BONDS AUTOMATED TRADING SYSTEM

(BATS)

REPORT OF REVIEW COMMITTEE CONSTITUTED BY THE SECURITIES AND

EXCHANGE COMMISSION OF PAKISTAN

TABLE OF CONTENTS

Preface.

Executive Summary

A review of existing corporate debt market ..

Review of BATS model and comparison with international practices

Review of risk management system

17

Review of pricing methodology

19

Unlisted TFCs ..

20

Roadmap

21

Annexure A

22

Annexure B

25

PREFACE
The Securities and Exchange Commission of Pakistan (SECP), in consultation with the relevant
stakeholders constituted a committee comprising of representatives from SECP, Karachi Stock
Exchange, National Clearing Company of Pakistan Limited, Mutual Fund Association of Pakistan
(MUFAP), Financial Markets Association of Pakistan (FMA) and Brokers to review Bond Automated
Trading System (BATS) as per the following term of reference:
1. Determine reasons for poor market reception of BATS and identify genuine practical problems
and shortcomings in existing regulatory and operational framework which needs to be
addressed to make BATS more acceptable for the debt market participants.
2. In light of the above, analyze modifications, if any, required in the BATS model and the
regulatory framework;
3. Review the existing risk management regime applicable for trading in the debt market
securities in line with international best practices best suited to our local capital market
needed to address any practical hindrances.
4. Determine suitable methodology for pricing of TFCs on BATS in light of current pricing
methodologies for TFCs and issues faced therein.
Members of the Committee are as follows:

1. Mr. Shamshad Nabi, CEO

Mutual Funds Association of Pakistan

2. Mr. Yasir Qadir, Director and Chairman

Board Committee for pricing and trading of
debt securities

Mutual Funds Association of Pakistan

3. Sani-e-Mehmood
Khan,
GMMarket
Development and New Product

Karachi Stock Exchange

4. Mr. Muhammad Lukman, CEO

National Clearing Company of Pakistan Ltd.

5. Mr. Muhammad Ismail Usuf, Assistant

Secretary

Financial Markets Association of Pakistan

6. Mr. Adnan Qaseem, SVP, Head of Fixed

Income and Corporate Treasury

BMA Capital

7. Mr. Mateenullah Khan, Joint Director

Securities
Pakistan

and

Exchange

Commission

of

8. Mr. Asif Iqbal, Joint Director

Securities
Pakistan

and

Exchange

Commission

of

9. Mr. Waseem Khan, Joint Director

Securities
Pakistan

and

Exchange

Commission

of

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EXECUTIVE SUMMARY
The Committee deliberated the situation of poor market reception for BATS with a view to identify
practical problems and shortcomings in existing regulatory and operational framework. Committee
followed a two step process whereby:

i)

the existing model was compared with international best practices to identify gaps and
anomalies; and

ii)

the practical problems and shortcomings were identified in the operational and regulatory
structure which could hamper the active participation of market participants

The results of research encompassing practices adopted by major jurisdictions are covered in detail in
section 2 and a snapshot is also provided in Annexure A of the report. The research reflected that
internationally the OTC markets are allowed and account for the major trading volumes in the
corporate debt market. Furthermore, the exchanges around the world offer automated undisclosed
systems parallel to features that facilitate negotiated dealings and reporting of the same. It was
observed that there is more focus on establishing a centralized reporting platform to ensure effective
price discovery and transparency in the market.

Committee feels that while the off-market trades act as an impediment to active participation on the
BATS, at the same time the small number of listed TFCs and the low level of liquidity implies that the
negotiated deals cannot be completely eradicated. For the success of an undisclosed-automated
order matching system, the liquidity and the availability of bid/offer with sufficient depth is essential.

The above factors call for first introducing a hybrid model with automated order matching and
facilitation for negotiated deals both available on the system and ensuring the reporting of all trades at
one platform. The next step should focus on allowing the negotiated dealing only for bulk deals,
whereas for regular trades the automated system should be used to encourage participation from all
segments and should be accompanied by appropriate market awareness efforts.

On the basis of above findings the Committee recommends that migration from the current OTC
based market to an exchange based model should be achieved in a phased manner to ensure a
smooth transition and prevent adverse impact on the market. Accordingly, as a first step, the offmarket transactions should be discontinued. Simultaneously, the BATS model should be equipped
with certain features to facilitate negotiation between market participants in a transparent manner.
These include the option to quote All/none orders, the Request for Quote feature, the option to
disclose the member ID and the indicative quotes. These recommendations are discussed in more

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detail in Chapter 2. Committee also recommends effective surveillance mechanism to capture the
manipulative trades executed between counter parties with a view to affect the net asset values of
mutual funds.

The review of operational and regulatory structure identified following areas requiring improvements:

1.

The risk management system (RMS) is recommended to be revamped. The margins are
recommended to be decreased considering the liquidity needs of the market. In the event
of default, a close out process is recommended to be followed with cash margins serving
as penalty and the defaulting party to be blacklisted.

2.

The Circuit Breakers are recommended to be removed to enable efficient price discovery
and prevent disruption in trading.

3.

Pricing methodology for BATS is proposed to be changed with a 30 day look-back period
and monetary thresholds of Rs. 15 million for issue sizes upto Rs. 1 billion and Rs. 25
million for issue sizes of more than 1 billion for selecting transactions that can affect a
change in the closing price to avoid manipulative trades. The proposed methodology is
provided in section 4 of the report

4.

Certain improvements are identified in the BATS interface, which are enlisted in Annexure
B of the report.

5.

Currently only a handful of TFCs are listed on more than one exchange which prevents
active participation by investors through BATS in TFCs which are listed at different
exchanges. Exchanges are requested to grant waiver in listing fees and share listing
information to facilitate cross-listing of TFCs across all exchanges.

