[Pakistan] Web-based trading: Where do we stand?

["Irfan Khan" <khania@super.net.pk>]

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From:           	"Seema Javed Amin" <seema@isb.sdnpk.org>
To:             	"Econo-list" <econo-list@isb.sdnpk.org>
Copies to:      	"Comp-list" <comp-list@isb.sdnpk.org>
Date sent:      	Mon, 4 Mar 2002 17:10:32 +0500



Web-based trading: Where do we stand?
The Dawn, By Farhan Mahmood, 4/3/2002
http://www.dawn.com/2002/03/04/ebr19.htm

On April 30 last year, in an article published in Dawn, "Prospects of 
Internet-trading in Pakistan" I had challenged the idea of 
introducing web-based trading in Pakistan at that point in time given 
the state of development of the country's stockmarkets.  

This current article is a review of where things stand presently, in 
the US, Asia and Pakistan in particular, and whether the probability 
of success of introducing such a product has changed. Simply put, 
does the current "bull run" justify such a platform?  

Asia's situation: Since December 2001, Hong Kong's leading on-line 
securities brokers with both global and blue-chip local brand names 
have with shut-down their Hong Kong stock brokerage businesses, 
slashed staff or both. The majority of trading (approximately 60 per 
cent or so) in Hong Kong is still done over the phone with brokers. 
The relative dearth of inter-net use in Hong Kong is certainly true 
with stock trading. In a survey by the Hong Kong Securities and 
Futures Commission (SFC) in October 2001, only 10 per cent of 1,000 
respondents said they traded stocks on-line. The US on-line trader, 
Charles Schwab, is discontinuing its Hong Kong trading in January as 
part of an international strategy to focus on the most promising 
areas.  

Not quite different: TD Waterhouse, the second-largest discount 
brokerage firm in North America, has said that its customers averaged 
trades that were 43 per cent lower from a year earlier. With the 
investment banking business undergoing the steepest decline since the 
1970s, all major brokerages are cutting back and laying off staff.  

Take the case of Merrill Lynch. The world's largest retail brokerage 
firm is under more pressure than most to shave costs because its 
profit has grown more slowly than that of its competitors, and its 
international brokerage business is losing money. Merrill began 
reducing its staff last year, lowering total employment to a current 
level of about 66,000. But in the wake of September's attacks and 
economic retreat, the firm launched a major review of all of its 
operations in order to slash nearly US$2 billion a year from about 
$20 billion in annual expenses.  

This trend is likely to continue into the second quarter of 2002. A 
retrenchment in the brokerage industry, accompanied by firms pulling 
out of the business, is by no means unusual. One of the big 
challenges of the brokerage industry is to deal with the cyclical 
nature of the business as it goes from boom to bust, with violent 
swings in earnings and market activity.  

Merrill and HSBC have a joint venture offering of an internet-based 
trading platform. While both firms initially said they would invest 
as much as $1 billion in the new unit, the decline in trading has 
quickly dampened expansion plans. In August, plans to move into 
Germany and Japan were put on hold, and then in October about one-
quarter of the 600 British employees were let go. Most online brokers 
acknowledge that among many firms, including Merrill Lynch HSBC, are 
struggling financially at the moment because of market conditions. 
However, they feel that the long-term potential for the business 
continues to be promising. Critics have their doubts.  

American example: An individual equipped with a computer and modem 
can gain access to an astonishing array of stock price information by 
tapping into a single inter-net site via the net. Web-based or on-
line-trading allows a computer-user to buy and sell securities 
through web. The concept was first developed, tested and introduced 
in the United States where, until a few months ago, a significant 
percentage of all stock market trades took place through the 
Internet.  

In America, on-line brokering is a volume business that had matured 
during the long bull market that reached its peak in March last year. 
There were three major reasons behind the widespread use of inter-net 
in the US for trading in the stock market.  

The first was the increased level of investor education and awareness 
regarding investment options and the investment decision-making 
process. The growth of on-line brokering had been led by the 
migration of existing investors from other channels. Discount 
brokers, such as Charles Schwab and Waterhouse had several years of 
experience drumming up business, and employees' 401(K) pension plans 
encouraged individuals to manage their investments more actively.  

Secondly, the "Great Bull Run" that started in 1991 combined with the 
mania for inter-net stocks and dotcoms had created an atmosphere 
where it had become a way of life to invest in the stock market. The 
surge in technology and Internet shares in the second half of 1999 up 
to March 2000 pushed up on-line trading volumes even further. Things 
are rather grim now. "On-line trading by individuals has ground 
almost to a halt. Who wants to turn on the computer, says Richard 
Strauss at Goldman Sachs, when looking at your portfolio makes you 
feel sick?" (The Economist, October 27th, 2001)  

Lastly, the high level of inter-net penetration had resulted in cost 
savings, convenience as well as ease for existing and potential 
investors. According to estimates, 52 per cent of all American house-
holds have access to the net. Naturally, with such a high level of 
penetration, investing on-line was much easier for the investing 
public. Of course, with the recent downward trend witnessed across 
global stock markets, especially the US, things are rather different 
now.  

