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APPENDIX V

OUTLINE OF BADLA FINANCING

1.  On 3rd September 2004 the Securities and Exchange Commission of Pakistan, (SECP)

issued a “Time-Bound Action Plan for The Phasing-Out of carry-Over Transactions(COT)’ 1 . This action followed the notification of ‘Margin Trading Rules 2004’

(MTR) on 30th June 2004.

2.  There had been a desire, for some years, to phase out COT transactions due to

inappropriate use of the BADLA (see figure 1). BADLA is a means of financing whichexacerbates speculative activity in Pakistan’s markets. Badla financing had reached anamount of over Rs. 35 billion and the Badla rate generally ranged between 10-18%.

3.  Margin Trading Rules had been finalized in consultation with the stock exchanges aswell as the Central Depository Company and these had been discussed with State Bank 

of Pakistan, which is simultaneously provided guidelines for banks covering marginfinancing.

BADLA

“Badla” is essentially a facility for financing share purchases

extended by brokerages and banks which allows buyers toobtain highly leveraged positions in the market. A brokerage

client can delay the payment for puchases indefinitely by

paying Badla overnight finance rates via an overnight sale

and buy back mechanism. The extent of leverage through

such non-bank financing for COT is not transparent andunderlying security transactions are typically speculative. A

feature of this short term finance provision is that a large

proportion of funding comes from insurance and mutual

funds. This excentuates the risk for both investors and users

of Badla finance. In addition Badla also creates scope formarket manipulation and increases systemic risk.

INVESTOR

Badla Investor wishes to lendmoney to BUY overnightshares at a price that should

give a return about 4%-5%above short term rates

At the same time as the BUY

they execute a next daySELL contract for the same

parcel.

 

SPECULATOR

Market holder can notfund a shareholding sothey overnight SELL to a

Badla Investor at a costof carry 4%-5% above

short rates. At the same

time they execute a nextday BUY contract for the

same parcel of shares.

 

Figure 1 

4.  The phase-out of COT was designed to lessen speculative forces and encourage speculators

to use individual stock futures, where the trade is financed pre trade, via an initial andmaintenance margin. Where outright ready purchased was comtemplated this would be

satisfied by the use of margin finance.

5.  To facilitate the increase in use of futures the number of counters available for futurestrading was increased up to 30 companies. These scrips were selected on the basis of 

liquidity, market capitalization and ‘past track record’.

6.  The list of securities that may be used for margin finance is about 50 shares as opposed to29 currently that were available for COT trading.

7.  Shares purchased for clients via margin finance were not be available to brokers to loanout.

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Timetable for Phase-Out of COT

8.  The schedule for phase-out of COT/BADLA was based on the figures for total investmentin COT as at 31

stAugust, 2004. This was about Rs 20 Bn. The schedule called for the

lowest investment to be phased out first. The phase-out is shown in the following table:Weekending # Share to be withdrawn

8 October 2004 1 SEPCO

22 October 2004 2 BSBF

5 November 2004 3 PICB

19 November 2004 4 TELE

3 December 2004 5 FABL

17 December 2004 6 UNBL

31 December 2004 7 ENGRO

7 January 2005 8 WCCL

14 January 2005 9 DSFL

21 January 2005 10 PGH

28 January 2005 11 FFC

4 February 2005 12 PICIC

11 February 2005 13 SSGS

18 February 2005 14 NML

25 February 2005 15 LUCK

4 March 2005 16 SNGP11 March 2005 17 ACBL

18 March 2005 18 MCB

25 March 2005 19 MLCF

1 April 2005 20 ICI

8 April 2005 21 FFBL

15 April 2005 22 BOP

22 April 2005 23 PT C

29 April 2005 24 HUBCO

6 May 2005 25 NBP

13 May 2005 26 POL

20 May 2005 27 DGKC

27 May 2005 28 OGDC

3 June 2005 29 PSO

Table 1: Timetable for COT/BADLA Phase-out

9.  The following graph of phase-out is based on recent trading of the COT shares. Asdepicted 70% of the phase out was to happen from mid April 2005.

Phase-Out of Badla/COT Trading

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

100.00%

 0  8  /   1  0  /    0 4 -  S E P  C  O

2 2  /   1  0  /    0 4 - B  S B F 

 0  5  /   1 1  /    0 4 - P I    C B 

1  9  /   1 1  /    0 4 - T E L E 

 0  3  /   1 2  /    0 4 - F A B L 

1 7  /   1 2  /    0 4 -  U N B L 

 3 1  /   1 2  /    0 4 - E N  GR  O

 0 7  /    0 1  /    0  5 - W C  C L 

1 4  /    0 1  /    0  5 - D  S F L 

2 1  /    0 1  /    0  5 - P  GF 

2  8  /    0 1  /    0  5 - F F  C 

 0 4  /    0 2  /    0  5 - P I    C I    C 

1 1  /    0 2  /    0  5 -  S  S  G C 

1  8  /    0 2  /    0  5 - N ML 

2  5  /    0 2  /    0  5 - L  U  C K 

 0 4  /    0  3  /    0  5 -  S N  GP 

1 1  /    0  3  /    0  5 - A  C B L 

1  8  /    0  3  /    0  5 - M C B 

2  5  /    0  3  /    0  5 - ML  C F 

 0 1  /    0 4  /    0  5 - I    C I   

 0  8  /    0 4  /    0  5 - F F B L 

1  5  /    0 4  /    0  5 - B  OP 

2 2  /    0 4  /    0  5 - P T  C 

2  9  /    0 4  /    0  5 - H  U B  C 

 0  6  /    0  5  /    0  5 - N B P 

1  3  /    0  5  /    0  5 - P  OL 

2  0  /    0  5  /    0  5 - D  GK  C 

2 7  /    0  5  /    0  5 -  O GD  C 

 0  3  /    0  6  /    0  5 - P  S  O