6.

For unlisted TFCs, the reporting of all transactions to exchanges must be made
mandatory. This information must be disseminated to market through BATS. Restrictions
in this regard should be imposed in the CDC and all settlements must be made through
NCCPL. Committee also recommends that an incentive package should be provided by
exchanges to those unlisted TFCs that meet the eligibility criteria for listing by waiving/
relaxing the listing fee and providing for a speedy mechanism for listing.

Committee also feels that the above recommendations should form the phase 1 of a long term
roadmap for the development of debt market and the Committee should re-convene after six months
to review the results and recommend future course of action in line with a vision to provide the market
with an efficient and transparent trading platform which enables equal participation from all segments
of investors. The next review should focus on introducing a VaR based RMS, prescribing thresholds

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above which the negotiated deal features would be allowed with a view to gradually move towards a
completely automated model and encourage participation from the retail segment, reviewing the
pricing mechanism in the light of trading information, suggesting the appropriate levels for the circuit
breakers and reviewing the reporting of trades in unlisted TFCs in accordance with its
recommendations and suggest improvements.

Committee also recommends that extensive efforts should be undertaken by exchanges and NCCPL
to create market awareness regarding BATS through presentations and workshops. The committee
observed that active participation of MUFAP members, banks and money market dealers is the key
for development of a well-functioning corporate debt market in Pakistan and requests all stakeholders
including money market association, PBA, members of all three exchanges and MUFAP to play their
due role in bringing Corporate and retail investors on BATS. The Committee noted that both
intermediaries classes eligible for trading of Government and Corporate Debt Securities need to
adhere and understand the principle of coexistence, cognizant of international practices best suited to
us and reciprocate the positive steps to introduce and open the pool liquidity to each other in the best
interest of an emerging economy which has a long way to go.
Committee also recommends active coordination between SECP and SBP to ensure consistencies in
policies and achieve a symmetrical approach for the development of debt market in Pakistan.

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1.

A Review of Existing Corporate Debt Market

1.1

The Corporate Debt market in Pakistan consists primarily of Term Finance Certificates
(TFCs), Commercial papers and Sukuks which represent Sharia compliant mode of raising
finance in the corporate debt market. Till date, the market is pre-dominated by TFCs which
contribute for more than 53% of the total corporate debt outstanding. As per the statistics as
on June 30, 2011, there are total

90 TFCs in issue with a total outstanding amount of

Rs.160.257 billion, whereas the total number of Sukuk in issue is 53 with a total outstanding
amount of Rs.138.720 billion. Following is the summary of corporate debt market:
No of TFCs
Number
Amount outstanding
(Rs. in billion)

Listed TFCs
40
69.087

140.0

140.0

120.0

120.0

100.0

100.0

80.0
60.0
40.0

1.2

CP
3% ListedTFC
24%
PPSukuk
49%

40.0

0.0

0.0

CPs

AmountRaisedthroughDebt
Instruments
(Dec31,2010)

60.0

20.0

Sukuk

Total
143
298.977

80.0

20.0

ListedTFCs PPTFCs

Sukuk
53
138.720

AmountOutstandingasonJune
30,2010

R s. in B illio n s

R s . in B illio n s

AmountRaisedtillJune30,
2010
160.0

Non-listed TFCs
50
91.170

ListedTFCs PPTFCs

PPSukuk

PPTFC
24%

CPs

The corporate debt market in Pakistan, particularly the listed TFC market, has failed to follow
the progress made by the equity segment and remains under-developed.

1.3

The details of exchange-wise listed TFCs are given in the table below:

Number of listed TFCs

Outstanding Value in Billion (as at 30 June 2010)
1.4

KSE
24
48.124

LSE
13
16.233

ISE
3
4.730

Unlisted
50
91.17

With regards to the secondary market of listed TFCS, Stock exchanges used to offer the
same trading platform which was available for the equity segment. As a result the secondary
market for TFC remained fairly illiquid and trading of listed and unlisted TFCs have always
been carried out at Over the Counter (OTC) market as a result of direct negotiation between
buyers and sellers and through brokers. The investor base of both listed and unlisted TFCs
primarily consist of Commercial Banks, DFIs, mutual funds, employee benefit funds,
insurance companies and other institutions with a very low participation from the retail sector.

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1.5

The transactions by the mutual funds in both listed and unlisted TFCs are reported to the
Mutual Funds Association of Pakistan (MUFAP) which also carries out the pricing of TFCs in
accordance with the requirements prescribed by the SECP vide its circulars. However, there
is no central platform for reporting of transactions outside the mutual fund industry.

1.6

The absence of an active trading platform and the unavailability of complete trading information
at one central portal have resulted in inefficiencies in the price discoveries of listed TFCs and
created misbalances in the market since although the mutual funds follow the pricing calculated
by MUFAP, other market participants do not have a transparent pricing medium. It is worth noting
that commercial banks use the prices quoted on the exchanges for calculating fair values of their
investments in listed TFCs and the quoted price or the trade price whichever is lower is used for
this purpose. No Mark-to-Market calculations are performed by banks for unlisted TFCs. As
evident, currently the prices quoted on exchanges do not represent the correct market value of
listed TFCs.

