Performance Evaluation Report

PPE: PAK 31108

Capital Market Development and Capacity Enhancement of the Securities Market (Loan 1576-PAK and TA Loan 1577-PAK[SF]) in Pakistan October 2005

Operations Evaluation Department

Asian Development Bank

CURRENCY EQUIVALENTS

Currency Unit – Pakistan rupee/s (PRe/PRs)

At Appraisal At Program Completion At Operations Evaluation (September 1997) (October 2001) (April 2005)

PRe1.00 = $0.0246 $0.0161 $0.0168 $1.00 = PRs40.62 PRs62.00 PRs59.52

ABBREVIATIONS

ADB – Asian Development Bank CDC – Central Depository Company of Pakistan CDNS – Central Directorate of National Savings CDS – central depository system CLA – Corporate Law Authority CMDP – Capital Market Development Program COT – carry-over transaction DSC – defense savings certificate FMGP – Financial (Nonbank) Markets and Governance Program ICP – Investment Corporation of Pakistan IMF – International Monetary Fund IPO – initial public offering ISE – Islamabad Stock Exchange KSE – Karachi Stock Exchange LAP – Leasing Association of Pakistan LSE – Lahore Stock Exchange MOC – Ministry of Commerce MOF – Ministry of Finance MUFAP – Mutual Fund Association of Pakistan NBFC – nonbanking finance company NCC – National Clearing Company of Pakistan NCSS – National Clearing and Settlement System NIC – National Insurance Company Limited NIT – National Investment Trust Limited NSS – national savings scheme OEM – operations evaluation mission OTC – over-the-counter PCR – program completion report PIC – Pakistan Insurance Corporation PPER – program performance evaluation report PRCL – Pakistan Reinsurance Company Limited RRP – report and recommendation of the President SECP – Securities and Exchange Commission of Pakistan SLR – statutory liquidity ratio SRO – self-regulatory organization TA – technical assistance TFC – term finance certificate

NOTES (i) The fiscal year of the Government ends on 30 June. (ii) In this report, “$” refers to US dollars.

Director General, Operations Evaluation Department : Bruce Murray Director, Operations Evaluation Division 2 : David Edwards Evaluation Team Leader : Tetsu Ito

Operations Evaluation Department, PE-667

CONTENTS Page

BASIC DATA iii EXECUTIVE SUMMARY iv I. BACKGROUND 1

A. Rationale 1 B. Formulation 1 C. Purpose and Outputs 2 D. Cost, Financing, and Executing Arrangements 2 E. Completion and Self-Evaluation 3 F. Operations Evaluation 4

II. PLANNING AND IMPLEMENTATION PERFORMANCE 4

A. Formulation and Design 4 B. Achievement of Program Measures 6 C. Cost and Scheduling 9 D. Organization and Management 10

III. ACHIEVEMENT OF PROGRAM PURPOSE 11

A. Performance Indicators 11 B. Program Outcomes 13 C. Sustainability 15 D. Technical Assistance Loan 16

IV. ACHIEVEMENT OF OTHER DEVELOPMENT IMPACTS 16

A. Organizational Impact 16 B. Socioeconomic Impact 16

V. OVERALL ASSESSMENT 16

A. Relevance 16 B. Efficacy 17 C. Efficiency 17 D. Sustainability 17 E. Institutional Development and Other Impacts 17 F. Overall Program Rating 17 G. Assessment of ADB and Borrower Performance 17

Tetsu Ito, evaluation specialist (team leader), was responsible for the preparation of this report, conducted document reviews and key informant interviews, and guided the fieldwork undertaken by Yawer Sayeed and Asif Ali Qureshi (staff consultants). Barbara Palacios, senior evaluation officer, and Vivien Ramos, evaluation officer, supported the team with research assistance from Manila.

The guidelines formally adopted by the Operations Evaluation Department (OED) on avoiding conflict of interest in its independent evaluations were observed in the preparation of this report. To the knowledge of the management of OED, there were no conflicts of interest of the persons preparing, reviewing, or approving this report.

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VI. ISSUES, LESSONS, AND FOLLOW-UP ACTIONS 18 A. Key Issues for the Future 18 B. Lessons Identified 20

APPENDIXES 1. Policy Matrix 22 2. Evaluation of TA Loan 1577-PAK(SF): Capacity Enhancement of the Securities 50 Market 3. Statistical Data 56

BASIC DATA

Program Preparation/Institution Building TA No.

Technical Assistance Name Type Person-Months

Amount ($’000)

Approval Date

2393 Capital Market Development ADTA 23.0 865 7 Sep 19952812 Interest Rate Management of National Savings

Scheme ADTA 9.5 100 18 Jun 1997

2825 Capital Market and Insurance Law Reform ADTA 4.0 100 14 Jul 19972865 Restructuring of Public Sector Mutual Funds ADTA 32.0 800 15 Sep 19972866 Reform of the Insurance Industry ADTA 40.0 700 15 Sep 19972867 Reform of Pension and Provident Funds ADTA 34.0 600 15 Sep 1997

Key Project Data ($ million) As per ADB Documents Actual

Loan 1576-PAK TA Loan 1577-PAK(SF)

Loan 1576-PAK TA Loan 1577-PAK(SF)

ADB Loan Amount/Utilization 250.0 5.0 250.0 3.6a Key Dates Expected Actual Loan 1576-PAK TA Loan

1577-PAK(SF) Fact-Finding 4–18 Apr 1997 3–16 Apr 1997 Appraisal 8–28 Jul 1997 Loan Negotiations 2nd week, Sep 1997 16–18 Sep 1997 Board Approval 1st week, Nov 1997 6 Nov 1997 Loan Agreement 5 Jan 1998 5 Jan 1998 Loan Effectiveness 5 Apr 1998 5 Jan 1998 First Disbursement 5 Apr 1998b 6 Jan 1998 27 Apr 1999 Second Disbursement 6 Jan 2000b 22 Jun 2000 Loan Closing 31 Dec 2000 31 Oct 2001c 30 Jul 2002 Months (effectiveness to completion) 33 46 55 Borrower Pakistan Executing Agency Ministry of Finance Mission Data Loan 1576-PAK TA Loan 1577-PAK(SF) No. of Missions Person-Days No. of Missions Person-DaysReconnaissance 1 52 Fact-Finding 1 70 Appraisal 1d 126 Project Administration

Contact Negotiations 1 37 Inception 1 126 Review 6 d 179 1 15 Program Completione Operations Evaluation 1d 48

ADTA = advisory technical assistance. a The remaining $1.2 million was canceled at loan closing. The amounts used and canceled do not add to $5 million

because of fluctuation in the $/SDR exchange rate. b For Loan 1576-PAK. c To complete program implementation, the loan closing date was extended twice. d For Loan 1576-PAK and TA Loan 1577-PAK(SF). e The program completion report was prepared with no program completion mission.

EXECUTIVE SUMMARY

On 6 November 1997, the Asian Development Bank (ADB) approved a loan of $250 million from its ordinary capital resources to the Government of Pakistan for the Capital Market Development Program (CMDP). The CMDP aimed to accelerate the mobilization of long-term resources and improve the efficiency of their allocation through a diversified and competitive capital market that encouraged the broad-based participation of issuers and investors.

The CMDP was to achieve its purpose by (i) creating a policy environment to enhance

competition and a level playing field, (ii) strengthening securities market governance, institutions, regulation, and supervision; (iii) improving and modernizing the market infrastructure and promoting its integration; (iv) developing the corporate debt market; (v) reforming the mutual fund industry; (vi) developing the leasing industry; and (vii) promoting contractual savings through reforms of the insurance sector and pension and provident funds. The policy matrix of the CMDP included 58 program measures. Of these, 30 actions were already taken before Board approval, and 28 actions were to coincide with or precede the release of the second tranche (11 were the conditions for the release).

In conjunction with the CMDP, ADB approved a technical assistance (TA) loan of $5

million equivalent from ADB Special Fund resources for the Capacity Enhancement of the Securities Market (TA Loan 1577-PAK[SF]). The TA loan aimed to support the (i) institutional strengthening of the Securities and Exchange Commission of Pakistan (SECP), (ii) strengthening of the self-regulatory mechanism for key market participants, (iii) establishment of the National Clearing and Settlement System (NCSS), and (iv) establishment of an over-the-counter (OTC) market to develop the secondary bond market.

The CMDP loan took effect on 5 January 1998. The first tranche of $125 million was

disbursed on 6 January 1998. The second tranche of the same amount was disbursed on 22 June 2000, 6 months later than originally scheduled, because of slow program implementation. At the release of the second tranche, ADB confirmed compliance with eight conditions for the release, substantial compliance with one condition, and partial compliance with two conditions. To complete the Program, ADB extended the loan closing date to 31 October 2001, 10 months later than first planned. TA Loan 1577-PAK(SF) closed on 30 July 2002, 19 months later than planned. The program completion report (PCR), prepared in November 2002, rated the CMDP successful.

The Operations Evaluation Mission (OEM) confirmed full compliance with 26 out of 30

policy conditions that were to be met before the release of the first tranche. Of the remaining four conditions, one had been partly complied with, one had not been complied with, while compliance with the other two conditions could not be verified. The OEM also confirmed full compliance with 20 out of the 28 conditions to be met by the time the second tranche was released. Of the remaining eight conditions, one had been complied with after major modification. Overall, the OEM found that 46 (79%) of the 58 conditions had been fully complied with. The PCR did not assess the status of CMDP conditions to be met before the release of the first tranche, but confirmed full compliance with 21 (75%) of the 28 remaining conditions.

In the OEM’s assessment, the CMDP was highly relevant. The assessment was based

on the following observations: (i) the key implementing agency, i.e., SECP (the Corporate Law Authority [CLA] at the time of loan approval), had taken ownership of the reforms and was supported by a favorable political economy of decision making; (ii) ADB processing missions had adequate knowledge and analysis of the country; (iii) ADB missions had extensive policy dialogue with the agencies concerned and broad consultation with stakeholders, (iv) the

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program purpose was consistent with the country’s development priorities and the ADB country and sector assistance strategy at appraisal and evaluation; (v) the lending modality, i.e., program loan, was appropriate, given the reform momentum and foreign reserves of the country; and (vi) the policy matrix was comprehensive, cohesive, and realistic, and it had a manageable number of appropriately sequenced program measures.

