Strategic investor can only be a (i) stock exchange; (ii) derivatives exchange; (iii) commodities exchange; (iv) depository company, with 10 years’ experience, US$200million capital & high reputation KARACHI STOCK E XCHANGE 13 Demutualization ushers in a new Era Segregation of Commercial and Regulatory Functions of the Exchange has led to formation of the Regulatory Affairs Committee (RAC) of the Board composed of only SECP nominated directors to minimize conflict of interest and have a strong compliance and governance eco-system RAC oversees the Regulatory Affairs Department (RAD) which is headed by the Chief Regulatory Officer, reporting directly to the Chairman of RAC Deutsche Bank has been appointed as the financial advisor to explore and identify strategic investor to purchase upto 40% equity stake with management control in KSE KARACHI STOCK E XCHANGE 14 Separation of Regulatory & Commercial Functions As per the Demutualization Act 2012, KSE’s organization structure has been segregated into separate regulatory and commercial functions to avoid any conflict of interest KSE’s POST DEMUTUALIZATION ORGANIZATION STRUCTURE BOARD OF DIRECTORS (4 independent directors) Regulatory Affairs Committee (6 independent directors, 4 broker directors) Other Board Committees Chief Regulatory Officer Managing Director Regulatory Affairs Department Commercial Functions Listed Securities Wing Brokers & Investors Affairs Compliance & Enforcement Wing Operations & I.T. Marketing & Product Development Finance, Admin. & Legal KARACHI STOCK E XCHANGE 15 Risk Management INVESTOR PROTECTION Brokers quality & capability Strong financial penalty & personal accountability Preemptive risk management regime Power to the Investors Investor Protection Fund SYSTEMIC RISK MITIGATION Market Liquidity Robust margining regime Trade settlement guarantee Clearing House Protection Fund KARACHI STOCK E XCHANGE 16 Strengthened Regulatory Regime post 2008 Crisis Strong risk management system & State-of-the-art technology platform Seamless electronic integration of Trading (KSE), Clearing & Settlement (National Clearing Co.) and Custody (Central Depository Co.) Fit & Proper Criteria for brokers; KYC & Anti Money Laundering guidelines implemented Universal Identification Number (UIN) for every investor & autotagging of CDC sub-account with the UIN and KSE’s KATS code for investor protection Rs 800+ million paid from Investor Protection Fund of KSE to investors affected by 2008 financial crisis, with 50% of claims fully settled KARACHI STOCK E XCHANGE 17 PAKISTAN MACRO PERSPECTIVE Macro Highlights CORPORATE EARNINGS Listed non financial companies’ sales growth has averaged 17% p.a. over last four years; after tax earnings have grown by 25% p.a. and ROE has ranged from 19-22% during this period. ECONOMY (DOMESTIC) Economy has shown recovery from the 2008 global financial shock with real GDP growth rising to 4.1% in FY13-14 and expected to reach 4.5% in FY14-15 ECONOMY (EXTERNAL) C/A deficit was contained at 1% due to remittances by overseas Pakistanis(US$15.8bn in 2014) & Bilateral & Multilateral Hours FOREIGN DEBT Foreign Debt as % of GDP declined from nearly 31.5% in 2009 to 24% in 2014. Pakistan was able to raise US$2.0billion Eurobonds after nearly 10 years KARACHI STOCK E XCHANGE 19 PAKISTAN: Large domestic demand base Total consumption is 68% of GDP Private Sector Consumption is 75% of Total Consumption Between 2009-2013, consumer spending grew @25% p.a. versus about 10% for Asia* This was driven by (i) substantial rise in rural incomes due to high global food prices & govt. support to agriculture; and (ii) sharp rise in remittances sent back by overseas Pakistanis Consumer companies were main beneficiaries, with listed consumer sector earnings rising by over 22% p.a. between 2009 and 2013 and expected to grow by 18% in 2014 *Source: Euromonitor International KARACHI STOCK E XCHANGE 20 Pakistan’s Resource Profile 25th largest economy in the world 7th largest labour force 50% of 180 million population below the age of 25 4th largest milk producer 4th largest sugarcane producer 4th largest rice exporter 5th largest