1.8

Introduction of BATS:
As a result of coordination between MUFAP, KSE, CDC and prominent market participants, in
2009 a separate trading platform developed specifically for trading of debt securities was
introduced by KSE with the name of Bond Automated Trading System (BATS) which aimed to
provide a trading interface suited to the needs of debt market participants with appropriate risk
management and pricing mechanisms and sought to remove the anomalies present in the
previous model. Despite the introduction of BATS, the major volumes of trading persisted to be
carried out at OTC or off-market. Following is a summary of the trading details of TFCs since the
inception of BATS in November 2009 to January 2011:

1.9

Category

Number of trades

Volume traded

Listed TFCs
BATS 1
Listed
TFCS-off
2
market
Unlisted TFCs 3

51

145,864

Value of trades
(Rs. in million)
672.503

597

3,820,481

17,661.5

263

1,255,658

5,948.1

Off-market transactions:
The BATS Regulations which were approved by SECP in September 2009 prohibited the
negotiated deals or off-market transactions carried out outside BATS. However, exemption is
being granted by SECP form this restriction for last one year, thereby allowing the off-market
transactions in the listed TFCs. Simultaneously SECP also made it mandatory to report all
transactions in listed TFCS executed outside BATS to the stock exchanges and restrictions were

Data as per KSE

Data as per MUFAP-trades reported by mutual funds
3
Data as per MUFAP-trades reported by mutual funds
2

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imposed in Central Depository System (CDS) upon transfers of listed TFCs which did not meet
the above condition. Subsequently, the reporting system of KSE was improved which now
provides the facility of real time reporting of off-market trades as compared to the previously
applicable system of reporting at the day end. Hence, the first stage of debt market development
is completed which represents development of a centralized reporting platform for all trades in
the listed debt instruments.

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2.

REVIEW OF BATS MODEL AND COMPARISION WITH

INETRNATIONAL PRACTICES

2.1

International Practices and Local Perspective

In order to determine the reasons for poor market reception of BATS, as a first step it was
considered necessary to compare the existing model with the international practices to
identify the gaps and areas for improvements. The Committee analyzed the models and
methods pursued by various jurisdictions including India, Thailand, Malaysia and many other
jurisdictions (Annexure A) while making recommendations.
The key findings of the analysis are as follows:

2.1.1

Hybrid structure
Majority of jurisdictions offer an exchange based model with undisclosed trading and
automatic order matching mechanism. However, OTC is also allowed in almost all
countries. It was also noted that in all jurisdictions, negotiated dealing is facilitated by
the exchanges in a variety of modes. For example, at Madrid Stock Exchange
(Spain), trading is conducted through an electronic trading system on anonymous
basis. Nevertheless, an option of bilateral netting is also made available which
enables communication of previously agreed trades which are disseminated and are
settled through the same systems as the rest of the transactions. Similarly, in the
Stock Exchange of Thailand (SET) two systems are offered to the investors namely
the Put through system (PTS) and the Automatic Order Matching system (AOM).
The PTS records and disseminates approved transactions negotiated privately by
members without relying on a price mechanism of the exchange, whereas under the
AOM method, brokers can key-in buy or sell orders directly from their offices to the
trading system of the SET then the orders are automatically arranged and matched
according to price and time priority principles. Once matching is done, confirmation is
sent simultaneously to the brokers terminals. In Bursa Malaysia, transactions in debt
securities can be carried out through three types of functions namely Order
Matching, Trade Negotiation and Trade Reporting. These features provide an
automated undisclosed interface together with the options for direct negotiation and
reporting of trades between identified counter parties.

2.1.2

Reporting of OTC Trades

Majority of jurisdictions are resigned to the fact that the bulk of trading volumes in the
bond market are carried out at OTC or on negotiated deal basis and efforts are more
concentrated towards establishing a centralized reporting platform which ensures that
all trades in debt securities are reported and disclosed to the market participants.
Examples of India and USA are most relevant in this regard. In USA, the NASD
launched the Trade Reporting and Compliance Engine (TRACE) system for reporting
and dissemination of last sale information on corporate bonds on July 1, 2002.
TRACE is a system that facilitates the mandatory reporting of OTC market

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transactions in eligible fixed income securities. NASD rules require dealers to report
trades on all eligible U.S. corporate bonds to the NASD on real time basis. TRACE
disseminates transaction information to the public on investment grade, high yield
and convertible corporate debt together know as TRACE eligible securities
representing all OTC market activity in these bonds. Liquidity of a corporate bond is
not a factor in deciding whether a transaction is reported to TRACE. In India, both
BSE and NSE have developed reporting platforms over which all trades in the debt
securities are reported. As mentioned above, the Bursa Malaysia also provides the
facility of reporting of off-market trades to the exchange.

2.1.3

Participation from the Retail Sector:

It is also interesting to note that in majority of countries, the trading in government
securities is carried out at the exchanges which have participation from the retail
segment. In India the Retail Debt Segment is being offered for trading of government
securities at exchanges. This implies that for successful trading of securities,
participation from general investors and a wide investor base is a pre-requisite. On
the contrary, corporate bonds are traditionally traded in large denominations among
institutions and the high net worth individuals, necessitating an OTC market or a
market segment with facilitation for negotiated deals.

2.1.4

KSEs Experience:
While reviewing international practices, the KSE experience in 1997 of KATS launch
was also considered, which faced similar challenges resulting in the negotiated deal
system to run parallel to KATS for about a year.
A thorough review of other jurisdictions revealed that Indian, Thailand, and Malaysian
models contained various commonalities and are therefore, briefly discussed in this
section, whereas a comparative matrix capturing a snapshot of market practices is
enclosed as annexure A to this report.

2.2

Case Studies
2.2.1

India
The regulator of the capital markets Securities and Exchange Board of India (SEBI)
- has adopted a phased approach for development of debt market and for
establishment of a trading platform with acceptance from all market segments.
The efforts for promoting trading of debt securities in India date back to 2003 when
SEBI released the basic norms for the development of Debt Market. SEBI also
formulated a committee to deliberate on the development of corporate debt market of
India, which suggested that in order to develop this market; a trading platform was
required that would cater specifically to the institutional buyers and sellers, as
globally, this market has been functioning as an OTC market.