The OEM deemed the CMDP efficacious in view of the outcomes of the seven

components and the performance indicators. The OEM noted the satisfactory achievements of the four components concerning (i) competition and level playing field; (ii) securities market governance, institutions, regulations, and supervision; (iii) securities market infrastructure; (iv) the leasing industry; and (v) the mutual fund industry. But, according to the OEM, the achievements of the corporate debt market component and the insurance and pension reforms component were only partly satisfactory. The mission’s assessment of the performance indicators was as follows: (i) the primary share market showed signs of recovery from fiscal year (FY) 2004; (ii) transactions in the secondary share market have significantly increased since FY2003; (iii) market capitalization started to increase in FY2003, reflecting the rapid increase in the index price; (iv) market infrastructure has been upgraded largely to the standards recommended by the International Securities Service Association; (v) the GDP share of total investment in leasing assets remained at the same level from FY1994 to FY2004; (vi) mutual funds have increased in size since FY2003; and (vii) total premiums collected by general and life insurance have progressively increased since FY1994.

The OEM assessed the CMDP as efficient for two main reasons: (i) the program effects

relative to costs met the expectations of the Government and stakeholders; and (ii) the program management was appropriate, in view of interagency coordination, monitoring and reporting, policy dialogue, and ADB’s disbursement decision at the release of the second tranche. Moreover, the OEM considered appropriate the extensions of the program period to monitor unaccomplished program measures. The SECP noted that continuity in staff assignment on the ADB side helped maintain a close and constructive partnership. If the associated TA loan had more effectively complemented program implementation, OEM could have assessed the CMDP as highly efficient.

The OEM’s assessment is that most CMDP achievements are likely to be sustainable, considering (i) the Government’s continued commitment to the program purpose, demonstrated through follow-on policy measures, and (ii) stakeholders’ support for the program achievements. However, the gains brought by sound capital market development remain at risk from the growing high-profile financial crimes and new forms of market manipulation as witnessed during the recent market upheavals. Based on lessons learned from this experience, SECP is further strengthening its surveillance function and enforcement of rules under the ongoing Financial (Nonbank) Markets and Governance Program.

The organizational development and other impacts of the CMDP, according to the OEM, were significant. The CMDP contributed to (i) the conversion of CLA to SECP, and empowerment of SECP as an independent oversight institution for the capital market and nonbank finance companies; (ii) the enhancement of accountability and improvement of operations of the stock exchanges; (iii) the establishment of the Central Depository Company of Pakistan and the National Clearing Company of Pakistan; (iv) the restructuring of the Investment Corporation of Pakistan and the National Investment Trust Limited; and (v) the corporatization of Pakistan Insurance Corporation and National Insurance Company Limited. However, the CMDP did not effectively support developing self-regulatory organizations in the capital and financial markets. The stock market rally in recent years significantly contributed to

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job creation in the market industry, in the OEM’s view, and to the broadening of the investor base in the country including individuals.

On the basis of the above, the overall rating of the CMDP is successful. The lack of verifiable records from the implementing agencies and ADB hampered the evaluation of TA Loan 1577-PAK(SF). From the limited data available, the OEM considered that TA outputs: (i) contributed marginally to the institutional strengthening of the SECP and the privatization of mutual funds, (ii) contributed significantly to the establishment of NCSS, and (iii) did not lead to the promotion of self-regulatory organizations and an OTC debt market. Overall, the TA loan contributed less than expected to the CMDP and is therefore rated partly successful. The OEM attributed the success of the CMDP to SECP’s ownership of reforms, supported by a favorable political economy and effective policy dialogues. The key ingredients of the effective dialogues were the following: (i) ADB processing missions knew enough about the country because an economic and sector work mission had been fielded before the reconnaissance mission; (ii) the reconnaissance mission had extensive policy dialogue with agencies concerned, especially CLA, and broad consultation with stakeholders; (iii) the policy matrix was drafted at an early stage of processing, and the Government took substantial actions before loan approval; (iv) ADB processing and review missions made efforts to come up with alternative policy measures leading to realistic solutions while enhancing ownership of reforms; (v) one ADB processing mission member remained responsible for program implementation until the end, contributing to a close and constructive partnership; and (vi) ADB continued to monitor unattained non-tranche program measures by extending the loan closing date. All these are considered good practices for ADB’s policy-based lending. The establishment of workable self-regulatory market institutions was one of the few unfulfilled items on the CMDP agenda. SECP believes that excessive autonomy granted to regional, mutualized stock exchanges may create self-interest clubs, and is therefore actively pursuing demutualization before the exchanges’ self-regulation replaces some of the SECP’s regulatory oversight. This approach could apply as well to other developing countries pursuing capital market governance reforms in some cases, depending on the ownership and management structure of their stock exchanges. Delays in the implementation of related stand-alone TAs and TA Loan 1577-PAK(SF) impeded timely compliance with the relevant conditions for the second tranche under CMDP. This experience underscores the need for realistic and consistent timelines. Presumably because of the lack of verifiable outputs and records, no overall rating was given to TA Loan 1577-PAK(SF) in the PCR on CMDP. No separate project completion report was prepared for this TA loan. The OEM’s review of the relevant project/program completion reports suggested a general weakness in ADB’s self-evaluation of TA loans attached to project or program loans.

Bruce Murray Director General Operations Evaluation Department

I. BACKGROUND A. Rationale 1. In the early 1990s, the economy of Pakistan grew modestly but was characterized by balance of payment and fiscal imbalances that undermined economic stability. From 1993 to 1996, the Government made several attempts under International Monetary Fund (IMF) programs to address the macroeconomic imbalances and deep-rooted structural problems. However, slippages in policy implementation as well as policy reversals muted the supply response, bringing the economy to the verge of a banking crisis in 1996. The economic instability and institutional constraints of the capital market induced vulnerability in the Karachi Stock Exchange (KSE) Index, which fell from around 2660 in March 1994 to 1332 on 10 September 1996. 2. Citing economic mismanagement and corruption, the President of Pakistan dismissed former Prime Minister Benazir Bhutto’s administration in November 1996, dissolved parliament, and called for elections. In February 1997, the Pakistan Muslim League, headed by former Prime Minister Nawaz Sharif, won a landslide victory at the polls and captured a majority of the seats in parliament. With a strong electoral mandate, the new Government quickly prepared a comprehensive stabilization and structural adjustment program, including banking and capital market reforms. In line with its country operational strategy for Pakistan of 1995,1 the Asian Development Bank (ADB) was to support the capital market reform. This support was premised on IMF and World Bank support for banking sector reform.2 3. The report and recommendation of the President (RRP) gave the following rationale for the Capital Market Development Program (CMDP):3 “The development of the securities market will facilitate the efficient allocation of resources in the economy and help broaden and deepen the financial sector, while providing alternative sources of funding to industry, which has traditionally relied on Government directed credit.” B. Formulation 4. In early 1997, the Government requested ADB to process the CMDP. Diagnostic studies for the CMDP relied on the findings of an economic and sector work mission from December 1996 to January 1997, supplemented by outputs of a preceding technical assistance (TA) grant. 4 Following extensive policy dialogue with relevant Government agencies and broad consultation with market participants, a reconnaissance mission in February–March 1997 determined the CMDP objective and components. A fact-finding mission in April 1997 reached broad consensus with the Government on the policy matrix, which included more than 40 actions to be taken before the release of the first tranche. Substantial progress was made on the prior actions. An appraisal mission was therefore fielded in July 1997 to fine-tune the policy matrix and discuss the scope of a TA loan to complement the CMDP. An ADB mission visited Washington, DC, in August 1997 to coordinate with the IMF and the World Bank on policy

1 ADB. 1995. Country Operational Strategy Study for Pakistan. Manila. 2 International Monetary Fund. 1997. Enhanced Structural Adjustment Facility; and World Bank. 1997. Banking

Sector Adjustment Loan. 3 ADB. 1997. Report and Recommendation of the President to the Board of Directors on Proposed Loans to the

Islamic Republic of Pakistan for the Capital Market Development Program. Manila (Loan 1576-PAK, for $250 million and TA Loan 1577-PAK[SF], for $5 million, approved on 6 November 1997).

4 ADB. 1995. Technical Assistance to the Islamic Republic of Pakistan for Capital Market Development. Manila (TA 2393-PAK, for $865,000, approved on 7 September 1995).

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support operations in Pakistan. The loan negotiation for the CMDP was held in September 1997. C. Purpose and Outputs 5. The purpose of the CMDP, as stated in the RRP, was “to accelerate the mobilization of long-term resources and improve the efficiency of its allocation through a diversified and competitive capital market, which encourages broad-based participation of issuers and investors.”5 The CMDP had seven components: (i) creating an enabling policy environment to enhance competition and a level playing field, (ii) strengthening securities market governance, institutions, regulation, and supervision; (iii) improving and modernizing the market infrastructure and promoting its integration; (iv) developing the corporate debt market; (v) reforming the mutual fund industry; (vi) developing the leasing industry; and (vii) promoting contractual savings through reforms of the insurance sector and pension and provident funds. The CMDP comprised a total of 58 policy actions (Appendix 1)—30 actions already taken before Board approval, and 28 actions to be taken by the time the second tranche was released (11 were conditions for the release). 6. TA Loan 1577-PAK(SF) for Capacity Enhancement of the Securities Market was to support the (i) institutional strengthening of the Securities Exchange Commission of Pakistan (SECP), (ii) strengthening of the self-regulatory mechanism for key market participants, (iii) establishment of the National Clearing and Settlement System (NCSS), and (iv) establishment of an over-the-counter (OTC) market to develop the secondary bond market (Appendix 2). D. Cost, Financing, and Executing Arrangements 7. On 6 November 1997, ADB approved a loan of $250 million from its ordinary capital resources for the CMDP. Counterpart funds generated from this program loan were to be used by the Government to finance the adjustment costs of around $514 million associated with the CMDP and high-priority development projects (para. 36). 8. The CMDP was to be implemented over a period of 3 years from the date of loan effectiveness. The loan was to be disbursed in two equal tranches of $125 million each, the first to be available upon loan effectiveness and the second after 2 years, as indicated in the policy matrix and the main text of the RRP. However, the program summary in the RRP indicated that the second tranche could be released within the 3-year program period. The Loan Agreement stipulated that “the proceeds of the Loan are expected to be utilized by 31 December 1999” while indicating the loan closing date to be 31 December 2000. The reason for this one-year discrepancy was not discussed. 9. The Ministry of Finance (MOF) was the Executing Agency for the program loan. It was to coordinate and monitor the overall implementation of the CMDP, and administer the utilization of the loan proceeds. MOF was to be supported by (i) SECP in overseeing and coordinating the implementation of the reforms in the stock exchanges, leasing industry, and mutual funds; and (ii) the Ministry of Commerce (MOC) in overseeing the implementation of the insurance industry reforms.

