Paga: 'The weakest point in the market is the brokerage community'
He began preparing for this task in 1989 when he was a member of a triumvirate, along with Wieslaw Rozlucki and Grzegorz Jedrzejczak, whose mission was to draft the legal framework and construct institutions for the capital markets. Paga is now chairman of Deloitte & Touche Group, Poland. In the 1980s, he was an economics professor at Katolicki Uniwersytet Lubelski in Lublin until he signed on to the stock-exchange project after the Roundtable Talks in 1989. A tough regulator, Paga took the line that it was best that the market immediately have a sound regulatory basis that would encourage long-term growth. On the occasion of the WSE's fifth anniversary, he spoke with the WBJ's Stephen Kirkland and David Reilly about the market today and his experience heading up the Securities Commission.. The following is an edited version of their conversation.
Q: Looking back at your time with the Securities Commission, is there something you should have done that you did not do?
A: There's always a few things. Nothing is perfect. We've been excellent with financial reporting. But I may say we should put more attention to the consolidation issue.
Q: Why?
A: The market and the nature of the market shows that each company, when it is growing very rapidly, usually tries to organize a holding structure. And the holding structure may transfer funds. And the mother company can show pretty good results, because it has some ability to show a better situation.
Q: Unclear financials - could that explain the difficulty in launching Mostostal Export's ADR issue?
A: With Mostostal there are two issues. It's usually not good for any company to proclaim something, and the delivery is after, say, two years. Secondly, everybody is looking at who is the auditor. In Mostostal, it is an unknown auditor. It may be the best, it may be the proper one. But it's a question of credibility given by an independent financial auditor.
Q: Concerning consolidation, what specifically should be done?
A: In relation to public companies, they need to be shown both as a mother company and as a holding company. The other thing which I understand will play a more important role is the question of minority shareholders' rights. We observe this with the case of Okocim. There is a gap, to some extent because we are still based on an old commercial code which mostly protects companies and not minority shareholders.
Q: Dom Plast can be seen as a successful example of a good Polish company coming to market and finding investors. How do you feel about its main shareholder, Rubbermaid, wanting to take the company off the exchange and the consequences for minority shareholders?
A: That's one of the issues we need to be sure happens in a civilized way. It may happen, because it has happened throughout the world. But it must be in a civilized way, (so there is) an exit strategy for small investors. Generally speaking, in all those minority shareholders' rights, it's a question of the proper price to be the only owner.
Q: When you drafted regulations for the Securities Act, what was the biggest mistake you made?
A: Hopefully, all the mistakes we made in the beginning we already verified and changed. I think probably, I don't know what has happened, I think it was something in the regulation, but the role of the brokerage houses. They did not develop themselves as they are supposed to develop after, say, five years of existence. We have a few publicly traded companies which can be compared with a lot of Western companies. They produce good quality, they (generate) a lot of money, and they have good management. It is not the same story that applies to all brokerage houses. Maybe we have too many, I don't know. In this area, I would probably redraft something, try to analyze why such instruments are not fully recognized, why they are not fully developed.
Q: Brokers would respond that you ruled with an iron fist and they asked for greater freedom to develop. Is that part of it?
A: No, definitely not. I do not represent the Securities Commission. But from my point of view, I also work in a regulated area. My internal regulations are stricter than, say, some of the Polish regulations. And the question of the conflict of interest and independence issues are, from time to time, pretty painful. So I know how it works, and I know it is painful. But if you want to have a healthy market and trust, which is the most important thing, the regulations may not be enough to some extent, especially with respect to the Chinese wall.
Q: Could you explain the reasoning behind the withdrawal of Bank Ćlski's brokerage permit?
A: I think it is the dilemma between (activities) acceptable by law, but not necessarily by ethical standards. Ethical standards are the most important thing if you'd like to have normal business in the long term, especially in the financial sector. Unfortunately, in the transition period there are a lot of changes, a lot of immediate opportunities. Some of the misunderstanding that happened, for example with Bank Ćlski, was simply that we expect people in the financial sector to represent the highest level of reputation. No one can, let's say, make an impression that someone is not representing the highest possible standard in management of the bank and brokerage house, that someone can take care of their private business (rather) than for their public business, which they are paid for. From that point of view, it was important that that action was taken. Of course, it was a difficult decision to withdraw the license of the largest brokerage house.
