In March, 2005, #KSE100 dropped ~30% in a matter of two weeks. There were allegations of gross manipulation by brokers, and a taskforce constituted to probe the matter discovered many manipulative practices, some still relevant today, which I thought I would detail here in a🧵 
2/ KSE100 went from 10,500 on 16th march to 7,500 on 16th April, 2005. Media,and protestors infront of KSE office,started demanding inquiry into the huge and sudden drop. Under public pressure,SECP set up a Taskforce on 12-04-2005 to investigate the developments in #StockMarket.
3/ Context was that KSE100 had experienced a steady bull run from 2002 to 2004. This was because interest rates had come down from 13% to 7%; there was increased liquidity due to higher remittances; corporate performance was improving;
4/ huge leverage was easily available to participants in from of badla/COT financing; and profitable PSEs were being divested with much public interest and participation. However, at start of 2005, these positive influences were starting to wane. SBP was raising policy rate;
5/ remittances were leveling off; badla financing was being phased out; yet from January to 15th March, 2005, KSE100 shot up. It increased by 65% from 6,218 on December 31, 2004 to 10,303 on March 15, 2005. For reference, KSE100 has traded in a range of only 20% for a year.
6/ With the sharp climb, value traded in a day was in a range of Rs.50-100 billion.(for reference, last Friday, traded value was only 17.8 billion. Even as inflation and devaluation has chipped away rupee value, traded value is not comparable even in nominal terms).
7/ during the climb,media was hyping up stock market. Gov. officials were linking the rise to good economic management. (@AribaShahid wasn't available to warn that stock market is not accurate indicator of the economy). Gov. announced accelerated privatization of profitable PSEs.
8/There were also wild rumors about new oil and gas finds which would raise OGDC stock's value manifold (tried & tested formula, still happens every 6 months). KSE100 at the time was full market cap. weighted index, and in jan, 2005, OGDC's weight in KSE100 was 20%.
9/ OGDC's price went from Rs.74.95 on December 31, 2004 to Rs.189.75 by March 15, 2005 (153% increase in a quarter). by the end, OGDC was contributing 33% weight to KSE100, and was solely determining rise & fall of index.
10/ Traded volume of OGDC in the month till 15th march was averaging at 150 million per day. (for reference, average daily volume for the whole index KSE100 for last two weeks is only 130 million).
11/ In this climate, brokers/mutual funds/asset mngmt/insurance companies/anyone with liquidity had money raining on them. Given the frenzy, futures would trade at premium upto 40% to ready market. Arbitrage (buy in ready, sell in futures,pocket premium) was extremely lucrative
12/ Brokers gave huge leverage in futures to their clients, (at some points, requiring only 10% initial margin-1to10 leverage; my man Bill Hwang got smoked on 1-5 leverage, I think). So, there was no shortage of futures buyers despite the ungodly premiums.
13/ Apart from futures, there was leverage in badla market (Carry-over Trades/COT), (This has now been replaced by Margin Finance System (MFS)).
14/ In badla, a client A could buy, say Rs.100 worth of stocks based on deposit of Rs.30. Broker would buy Rs100 worth of stocks, where the rest of Rs.70 would come from badla financier (which could be brokers themselves/asset mngmt companies/insurance companies).
15/ these badla shares would be held separately in CDC in the name of badla financier, and come settlement day in 60 days, these shares would be transferred to client A on deposit of Rs.70 as well as badla premium (capped at 18% of badla money).
16/ As badla financing would mostly be rolled over to next duration instead of settlement, it resembled more like Total Return Swap instruments. Badla/COT differed with today's Margin Finance System, as it was scrip specific; financiers chose which scrip they would finance
17/ whereas MFS is applicable to all MFS eligible securites (eligibility is determined based on Value-at-Risk (VAR) models). There was also difference between how badla and MFS securities were held.
18/ So brokers/instutions were making money in arbitrage because of big premiums in futures market. They were also earning interest in badla financing (Badla rates were capped at 18% in KSE, but in uncapped LSE, rates rose to over 100%, while 6M KIBOR was only 8%).
19/ some brokers were even lending out clients' money in badla financing, earning free interest.
So, investors were earning money as stocks rose more than badla costs, brokers/funds/banks made huge profits at high Badla rates as well as arbitrage premiums, whereas
So, investors were earning money as stocks rose more than badla costs, brokers/funds/banks made huge profits at high Badla rates as well as arbitrage premiums, whereas
20/ futures buyers made money as price of shares rose more than the premiums. So, everyone was happy and making money- as long as the music kept playing.
21/ In all this, the report found, major Badla providers were the same people who were selling in the futures
market. They were pumping stocks through media appearances, rumors, and injecting liquidity, all the while they themselves were net sellers in futures.
market. They were pumping stocks through media appearances, rumors, and injecting liquidity, all the while they themselves were net sellers in futures.