5 The Loan Agreement stated that the CMDP objective is “to develop the Borrower’s capital market by enhancing

investor confidence and promoting a diversified, competitive and market-based capital market through, among other things, appropriate regulatory and institutional reform.”

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10. TA Loan 1577-PAK(SF) (footnote 3) for $5 million was approved in conjunction with the CMDP. SECP was the Executing Agency for the TA loan. The Central Depository Company of Pakistan (CDC) was to provide support in implementing the NCSS component, while a separate legal entity, with the support of the stock exchanges and lead financial institutions, was to be set up for the establishment of an OTC market. 11. To complement the CMDP, ADB also approved the following stand-alone TAs in June–September 1997: (i) TA 2812-PAK: Interest Rate Management of National Saving Scheme,6 (ii) TA 2825-PAK: Capital Market and Insurance Law Reform,7 (iii) TA 2865-PAK: Restructuring of Public Sector Mutual Funds, 8 (iv) TA 2866-PAK: Reform of Insurance Industry, 9 and (v) TA2867-PAK: Reform of Pension and Provident Funds.10 E. Completion and Self-Evaluation 12. The CMDP loan took effect on 5 January 1998.The first tranche of $125 million was disbursed on 6 January 1998. The second tranche of the same amount was disbursed on 22 June 2000, 6 months later than originally scheduled. To allow monitoring of the progress of unaccomplished program measures, the loan closing date of Loan 1576-PAK was extended twice to 31 October 2001, 10 months later than initially planned (para. 40). TA Loan 1577-PAK(SF) closed on 30 July 2002, after four extensions and 19 months later than initially planned. The program completion report (PCR)11 on both the CMDP and the TA loan was circulated to the Board in November 2002. 13. The PCR rated the CMDP successful on the basis of the following: (i) the Program was highly relevant to the country and maintained its relevance during implementation; (ii) the Program achieved definite results in key reform areas, e.g., modernization of the stock market infrastructure, establishment of SECP, and improved efficiency and enhanced accountability of the stock market; and (iii) CMDP outputs and outcomes were likely to be sustained. The PCR confirmed full compliance with 51 policy requirements, substantial compliance with 2 requirements, 12 and partial compliance with 3 requirements, 13 while considering 2 other requirements14 inappropriate, in accordance with the opinion expressed by the consultant under TA Loan 1577-PAK(SF). The PCR recommended independently evaluating the CMDP within 3 years.

6 ADB. Technical Assistance to Pakistan for Interest Rate Management of National Saving Scheme. Manila (TA

2812-PAK, for $100,000, approved on 18 June 1997). 7 ADB. Technical Assistance to Pakistan for Capital Market and Insurance Law Reform. Manila (TA 2825-PAK, for

$100,000, approved on 14 July 1997). 8 ADB. Technical Assistance to the Islamic Republic of Pakistan for Restructuring of Public Sector Mutual Funds.

Manila (TA 2865-PAK, for $800,000, approved on15 September 1997). 9 ADB. Technical Assistance to the Islamic Republic of Pakistan for Reform of Insurance Industry. Manila (TA 2866-

PAK, for $700,000, approved on 15 September 1997). 10 ADB. Technical Assistance to the Islamic Republic of Pakistan for Reform of Pension and Provident Funds. Manila

(TA 2867-PAK, for $600,000, approved on 15 September 1997). 11 ADB. 2002. Program Completion Report on the Capital Market Development Program (Loan 1576-PAK) and

Capacity Enhancement of the Securities Market (TA Loan 1577-PAK[SF]) in Pakistan. Manila. 12 These concerned (i) upgrading of corporate legislation (second-tranche condition), and (ii) improvement of credit

administration in the leasing industry (non-tranche condition). 13 These concerned (i) establishment of NCSS (second-tranche condition), (ii) restructuring of mutual funds run by

state-owned investment companies (second-tranche condition), and (iii) upgrading of the Pakistan Insurance Institute (non-tranche condition).

14 These concerned (i) development of the Mutual Fund Association of Pakistan and Leasing Association of Pakistan as self-regulatory organizations, and (ii) establishment of an OTC market for government and corporate debts.

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14. The PCR adequately assessed the CMDP outputs and outcomes. However, it did not discuss compliance with the conditions for the second tranche at the time of its actual release15 and the appropriateness of ADB’s disbursement decision. Moreover, the PCR did not include enough information to allow an evaluation of TA Loan 1577-PAK(SF) and, hence, did not give an overall rating (para. 84). The PCR’s findings on the TA loan can be summarized as follows: (i) two components, i.e., institutional strengthening of SECP and establishment of the NCSS, complemented CMDP; (ii) program measures related to two other components, i.e., strengthening of the self-regulatory framework and establishment of an OTC market for the secondary bond market, were premature; and (iii) another component added in January 2000 to support the restructuring of mutual funds run by state-owned companies complemented CMDP. F. Operations Evaluation 15. An Operations Evaluation Mission (OEM) was undertaken from 25 April to 10 May 2005. The OEM met with representatives of the following: MOF, MOC, State Bank of Pakistan (SBP), SECP, Privatization Commission, Central Directorate of National Savings (CDNS), KSE, Lahore Stock Exchange (LSE), Islamabad Stock Exchange (ISE), CDC, National Clearing Company of Pakistan (NCC), Leasing Association of Pakistan (LAP), and other agencies concerned and market participants.16 This program performance evaluation report (PPER) incorporates OEM findings, survey results, observations of ADB staff concerned, and a review of reports and documents related to the CMDP. The draft PPER was circulated to the Government and within ADB. Comments received were considered in finalizing the PPER. 16. This report also considers the earlier evaluation of related TAs,17 which rated TA 2812-PAK (footnote 6) highly successful; TA 2825-PAK (footnote 7) and TA 2866-PAK (footnote 9) successful; and TA2865-PAK (footnote 8) and TA2867-PAK (footnote 10) partly successful.

II. PLANNING AND IMPLEMENTATION PERFORMANCE

A. Formulation and Design 17. The OEM considered the CMDP formulation appropriate in view of the following observations: (i) the key implementing agency, i.e., SECP (Corporate Law Authority [CLA] at the time of loan approval), had taken ownership of reforms and was supported by a favorable political economy; (ii) ADB processing missions had adequate knowledge and analysis of the country; (iii) ADB missions had extensive policy dialogue with concerned agencies, especially CLA, and broad consultation with stakeholders (except on self-regulatory organizations [SROs]) and the OTC debt market); (iv) a policy matrix was drafted at an early stage of processing, and the Government took substantial actions18 before loan approval; and (v) ADB missions made

15 ADB. 2000. Capital Market Development Program Progress Report: Release of Second Tranche. Manila. In this

report, ADB confirmed compliance with eight conditions, substantial compliance with one, and partial compliance with two.

16 Before the OEM, the domestic consultant surveyed the outcomes of the CMDP through semi-structured interviews with five reputed market players. OEM conducted interviews on the basis of the survey findings.

17 ADB. 2003. Technical Assistance Performance Audit Report (TPAR) on Selected Advisory Technical Assistance for Capital Market Development in Pakistan. Manila.

18 The key policy actions included (i) reforms of taxes on equity transactions, (ii) relaxation of investment guidelines for institutional investors, (iii) promulgation of SECP Act 1997, (iii) reforms of governance in stock exchanges, (iv) introduction of an automated share trading system, and (v) promulgation of the Central Depository Act 1997.

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efforts to come up with alternative policy measures19 leading to realistic solutions to bottleneck issues faced by the country and its institutions. The OEM also noted that ADB had identified the need for a full-fledged Program through the less-than-satisfactory Financial Sector Intermediation Loan,20 which was hybrid in nature, addressing the need for investment financing and policy reforms. 18. The OEM assessed the CMDP design as appropriate for the following reasons: (i) the program objective was consistent with the country’s development priorities and ADB’s country and sector assistance strategy, both at appraisal and at evaluation; (ii) the lending modality, i.e., program loan, was appropriate in view of the reform momentum and foreign reserves of the country;21 (iii) the policy matrix was comprehensive, cohesive, and realistic, and consisted of a manageable number of appropriately sequenced program measures; (iv) the program framework identified workable performance indicators; (v) risk-mitigating measures based on adequate risk analysis were in place; (vi) the TA loan and grants provided were enough to support CMDP implementation; and (vii) CMDP was designed to complement the IMF’s Enhanced Structural Adjustment Facility (ESAF) and the World Bank’s Banking Sector Adjustment Loan. 19. The OEM largely supported the policy matrix, with some reservations on two policy measures: (i) self-regulation of market participants, and (ii) development of the corporate debt market. For the first item, the program measure for the release of the second tranche required the SECP to set minimum criteria for granting a SRO status to stock exchanges. However, the SECP Act 1997 already assumes stock exchanges to be SROs under the oversight of SECP. Hence, the policy matrix should have specified the criteria that stock exchanges had to follow to maintain the SRO status. With such guidance, the SECP could have put more effort into pursuing this particular program measure. Another program measure related to the SRO status for the Mutual Fund Association of Pakistan (MUFAP) would have been meaningful only after the Government divested itself of its majority shareholding in the mutual fund industry. As to the corporate debt market, CMDP included the following measure: “market participants will develop and establish an OTC market.” This should have been a program outcome rather than a program measure. The policy matrix should have specified who should do what to achieve the expected outcome. 20. TA Loan 1577-PAK(SF) was designed to support the agencies concerned in meeting the CMDP conditions for the second tranche that were not supported under previous stand-alone TAs. Unlike the CMDP, the TA loan did not have a clear scope until the last phase of CMDP formulation, and the RRP did not spell out the terms of reference in detail.