Q: Was that the right decision?
A: In withdrawing the license, yes.
Q: Besides the Bank Ćlski issue, was there another pivotal moment during your tenure as head of the commission?
A: All those things in the beginning, setting the standards. In the beginning there were no such standard rules. 'To keep the standards' - people didn't understand the value of this. Our ministers (said) that I was trying to break the privatization process. The concept of an over-regulated market was repeated, repeated, and some people started to believe that it was an over-regulated market. It was such an atmosphere in the beginning, because you did not have enough companies traded on the stock exchange. The listing criteria was pretty high. The question was, 'What to do next?', because there was not a long queue of companies waiting to be on the market. There was one wave, then nothing. We almost waited one year. It looked in the beginning like we'd been given very expensive toys to enjoy and (could) not make progress. After some waiting, there was a growing wave which helped us show to the audience, to outsiders, that there is something to support. I think, if a lot of people had a difficult time when the market dropped down, there was not a crisis. People lost money, true, but because of an investment decision, because they've been impatient, they came too late - but not because they've been treated differently.
Q: When the Mass Privatization Program comes to market and maybe 200 companies come to the exchange through the program, are regulation and structures in place capable of handling the explosion?
A: When we're talking about the regulations, I have difficulties to comment on particulars, let's say, the OTC market. Let's assume yes. The problem is with the structures. That is the real problem. It was our vision to have the stock exchange created as, say, a kind of a block structure. So we have a solid basement and we can create the next floors as required. But of course there are some problems, you mentioned with Bank Ćlski. The question was with the number of securities accounts in the brokerage houses. The problem is to come to the next stage of the market, which is continuous trading. If you would like to have foreigners investing in Poland, they just play the game 24 hours a day. So the very old trading system may be a problem. Related to this is the central depository system. Some of this issue has been discussed since the beginning. For example, our first draft included the proxy, which does not exist in the commercial code. We've been told we cannot do something which is (against) the principle of the legislation. Another story is the question of derivatives. This part of the financial market is viewed as riskier, and we do not have enough experience in this. Also the brokerage houses, the settlement system, they are not ready for the introduction of derivatives right now. But it is demanded more and more. So the market needs this.
Q: The Prague exchange just moved to continuous trading. Budapest has had continuous trading for some time. Why has it taken Warsaw so long to start continuous trading?
A: Two years ago I tried to push a shareholders meeting of the Warsaw Stock Exchange to make a timetable for continuous trade. Rozlucki may respond, 'I'm ready, but the brokerage houses are not ready.' Probably, there was not enough pressure on the major players. From my feeling, it was supposed to be a meeting of major players saying, 'Half, one year, from now we'll start continuous trading and everybody who does not apply the technology system, let's say, is out of the business.' There would probably be a lot of criticism, but that's always if you would like to make some changes. To some extent the players, the brokerage houses, have not been pushing enough. If it is only a regulator pushing for investment, it would not help.
Q: Would you say it's the same with the derivatives market? Budapest has not only one, but two.
A: I think it's an absolutely different story. I was always against derivatives being introduced in the beginning of the market. It's bullshit. You need to be responsible. Slovakia is one of the cases. They have derivatives before they have an equity market. I have personally been against the derivatives being introduced immediately, because with the derivatives market you have some risk. For example, we need to have a new regulation about short sales. We need to learn about short selling and how to protect yourself against the risk. Then you can develop something which is the next stage. From my point of view, these processes need to be speeded up, but there is a normal way of development of the financial market.
Q: Stock Exchange President Rozlucki told us in an interview that he didn't envision a Microsoft-type company coming to market in Poland. What is your vision of the market 15 or 20 years down the road and the role the commission will play?
A: Of course, Dom Plast finished in a different way, but that was a family business started from nothing, grown to a level that became an interesting target for an international company. Maybe they gave up too quickly. It's difficult to assess different approaches. But the capitalization of Poland is very much below expectations, and it really depends on the banking side (and pension fund) activities. When we started with the capital market, this pre-emerging market, we just kept it like a baby. The population is growing, more mature and richer. The process of Polish capital and foreign capital is the process of merger and acquisition. I think Polish companies need to learn how to protect themselves from unfriendly acquisition, how to install 'poison pills' or whatever it is.
