NBFC & Notified Entities Regulations 2007

Transitions History

CATEGORY REGULATOR FRAMEWORK

NBFCs SECP NBFC Rules 2003

Modarbas SECP Modarba Companies Ordinance 1980 & rules

DFIs SBP PRs

In November, 2002 The NBFIs were divided into:

April 2003 NBFC 2003 rules notified 2004 PRs for NBFCs notified Nov 2007 NBFC and NE Regulations, 2007 notified

The Scope of the Framework

Establishment of NBFC

Operations of NBFC & N.ENBFC & NE Regulations,

2007

NBFCRules, 2003

Transition from 2003 Framework

NBFC Rules 2003

Prudential Regulations for NBFCs

issued by SECP

NBFC & NE Regulations,

2007

Regulates Establishment of NBFCs

Regulates operations

Now superseded

What are NBFCs?

Under section

282 A (a)

Leasing Investment

FinanceHousing Finance

Asset Management

Discounting Services

Investment Advisory Services

VCI

Same license

And Notified Entities?

“A Company or class of companies or corporate body or trust or person as notified by the Federal Government”

These entities are engaged in business not covered by 282 A (a)

New!

The Finance Act 2007

Introduced the Notified Entities

SEC Powers enhanced: to make regulations under 282 B (2) to impose penalty upto Rs 50 million for violation

of Section VIIIA of the Ordinance For Rehabilitation of NBFCs and NE

A BRIEF LOOK

AT THE AMMENDMENTS

IN

THE 2003 NBFC RULES

Summary of changes

The operating requirements (rules 12 to 86) moved to regulations

Terminology Scope of work of investment advisor changed Fit and proper criteria introduced External and internal audit and compliance

requirements strengthened Restrictions on certain investments and transactions

imposed Bar on acquiring controlling interest withdrawn

Terms excluded

The following terms have been excluded from the rules and the regulations:

Administrator Liquid Net worth Net capital Risk Assets Small Entrepreneurs

Terms Defined

The following terms are now defined in the 2003 regulations:

Brokerage business Discounting services Major shareholder Promoter / sponsor Regulations

Expanded Terms

Asset management services extended to collective investment schemes

Connected persons include: The managing NBFC to the Collective investment

scheme The trustee/custodian to the collective inv scheme

Custodian now includes Trust Co that is subsidiary of Banking Co NBFC engaged in IFS & approved by SEC Other Co. approved by SEC

Expanded Terms contd.

Equity now includes subordinated loans Redeemable preference shares Less: accumulated losses

Leasing definition expanded from IAS definition to include any mode admissible by SEC

Revised Terms Housing finance Services restricted to

Loans (as compared to financial services previously) Residential (as compared to residential and

commercial previously)

Investment Advisor services changed from management of closed-end funds to discretionary and non discretionary client accounts for indiv &institutional investors

Investment company is a notified entity

Important amendments

RULE TITLE AMMENDMENT

3 Eligibility criteria

It now refers to the Fit and Proper Criteria

5 Condition to form NBFC

Licensing of AMS / IA/ both – no other business

IFC/HFC/LC/DH cant obtain any other license

IA cannot manage closed-end funds

Conditions of: Minimum tiers of capital, 25% capital allotted to promoters, Promoters / directors to hold shares in blocked CDC a/c,

Important amendments contd.RULE TITLE AMMENDMENT

6 Commencement of Operations

License cancelled if no operations within 1 year of issue

7 Conditions applicable to NBFCs

Of Management:CFO experience requirement now 3yrs

1/3 directors to be independent

2 directors (ex-CEO) with Sr. Management experience

CEO / directors/executives to meet fit and proper criteria

Important amendments contd.

RULE TITLE AMMENDMENT

7 Conditions applicable to NBFCs

Of Compliance officers:

Auditor to be appointed from approved list

Internal auditor

Compliance officer

Of investments:

Investment in unquoted securities limited to 20% of NBFC equity

Invest. in subsidiary allowed from excess equity

Of Records & accounts:

Minutes of credit, investment & audit committee

Annual a/c filing period for all NBFCs 3 months

Important amendments contd.