19 For instance, a regulatory architecture envisaged at the start called for SECP to provide off-site supervision while

the proposed National Self-Regulatory Association (NSRA) provided on-site and continuous surveillance. At the same time, however, ADB and CLA agreed to promote self-regulatory organization as an alternative to the creation of the NSRA. The Government pursued this alternative. Likewise, ADB was open to two policy options: (i) SECP overseeing the securities market while creating a separate entity to supervise corporate affairs; or (ii) SECP overseeing both the securities market and corporate affairs. The Government pursued the latter option.

20 ADB. 1995. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Islamic Republic of Pakistan for the Financial Sector Intermediation Loan. Manila (Loan 1371-PAK, for $100 million, approved on 7 September 1995).

21 In Pakistan, fiscal and external imbalances became unsustainable in 1996, resulting in an unprecedented decline in foreign exchange reserves to the equivalent of 2 weeks of imports in November 1996.

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B. Achievement of Program Measures 21. The OEM confirmed full compliance with 26 out of 30 policy conditions that were to be met before the release of the first tranche. Of the remaining four conditions, one had been partly complied with, one had not been complied with, while compliance with the other two conditions could not be verified. The policy condition deemed partly complied with concerned the privatization of mutual funds run by the state-owned National Investment Trust Limited (NIT). The condition deemed not complied with concerned SRO status for MUFAP and LAP. The OEM could not independently verify if the program conditions for the OTC debt market and the Pakistan Insurance Institute had been met. 22. The OEM confirmed full compliance with 20 out of 28 conditions for the second tranche. Of the remaining eight conditions, one had been complied with after major modification (para. 34), five had been partly complied with, and two had not been complied with. The policy conditions that were deemed partly complied with concerned (i) development of an OTC debt market, (ii) strengthening of the regulatory framework, and monitoring and inspection of mutual funds, (iii) privatization of NIT’s mutual funds, (iv) reinforcement of lessors’ right of repossession, and (v) reconstitution of the Insurance Claim Settlement Board. The conditions deemed not complied with concerned (i) setting of minimum criteria for SRO status for the stock exchanges, and (ii) granting of SRO status to MUFAP and LAP. 1. Create an Enabling Policy Environment to Enhance Competition and a Level Playing Field 23. This component had several key policy achievements. It (i) relaxed investment restrictions for employee provident funds and life insurance companies, (ii) rationalized tax anomalies in the equity market, (iii) reformed the interest rate and tax structures of the national savings scheme (NSS), 22 and (iv) rationalized the tax regime for mutual funds. Complemented by TA 2812-PAK (footnote 6), CMDP made particularly noteworthy progress in NSS reform. It (i) aligned NSS returns with yields on market-traded Government bonds, and (ii) ended the tax exemption on NSS by applying uniform tax rates to fixed-income securities. As a key non-CMDP measure implemented in conjunction with the above measures, institutional investors were barred from investing in the NSS. 24. Since CMDP implementation, NSS rates have been adjusted every 6 months since July 2002 to align them with yields on market-traded Government bonds. The yield on 10-year defense savings certificates was revised from 14% to 11.6% in July 2002, 10% in January 2003, 8.5% in July 2003, 7.96% in January 2004, and 8.15% in July 2004. CDNS, the institution responsible for managing NSS, is being rationalized under the Financial (Nonbank) Markets and Governance Program (FMGP).23

22 Administered by CDNS of MOF, NSS is a source of nonbank financing for the fiscal deficit. There are various

schemes under NSS, but two major ones are 3-year special savings certificates (SSCs) with semiannual interest payments and 10-year defense savings certificates with single payment of profit plus principal at maturity. Aside from being risk-free, NSS investments are on tap, and until March 2000 were also available to institutional investors, which could benefit from higher-than-market returns and the tax-exempt status of the investments. These NSS peculiarities hampered the growth of both the banking system and the capital markets. As of June 2000, total investment in NSS was PRs715 billion, equivalent to about 60% of all deposits in the banking sector.

23 ADB. 2002. Report and Recommendation of the President to the Board of Directors on Proposed Loans and Guarantees to the Islamic Republic of Pakistan for the Financial (Nonbank) Markets and Governance Program. Manila (Loans 1955/1956/1957-PAK, for $260 million, approved on 5 December 2002).

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2. Strengthen Securities Market Governance, Institutions, Regulations and Supervision 25. The promulgation of the SECP Act in December 1997 and the operationalization of SECP in January 1999 were the key achievements of CMDP. The SECP Act gave operational and financial autonomy to SECP in regulating the securities markets, nonbanking finance companies (NBFCs), and corporate affairs by empowering it to administer the Securities and Exchange Ordinance of 1969, Modaraba Companies (Floatation and Control) Ordinance of 1980, and Companies Ordinance of 1984. 26. As envisaged under CMDP, the three stock exchanges (i) adjusted their board and management structures,24 (ii) promoted the corporatization of member brokers, and (iii) created investor protection funds. SECP issued most of the rules that the stock exchanges were required to adopt under CMDP. These were (i) trade reporting rules including penalties for insider trading, (ii) inspection rules, (iii) licensing standards for traders and agents, (iv) listing requirements and guidelines, and (v) model contractual agreements. SECP has not set minimum criteria for SRO status for the stock exchanges, as envisaged under CMDP (para. 19). SECP directives have been more dominant than self-regulation on stock exchanges in introducing regulatory changes. While CMDP supported SRO status for MUFAP and LAP, there was little progress toward this end. The consulting team under TA Loan 1577-PAK(SF) submitted a report on the framework for self-regulation by the targeted agencies, but the OEM could neither obtain a copy of this report nor verify SECP’s response to it. The SECP, in consultation with the industry, is now trying to decide whether a single SRO will suffice for all NBFCs or a separate SRO is needed for each licensed activity. 27. In recent years, SECP’s Securities Markets Division has strengthened its enforcement function against insider trading and market manipulation. SECP also aims to phase out the decades-old system of carry-over transactions (COTs),25 which permit excessive leveraging, and is encouraging its substitution with margin financing. Another key follow-on measure being pursued by SECP is demutualization26 of the stock exchanges. While all three stock exchanges have in principle agreed on demutualization and submitted their plans to SECP, LSE and ISE have announced their plan to integrate.

24 The number of directors on board of stock exchanges has been reduced from 18 to 10, half of whom (including the

managing director) are nonmember directors. Member directors are elected by members of the stock exchanges, while external directors are nominated by SECP from various trade and professional bodies. The chairmen of the exchanges are elected by the board from the elected directors. The operational and administrative activities of the exchanges are managed by the full-time chief executives, whose appointments are subject to the approval of SECP.

25 A COT is essentially financing for leveraged transactions in the form of a repurchase agreement with a few peculiar characteristics. There is a separate market session for COT financing through the same automated trading system used for cash transactions. However, the COT session takes place after the close of trading hours for the regular market. So the borrower first buys a stock in the regular market and then seeks financing in the COT session by selling the stock to the COT financier at the closing price of the stock. The borrower commits to buy back the stock at a higher price the next day but has the option to roll over the position daily for up to 10 days. COT financing is for 100% of the share value without any margin. The difference between the purchase and sale prices is the return to the COT financier. As COT financing session takes place after the close of the regular market, the borrower is not assured of COT financing at the time of trade and may need to arrange financing from some other source. Both borrowers and financiers in the COT market transact through brokers. Those who provide COT financing are banks, development finance institutions (DFIs), NBFCs, and individuals.

26 SECP in February 2004 set up an expert committee, which released its report in October 2004 supporting the demutualization and integration of all three stock exchanges. An alternative model that was considered involved setting up a new national stock exchange.

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3. Improve and Modernize the Securities Market Infrastructure and Promote Its Integration 28. This component (i) introduced automated trading systems in the stock exchanges; (ii) operationalized the central depository system (CDS); and (iii) developed the NCSS. The first two conditions were met during the program period. In conjunction with these achievements, the open outcry system was completely phased out in 1998 and replaced by computerized, screen-based systems, which improved the efficiency and handling capacity of the stock exchanges. Moreover, the stock exchanges have allowed the use of remote trading terminals, and are implementing Internet-based trading systems. NCSS was fully operationalized in December 2001. Delay in operationalization reflected the slower-than-expected implementation of TA Loan 1577-PAK(SF). Since January 2004, all securities in the CDS have also been added to NCSS. NCC, the operator of NCSS, was developed within CDC but is now being separated from it, with the information technology, the only shared function still handled by CDC. NCC is now modifying its systems in preparation for the implementation of the margin financing module. 29. LSE and ISE recently announced their integration plan. KSE, which has reservations about integration, has sought clarification from SECP on a few issues. 4. Develop the Corporate Debt Market 30. This component was intended to (i) set up a working group of market participants to devise a centralized electronic trading system, (ii) establish and develop an OTC debt market, and (iii) introduce prudential guidelines for the use of repurchase agreements in private debt securities. Whereas (iii) was implemented, (ii) was not vigorously pursued during the CMDP period and OEM could not independently verify if (i) had been implemented. The consulting team under TA Loan 1577-PAK(SF) concluded that an OTC debt market was premature considering the level of capital market development in the country. Since CMDP implementation, however, trading, clearing, and settlement systems and procedures have been developed for stocks and term finance certificates (TFCs), or corporate debt, on the OTC market.27 The legal framework is also in place. The OTC market is expected to be functional once securities are listed on the OTC Board. In view of these developments after the CMDP, (ii) is considered partially complied with. 5. Reform the Mutual Fund Industry 31. As envisaged under this component, (i) SECP has been given regulatory control over public and private sector mutual funds through the SECP Act, and (ii) the updating of the policy framework has allowed the emergence of sector-specific funds and liberalized investment requirements, thus facilitating portfolio diversification. Moreover, the management rights of all 26 funds of the state-owned Investment Corporation of Pakistan (ICP) were sold in three lots to private sector institutions from September 2002 to April 2003 (Appendix 3, Table A3.7). Representatives of ICP and the Privatization Commission are of the opinion that TA 2865-PAK (footnote 8) and TA Loan 1577-PAK(SF) contributed only marginally to this accomplishment, since they failed to offer practical solutions to bottleneck issues that caused delay in meeting this program requirement. 27 KSE has increased the paid-up capital requirement for securities to be listed on its Ready Board from PRs50

million to PRs200 million. This development should encourage small companies to seek a listing on the OTC market, where the minimum capital requirement is PRs10 million. The exchanges are now turning to leading corporate brokerage houses and professional firms that do consulting and advisory work on initial public offerings (IPOs) for help with market making for scrips to be listed on the OTC market.

