SECP Applies New Regulations on Securities Brokers

The Securities and Exchange Commission of Pakistan (SECP) has approved amendments to the Securities Brokers (Licensing and Operations) Regulations 2016. The amendments were finalized in light of comprehensive consultations with all stakeholders in a bid to minimize custody risks and safeguard the investors.

The amended regulations introduce the categorization of securities brokers with enhanced measures for investor protection through safe custody of their assets, improved governance standards in the brokerage industry, transparency and risk management.

This move will help address repeated broker custody defaults that the market had witnessed in the past, which shattered investor confidence and market integrity. The regulations also catalyze migration to an effective risk-based compliance culture and a shift from the traditional way of regulating brokers alike resulting in over-regulating smaller brokers.

A concept paper proposing to introduce the new broker regime, based on global benchmarks, was first released in April 2019. Taking into consideration valid suggestions of the stakeholders a revised concept note was issued for public consultation in November 2019. This was followed by more meetings with the stakeholders in November and December of 2019. Subsequently, the draft regulations were made public for consultation on January 10, 2020.

Presently, contrary to global benchmarks, all brokerage houses retain custody of investor assets and are subject to the same compliance requirements regardless of their size or capacity thus making it difficult for many brokers to comply with the law and ensure adequate investor protection.

The SECP has reduced the minimum net worth requirement for the Trading & Self-Clearing (TSC) brokers from Rs. 150 million to Rs. 75 million under the plan to provide maximum facilitation to market participants.

Classifications of Securities Brokers

Brokers will now be categorized according to their net worth and governance requirements into three categories, namely:

• Trading & Clearing broker (T&C)
• Trading & Self-Clearing (TSC)
• Trading Only (TO).

T&C and TSC categories shall be permitted to retain custody of client assets whereas TO broker will only have custody of its proprietary book, directors and sponsors and their close relatives. TO will, therefore, operate with significantly reduced compliance requirements. The net worth requirement for TO brokers has also been reduced from Rs. 35 million to Rs. 15 million.

As compared to most regional and global markets, Pakistan’s capital market has a very narrow investor base. One of the reasons is that insufficiently capitalized brokers have lacked the capacity to spread their branch network. These weak brokers also lack internal controls, compliance procedures, and infrastructure and governance standards.

This was evidenced particularly when implementing AML/FATF requirements which require intermediaries to have comprehensive protocols to curtail money laundering and terrorism financing risks. The new broker regime is expected to bridge the regulatory compliance gap while increasing the commercial viability of the brokerage industry.

As a result of an in-depth consultation and considering practical suggestions of the stakeholders’ community, the SECP significantly revised the regulations in the following areas:

1. The minimum net worth requirement for TSC broker has been reduced from Rs. 150 million to Rs. 75 million.
2. Requirement on TSC broker to comply with the Code of Corporate Governance for listed companies (Code) has been removed.
3. Requirement on TSC broker to appoint at least two independent directors has been relaxed with at least one only.
4. Requirement on TSC broker for the minimum qualification of Chief Financial Officer and Head of Internal Audit has been removed.
5. Requirement on TSC broker to constitute the audit committee has been relaxed and more simplified provisions will be specified by SECP.
6. TSC broker has been given the flexibility to appoint an auditor either from category A or B of SBP panel.
7. The regime shall be implemented once at least three T&C brokers or PCM is available;
8. T&C brokers shall be required to submit an expression of interest which shall include feasibility study, system and human resource requirements, operational and risk management model, legal documentation requirements, an arrangement to ensure confidentiality of trading and customer-related information of TO brokers and proposed fee structure.
9. TO broker has been allowed to keep custody of proprietary assets and assets of its sponsors and directors and their close relatives;
10. To safeguard the interests of TO broker, a restriction has been placed on the T&C broker from soliciting any customer of TO broker for two years;
11. Restriction on TO broker relating to the opening of new customer accounts has been removed.

The notified regulations now provide maximum facilitation to market participants while ensuring enhanced investor protection and ease of doing business. To ensure no disruption to the market and a seamless transition the timeline for implementation of the new regime has been extended by three months from July 1, 2020, to October 01, 2020.