JSX to tackle stock liquidity problems

JSX to tackle stock liquidity problems

JAKARTA (JP): A low liquidity of shares listed on the Jakarta
Stock Exchange (JSX) remains a daunting problem and hinders the
exchange's transformation into a leading market in the region.

JSX's president, Cyrill Noerhadi, acknowledged that many
issues listed on the exchange are still infrequently traded. The
major reason for this is that initial issues were not widely
distributed and thereby the basis for a strong secondary market
has not been created.

Therefore, the medium and long term solutions to the liquidity
problem should include improving the distribution of stocks,
especially when a company conducts its initial public offering of
shares so that the new issues are broadly distributed among
investors.

Apart from share issuers' efforts, Cyrill noted, JSX has set
six-step programs to help tackle stock liquidity problems in a
bid to encourage more domestic investors to enter equity
investment.

The six-step programs include improving information
dissemination, reforming auction techniques, facilitating trading
between institutional and retail markets, reducing trading credit
risk by establishing the Clearing and Guarantee House, developing
a safe, efficient Central Securities Depository and reducing
trade costs through book-entry settlement.

Information

"Capital markets thrive on information," Cyrill said at a
business luncheon here last week.

The 1995 Capital Market Law sets disclosure standards which
require issuers to provide necessary information to investors.
However, most of the time such information is not well
distributed to all investors who need it. Thus, it is necessary
to improve the techniques of information dissemination in such a
way that information reaches all investors evenly and instantly.

Under its new listing guidelines, JSX will help listed
companies distribute important news quickly via its electronic
networks.

"Our objective is to ensure that necessary information on
listed securities will be immediately made available to all
investors through national and international networks," Cyrill
said.

As part of its surveillance program, Cyrill said, JSX's
management team will contact issuers immediately to ascertain
reasons, if any, for unusual changes in trading activities and
ensure that such news will be quickly disseminated to all
investors.

JSX will also enhance its real-time price reporting to not
only broaden its distribution network but also to provide a more
detailed breakdown of relevant data to investors, Cyrill said.

Like most exchanges in the Asia Pacific region, JSX currently
uses an automated real-time matching system for securities
trading, in which offers to sell and buy stocks are entered into
a computer and immediately matched.

Such an immediate matching technique works well for widely-
distributed securities. However, many listed companies do not
have enough shareholders to generate constant buy-sell order
flows. Sometimes there may be an offer to buy without a
corresponding offer to sell registered in the computer. Such
unbalanced flows of buy-sell offers lead to sharp price
volatility.

One solution to this particular problem is to hold orders on
the system for several hours or even for a day before matching
orders. This type of "call system" is used effectively in some
order-driven markets, such as the Frankfurt Stock Exchange.

"JSX is currently studying ways to implement the call system
for less liquid listed securities," Cyrill said.

Retail market

A large part of the trading activities on JSX today is made up
of international institutional trades, many of which are
registered on the "crossed market." The price executed on this
market is quite unseen as the same broker represents both the
buyer and the seller.

The fundamental reason for the large volume of crossed trades
is that the settlement in the international market is risky and
such a risk is reduced when a single broker acts both for the
buyer and the seller.

Currently, the prices of crossed trades are not closely tied
to the prices in the regular market. This results in less
accurate price determination and consequently less liquidity in
both crossed and regular markets.

It will be possible to remove some or all of the barriers
between the crossed trading market and the regular market only
after the call market and book-entry settlement are operational,
Cyrill said.

Book-entry settlement

The fundamental strategy to improve liquidity is by increasing
the participation of local investors, especially retail
businesses which call for much lower transaction costs.

Today's certificate-based trading is still quite expensive,
and it is still affordable for institutional investors but not
for retails.

"The solution to this problem is to initiate scripless trading
and book-entry settlement," Cyrill said, adding that the
implementation of scripless trading is one of the major
challenges facing the JSX.

At the macro level, the development toward scripless trading
and book-entry settlement was initiated it 1993 through the
operation of Indonesian Securities Clearing Depository (PT KDEI )
in February 1993.