Q: Does the tiger have teeth? Does the brokerage community fear the Securities Commission?
A: I think, yes. No one can complain that the Securities Commission lacks the professional approach, the lack of good attitude toward the market. When you look at the (amount) of the financial fines, it's a pretty good collection of fines. It's pretty painful.
Q: Some brokers say that if they criticized you, you would search their offices.
A: It's always a question of style. I don't think I had an easy hand to handle the market. But that was my responsibility. But all this bullshit about, you know, this ... probably I don't even remember the individual comments of the brokers. I've always been completely upset when I've found out about some stupid comments about the market situation, a lack of responsibility. Of course, when you hear such comments that are stupid, then it comes to your mind not as a regulator, but as a supervisor: 'Okay, if this guy is so foolish, maybe it's better to check how he is running his business,' because if he makes publicly such a stupid statement, he is even worse with his other business. But it was never feedback like 'I comment against Paga ...' That's bullshit.
Q: Do you see a large number of small brokerage houses or a few large brokerages as the future of the Polish market?
A: When we offered licenses, we always asked brokerage houses, 'What will your situation be? If we increase the financial requirements, are you able to fulfill this?' And everybody was very enthusiastic about their business. I've been also criticized that I'm in support of the bank-brokerage houses, which has never been true. I was always looking for very active, powerful brokerage houses. Almost half a year before my departure, I tried to send a very clear message. The Securities Commission, whoever will be in charge, will increase the capital requirements, because it is the nature of the market. If, say, a derivatives market develops, there will be additional capital requirements. You need to do some scale, to prepare people to be professionals in different areas. Otherwise, you are just trade makers. I expected there would be more mergers among the brokerage houses. Why this did not happen? Probably because they were not mature enough. So I'm saying the weakest point in the market is the brokerage community.
Q: Do you ever see yourself going back to public service and government?
A: If I can respond in this way: If someone would have told me when I was in a small prison during martial law, walking on a small circle each morning for half an hour, that after 15 years I'd have been the first chairman of the Securities Commission, chairing an international business in this region, I may say, 'Well, come on.' So, I have a problem. In my life, in a lot of my dreams, I've not only realized 100%, but 150%. So the problem is how to establish new goals for the next 20 years.
Q: Looking back at your time with the Securities Commission, is there something you should have done that you did not do?
A: There's always a few things. Nothing is perfect. We've been excellent with financial reporting. But I may say we should put more attention to the consolidation issue.
Q: Why?
A: The market and the nature of the market shows that each company, when it is growing very rapidly, usually tries to organize a holding structure. And the holding structure may transfer funds. And the mother company can show pretty good results, because it has some ability to show a better situation.
Q: Unclear financials - could that explain the difficulty in launching Mostostal Export's ADR issue?
A: With Mostostal there are two issues. It's usually not good for any company to proclaim something, and the delivery is after, say, two years. Secondly, everybody is looking at who is the auditor. In Mostostal, it is an unknown auditor. It may be the best, it may be the proper one. But it's a question of credibility given by an independent financial auditor.
Q: Concerning consolidation, what specifically should be done?
A: In relation to public companies, they need to be shown both as a mother company and as a holding company. The other thing which I understand will play a more important role is the question of minority shareholders' rights. We observe this with the case of Okocim. There is a gap, to some extent because we are still based on an old commercial code which mostly protects companies and not minority shareholders.
Q: Dom Plast can be seen as a successful example of a good Polish company coming to market and finding investors. How do you feel about its main shareholder, Rubbermaid, wanting to take the company off the exchange and the consequences for minority shareholders?
A: That's one of the issues we need to be sure happens in a civilized way. It may happen, because it has happened throughout the world. But it must be in a civilized way, (so there is) an exit strategy for small investors. Generally speaking, in all those minority shareholders' rights, it's a question of the proper price to be the only owner.
Q: When you drafted regulations for the Securities Act, what was the biggest mistake you made?