RULE TITLE AMMENDMENT

7 Conditions applicable to NBFCs

Of TransactionsOne broker < 10% of total annual brokerage exp

Restriction on transactions, except as notified by SEC:

Real estate on its own account

Unsecured facilities

Raise funds from individuals

Restricted the encumbrance of client securities for own benefit

Transactions with directors, employees can be allowed by BoD policy (director transactions would need prior approval of SEC)

Important amendments contd.RULE TITLE AMMENDMENT

7A Monitoring Fee An NBFC engaged in deposit taking shall, Payable annually to SEC within 3 months of yr end

8 Opening/ closing of bank a/c, broker a/c or branch

Previously only dealt with opening of branches

Approval of BoD required with notice to SEC

9 Insurance cover SEC power of specifying nature/limit withdrawn

11 Bar on acquiring controlling interest

Withdrawn

12-86 Operating rules Moved with amendments to 2007 regulations

Non-Banking Finance Companies and Notified Entities Regulations,

2007

The Scheme of Regulations

MAIN SECTIONS ABOUT

Part I All forms of business

Part II NBFCs engaged in Leasing, Investment Finance Services, Housing Finance Services

Part III (i) NBFC in Venture Capital Investment &

(ii) Venture Capital Funds

Part IV (i) NBFC engaged in Asset Management Services /Investment Advisory Services,

(ii) Collective Investment Schemes managed by such NBFC and

(iii) Investment Companies

Minimum Equity Requirement (All NBFCs)

Form Of Business

Min Equity

Time line

From June 30, ’08

June 30, ‘09

June 30, ‘10

IFS 1,000 300 500 700 1,000

Leasing 700 200 350 500 700

AMS 200 30 100 150 200

IAS 50 30 35 40 50

HFS 700 100 300 500 700

VCI - 50 - - -

-All amounts in Millions of Rupees-

Aggregate & Contingent Liabilities (All NBFCs)

0123456789

10

YR 1 YR 2 YR 3 YR 4 YR ~

AL

CL

•Where the X column represents No. of years of operation, &

•Y column represents the number of times of equity of the NBFC

•Aggregate liabilities exclude contingent liabilities and security deposits

Other Provisions (All NBFCs) Internal audit department mandatory.

Reporting to BoD Compliance with NBFC rules/regulations/company policy

Periodic returns as specified by SEC Compliance with code of conduct of Association Steps to be taken to comply with Money laundering regulations

including: Account Opening forms in name of each new a/c holder KYC, verify identities Avoid illegal money transactions Monitor customer status, account movement Cash payment / receipt for one transaction <Rs 50,000

Appointment/ change in directors / CEO to be approved by SEC – Complete application to be received 14 days before change– Any deficiency to be completed within 14 days of intimation

New

NBFCs engaged in Leasing, Investment Finance Services &

Housing Finance Services

Minimum investment by NBFC having multiple licenses

Leasing

IFS

HFS

Other

•Investment of assets in Leasing /IFS/ HFS business should be at least 20%

•Exclude Cash& bank, unquoted shares, *(govt. securities, listed investment that a PF can make)

New

Raising funds1. Certificate of Deposits (CoIs excluded) NBFC Criteria

2 years of profitable operations NBFC/directors lawful conduct Annual credit rating exceeds minimum Inv. Grade Disclosure statement to accompany application for permission

Credit rating to be published in all ads No CoD if credit rating falls below criterion

Issuance conditions: CoD in specific name Maturity >30 days Rate fixed /floating Deposits from individuals < 3Xequity of NBFC >15% of funds raised from CoD to be invested in * Return for different CoDs can be different eg. based on maturities

2. Commercial paper, foreign debentures, redeemable capital, Lines of Credit, rediscounting

Exposure Limits

0%10%20%30%40%50%60%

70%80%90%

100%

Single Group Aggregate

Clean

Funded

Total

•Column Y represents the maximum limit of exposure as % of NBFC equity

•Exposure excludes liquid collateral subject to margins

•No exposure against NBFCs’/borrowers’ own shares, unsecured credit for financing share floatation, director personal guarantee