22/ The market PE ratio was now over 14 compared to about 10 during the bull-run. During, this frenzy, the report identified some cases of market abuse; players had undertaken “wash trades”.
23/ In wash trade, an investor simultaneously buys and sells shares in a company through two different brokers (similar is circular trading, where a group of investors buy and sell between themselves), bringing price up or down.
24/ brokers closed out any balance left from these trades with “off-market difference trades” or just settled in cash. The report found wash trades between 7 brokers, which is given in a poorly drawn diagram here.
25/ Brokers also undertook excessive day trades to push the price up/down.The report estimated that 0.1% of investors accounted for over 98% of turnover. One broker, Worldwide Securities traded Rs115 bn worth of shares in March, 2005 almost exclusively as day trades.
26/ Anyway, so on March 3, 2005, badla financing was Rs.33 billion (70% of which was accounted for by five scrips, PSO, POL, NBP, OGDC and PTCL) (for reference, outstanding MFS on friday was Rs5.5 billion).
27/ while investors were enjoying the party, KSE management, apparently worried about possibility of default in a highly leveraged market, called up various brokers and banks to reconfirm that the brokers would be able to honor their obligations in the futures contracts.
28/ This set the alarm bells ringing. Badla financiers started to pull badla out. Then, suddenly around March 8, on corporate announcement/adjustment in PSO, some of the Badla financiers decided to reduce lending in PSO.
29/ Badla financing for PSO declined overnight by 62% from Rs.6.3 billion on March 8, to Rs.2.4 billion on March 9. Between 7th to 15 march, Rs 5.7 billion or 17% of overall financing was withdrawn in Badla finance.
30/ While badla money was being pulled out,scrip prices were increasing and the index was still rising. In graph below, strong divergence in badla finance and share price can be seen from 8th march, where badla is drastically reducing while prices keep increasing
31/ On top of reduced financing, a rumor started floating that the futures contracts for March would only be settled, and wouldn't be rolled over into April. This created panic among investors holding futures (ain't no one got money to settle; everyone's holding to roll over)
32/ Badla providers explained that they stopped financing because they began to worry about sustainability of market rise and consequent ability of Badla borrowers to repay their loans. However, despite their concerns, they were net buyers in ready market.
33/at that time,sell trade in futures werent labelled accurately as hedge/arbitrage or short.So,it's possible that brokers who were pulling badla out, were also selling in ready market,while holding sell position in futures (turning arbitrage into a "naked short").
34/ With sharp contraction in liquidity and turnover, prices of scrips affected by Badla withdrawal plunged on March 16. OGDC, NBP, PSO, PPL, POL and PTC, which represented over 60% of KSE Index on March 15, 2005 contributed to over 75% of the fall in the index.
35/ Investors in ready market who wanted to exit could not sell due to locks that became operational because of the circuit-breakers. Nor could they roll over their position as Badla financing was drying up.
36/ circuit breakers were set at 5% on down-side and 7.5% on up-side. Trading would open at lower locks, and investors weren't able to sell. (currently, circuit breakers are at +/- 7.5%, while PSX plans to enhance them to +/- 10%).
37/ During fall, sellers in futures market who had locked in arbitrage profits, and were holding shares in ready market, were also not certain of realizing their profits in case of default by weak holders. It was in their interest to help potential defaulters pick up these shares
38/ But there were other futures seller, who may not have held the shares that they had sold in the future, but had planned to buy these after the market fell (short sellers). They didn't care about the falling market, as it went in their favors.
39/ long story short, KSE management and some large brokers began efforts to bail out potential defaulters starting March 24, possibly aimed at protecting their own interests, as defaults in futures market could've triggered a domino effect on others.
41/ COT session was extended for one hour on Friday, and on Saturday-Sunday. Chairman, SECP met with Governor, SBP, and SBP withdrew restriction of maximum exposure in COT, imposed on Banks earlier.
41/ From Friday-Sunday (25-27 march) badla financing was provided to weak buyers (over Rs 12 billion). Here too, brokers/financiers made money, as Badla rate was enhanced from 18% to 24%. Also, as brokers were net sellers, these buyers took this loan and simply paid it back (lol)
42/ because of net sell positions, these brokers/badla financiers had receivables in futures. They just provided this money at 24% to buyers, who paid it back to them (*chef's kiss- absolutely beautiful)
43/ no story of fraud can be complete without public exchequer getting the stick. Through bailout badla financing, positions in PSO, POL, NBP, and PTCL were settled, but no one was touching OGDC.
44/ So, National Investment Trust (NIT), State life Insurance, and NIC came forward to buy shares of OGDC at Rs.117.50 from a whole range of sellers.
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