These factors combined with extensive economic documentation, 
effective tax system, vigilant regulation and efficient 
infrastructure have altered investor psychology and thus, the mindset 
of the average American stock market investor. Internet trading has 
brought about a clear shift in individual investor behaviour.  

Pakistan's case: In Pakistan, there are three major obstacles in the 
way of successful on-line trading. These are a low level of 
investment awareness of the individual investor, small degree of 
Internet penetration and dislike for documentation owing to the 
"phenomenon" of the underground economy. In addition, there are 
issues of technological infrastructure and bandwidth.  

The level of investor awareness regarding investment opportunities is 
very limited. There are a handful of sophisticated stock market 
investors, if any. Investors need input and advice from stockbrokers 
to make investment decisions; this is quite different from the 
proverbial "tip" that one gets from one's broker. Many individual 
investors have an acute aversion to risk, which suggests that a big 
chunk of savings is invested in fixed-income but relatively safer 
deposits.  

In the absence of direct communication with brokers, what will the 
investor base investment decisions upon? Moreover, regulation has 
failed to keep pace with change, let alone technological change. How 
will the law protect investors? Has the Securities and Exchange 
Commission of Pakistan (SECP) framed draft rules, or is it in the 
process of developing any guidelines for safeguarding the interest of 
the investor for on-line trading?  

Secondly, the low degree of Internet penetration, approximately 1.5 
million users, limits the scope of the on-line product. The profile 
of these Internet-users is unknown. An educated guess would point in 
the direction of not many among these to be market speculators or 
investors.  

A major stumbling block will be averseness to documentation in our 
society. Because the quantum of the black economy is approximately 70 
per cent of Pakistan's GDP, meaningful progress is not possible 
without accommodating it. Cash is a preferred mode of conducting 
transactions and business for many. Unlike trading off-line, i.e., 
directly through a broker via phone or personal visit, on-line 
investment will leave an audit trail of the entire trading process. 
Cheques will need to be exchanged. This will be discomforting for 
quite a few. Many investors will not be comfortable with the thought 
of disclosing their sources of wealth, which will be used to fund 
transactions, or speculate.  

Another aspect is that of regulation. Obvious concerns are regulation 
of commerce on the Internet, web-based trades and available avenues 
for re-dress for the investor. The settlement system would also need 
to be integrated with this mode of trading. America's market 
watchdog, the Securities and Exchange Commission (SEC) set up an 
"Office of Internet Enforcement" over two years ago. Examples of 
misuse include attempts to raise money for bogus companies, 
"scalping" and "pumping and dumping". However, at the same time, the 
Internet has made the SEC's job much easier, notably in tracing 
evidence due to the presence of audit trails.  

Reluctance to change: Investors change their habits very slowly, even 
when they are offered what appears to be a compelling deal. Thanks to 
the impact of technology, stock brokering seems sure to change in 
some ways. Thanks to people and their persistent habits, it is hard 
to 
predict the timing of technology's impact. With a low degree of 
investor awareness and 
Internet-penetration rate, phobia for documentation and lack of 
reliable technological 
infrastructure, the Internet-trading equation does not balance right 
now. Pakistan's stock 
market is still in its initial stages of development. Ranked by 
market capitalization, the 
Karachi Stock Exchange is the smallest of Asia's major markets while 
trading volumes are 
confined to a handful of stocks. Perhaps the introduction of on-line 
trading may be premature. 
 

One thing is certain. For inter-net trading to be successful, a 
prolonged bull-run is 
essential. Otherwise, the retail investor's interest is not 
stimulated. In August last year, 
there was a lot of euphoria about Internet Trading in Pakistan and 
its potential contribution 
to the development of the country's capital market. With all this 
hype around it, what is the 
utility of online-trading for the investor in a stock market like 
Pakistan?  

Is it really worth the investment in technological systems and 
infrastructure support in a 
country where there are other, more pressing issues, like corporate 
governance, exchange 
regulation (a faked announcement of Hubco-lenders approval in 
November last year a case in 
point), fair disclosure and accounting standards confronting the 
capital market?  

Any further delay or failure to address these outstanding issues is 
likely to stall the growth 
of the country's stock market. Once the euphoria of the current bull 
run wears out, the ground 
realities will once again resurface. For meaningful long-term 
development of Pakistan's stock 
market, these issues need to be taken care of. Or we will continue to 
lag behind among the 
emerging markets.  


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