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In December 2006, SEBI introduced the first phase of creation of a unified trading
platform by launching a

system to capture all information related to trading in

corporate bonds as accurately and as close to execution as possible through an

authorized reporting platform. BSE was initially mandated to provide a corporate
bond reporting platform. All issuers, intermediaries and contracting parties were
granted access to the reporting platform for reporting of trades. The non-members of
the exchange were also granted access through Virtual Private Network (VPN). All
transactions in corporate bonds of the value of Rs. 100,000 or more were required to
be reported on this platform within 30 minutes of the closing of the deal. The
information on settlement was to be reported within 1 trading day from completion of
settlement. Subsequently in March 2007, NSE was also instructed to launch a similar
reporting platform.
In April 2007, the second phase was introduced and both BSE and NSE were
permitted to have in place corporate bond trading platforms to enable efficient price
discovery and reliable clearing and settlement in a gradual manner. To begin with, the
trade matching platform was to be order driven with essential features of OTC
market. Eventually, a system of anonymous order matching was to be established. All
trades on the exchanges were to be carried out through the registered stock brokers.
Participants were also provided with the options of undertaking OTC trades which
were to be reported to the exchanges. Initially the parties were provided the option of
bilateral settlement. Subsequently, the settlement of trades between specified
institutions was made mandatory through the Indian Clearing Corporation Limited.
Today trading in corporate debt securities is carried out at the Whole Sale Debt
Segment (WDM). The trades on the WDM segment can be executed in the
Continuous or Negotiated market.
In the continuous market, orders entered by the trading members are matched by the
trading system. For each order entering the trading system, the system scans for a
probable match in the order books. On finding a match, a trade takes place.
In the negotiated market deals are negotiated outside the exchange between the two
counter parties and are reported on the trading system for disclosure to the market.
Trades in the WDM segment are directly between the participants on the Delivery Vs
Payment basis (DVP), who take exposure to the settlement risks attached to any
unknown counter party. For every trade, it is necessary to specify the number of
settlement days and the trade type. On the scheduled settlement date, the Exchange
provides data/information to the respective member/participant regarding trades to be
settled on that day with details like security, counter party and consideration. The
Exchange closely monitors the settlement of transactions through the reporting of
settlement details by members and participants.

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For trading in continuous market, every participant can set up counter party exposure
limits to ensure that all his trades are within the exposure limits set up for the
respective counter party. This provision enables the participants to minimize the
counter party risk associated with any counter party.
In the negotiated market, since the buyers and sellers are identified, no counter party
exposure limits need to be invoked.
However, despite repeated efforts by SEBI, NSE and BSE, anonymous automated
order matching system for the debt market could not gain momentum primarily
because the debt market players are not comfortable with an order matching system
where they do not know the counterparty to the trade. SEBI understands the market
sentiments and has therefore been cautious in aggressively pursuing shifting of
corporate debt trading market to anonymous trading system.

2.2.2 Thailand
The Bond Electronic Exchange (BEX) is a subsidiary of Stock Exchange of Thailand
(SET) and was established in 2003 to support Thailands secondary bond market. It
provides trading platform for government and corporate issues for both wholesale and
retail segments. Prior to BEX, bonds were traded in the OTC market, which was
mainly the institutional investors arena. Small investors were unable to get into that
particular market due to its size and its ambiguity or simply the lack of information.
Currently only publicly listed companies bonds are allowed to trade on BEX, nonlisted companies will soon be able to have their bonds traded on the exchange as
well.
Automatic Order Matching (AOM)
Investors can place orders through BEX member firms or through brokerage
companies who in turn, enter the order into BEXs trading platform. Orders follow are
prioritized based on price then the time the order is received. If the bid or offer price
and volume match, the orders are done automatically.
Put Through (PT)
When the trading value crosses over 10,000 units, which is equivalent roughly to 10
million Baht, an alternative method provided by BEX called Put Through must be
selected. The counterparties can negotiate off the exchange. Once the deal is
concluded, the seller can initiate the put through transaction, which then needs to be
verified by the buyer. Once the confirmation process is completed, the buyer will
allow that transaction to go to the next process of clearing and settlement.

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2.2.3

Malaysia
Bursa Malaysia introduced the Electronic Trading Platform (ETP) in 2008 for the
Malaysian bond market. This new platform was introduced to boost transparency and
liquidity as well as increase efficiency in bond trading.
ETP was developed and customized based on the Korea Exchange's bond trading
system and allows dealers to match bids with offers, negotiate deals and access
historical data through a common computerized network. ETP offers investors a realtime price quotation and facilitates the trading and reporting of all secondary market
activities.
Member Participants can carry out transaction through 3 types of functions, namely:
a. Order Matching
Order matching refers to the matching of identical orders placed by the buyer
and seller into the pool that will automatically match the order in the pool
according to the matching mechanism with a set of predefined matching
principles. Once matched, an acknowledgement will automatically be sent to
both parties.

b.

Trade Negotiation
It is a process whereby the trader advertises the quotes to selected participants.
The respective parties may respond to the quotes advertised and negotiate
electronically with the initiator to reach a favorable and agreeable price/volume.

c. Trade Reporting
A function to report any trade concluded between buyer and seller that has been
trade outside the system. The system shall allow the parties involved in off
market trades to report all transactions immediately regardless whether one or
both of the parties to the transaction is a member participant, whether for own or
clients account.