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32. According to the OEM, the following program measures were partially complied with: (i) strengthening of the regulatory framework of SECP and development of its monitoring and inspection capabilities, and (ii) privatization of mutual funds run by NIT. Those interviewed by the OEM gave mixed feedback about the first measure. So far, SECP has made no on-site inspection of any mutual fund. As to the second measure, the Privatization Commission has developed a plan that would split NIT into sub-funds, hand over management rights of some sub-funds to the large unit holders in lieu of letters of comfort for a minimum guaranteed price, and sell management rights of the remaining funds to the private sector. Once this plan is approved by higher authority, the Privatization Commission will take the transaction to the market. 6. Develop the Leasing Industry 33. Under this component the CMDP (i) transferred regulatory control of the leasing sector to SECP, (ii) secured compliance with increased capital requirements and prudential norms, and (iii) set the legal framework for asset-backed securities. Moreover, SECP urged LAP to collaborate with SECP to strengthen (i) industry standards for credit administration, pricing, and portfolio and asset-liability management; and (ii) lessor’s right of repossession. However, as LAP did not take any substantial action, SECP addressed these issues instead in the prudential regulations for NBFCs. 7. Promote Contractual Savings through Reforms of the Insurance Sector, and Pension and Provident Funds 34. The key CMDP achievements in insurance reform were (i) progressive increase in the minimum paid-up capital requirement for insurance companies, and (ii) corporatization of the state-owned National Insurance Company Limited (NIC) and Pakistan Insurance Corporation (PIC). In conjunction with the corporatization, PIC was renamed Pakistan Reinsurance Company Limited. TA 2866-PAK (footnote 9) complemented these achievements. Another key program measure, i.e., the establishment of an independent regulator for the insurance sector, was implemented with a major modification: the Government withdrew its original plan to establish the Pakistan Insurance Regulatory Authority (PIRA) and instead assigned SECP to regulate the insurance industry through an amendment to the SECP Act. However, the oversight arrangement over the insurance industry remains unclear. SECP and MOC have issued their own rules while SECP has neither significant enforcement powers nor the power to revoke licenses. Neither the Pakistan Insurance Institute nor the setting of industry standards has been upgraded as envisaged under CMDP. 35. The implementation of TA 2867-PAK (footnote 10) was a key CMDP measure in the area of pension and provident funds reform. However, according to the TA performance audit report (footnote 17), “the TA made negligible impact and sustainability of its outputs is assessed as less likely.” Accordingly, there was little progress in reform during CMDP. Subsequently, SECP issued the Voluntary Pension Fund Rules 2004 supported under FMGP, permitting asset allocation based on the age profile of participants. Under these rules, asset management companies and life insurers can register with SECP as managers of voluntary pension funds. C. Cost and Scheduling 36. The RRP estimated the adjustment costs associated with CMDP at $514 million, comprising (i) revenue losses from tax reforms on selected financial instruments ($250 million);

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(ii) increased cost of Government financing as a result of NSS rationalization and the relaxation of investment guidelines for institutional investors ($40 million); (iii) settlement of liabilities of NIT ($100 million) and ICP ($40 million); (iv) severance payments to employees laid off from NIT, ICP, CLA, and Controller of Insurance ($5 million); (v) modernization and automation of stock exchanges ($12 million); (vi) setup cost of NCSS and the OTC market ($10 million); and (vii) cost of transforming CLA to SECP, establishing PIRA, and strengthening the Pakistan Insurance Institute ($10 million). To fill the financing gap, the Export-Import Bank of Japan considered cofinancing of up to $250 million. However, this did not materialize. The OEM could not verify either the actual cost associated with the CMDP or the use of the counterpart fund generated out of the loan, as the Government did not earmark the loan for any particular purpose. 37. The second tranche of $125 million was disbursed on 22 June 2000, 6 months later than originally scheduled.28 The delayed program measures (as conditions for the release of the second tranche) concerned (i) capital market regulations and enforcement, (ii) operationalization of NCSS, (iii) privatization of the mutual funds run by NIT and ICP, (iv) finalization of insurance legislation, and (v) corporatization of NIC and PIC. The slower-than-expected progress in (i) and (ii) were closely related to the delayed implementation of TA Loan 1577-PAK(SF). Delayed implementation and partial success in TA 2865-PAK (footnote 8) slowed progress in (iii), while delayed implementation of TA 2825-PAK (footnote 7) and TA 2866-PAK (footnote 9) slowed progress in (iv) and (v) (footnote 17). 29 D. Organization and Management

38. All the agencies concerned supported the CMDP objectives. MOF, the Executing Agency, rationalized the NSS. SECP played a pivotal role in capital market and NBFC reforms. KSE, ISE, and LSE undertook governance reforms and significantly upgraded their infrastructure. MOC was responsible for insurance legislation and corporatization of state-owned insurance companies. The Privatization Commission carried out technical work on the privatization of ICP’s and NIT’s mutual funds. Interagency coordination was largely satisfactory. The Government has remained committed to the agreed reforms under the CMDP. 39. ADB devoted considerable resources to CMDP implementation. Over the program period, ADB maintained adequate policy dialogue with the agencies concerned through six review missions and regular correspondence. One processing mission member remained responsible for program implementation almost until the end of the program period. Representatives of SECP acknowledged that the continuity in ADB staff assignment had contributed to maintaining a close and constructive partnership. 40. The OEM deemed appropriate ADB’s assessment of compliance with the tranche and non-tranche conditions by the release of the second tranche. By the time of release, eight of 11 conditions tied to the disbursement had been fully complied with, one had been substantially complied with,30 and the remaining two conditions had been partially complied with.31 The OEM gave the following reasons to justify ADB’s decision to release the second tranche: (i) ADB had maintained adequate policy dialogue with the agencies concerned on all the outstanding

28 The RRP noted, “the second tranche, equivalent to $125 million, will be released over 1998 to 1999 period.”

However, the Loan Agreement did not give this timeline for the release of the second tranche. 29 The TPAR (footnote 17) indicated the delayed completion of TA 2825-PAK by 16 months, TA 2865-PAK by 8

months, and TA 2866-PAK by 13 months. 30 This condition concerned capital market regulations and enforcement. 31 These conditions concerned (i) the establishment of NCSS, and (ii) the privatization of the mutual funds of NIT and

ICP.

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program measures; and (ii) the three remaining measures tied to the tranche release were in progress or under reconsideration. OEM also considered appropriate the extensions of the program period to allow the monitoring of unaccomplished non-tranche program measures. Most remaining items on the CMDP agenda (except privatization of NIT’s mutual funds) are being addressed under FMGP. 41. The RRP contained an inconsistency on the timeline for the release of the second tranche as noted in para. 8. Since the program summary of the RRP indicated a less onerous time frame than the 2 years envisaged in the policy matrix and the main text, the Government may not have put in the full effort needed to implement the 11 program measures tied to the release of the second tranche. Had the timeline been more consistently defined and closely managed, the Government might have implemented some of the program measures and TA Loan 1577-PAK(SF) more expeditiously.

III. ACHIEVEMENT OF PROGRAM PURPOSE

A. Performance Indicators 42. Table 1 gives the performance indicators for the CMDP and other relevant data identified in the RRP. The OEM’s assessment of the indicators is as follows: (i) the primary share market has shown signs of recovery since FY2004,32 (ii) transactions in the secondary share market have significantly increased since FY2003, (iii) market capitalization started to increase from FY2003 reflecting a rapid increase in the index price, (iv) market infrastructure has been upgraded largely to the standards recommended by the Group of Thirty Consultative Group on International Economic and Monetary Affairs, Inc. (G30) of the International Securities Services Association (ISSA), (v) the GDP share of investment in leasing assets remained within a range of 0.8–1.1% from FY1994 to FY2004, (vi) the total size of mutual funds has increased since FY2003, and (vii) total premiums collected by general and life insurance companies have progressively increased since FY1994. These performance indicators suggest largely satisfactory progress in achieving the CMDP purpose. The ensuing paragraphs further elaborate this finding.

Table 1: Key Statistical Data

Item Unit FY1994−FY1996 FY1997−FY2002 FY2003 FY2004 A. Performance Indicators of CMDP

1. Number/Size of Equity IPOs 37−59 0−8 2 10

Number/Size (PRs million) 3,208−11,044 0−1,418 311 10,466

2. Average Daily Trading Volume Million shares 6.5−22.9 33.9−192.7 214.4 387.1 3. Market Capitalization (at end of period) % of GDP 17.6−25.9 8.2−20.3 15.7 26.0 4. Compliance with G30

Recommendations — — 8 of 9 conditions

complied witha 5. Total Investments in Lease Finance % of GDP 0.81−0.96 0.8−1.09 0.74 0.81 6. Total Mutual Funds’ Assets % of total

bank deposits

— 1.47–3.33 2.90 4.32

7. Total Premiums Collected by General Insurance Companies

PRs billion 6.7–9.1 9.4–15.3 19.6 22.0

32 There was a surge in equity IPOs in FY1994–FY1996. This was the period of large foreign portfolio investments

following the opening of equity markets to foreign investors in the early 1990s. The high domestic interest rates during these financial years made equity finance attractive.