copper resources 6th largest coal resources KARACHI STOCK E XCHANGE 21 Actual Economy larger than official numbers Official GDP (FY13-14) = US$250billion → Per Capita = $1,368 HOWEVER, The undocumented economy is estimated at 50% or more of Official Thus, EFFECTIVE GDP = US$375billion → Per Capita = $2,055 Top 20% of households have estimated annual income of $8000-10,000 This represents around 30 million strong middle class By 2020, this population segments’ annual income should be $12000-15,000 and effective GDP should be OVER $500billion KARACHI STOCK E XCHANGE 22 Mind MAP for Pakistan’s Industrialization ENERGY SELF-SUFFICIENCY & IMPORT SUBSTITUTION BASIC INDUSTRIES INFRASTRUCTURE AGRICULTURE AGRI VALUE ADDED PRODUCTS TRADITIONAL INDUSTRIES RESTRUCTURING COAL OFFSHORE & SHALE OIL & GAS COAL BASED LIQUIDS REFINERY PETROCHEMICAL COMPLEX POWER COPPER & MINERALS ALTERNATIVE ENERGY COPPER COPPER SMELTING STEEL STEEL FABRICATION ROADS RAILWAY PORTS MAJOR CROPS YIELD INCREASE DAIRY CORPORTE FARMING FRUITS & HORTICULTURES FISHERIES VALUE ADDED MILK VALUE ADDED HYGIENIC VEGETABLE & FRUIT PRODUCTS MEAT & FISH PRODUCTS INDUSTRY EXPORT INCENTIVES INSTRUMENTATION REJUVINATING SIALKOT INDUSTRIES CARPETS & COTTAGE INDUSTRY EXPORTS TEXTILES INTEGRATED MANUFACTURING & ELECTRICAL COMPONENTS KARACHI STOCK E XCHANGE 23 Industrialization will need large long-term funding How will critical infrastructure and industry creation by financed? Both domestic and global savings have to be tapped for this purpose Multilateral / supra national financial institutions will need to play a major role in raising long term finance for infrastructure & industrial projects (eg. IFC offshore Rupee Bonds) The funding mechanism will have to be different from the past New mechanism will need to be centered around capital market as the primary clearing house for supply & demand of long-term capital KARACHI STOCK E XCHANGE 24 Key Hurdle in Involving Private Investors in Devl. Projects In many cases external economic benefits for the society / citizens as a whole may not translate into near-term and easily quantifiable economic benefit for private sector investors, eg: i. Congestion removing signal free urban road by passes ii. Farm-to-market roads iii. Water-purification schemes iv. Environment protection projects (mangrove swamp rehabilitation to safeguard coastline, reforestation, etc.) v. Alternative energy projects providing long-term environment sustainability but requiring short term subsidies through incentivized tariff structures, tax-incentives to suppliers & investors KARACHI STOCK E XCHANGE 25 Sources of long-term debt There are several tried and tested sources of long-term debt: Infrastructure bonds with underlying assets as primary collateral Local currency global bonds with Supranational (eg. IFC) credit rating Diaspora bonds with special incentives for overseas Pakistanis Provincial / Municipal revenue bonds with special tax exemptions and steady cash flow stream Global infrastructure securities had market capitalization of US$1.1trillion at the end of 2012 It is estimated that demand for infrastructure funding in emerging markets will be US$1.0trillion ANNUALLY until 2030 with Asia accounting for 50% KARACHI STOCK E XCHANGE 26 Capital Suppliers’ Perspective Infrastructure bonds are of particular interest to suppliers of long term capital (global pension funds, insurance comps.) because: 1. Such bonds enable creation of long term underlying assets essential to support economic growth 2. Infrastructure generally generates steady cash flows and above average yields 3. Infrastructure projects have limited competition and usually high barriers to entry 4. Although initially capital intensive, infrastructure assets have modest operational expense and therefore have high operating margins that support debt servicing 5. Presence of underlying assets means that possibility of Shariah Compliance financing options are also available KARACHI STOCK E XCHANGE 27 THANK YOU Serving Investors & Industry Stock Exchange Building, Stock Exchange Road, Karachi-74000, Pakistan. Tel: 111-001-122 Website: www.kse.com.pk