2.3

Conclusion:
The above analysis lead the Committee to conclude that in order to promote the debt market
and provide market participants with an efficient trading platform, a hybrid structure will be
required which provides an automated order-driven trading interface together with the
flexibility embedded to facilitate the negotiation between market participants. However, it was
also observed that as long as the off-market transactions are continued to be permitted by
SECP, market participants will not prefer to actively participate on the BATS due to inherent

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ease of trading on OTC market and the lack of transparency which facilitates the transactions
between identified parties with specific motive to manipulate the prices.

While agreeing to the need of discontinuing the off-market trades, the Committee also
concludes that the transition from OTC to a purely exchange based undisclosed automated
system should be accomplished in a phased manner and a complete switch to the
anonymous trading will be a significant deviation from the international practices.
Consequently Committee feels that the BATS model should be equipped with features that
also facilitate the negotiation between counter parties in light of small number of market
participants and the existing low level of liquidity in order to provide impedes to the developing
market. It is noted with satisfaction that reporting of all trades carried out in the listed TFCs
has already been made mandatory and the second phase of market development should
focus on restricting the off-market trades by discontinuing the relaxation being granted by
SECP, at the same time revamping the BATS model to provide the required degree of
flexibility. Following are the recommendations in this regard:

2.3.1

All or None Option

It is recommended to add a new order type in BATS called All or None which shall be
used by sellers to fill the order completely or not at all. If there is insufficient supply to
meet the quantity requested by the order then it is canceled at the close of the market.
This feature is being added considering the dynamics of debt market where the buyers
and sellers prefer to trade in pre-defined lots and the fear of partial execution of orders
can hamper the active participation in the market. Although the option of All or None
orders is currently available for buyers, similar option may be provide for sellers so that
partial orders cannot be executed.

2.3.2

Request For Quotation (RFQ)

Request for Quotation is recommended whereby an interested party can ask for quotes
from the market or selected participants. This feature will facilitate the system based
negotiation between the parties and assist in efficient price discovery.

2.3.3

Indicative quotes
Considering the existing small number of market participants and low level of liquidity, it
is recommended that market participants should be able to provide indicative quotes
which will encourage the online negotiation without the fear of having committed oneself
to an inefficient price. The role of market maker has importance in debt market and this
functionality will equally fulfill the needs of market maker.

2.3.4

Disclosed Trading
The committee recommends buyer and seller member codes should be displayed on the
TWS on optional basis to facilitate the negotiations between the parties considering the

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revised risk management regime which places greater emphasis on the counter party
risk as discussed below.

2.4

Review of BATS model

Committee also reviewed the existing BATS model and aimed to identify the practical issues
which can hinder the active participation from the market. Following improvements are
suggested:

2.4.1

Circuit Breakers:
Price Discovery is the key element for the development of secondary market, which gets
impeded by Circuit Breakers (CBs). Yet, they protect clearing-house, investors and
intermediaries from large defaults caused by extreme market movements and provide
time-outs to the market when they get overheated and investors are unlikely to act
rationally.
Committee debated in detail the current level of circuit breakers which restrict the
maximum price movement in a TFC to Rs.5. It was observed that that the current
MUFAP prices are not indicative of true market value in all cases and therefore do not
provide an adequate basis for opening prices on which CBs can be levied. In this regard,
the practice adopted for the equity segment was also discussed in detail whereby no
CBs are imposed on the first day of trading in order to facilitate the price discovery. It
was noted that due to illiquid nature of the debt market, extended period will have to be
allowed for price discovery. It was also noted that due to the low level of liquidity, the
price of TFCs can fluctuate beyond the corridors of CBs. It was also noted that the
current system will update the price on the basis of weighted average of bid and offers
after three days which may prevent market participants, specially mutual funds, from
taking timely exit and meeting their liquidity demands.
One of the key reasons for imposing the CBs is the risk management system (RMS)
which requires CBs in order to ensure the sufficiency of collaterals collected by the
clearing company. Since the Committee has proposed a revised RMS regime which will
close out the deal in case of default and will use the margins as a penalty, it is felt that at
the initial stage, the system should operate without CBs in order to facilitate efficient
price discovery and prevent any adverse impact on the market participants.

2.4.2

Enhancing BATS trading interface

The committee revisited the BATS interface and noted some shortcomings, which are
annexed as Annexure B; the exchanges are requested to make the said changes in their
BATS interfaces, in order to make BATS interface in line with practices and terms
applicable and suited to debt market.

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2.4.3

CVT Anomaly
Currently 0.02% Capital Value Tax (CVT) is still charged on purchase of TFC along
with 0.01% Withholding Tax (WHT) whereas CVT has been waived on equity segment
through Finance Act 2010 and only federal excise duty is applicable on trades of equity
segment. This double taxation discourages investors from investing in TFC. The
committee recommends abolishing CVT on TFC.

2.4.4

Cross Listing
One of the problems associated with the trading of TFCs on BATS is the fact that
TFCs are not listed on all exchanges. As a result, investors of one city face difficulties
in trading through BATS in a TFC which is listed in a different city. It is observed that
if off-market transactions are completely restricted, only those brokers which have
dual membership of more than one exchange will be able to trade in TFCs listed at
different exchanges. To resolve this issue, it is imperative that innovative solutions
are provided to enable the listing of TFCs across all exchanges. It must be noted that
the issuers of existing TFCs have already completed the capital raising process and
therefore have no incentive in getting listed on different exchanges. Exchanges
therefore need to come forward and facilitate cross-listing by providing relaxations in
the listing fees and sharing the documents submitted by the issuer.

Currently 1/20th of 1% is the usual annual listing fee charged by the exchanges.
Exchanges are requested to devise mechanisms and procedures as such that once
listed with one Exchange, the TFC is deemed listed at all exchanges and the listing fee
are divided amongst all the three exchange. The committee requests that such practice
may be adopted for at least five years or till such time deemed appropriate by the all
exchanges.