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Item Unit FY1994−FY1996 FY1997−FY2002 FY2003 FY2004 8. Total Premiums Collected by Life

Insurance Companies PRs billion 4.5–6.5 5.9–7.8 10.0 11.8

B. Memorandum Items

1. KSE-100 (at end of period) 1,607−2,331 880−1,770 3,402 5,279 2. Equity Subscriptions Received PRs million 9,949−40,739 0−1,134 1,193 46,470 3. Number/Size of TFC IPOs 0−2 1−17 21 3

Number/Size (PRs million) 0−175 50−2,250 2,025 400

4. Treasury Bill Yield: 6-Monthb % 10.8−15.1 6.5−16.3 1.7 2.2

— = not available, CMDP = Capital Market Development Program, G30 = Group of Thirty Consultative Group on International Economic and Monetary Affairs, Inc., GDP = gross domestic product, IPO = initial public offering, TFC = term finance certificate. a International Securities Services Association (ISSA). 2003. ISSA Pakistan Handbook, Eighth edition. Zurich. The

condition not complied with concerns the real-time gross settlement system and trade netting system provided for in this handbook.

b Average of auction cutoff yields in June. Source: Appendix 3. 43. Stock market transactions have significantly increased since CMDP implementation. However, strong demand for equity securities has not been matched by a supply of fresh issues. Equity subscriptions were four times the size of equity IPOs from FY2002 to FY2004. The immediate reason for this demand-supply gap in the stock market was a substantial reduction in interest rates, leading to a secondary stock market rally during this period. The CMDP achievements, together with favorable macroeconomic and external conditions, also contributed to this rally. 44. Though market capitalization has grown significantly in recent years, the Government’s shareholding still represents about 50% of the market capitalization33 of KSE-100. Moreover, the Government remains the largest raiser of funding through the primary equity market, comprising more than 60% of IPO value during FY2002–FY2004,34 and there were also secondary offerings and direct sale of shares of listed companies by the Government. IPO issuance by the private sector has been relatively small; market participants have given the following reasons for this: (i) very low interest rates and easier credit conditions, encouraging companies to make greater use of bank loans for their financing needs; (ii) the phaseout of the fiscal incentive of a lower tax rate for listed companies with the unification of corporate tax rates; and (iii) stricter corporate governance and reporting requirements for listed companies. 45. The Pakistan stock market experienced a major bullish run in early 2005. The KSE-100 index, which surged by 65% from January 2005 to a peak of 10,303 on 15 March 2005, fell by about 35% to 6,725 on 13 April 2005. To investigate this incident, SECP has immediately formed a task force, which submitted the report to SECP in June 2005. The report highlighted the remaining weakness in market governance. On this basis, SECP has penalized several stock brokers. OEM interviewees had divergent views on the market situation. Some said that futures contracts had caused the excessive volatility in the market. Others believed that the sharp rise and subsequent drop of stock prices had been manipulated by a few large market players. Some interviewees criticized SECP and SBP for not taking preemptive policy actions to check the accelerated rise in the market before it crashed. On the positive side, the KSE management took credit for the fact that no broker had defaulted during the market crash; their stringent risk management measures averted broker default, the KSE said. Against the 30 33 OEM estimates based on stock prices as of 6 May 2005. 34 This refers to the IPO of the Pakistan Oil and Gas Development Company Limited in 2003.

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March 2005 settlement of PRs30 billion, which was the highest single settlement in KSE’s history, NCC had PRs10 billion in the form of margins already collected from members. B. Program Outcomes 1. Create an Enabling Policy Environment to Enhance Competition and a Level Playing Field 46. The survey results confirmed the contribution of the CMDP to an improved policy environment by increasing competition and creating a more level playing field. Interviewees especially acknowledged the following CMDP measures: (i) the easing of investment restrictions for employee provident funds and life insurance companies, (ii) the rationalization of tax anomalies in the equity market, (iii) the rationalization of the tax regime for mutual funds, and (iv) the reform of the interest rate and tax structures of NSS. Aside from CMDP, most interviewees considered the elimination of institutional investments in NSS, in place since March 2000, as the most important contributory factor. Net investment in NSS increased from PRs37 billion in FY1994 to PRs140 billion in FY1999 but declined to PRs257 million in FY2004 and has shown a net withdrawal in FY2005 (Appendix 3, Table A3.8).35 Overall, the performance of this component was satisfactory. 2. Strengthen Securities Market Governance, Institutions, Regulations, and Supervision 47. The survey results confirmed the substantial improvement in market institutions, regulation, and supervision that resulted from CMDP. Interviewees unanimously held the view that the creation of SECP was the main factor. Overall, the performance of this component was satisfactory. 48. Off-sight inspection and investigations led the SECP in 2004 to (i) penalize brokers and suspend their license for violations of the Securities and Exchange Ordinance of 1969 and its Rules and Regulations; (ii) issue warnings to the management and board of directors of a listed company for the improper dissemination of price-sensitive information; and (iii) impose a fine of PRs535,000 on a financial institution for involvement in insider trading in the shares of a listed company (the first proven case of insider trading in the history of the capital market in Pakistan). To further strengthen its enforcement and investigative capacity, the SECP is now in contact with international firms for the purchase of a tailor-made market surveillance system, which will be customized to suit local needs. 49. In the area of on-site inspection, SECP has started implementing a comprehensive inspection plan for members of the stock exchanges to protect investors by maintaining fair, orderly, and efficient dealing by brokers and agents at the stock exchanges. Moreover, SECP has fully implemented a risk-based methodology for selecting and setting examination and inspection cycles for brokers and agents. These inspections have addressed the compliance problems and system loopholes. SECP intends to inspect the operations of about 5% of the members/brokers of each stock exchange yearly. 50. SECP has vigorously pursued institutional capacity building in response to claims from some market participants that its institutional development has not fully kept pace with market developments in recent years. In FY2003–FY2004, SECP recruited 63 officers with expertise in 35 NSS showed a net withdrawal of PRs8 billion in the first 8 months of FY2005 up to February 2005.

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chartered accountancy, business administration, law, and information technology. New staff included professionals with knowledge of market surveillance, inspection and broker registration, commodity exchange, and NBFC regulation. SECP employees have also undergone training in-house and abroad. 51. As regards rules and regulations, SECP has recently approved (i) Clearing House (Registration and Regulation) Rules of 2004, (ii) Margin Trading Rules of 2004, (iii) Margin Trading Regulations of 2004, (iv) Property Trading Regulations of 2004, (v) Regulations for System Audit of Brokers of the Exchanges of 2004, (vi) NCSS Regulations of 2004, and (vii) Internet Trading Guidelines of 2005. 52. Stock exchanges adjusted their management structure, and are now carrying out the system audit of brokerage houses. However, the stock exchanges still suffer from generally poor public perceptions about their governance and transparency, and their self-regulatory functions are weak. SECP believes that excessive autonomy granted to regional, mutualized stock exchanges may create self-interest clubs, and is therefore actively pursuing demutualization. Considering all these achievements and the SECP’s ongoing efforts, the overall performance of this component was satisfactory. 3. Improve and Modernize the Securities Market Infrastructure and Promote Its Integration 53. All the survey interviewees noted major improvements in market infrastructure. They acknowledged the significant contribution of the CMDP, and shared the view that automated trading had improved price transparency in order execution while CDS had reduced the incidence of fraud related to counterfeit shares in physical deliveries. The OEM believed that the implementation of the margin financing module by NCC would contribute to further efficiency gains in the stock market. Overall, the performance of this component was satisfactory. 4. Develop the Corporate Debt Market 54. The issuance of listed TFCs, or corporate bonds, increased during FY2001–FY2003 but declined substantially from FY2004 onward (Appendix 3, Table A3.2). Though these TFCs are listed on the stock exchanges, there is virtually no secondary market in these instruments. According to market participants, the very low interest rates (Appendix 3, Table A3.10) made bank loans more attractive and, hence, were the key factor behind the decline in TFC issuance. In FY2003–FY2004, PRs2.4 billion was raised in TFC IPOs versus a PRs386 billion increase in private sector borrowing from banks. As envisaged under the CMDP, SECP has approved the listing of TFCs on the OTC market. SECP expects the trading of TFCs to make the corporate debt market more vibrant, efficient, and liquid. Overall, the performance of this component was partly satisfactory. 5. Reform the Mutual Fund Industry 55. The mutual fund industry has witnessed strong growth in recent years, reflected in the increased participation of the private sector with the launch of new funds and the expansion in the aggregate value of mutual funds (Appendix 3, Table A3.3). This growth was attributed partly to the privatization of the closed-end mutual funds that used to be managed by ICP. As noted earlier, the finalization of the transaction structure for the privatization of the open-end mutual fund managed by NIT has been delayed. However, perhaps reflecting the expectation that the fund will be privatized soon, open-end funds have also grown in recent years. Most market

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participants interviewed by OEM considered the barring of institutional investment in NSS and the buoyant equity market as major contributors to the growth in the size of the mutual fund industry. Overall, except for the delay in the restructuring of NIT, the performance of this component was satisfactory. 6. Develop the Leasing Industry 56. Whereas the GDP share of leasing assets largely remained constant from FY1994 to FY2004 (Appendix 3, Table A3.6), leasing companies’ profitability has significantly improved in recent years (Appendix 3, Table A3.5). The interviewees acknowledged the contribution of CMDP measures in (i) streamlining the regulatory framework, (ii) strengthening the capital base, and (iii) developing alternative long-term financing sources for the industry. The transfer of the regulatory responsibility for leasing from SBP to SECP has facilitated these developments. SECP has developed some capacity to effectively regulate the leasing industry by employing people from the industry. However, its capacity for on-site examination needs to be further strengthened. Overall, the performance of this component was satisfactory. 7. Promote Contractual Savings through Reforms of the Insurance Sector, and Pension and Provident Funds 57. The total gross premiums collected by general insurance companies substantially increased from PRs6.7 billion in 1994 to PRs22 billion in 2004 (Appendix 3, Table A3.4). From 1996 to 2004, the number of general insurance companies fluctuated between 49 and 62, while the market share of NIC has been constant at around 17–19%. The total gross premiums collected by life insurance companies increased from PRs4.5 billion in 1994 to PRs11.8 billion in 2004. During this period, the number of general insurance companies increased from three to five, while the market share of State Life Insurance Corporation was progressively reduced from 98% to 70%. OEM could not obtain the relevant quantitative data on pension and provident funds. Despite the steady growth of the insurance industry in the last decade, survey interviewees did not particularly acknowledge the contribution of CMDP. They instead pointed out a continued weakness in the regulatory framework of the insurance industry as well as the continued predominance of state-owned life insurance and reinsurance companies. Nonetheless, they considered the development of the capital market, as an outcome of CMDP, to be conducive to the promotion of contractual savings. Market participants also see the potential of the insurance and pension industry and expect further progress in reforms under the FMGP. Overall, the performance of this component was partly satisfactory. C. Sustainability 58. Most policy achievements discussed in paras. 23–35 appear to be sustainable considering (i) the Government’s continued commitment to the program purpose demonstrated through follow-on policy measures, and (ii) stakeholders’ support for the program achievements. However, the gains brought by sound capital market development remain at risk from the growing high-profile financial crimes and new forms of market manipulation as witnessed during the recent market upheavals. Based on lessons learned from this experience, SECP is further strengthening its surveillance function and enforcement of rules supported under the FMGP.