A: Hopefully, all the mistakes we made in the beginning we already verified and changed. I think probably, I don't know what has happened, I think it was something in the regulation, but the role of the brokerage houses. They did not develop themselves as they are supposed to develop after, say, five years of existence. We have a few publicly traded companies which can be compared with a lot of Western companies. They produce good quality, they (generate) a lot of money, and they have good management. It is not the same story that applies to all brokerage houses. Maybe we have too many, I don't know. In this area, I would probably redraft something, try to analyze why such instruments are not fully recognized, why they are not fully developed.
Q: Brokers would respond that you ruled with an iron fist and they asked for greater freedom to develop. Is that part of it?
A: No, definitely not. I do not represent the Securities Commission. But from my point of view, I also work in a regulated area. My internal regulations are stricter than, say, some of the Polish regulations. And the question of the conflict of interest and independence issues are, from time to time, pretty painful. So I know how it works, and I know it is painful. But if you want to have a healthy market and trust, which is the most important thing, the regulations may not be enough to some extent, especially with respect to the Chinese wall.
Q: Could you explain the reasoning behind the withdrawal of Bank Ćlski's brokerage permit?
A: I think it is the dilemma between (activities) acceptable by law, but not necessarily by ethical standards. Ethical standards are the most important thing if you'd like to have normal business in the long term, especially in the financial sector. Unfortunately, in the transition period there are a lot of changes, a lot of immediate opportunities. Some of the misunderstanding that happened, for example with Bank Ćlski, was simply that we expect people in the financial sector to represent the highest level of reputation. No one can, let's say, make an impression that someone is not representing the highest possible standard in management of the bank and brokerage house, that someone can take care of their private business (rather) than for their public business, which they are paid for. From that point of view, it was important that that action was taken. Of course, it was a difficult decision to withdraw the license of the largest brokerage house.
Q: Was that the right decision?
A: In withdrawing the license, yes.
Q: Besides the Bank Ćlski issue, was there another pivotal moment during your tenure as head of the commission?
A: All those things in the beginning, setting the standards. In the beginning there were no such standard rules. 'To keep the standards' - people didn't understand the value of this. Our ministers (said) that I was trying to break the privatization process. The concept of an over-regulated market was repeated, repeated, and some people started to believe that it was an over-regulated market. It was such an atmosphere in the beginning, because you did not have enough companies traded on the stock exchange. The listing criteria was pretty high. The question was, 'What to do next?', because there was not a long queue of companies waiting to be on the market. There was one wave, then nothing. We almost waited one year. It looked in the beginning like we'd been given very expensive toys to enjoy and (could) not make progress. After some waiting, there was a growing wave which helped us show to the audience, to outsiders, that there is something to support. I think, if a lot of people had a difficult time when the market dropped down, there was not a crisis. People lost money, true, but because of an investment decision, because they've been impatient, they came too late - but not because they've been treated differently.
Q: When the Mass Privatization Program comes to market and maybe 200 companies come to the exchange through the program, are regulation and structures in place capable of handling the explosion?
A: When we're talking about the regulations, I have difficulties to comment on particulars, let's say, the OTC market. Let's assume yes. The problem is with the structures. That is the real problem. It was our vision to have the stock exchange created as, say, a kind of a block structure. So we have a solid basement and we can create the next floors as required. But of course there are some problems, you mentioned with Bank Ćlski. The question was with the number of securities accounts in the brokerage houses. The problem is to come to the next stage of the market, which is continuous trading. If you would like to have foreigners investing in Poland, they just play the game 24 hours a day. So the very old trading system may be a problem. Related to this is the central depository system. Some of this issue has been discussed since the beginning. For example, our first draft included the proxy, which does not exist in the commercial code. We've been told we cannot do something which is (against) the principle of the legislation. Another story is the question of derivatives. This part of the financial market is viewed as riskier, and we do not have enough experience in this. Also the brokerage houses, the settlement system, they are not ready for the introduction of derivatives right now. But it is demanded more and more. So the market needs this.
Q: The Prague exchange just moved to continuous trading. Budapest has had continuous trading for some time. Why has it taken Warsaw so long to start continuous trading?