2.4.5

Market Maker
Clause XIII of Chapter IV- 12 of SECP guidelines for TFC state that In order to make
the TFCs more liquid, the issuers are encouraged to appoint a Market Maker. The
Market Maker shall give the offer and bid prices of TFCs daily in the secondary market.
A market maker may be a Brokerage House or an Investment Bank.

The committee observed that since launch of BATS, no official market maker has been
designated. Therefore the committee recommends all exchanges to enforce issuers to
appointment at least one market maker amongst brokers for each listed TFC.

Report on Review of BATS

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2.4.6

Availability of BATS with all NBCMS

Trades can only be entered into BATS through brokers of the exchanges. In order to
provide institutions with direct access to the market, it is recommended that BATS
terminals should be provided by the brokers to the Non-Broker Clearing Members
(NBCMs) of the exchanges and trades executed from these terminals should be autoinitiated for IDS transactions. NCCPL should coordinate with the exchanges and
NBCMS in this regard.

2.4.7

Market awareness
Committee noted that one of the key issues underlying the performance of BATS is the
level of market awareness particularly form the banking industry. It is recommended that
extensive efforts should be concentrated in this area by exchanges and NCCPL by
holding presentation and workshops to explain the modalities and features of BATS to
the market participants. It is also recommended that effective reference material is
developed and made available with all brokers to facilitate and educate general investors
regarding the TFC market.

Report on Review of BATS

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3.

REVIEW OF RISK MANAGEMENT

3.1

Currently a slab based margining regime is applicable on BATS with normal default
management procedures which largely rely on the selling/ purchasing of the underlying
security in the event of default through square up market and allocation of losses to all market
participants in case the collaterals are not sufficient. It is noted that the low level of liquidity in
the market and the absence of VaR figures can lead to large losses. There is also the general
misconception regarding the NCCPLs role which does not act as a central counter party or
the guarantor of every trade and only acts as a facilitation agent. It is also noted that large
margin percentages will hamper the trading activities due to liquidity constraints. Taking these
factors into account, considering the practical example of India where the settlement are
based on counter party risk, the Committee recommends that the RMS of BATS should be
revamped in the following manner with a view to facilitate the market development process:

The margin slabs should be changed in the following manner:

3.1.1

Existing:

Description

Exposure Margin

Par Premium
Margin

TFC (having minimum credit

rating of A) > par premium

2.5% of the
Exposure amount

50% amount of the

excess market
value

TFC (having minimum short

term credit rating of A) < par
(discount)

2.5% of the
Exposure amount

25% of the amount

of discount with par
value

TFC (having minimum short

term credit rating below of A)
> par premium

5% of the Exposure
amount

100% amount of the

excess market
value

TFC (having minimum short

term credit rating below of A)
< par (discount)

5% of the Exposure
amount

25% of the amount

of discount with par
value

Report on Review of BATS

Total Margin
2.5% of the
Exposure amount
+ 50% amount of
the excess
market value
2.5% of the
Exposure
amount+25% of
the amount of
discount with par
value
5% of the
Exposure amount
+ 100% amount
of the excess
market value
5% of the
Exposure
amount+25% of
the amount of
discount with par
value

Page 17 of 27

3.1.2

Proposed margin slabs:

Issue size
Upto Rs.1 billion
Between Rs.1 billion and Rs.3 billion
Above Rs. 3 billion

Margin %
1%
1.5%
2%

The margins are recommended to be strictly in cash. In future, when stock exchanges
have developed the valuation methodology for T-bills, the same may accepted as
collateral. The option of pre-settlement delivery is also recommended which will
enable a seller to deposit the underlying shares with the NCCPL before the
settlement date and all margin requirements shall be waived.

3.1.3

Close out process

On the occurrence of a failure by a Debt Market Clearing Member (DMCM) to fulfill
his settlement obligation, the Closed-out process shall be initiated by NCCPL on
Counter-Party basis as follows:

In case of default by buyer DMCM i.e. failure in payment of its money obligation,
such trade shall be closed-out at the trade price and the delivered TFCs shall be
returned to the seller DMCM along with the margins so collected from the
defaulted buyer DMCM at the time of trade.

In case of default by seller DMCM i.e. failure in its delivery obligation, such trade
shall also be closed-out at the trade price and paid amount shall be returned to
the buyer DMCM along with the margins so collected from the defaulted seller
DMCM at the time of trade.

3.1.4

Blacklisting
It is recommended that any defaulting investor should be suspended from the debt
market for a period of six months. In case of multiple defaults from a same broker, the
broker must also be suspended for a period of six months.

Report on Review of BATS

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4.

REVIEW OF CURRENT PRICING METHODOLOGY

4.1

The committee reviewed in detail the existing pricing methodology which stipulates that:
For Debt Market, the closing price shall mean the volume weighted average price of the
trades during whole day. In case of no trading in that particular security for three continuous
Business Days, then, in such case, the closing price shall be updated on the basis of bid and
offer mechanism whereby Bid/Offer must be better than last traded price and satisfy the
following conditions:
(i) Bid/Offer is available for trade at the time of closure of the market.
(ii) Bid/Offer remains un-changed during this time
For the purpose of above, the volume weighted average of bid and offer of last three days on
which the bid and offer are available shall be considered
The Committee discussed that due to low level of liquidity and frequency of trades, the above
policy is not appropriate and system must have a reasonable look-back period for calculating the
closing price. Furthermore, there must be a threshold for selecting the transactions that can
affect the closing price in order to prevent the manipulation of prices on the basis of small
transactions.