•No exposure to directors without approval of majority of NBFC directors

New

Conditions for Grant of Facilities

CIB report Exposure> Rs 1,000,000 F/s Exposure >Rs 1,000,000 Loan application form & basic fact sheet Margins applicable to all securities Borrower’s:

total exposure< 10 X equity of borrower Current ratio 1:1 (may be relaxed to 0.75:1)

New

Provisioning Time based Classification into:

Substandard(90 days), doubtful(180 days); and Loss (1 yr, TBs 180 days, Credit Card 180 days)

Provisioning @ 25%, 50% & 100% No provisioning for Govt. guaranteed exposure Additional subjective evaluation Declassification of rescheduled loans FSV ( other than realizable assets)

In case of leasing & IFS: Discounted for yr 1, 2 & thereafter as 80%, 70% & 50% Revaluation every 3 years by independent valuer

In case of HFS Discounting @ 70% Revaluation every 10 years by independent valuer

Types of charges Quarterly credit review by NBFCs, annual by Auditors Reversal of provision Cash receipt> 20%, 50%, 100% of NPL) Quarterly list of delinquent / rescheduled accounts to SEC

New

(I) Leasing An NBFC engaged in Leasing shall meet the

following conditions:

Assets invested > 70% of total assets

Investment in Shares < 50% equity of NBFC

Investment in shares Of one company < 10% equity of NBFC/Co

Lease period > 3 years

May not engage in land / residential building leases

(II) Investment Finance Services

Scope of work and Inv. Limits Scope of work includes:

Money market activities, Capital market activities (including managing client portfolios) Project financing activities; & Corporate finance services General activities

Investment limits %age of NBFC equityShares < 100Shares of1 company < 10Equity futures < 100Single future < 10Reverse Repo & CFS < 250Single CFS security < 25 (i.e. 10% of above) Margin LoansTotal < 50To 1 client < 10(Margin shall be at least 30% of loan)Margin loans approved according to pre-defined BoD policy Underwriting commitments fully backed

Managing Client Portfolios

Both discretionary and non-discretionary Conditions include:

Must inform SEC Eligible investors only Separate management and disclosure Compliance with SEC regulations

(III) Housing Finance Services Additional functions w.r.t property:

Mortgage finance to purchase/construct/alter property Surveys and valuation Arrange insurance Manage mortgage investments

Investment in: Limit HFS > 70% total assetsShares < 50% NBFC equityShares of 1 co < 10% -do-Financing:One party < Rs 20 millionTotal Monthly Installments –Consumer loan < 60% NDI DE ratio < 85:15Period of Mortgage loan < 20 years Appoint Lawyer, valuer Review market every quarter

(IV) Venture Capital Investment & VCF

Venture Capital Company Exposure by NBFC to one person/group of Cos. <

40% of equity Raise funds by: shares issue and private placement

for VPVenture Capital Fund VCF conditions:

A Company, engaged solely in VPs with equity of Rs 50 m & managed by VCC

Exposure to one person/grp of Cos. < 40% of equity Exposure to director < 10% of total exposure Each investor to invest at least Rs 1,000,000 Registration can be suspended by SEC for 60 days. Can

lead to cancellation

(v) Asset Management Services

Asset Management services- Structure

AMC

Fund managerInvestment Committee

CIS CIS CIS

Sharia

If Islamic

trustee trustee trustee

Asset Management services- Terms and conditions

Designation of qualified fund manager to manage upto 3 CIS

At least 1 investment Committee, formed by BoD Comprise fund manager, Chief Investment Officer other

Key Personnel of AMC Reportable to CEO Quorum for investment decisions is 2/3 Ensure compliance with constitutive documents/policies