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D. Technical Assistance Loan 59. There was an inordinate delay of over 10 months in the recruitment of consultants for TA Loan 1577-PAK(SF). The TA loan implementation was delayed further by the time-consuming consensus building for the design and location of the NCSS. The loan closing date was extended four times from the original date of 31 December 2000 to 30 July 2002. This delay impeded timely compliance with the relevant conditions for the second tranche of the CMDP. The lack of verifiable outputs and records from the implementing agencies and ADB hampered the evaluation of this TA loan. From the limited data available, the OEM came to the conclusion that the TA outputs (i) contributed marginally to the institutional strengthening of SECP and the privatization of state-owned mutual funds, (ii) contributed significantly to the establishment of NCSS, and (iii) did not support the development of SROs and an OTC debt market. Overall, the TA loan contributed less than expected to CMDP and is therefore rated partly successful. A detailed assessment for this rating is given in Appendix 2.

IV. ACHIEVEMENT OF OTHER DEVELOPMENT IMPACTS

A. Organizational Impact 60. The CMDP contributed to (i) the conversion of CLA to SECP, and the empowerment of SECP as an independent oversight institution for the capital market and NBFCs, (ii) the enhancement of accountability and the improvement of operations at the stock exchanges, (iii) the establishment of CDC and NCSS, (iv) the restructuring of ICP and NIT, and (v) the corporatization of PIC and NIC. But CMDP did not effectively support the development of SROs in the capital and financial markets. B. Socioeconomic Impact 61. ICP has reduced the number of its staff from more than 600 to 49 in two golden-handshake phases in conjunction with the privatization of its mutual funds. NIC has reduced its staff strength from 600 to 400 in conjunction with corporatization. On the other hand, PIC corporatization has not led to a reduction in staff strength. The survey results suggest that the stock market rally in recent years contributed significantly to job creation in the industry and to the broadening of the investor base in the country including individuals.

V. OVERALL ASSESSMENT A. Relevance 62. The OEM considered CMDP highly relevant because of the following observations: (i) the key implementing agency, i.e., SECP (CLA at the time of loan approval), had taken ownership of reforms and was supported by a favorable political economy of decision making; (ii) ADB processing missions knew enough about the country; (iii) ADB missions had extensive policy dialogue with the agencies concerned and broad consultation with stakeholders; (iv) the program purpose was consistent with the country’s development priorities and the ADB country and sector assistance strategy at appraisal and evaluation; (v) the lending modality, i.e., program loan, was appropriate in view of the reform momentum and foreign reserves of the country; and (vi) the policy matrix was comprehensive, cohesive, and realistic, and had an appropriate number of program measures.

17

B. Efficacy 63. The OEM confirmed full compliance with 46 out of the 58 policy conditions, and considered the outcomes of five (of the seven) CMDP components satisfactory. These components concerned (i) competition and level playing field; (ii) securities market governance, institutions, regulations, and supervision; (iii) securities market infrastructure; (iv) the leasing industry; and (v) mutual funds. But the insurance and pension reforms component and the corporate debt market component were only partly satisfactory in the OEM’s view. The performance indicators and other relevant data suggest largely satisfactory achievement of the CMDP purpose. Overall, therefore, the OEM assessed the CMDP as efficacious. C. Efficiency 64. The OEM considered the CMDP efficient for two main reasons: (i) the program effects relative to costs met the expectations of the Government and stakeholders; and (ii) interagency coordination, monitoring and reporting, policy dialogue, and ADB’s disbursement decision at the release of the second tranche release—the various elements of program management—were appropriate. OEM also considered appropriate the extensions of the program period to allow the monitoring of unaccomplished program measures. SECP noted that continuity in staff assignment on the ADB side contributed to maintaining a close and constructive partnership. If the associated TA loan had more effectively complemented program implementation, the CMDP could have been assessed as highly efficient. D. Sustainability 65. The OEM deemed the sustainability of CMDP accomplishments likely, given the assessment presented in para. 58. E. Institutional Development and Other Impacts 66. The OEM considered the organizational development and other impacts of the CMDP significant in view of the assessment presented in paras. 60–61. F. Overall Program Rating 67. On the basis of the above, the overall rating of the CMDP is successful. G. Assessment of ADB and Borrower Performance 68. MOF, MOC, SECP, the Privatization Commission, the three stock exchanges, and CDC all performed their expected roles under the CMDP, while coordinating with one another. SECP’s ownership of reforms, supported by a favorable political economy of decision making, was especially noteworthy. The OEM also noted (i) the Government’s continued commitment to the CMDP purpose demonstrated through follow-on policy actions, and (ii) stakeholders’ support for the CMDP achievement. From these observations, the OEM assessed the performance of the borrower as satisfactory. 69. ADB’s performance in CMDP formulation and implementation was generally appropriate and associated with good practices (para. 79). Representatives of the relevant agencies acknowledged the significance of policy dialogues with the ADB officers concerned, who had in-

18

depth understanding of bottleneck issues that the country and its institutions faced. Given this feedback from borrower representatives, the OEM found the performance of ADB satisfactory.

VI. ISSUES, LESSONS, AND FOLLOW-UP ACTIONS A. Key Issues for the Future 1. Capital Market Regulation and Governance 70. Since its transformation from CLA in 1997, SECP has played a pivotal role in bringing about visible reforms in the capital market and corporate affairs. The current regulatory architecture deviates from that originally envisaged under the CMDP, which emphasized self-regulation by market participants. This deviation can be justified in view of the slow progress in creating a functional self-regulatory mechanism and the rapid market growth in recent years. SECP needs to further enhance its capacity for market surveillance and enforcement of regulations and rules, especially through on-site examination. To effectively and efficiently exercise this function, SECP should set up office in Karachi. This would also enhance consultation with market participants, possibly leading to a more market-friendly regulatory environment. In pursuing good corporate governance and responsible market practices SECP may also consider fixing the qualification criteria for market analysts and financial reporting standards. 71. Stock exchanges significantly improved their operational efficiency and undertook governance reforms as envisaged under CMDP. However, a self-regulatory mechanism has not been effectively put in place. The OEM held the view that a workable and viable self-regulatory framework presupposes demutualization to increase the accountability of the stock exchanges. Inherent conflicts of interest observed in regional, mutualized stock exchanges may threaten the basic objective of ensuring a transparent and efficient market for investors. The OEM therefore supported demutualization. 2. Regulation on NBFCs and the Insurance Industry 72. Under the NBFC Rules 2003, SECP is responsible for governing investment finance services, leasing, venture capital investments, discounting services, investment advisory and asset management services, and housing finance services. However, its broad oversight functions have been constrained by the small number of experts in those businesses. On-sight inspection of NBFCs especially needs significant upgrading. 73. Several of those interviewed by OEM underscored the need to improve the policy and regulatory framework for mutual funds, by (i) streamlining the process of approving investment schemes, (ii) formulating rules for specialized funds such as hedge funds and real investment trusts, and (iii) rationalizing the rules for the conversion of a closed-end fund into an open-end fund. The survey results suggested that the industry lacked fund management skills and stressed the need to license fund managers on the basis of appropriate criteria. The interviewees all believed that, despite growth in the size of mutual funds, the investor base had not broadened. Market participants traced this to the weak return performance of mutual funds and the very small distribution network. Improvement in these areas would enhance the overall efficiency of the mutual fund industry.

19

74. The oversight arrangement in the insurance industry remains unclear; SECP and MOC have issued their own rules but SECP has neither significant enforcement powers nor the power to revoke licenses. This dichotomy has fueled uncertainty and weakened the ownership of the regulatory framework. SECP’s exercise of its regulatory function is not made any easier. From this perspective, the Government is considering transferring jurisdiction from MOC to MOF as an alternative regulatory arrangement. This is expected to clarify an issue that could cause a regulatory loophole. 3. Development of the Primary Equity Market 75. Though the flow of primary equity offerings has increased in FY2004–FY2005, the supply has been smaller than demand. Recent IPOs have been heavily oversubscribed as a result. In terms of value, the listing of Government-owned entities has dominated fresh offerings while equity IPOs in the private sector have been relatively small. The capital market, it would seem, remains below its potential in mobilizing the resources of the non-state corporate sector. The OEM therefore supported SECP’s recent initiative to assess the remaining impediments to the development of the primary market. 4. Development of the Debt Market 76. While the NSS no longer corners investible funds from institutional investors, the debt market has not appeared to develop as a full substitute. The size of the corporate debt market vis-à-vis private sector bank credit is very small, and secondary market liquidity is virtually nonexistent. Though TFC issuance started picking up in FY2001, it declined in FY2004–FY2005. Identifiable factors behind the slower-than-expected development of the corporate debt market include (i) high issuance costs associated with stamp duties, brokerage fees, bank commissions, and prospectus publication and distribution, which become more prohibitive for shorter-term securities; and (ii) the limited distribution system for debt securities in general. Moreover, some banks indicated concerns about the recent approval of TFC listing on the OTC market in view of (i) anonymity of trades, (ii) settlement risk, and (iii) delivery versus payment. SECP and the stock exchanges should tackle these issues in consultation with market participants. 5. Level Playing Field 77. The rationalization of the NSS under the CMDP contributed significantly to a more level playing field across financial instruments. But there are still some distortions, such as (i) the small prepayment penalties on the premature withdrawal of investment in NSS, (ii) the capital gains tax levied only on insurance companies, and (iii) zakat (religious levy) imposed on private mutual funds but not on public sector funds. In relation to (i), the NSS instruments can be prematurely encashed at face value with the only penalty being a lower interest rate depending on the term. This provides price protection against adverse movements in interest rates. For listed fixed-income securities, on the other hand, price variations with changing interest rates are much greater. 6. Market Irregularities 78. With technology, the risk of growing high-profile financial crimes and new forms of market manipulation cannot be discounted. The report of the Stock Market Review Task Force, issued in June 2005, attributed the recent upheavals in the stock market partly to manipulated and syndicated activities of market participants. Apart from the market upheavals, market