4.2

Recommendations
The Committee recommends Pricing of listed TFCs based on the following rules:

If the issue size of TFC is below Rs. 1 Billion, then the maximum cut-off threshold
considered for price calculation shall be Rs. 15 million

If the issue size of TFC is above Rs. 1 Billion, then the maximum cut-off threshold
considered for price calculation shall be Rs. 25 million

The volume weighted average price of the trades during last thirty days shall be
considered for each TFC within the above thresholds.

In case of no trading in that particular TFC or trades below the above mentioned
thresholds during last 30 days, the last reported trade price or the weighted average
of offers made by sellers, whichever is lower, shall be considered for calculating the
price. Provided that only those offers with a minimum volume of Rs.10 million shall be
considered for this purpose.

The system should clearly identify whether the closing price is calculated on the basis
of weighted average of trades or is reflecting the last reported trade.

Committee also recommends that there must be an effective mechanism for surveillance of debt market
trades by Exchanges and SECP in order to detect any manipulative trades which have been carried out
with a view to inflate or decrease the price. Currently the debt market is infected with such trades which
are effected between parties for an agreed period of time and are subsequently reversed with an
objective to affect the net asset value of mutual funds. It is recommended that such trades should be
identified on a prompt basis, investigated and excluded form the calculation of closing price.

Report on Review of BATS

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5.

UNLISTED TFCS

5.1

A major portion of the corporate debt is constituted by unlisted TFCs which are currently traded
at OTC market or off-market as a result of direct negotiation between the parties. In order to
ensure efficient price discovery and transparency, it is important that a centralized platform is
provided for trading or reporting of trades carried out in such securities. While the most easy
solution appears to recommend the mandatory listing or technical listing of all these TFCs, it is
noted that there are several considerations underlying such approach. Many of the unlisted TFCs
are represented by re-structured loans. Further, as per the current legal framework, listing of any
security of a company grants that company status of a listed entity. It must be appreciated that
there are many privileges and responsibilities associated with this status such as corporate
governance, increased public disclosures and tax advantages/ consequences. Accordingly, care
is required while providing the listing status to any company especially in case of privately placed
TFCs of small sizes. Committee has noted with satisfaction that KSE has already launched a
platform which facilitates listing by providing a much simplified process and trading is limited to
Qualified Institutional Buyers in that platform.

5.2

Many stock exchanges around the world provide trading facilities for unlisted debt securities
also. However, the requirements of section 8 of the Securities and Exchange Ordinance,
1969 prohibits the trading of any unlisted security at the exchanges.

5.3

In view of the above, it is recommended that reporting of trades of unlisted TFCs to stock
exchanges should be made mandatory on a real time basis. Such trades should be disseminated
to market on the BATS alongside the trades of listed TFCs with appropriate identification.

5.4

Restrictions should be imposed upon the transfers of unlisted TFCs in the CDS and only those
transfers should be allowed which are represented by trades reported to stock exchanges.
Another useful option would be the mandatory settlement of unlisted TFCs through the NCCPL.
If that option is exercised, the reporting of trades to stock exchanges will also be facilitated since
the reporting function can be performed by NCCPL. It is felt that complete reporting of all trades
in unlisted TFCs at a centralized platform will lead to more efficient price discovery.

5.5

In addition to above, the Committee recommends that for unlisted TFCs that meet the eligibility
criteria for listing on normal counter or the OTC counter, an incentive scheme should be
launched by the stock exchanges by providing waivers/ relaxation in the listing fees and
providing a speedy process to encourage listing of such instruments. Committee also
recommends that exchanges and SECP should conduct a thorough review of the listing process
with an aim to curtail the unnecessary formalities or documentations and reduce the timeframe
for the listing process.

Report on Review of BATS

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6.

ROADMAP

6.1

In order to ensure the development of debt market, it is essential that a long term road map is
developed which is augmented by appropriate policies and milestones. Committee therefore
recommends that a review is conducted after six months with following milestones:

The features for negotiated deals should be reviewed and if considered appropriate,
monetary thresholds should be defined above which negotiated trades would be
allowed. For trades below such thresholds, the automated order matching system
must be used.

The RMS must be reviewed with a view to introduce a VaR based model or any
another model based on international best practices and applying a robust margining
regime

The appropriate level of circuit breakers should be decided

The pricing methodology should be reviewed and suggestion be provided for

improvements

The reporting of trades in unlisted TFCs should be reviewed and recommendations

should be provided for improvements

Report on Review of BATS

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ANNEXURE A
International Bond Markets Jurisdictions
Country

Trading Venue
OTC Market

Earliest year of
Operation
1980s

Execution
Methodology
Bilateral

Australia

Australian Stock Exchange

1999

Brazil

Yield Broker
BovespaFix(Sao Paulo Stock
Exchange)

2001
2001

Cross Matching
Order Driven
Bilateral
Cross Matching
Order Driven

Canada

CETIP(OTC market)
Inter- dealer Bond
Brokers(4IDBs)

1986
1975

ATS (3 systems)

2001

OTC market

France

Italy

Japan

Electronic

Dealers
Dealer to Dealer

Electronic
Electronic or by Phone

Dealers
Dealer to Dealer

By Phone
Electronic or by Phone

(i) Cross-matching
Dealer -to Institution
(ii) Request for Quote Institution-to-institution
dealers acting as
Retail Investors Can access
liquidity
One system indirectly
through dealers
providers
(iii) Order-driven,
anonymous trading

Electronic

Bilateral
Principal market

Dealers
Institutional investors
Retail investors

By phone
Fax
Electronic (dealer
systems)

1987 (first trades

of corporate bonds
on the exchange)