KDEI's president, Sumantri Slamet, explained here recently
that his company had initiated clearing operation in the form of
presenting reports of transactions that take place on JSX to the
respective members as well as facilitating possible corrections
and confirmations of the transactions. As of January 1994, KDEI
expanded its scope of operation by physically conducting
transaction settlements for all members of the exchange.

The development toward scripless trading was then strengthened
by the operation of the Jakarta Automated Trading System in mid-
1995, which resulted in a dramatic increase in terms of volume,
value and number of transactions.

An increase in volume of transactions automatically raises the
volume of physical settlement. To reduce possible errors, such
physical settlement must be minimized and abandoned gradually and
changed by book-entry settlement.

To facilitate scripless trading and book-entry settlement, it
is necessary to form the Depository and Settlement Institution
and the Clearing and Guarantee House -- as mandated by the 1995
Capital Market Law.

Sumantri said the two supporting institutions will be
established within the next two to three months by a special task
force, which was formed by the Capital Market Supervisory Agency.

A number of critics have blamed the agency and also JSX for
such belated formation of the two institutions, which should have
been formed earlier this year.

The Depository and Settlement Institution will act as central
depository and central custodian of the currently existing
custodian banks. As a central depository, the Depository and
Settlement Institution must segregate participants' deposited
assets and its own assets.

Meanwhile, the Clearing and Guarantee House will function as a
guarantor for settlement of transactions between JSX
participants.

The establishment of the two supporting institutions is
inevitable for the implementation of the book-entry settlement
system, Sumantri said.

However, a number of parties consider the establishment of the
two institutions redundant. They contended that there should be
one instead of two. Former JSX president Hasan Zein Mahmud, for
instance, criticized it as a backward movement in Indonesia's
stock exchange.

Scripless

Despite being targeted with criticism, the Capital Market
Supervisory Agency, the JSX and KDEI continue with their plans to
establish the two agencies to facilitate scripless trading and
book-entry settlement.

Sumantri explained that the Central Securities Depository, as
a subsystem in the book-entry settlement system, will conduct and
monitor the physical stock conversion into electronic accounts as
well as the withdrawal of stocks from the system. The function of
the central depository is to facilitate the electronic stock
transfer between brokers and their counterparts, the custodian
banks.

The transfer of stocks and cash will be electronically
conducted by debiting or crediting the stock and cash position of
the participant. The central depository will electronically
report particular deficiencies, such as default in delivery or
payment, to the Clearing and Guarantee House. As a counterpart
and guarantor of stock transactions, the institution will take
the necessary action to secure a complete settlement.

The role of participants will be gradually extended beyond
their current operations. Their physical stock deliveries will be
changed to electronic deliveries through the book-entry
settlement. The process of recording transactions, which is at
present performed manually, will be transformed into the use of
electronic ledgers in compliance with the general practice of
accounting standards.

All deliveries between custodian banks and brokers will be
conducted within the integrated electronic network, which is
directly linked to the central depository. After payment is
confirmed, deliveries can be carried out through settlement
instructions to the central depository.

After the gradual implementation of book-entry settlement
through an electronically integrated system, the recording of
trades which, at present, is largely conducted manually will be
automated by using the system.

Furthermore, the implementation of submodules will be also
conducted stage by stage. Complicated features will not be
introduced in the initial stage. In other words, the simplest
standard configuration will be applied first, while advanced
features will be used in time when operational needs arise,
Sumantri said.

He noted that the conversion of physical stocks converted into
electronic accounts will also be carried out gradually. The first
stocks to be converted into electronic accounts are most
definitely not those of the highest liquidity.

"The objective here is to assess the operational capacity of
the entire system and to evaluate its performance under maximum
pressure," Sumantri said.

He noted that the conversion of physical stocks into
electronic accounts will take time. Singapore and Malaysia, for
instance, require four to five years to convert all physical
stocks into electronic accounts. Malaysia begun stock conversion
into electronic accounts in 1993 and expects to end the process
by the end of this year.

"Challenges will always exist. However, the pressure toward
immediate implementation of scripless trading and book-entry
settlement is equally great in order to improve the
competitiveness of the JSX," Sumantri said. (rid)