AMC to fulfill SEC conditions for managing multiple CIS

Shari’a appointed for Islamic CIS

Trustee of a Scheme Appointed with SEC approval for each open and closed end

scheme Trustee to be a

Scheduled bank Trust company Foreign bank CDC NBFC engaged in IFS Other SEC approved trustee

Obliged to take custody of, manage, a/c for loss of property of scheme

Issue trustee report to form part of annual report Ensure AMC/ IA has arranged for a diverse panel of brokers Ensure units of open end scheme \issued after sub money received Review adequacy of AMC/IA unit value calculation

May retire or be removed by the NBFC Will be independent of the AMC

Asset Management Companies- Restrictions & obligations Restrictions:

Acquiring control of an investee through CIS Transaction with 1 broker>10% annual brokerage exp Accepting deposits from CIS Loans from CIS assets Undertake brokerage services Enter underwriting contracts, invest in CIS except as

allowedCompliance required within 12 months of notification of Regulations

Obliged to manage assets in good faith and a/c to trustee for losses, maintain records, prepare a/cs, appoint auditor Annual report within 3 months of yr end, including No. of unit

holders and details of personnel of AMC Quarterly reports in 1, 2 and 1 month of qtr end Rating of scheme done annually.

Open & Closed End Schemes Registration as a notified entity

Application to be accompanied also by undertaking of AMC guaranteeing investment

3 months notice for winding up by AMC / Cancellation by SEC Ads to be approved by SEC & circulated within 60 days of

approval Offering document / prospectus to include investment policy,

type of securities it will invest in and the risk associated. Closed end schemes: securities offered at par if investment is

arranged by IA and the offer is underwritten Open end schemes:

Investment made after conclusion of issue of units 4 regular dealings per week Offer price and redemption price Redemption to be completed in 6 working days

Exposure Limits for CISLimit

By CIS to1 person< 10% Net Assets of scheme/ 10% of issued capital of person

By all CIS to 1 person < 49% of issued capital of the person

By CIS in 1 sector< 25% of net asset value of scheme By CIS in one group < 35% of net assets of CIS

By CIS in listed group Cos. Of AMC < 10% of net assets of CIS

Invested by equity based CIS in non listed securities < 0% (Pre-IPO 15%)

Open & Closed End Schemes (contd)

Limitations on AMC of scheme include short selling, forward purchase contracts, real estate dealing, delisting without SEC approval, lend/ borrow.

No transactions by AMC of scheme with connected persons Direct transactions b/w CIS of 1AMC notified to SEC in 2 days IA(AMC) to bear all inc. exp. Of closed (open) end scheme NAV notified to SE,SEC& self regulatory association 14 days of month end Discretionary and non discretionary a/cs:

DESCRIPTION BY TO AMOUNTAMC

remuneration

CIS AMC 5yrs: 3% of Avg. annual net assets of CIS

Afterwards, 2%

Annual fee AMC SEC 0.1% of AANA

Dividend AMC Shareholders of CIS

90% income

(VI) Investment Companies & IAs

Investment company(closed end fund)

Investment Advisor Custodian

Discretionary ClientPortfolio

Non discretionaryportfolio

External auditor-SEC panel

Investment Companies Registered as a Notified Entity A public co with Rs 250m equity & directors of integrity Application for registration can be cancelled if operations don’t

start in 6 months Investment Advisor

Appointed with SEC approval, for a period of upto 10 years Change of IA requires prior approval of SEC

Custodian: Appointed with SEC approval scheme of custody of assets settled with IC Custodian not to be AMC or IA Custodian to be independent of IC and IA

IC to report annually and qtrly to shareholders and SEC. The P&L of the IC will include that of the IA

Auditor Appointed from the SEC approved list Auditor rotation after 5 years Auditor of IC different from auditor or custodian or IA

Open & Closed End Schemes- (contd.)

Discretionary and non discretionary a/cs: Notice to SEC Due diligence Separate management & disclosure

Conversion of closed end fund to open end scheme: By Special resolution of certificate holders 5 years after fund launch Cert. holders not in favor can sell @ discount<3% of NAV Approval of SEC