Cross-matching
Continuous auction
market

Participating organizations
(dealers)
Institutions and retail
investors access the
exchange
indirectly through dealers

Electronic access to
the
exchange
Orders may be called
in to the
dealer

Euronext

1990
(first year of
electronic bond
trading)

Cross-matching
Auto-matching
Order-driven

Exchange members

Electronic

Bilateral

Dealers
Institutions

Electronic or by phone

Order-driven

Exchange participants

Floor trading and

electronic

Bilateral

Dealer-to-dealer

By phone

Frankfurt Stock
Exchange

Frankfurter
Wertpapierbrse:
1585; Deutsche
Brse AG
(operator holding):
1993

OTC market
Hong Kong

Dealer
Institutions
ASX Broker Participants

Electronic or by
phone
Electronic by Phone

Toronto Stock
Exchange

OTC market

Germany

Bilateral
Bilateral
Order- Driven

Direct Participants

Stock Exchange of
Hong Kong

1986

Cross-matching
Auto-matching
Order-driven

Dealers (exchange
participants)

Electronic

Bloomberg

1999

Multi--dealer auction

Dealer-to-dealer

Electronic

Italian Stock
Exchange

1994

Cross-matching
Order-driven

Dealer-to-dealer
Retain investors can access
indirectly through dealers

Electronic

MITS

1988

Quote-driven

Dealer-to-dealer
Retain investors can access
indirectly through dealers

Electronic

TLX

2003

Cross-matching
Order-driven

Dealer-to-dealer
Retain investors can access
indirectly through dealers

Electronic

ATS

Cross-matching
Multi-dealer
Order-driven

Dealer-to-dealer
Retail investors can access
indirectly through dealers

Electronic

OTC Market

Bilateral

Dealers

By phone

Auction

Authorized intermediaries

Electronic

Stock Exchanges

Report on Review of BATS

1966

Page 22 of 27

Malaysia

Mexico

Singapore

OTC market
ATS(2

1948

Bilateral
Multi-dealer

Dealer-to-client
Multi-dealer

Electronic or by phone

OTC market

1989

Bilateral

Dealers

Electronic and By
phone

Kuala Lumpur
Stock Exchange
(KLSE)

1989

Order-driven

Exchange members

Electronic

BMV(3) (Mexican
Stock Exchange)

1975

Cross-matching
Order-driven

Dealer-to-dealer

Electronic

Brokers

1998

Dealer-to-dealer

Electronic or by phone

Singapore
Exchange
Securities Trading
Limited (SGX-ST)

1998

Cross matching
Order-driven

Dealer-to- Dealer
Institutions and retail
investors access the
exchange
indirectly through dealers

Electronic

Bilateral

Dealers
Institutional investors
Retail investors

Electronic or by phone

Dealer-to-client
Dealer-to-dealer

By phone

OTC market

Spain

AIAF market

1991

Bilateral

Madrid Stock
Exchange

1993

Cross-matching
Order-driven

Electronic

1993

Bilateral

Electronic

1996

Cross-matching
Auto-matching,
Order-driven but also
offer
order books such as
bilateral trade
matching

Switzerland

Swiss Exchange

United
Kingdom

London Stock
Exchange

Market maker

Exchange members

Electronic or by phone

ATS

i) Multi-dealer
ii) Order-driven

Dealers, fund manager and

other investment firms

Electronic
Electronic

OTC Market

Bilateral

Dealer-to-institution
Dealer-to-dealer

Electronic or by phone

Dealers
Institutions

Electronic

United States

Multi-dealer
alternative trading
systems (2
systems)

1999

Inter-dealer broker
alternative trading
systems (2
systems)

2000

Order-driven

Dealer-to-dealer
Dealer-to- institutions

By phone

Single dealer
trading system

1999

Automated limit order

book

Dealers
Institutions

Electronic

Alternative trading
systems (3
systems)

2000

Cross-matching

Dealer-to-institution
Retail and institutions
through
dealers

Electronic

Auction
alternative trading
system

2000

One-sided
Bids-wanted

Dealers
Institutions

Electronic

New York Stock

Exchanges
Automated Bond System
System

1977

Cross-matching
Order-driven

NYSE members

Electronic

In order to study the corporate debt market of other jurisdictions, the committee studied over a
dozen different markets ranging from underdeveloped, developing and developed markets

Report on Review of BATS

Page 23 of 27

from Asia/Asia-Pacific, Europe, and North-America etc. The Debt Market Development
process in various markets has been a very old phenomena dating back to as long as from
mid-1970s. Amongst the markets studied by the committee, fourteen markets had Order
Driven systems and a dozen had bilateral system. The market participants in around ten
markets were Dealer to Dealer, three had Dealer to Client access and around four had Dealer
to Institutions linkage. Four markets had retail investors access to Exchange, nine had
Electronic and Phone based order matching system, a dozen Exchanges have Electronic and
about half a dozen had Phone based system.

Report on Review of BATS

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ANNEXURE B

Report on Review of BATS

Page 25 of 27

DEAL TICKET
Deal Ticket requires adding of price entry mechanism input as to obtain yield when price is entered.
Current Value should be named as unredeemed value.
Benchmark rate is to be termed as Current Coupon Rate.
Coupon rate should be named as Base Rate.
Total Amount should be named as Purchased Value.
In calculating Accrued Interest the number of days convention is taken as 365 days currently.

Report on Review of BATS

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YIELD CALCULATOR
Rate to IRR should be changed with price to yield.
IRR to rate should be changed to yield to price.
6 Month KIBOR should be used for the 6 Month TFC and for 3 month TFC 3 month KIBOR should
be used.

Report on Review of BATS

Page 27 of 27