A: Two years ago I tried to push a shareholders meeting of the Warsaw Stock Exchange to make a timetable for continuous trade. Rozlucki may respond, 'I'm ready, but the brokerage houses are not ready.' Probably, there was not enough pressure on the major players. From my feeling, it was supposed to be a meeting of major players saying, 'Half, one year, from now we'll start continuous trading and everybody who does not apply the technology system, let's say, is out of the business.' There would probably be a lot of criticism, but that's always if you would like to make some changes. To some extent the players, the brokerage houses, have not been pushing enough. If it is only a regulator pushing for investment, it would not help.
Q: Would you say it's the same with the derivatives market? Budapest has not only one, but two.
A: I think it's an absolutely different story. I was always against derivatives being introduced in the beginning of the market. It's bullshit. You need to be responsible. Slovakia is one of the cases. They have derivatives before they have an equity market. I have personally been against the derivatives being introduced immediately, because with the derivatives market you have some risk. For example, we need to have a new regulation about short sales. We need to learn about short selling and how to protect yourself against the risk. Then you can develop something which is the next stage. From my point of view, these processes need to be speeded up, but there is a normal way of development of the financial market.
Q: Stock Exchange President Rozlucki told us in an interview that he didn't envision a Microsoft-type company coming to market in Poland. What is your vision of the market 15 or 20 years down the road and the role the commission will play?
A: Of course, Dom Plast finished in a different way, but that was a family business started from nothing, grown to a level that became an interesting target for an international company. Maybe they gave up too quickly. It's difficult to assess different approaches. But the capitalization of Poland is very much below expectations, and it really depends on the banking side (and pension fund) activities. When we started with the capital market, this pre-emerging market, we just kept it like a baby. The population is growing, more mature and richer. The process of Polish capital and foreign capital is the process of merger and acquisition. I think Polish companies need to learn how to protect themselves from unfriendly acquisition, how to install 'poison pills' or whatever it is.
Q: Does the tiger have teeth? Does the brokerage community fear the Securities Commission?
A: I think, yes. No one can complain that the Securities Commission lacks the professional approach, the lack of good attitude toward the market. When you look at the (amount) of the financial fines, it's a pretty good collection of fines. It's pretty painful.
Q: Some brokers say that if they criticized you, you would search their offices.
A: It's always a question of style. I don't think I had an easy hand to handle the market. But that was my responsibility. But all this bullshit about, you know, this ... probably I don't even remember the individual comments of the brokers. I've always been completely upset when I've found out about some stupid comments about the market situation, a lack of responsibility. Of course, when you hear such comments that are stupid, then it comes to your mind not as a regulator, but as a supervisor: 'Okay, if this guy is so foolish, maybe it's better to check how he is running his business,' because if he makes publicly such a stupid statement, he is even worse with his other business. But it was never feedback like 'I comment against Paga ...' That's bullshit.
Q: Do you see a large number of small brokerage houses or a few large brokerages as the future of the Polish market?
A: When we offered licenses, we always asked brokerage houses, 'What will your situation be? If we increase the financial requirements, are you able to fulfill this?' And everybody was very enthusiastic about their business. I've been also criticized that I'm in support of the bank-brokerage houses, which has never been true. I was always looking for very active, powerful brokerage houses. Almost half a year before my departure, I tried to send a very clear message. The Securities Commission, whoever will be in charge, will increase the capital requirements, because it is the nature of the market. If, say, a derivatives market develops, there will be additional capital requirements. You need to do some scale, to prepare people to be professionals in different areas. Otherwise, you are just trade makers. I expected there would be more mergers among the brokerage houses. Why this did not happen? Probably because they were not mature enough. So I'm saying the weakest point in the market is the brokerage community.
Q: Do you ever see yourself going back to public service and government?
A: If I can respond in this way: If someone would have told me when I was in a small prison during martial law, walking on a small circle each morning for half an hour, that after 15 years I'd have been the first chairman of the Securities Commission, chairing an international business in this region, I may say, 'Well, come on.' So, I have a problem. In my life, in a lot of my dreams, I've not only realized 100%, but 150%. So the problem is how to establish new goals for the next 20 years.