20

participants generally believe that market irregularities are still prevalent. SECP has recently taken punitive actions against specific instances of insider trading and price manipulation, but monitoring and surveillance activities in this regard could stand further strengthening. B. Lessons Identified 79. The OEM attributed the success of CMDP to SECP’s ownership and leadership in reforms, supported by a favorable political economy and effective policy dialogues. The key ingredients of the effective dialogues were the following: (i) ADB processing missions gained enough knowledge about the country from the economic and sector work mission that preceded the reconnaissance mission; (ii) the reconnaissance mission had extensive policy dialogues with the agencies concerned, especially CLA, and broad consultations with stakeholders; (iii) the policy matrix was drafted at an early stage of processing, and the Government took substantial actions before loan approval; (iv) ADB processing and review missions made an effort to come up with alternative policy measures, which led to realistic solutions while also enhancing ownership of reforms; (v) one ADB processing mission member remained responsible for program implementation almost until the end, contributing to a close and constructive partnership; and (vi) ADB continued to monitor unattained non-tranche program measures by extending the loan closing date (which was 16 months after the release of the second tranche). All these are considered good practices for ADB’s policy-based lending. 80. The RRP identified the following performance indicators for the CMDP: (i) the number and size of equity IPOs, (ii) daily trading volume, (iii) market capitalization, (iv) compliance with G30 recommendations, (v) total investments in leasing assets, (vi) total assets of mutual funds, and (vii) the number of insurance policyholders and the premiums collected by insurance companies. These indicators alone are inadequate for an analysis of the extent to which the development of the capital market can be attributed to the CMDP. A benchmark interest rate and data showing the investors’ demand for equity instruments, for instance, should have been included. The amounts of equity subscriptions, which were four times larger than the size of IPOs during FY2002–FY2004, reflected low interest rates and contributed to the significant increase in transactions in the secondary market. Other important aspects of the recent development of the capital market are the following: (i) the Government’s shareholding represents about 50% of the market capitalization of KSE-100, and (ii) the listing of Government entities represented the majority of IPO values from FY2002 to FY2004. These suggest that the capital market remains below its potential in mobilizing the resources of the non-state corporate sector. The absence of any analysis of these aspects weakens the PCR assessment of the capital market development. 81. The establishment of workable self-regulatory market institutions was one of the few unfulfilled items on the CMDP agenda. The SECP believes that excessive autonomy granted to regional, mutualized stock exchanges may create self-interest clubs, and is therefore actively pursuing demutualization before the exchanges’ self-regulation replaces some of the SECP’s regulatory oversight. This approach could apply to other developing countries pursuing capital market governance reforms, depending on the ownership and management structure of their stock exchanges. 82. Delays in the implementation of related stand-alone TAs and TA Loan 1577-PAK(SF) impeded timely compliance with the relevant conditions for the release of the second tranche under CMDP. This experience underscores the need for timelines that are realistic and consistent between programs/projects and the TAs/TA loans that are meant to complement the programs/projects.

21

83. The lack of verifiable outputs and records from both the implementing agencies and ADB hampered the evaluation of TA Loan 1577-PAK(SF). Presumably for this reason, no overall rating was given to the TA loan in the PCR on CMDP. No separate project completion report was prepared for this TA loan. To the OEM, this could reflect a general weakness in ADB’s self-evaluation of TA loans attached to project or program loans in view of the observations presented in the next paragraph. 84. ADB’s Project Administration Instructions (PAIs) do not distinguish between a TA loan and other types of loans as to their standard requirements for project completion reports (PAI 6.07). Likewise, the PAI does not distinguish between a stand-alone TA loan and a TA loan attached to a project or program loan. Hence, all TA loans should have separate project completion reports in accordance with the General Guidelines for Preparing Project Completion Reports (project, multi-project, sector, program, sector development program, and TA loans) (PAI 6.07, Appendix 2) revised in August 2001.36 Since then, self-evaluation of eight attached TA loans has been conducted. However, self-evaluation of six (including TA Loan 1577-PAK[SF]) of the eight was subsumed in the four PCRs37 of associated program loans, and only two TA loans have separate project completion reports38 following their salient features as defined in PAI 6.07. 85. The OEM did not identify the need for any significant follow-up action.

36 Before the revision in August 2001, the General Guidelines did not refer to TA loans. 37 ADB. 2002. Program Completion Report on the Financial Intermediation and Resource Mobilization Program and

Commercial Bank Audits to the Kyrgyz Republic. Manila; ADB. 2002. Program Completion Report on the Public Sector Reform Program to the Solomon Islands; ADB. 2002. Program Completion Report on the Trade Export Promotion, and Industry Program in Pakistan. Manila; and the PCR on Loan 1576-PAK and TA Loan 1577-PAK(SF) (footnote 11).

38 ADB. 2003. Project Completion Report on Institutional Strengthening of the Financial Sector to the Republic of Korea. Manila; and ADB. 2003. Project Completion Report on Upgrading Skills and Systems of Commercial Banks in Mongolia. Manila.

22 Appendix 1

POLICY MATRIX

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

I. Create an Enabling Policy Environment to Enhance Competition and a Level Playing Field Liberalize investment restrictions on institutional investors.

I.A.1. Lower the mandatory investment requirements for life insurance companies in Government and Government-approved securities from 60% to 50% of their investible funds. June 1997.b

I.B.1 Reduce this investment restriction further by 10%. June 1998.c

Implemented. The Insurance Ordinance of 19 August 2000, set the minimum investment requirement for life insurance companies in Government securities at 40% of their investible funds. Subsection 7 of section 35 of the Ordinance empowers the federal Government to prescribe a percentage of the shareholders funds or of a statutory fund of a life insurer to be invested in Government securities or in a combination of Government securities and other approved securities; subsection 8 provides for mandatory limits of not more than 40%. Immediately before the promulgation of the Ordinance, the minimum requirement was 50%; in 1997, it was 60%.

Complied with. Implemented measures remain in place with no further changes in investment limits, i.e., life insurance companies are required to maintain at least 40% of their investible funds in Government securities or in a combination of Government securities and other approved securities.

I.A.2. Raise the investment cap for provident funds in stocks and listed corporate fixed-income securities from 10% to 20% of their investible funds; and within this cap, raise the limit on investment in listed corporate fixed-income securities from 1% to 5%. June 1997.b

I.B.2 Raise this investment cap further to 30%. June 1999.c

Implemented. Employees’ Provident Fund (Investment in Listed Securities) Rules of 1996, which provided for 10% investment of provident funds in listed securities were amended in 1997 and the maximum limit was raised to 20%. In November 1998, the limit was raised further to 30%. In 1997, the maximum investment limit of 1% in the listed securities (both equity and fixed income) of a company was also removed.

Complied with. The Employees Provident Fund (Investment in Listed Securities) Rules of 1996 were amended through Statutory Regulatory Order 410(I)/97 dated 6 June 1997 and the limit for investment in listed securities was raised from 10% to 20%. The same regulatory order also did away with the restriction that investment in any one company or instrument should not exceed 1% of the provident fund. However, a new condition was that investment in shares or other listed securities of a particular company should not exceed 5% of its paid-up capital. The limit for investment in listed securities was further raised from 20% to 30% through Statutory Regulatory Order 1260(I)/98 dated 2 November 1998.

Appendix 1 23

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

The Rules were further amended through Statutory Regulatory Order 261(I)/2002 dated 10 May 2002, which allowed provident funds to invest up to 50% of the provident fund in unit trust schemes registered under the Asset Management Companies Rules of 1995 but set an upper limit on investment in any one unit trust scheme at 25% of the provident fund. More recently, the Voluntary Pension System Rules of 2004 issued by the Government revised the parameters for asset allocation.

I.A.3 Allow listed corporate fixed-income securities to be treated as eligible investments for the purpose of meeting the statutory liquidity requirement for nonbank financial institutions (NBFIs) and for investment requirements of provident funds. June 1997.b

State Bank of Pakistan’s (SBP) Rules of Business for NBFIs make listed debt securities (corporate fixed-income securities) eligible investments for meeting the statutory liquidity requirements of NBFIs. Provident funds can also be invested in listed corporate fixed-income securities.

Complied with. Implemented measure remains in place with no further changes. For the statutory liquidity ratio (SLR), Rule 6 of the Rules of Business for NBFIs amended through the Banking Policy and Regulations Department Circular No. 17 dated 10 June 1997 also allows NBFIs to invest in listed debt securities aside from Government securities, shares of listed companies, and National Investment Trust Limited (NIT) units. However, total investment in listed securities should not exceed 1% of the total liabilities. Employees’ Provident Fund (Investment in Listed Securities) Rules of 1996 issued on 26 February 1996 allow provident funds to invest in listed corporate fixed-income securities provided they have been rated as investment-grade with a minimum rating of “BBB” by a credit rating agency registered with the Securities and Exchange Commission of Pakistan (SECP).

24 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

Rationalize tax anomalies in the equity market.

I.A.4 Implement the following key tax reforms: (i) extend exemption from capital gains tax on listed securities on the stock exchange at least until 2001; (ii) abolish the tax on bonus shares and earnings from the sale of rights shares, as well as the 0.5% turnover tax on shares; and (iii) for the provinces, reduce the stamp duty on the transfer of securities for Central Depository Company of Pakistan Ltd. (CDC) transactions from 1.5% to 0.1%. June 1997.b

I.B.3 The Government will study the stamp duty structure of the federal area and the provinces, and recommend rationalization of the tax rates on financial transactions and asset-backed securities. June 1999.c

Implemented. (i) After extending exemption from capital gains tax on listed securities until 2001, in 1997, the Government further extended exemption till 2004. (ii) Tax on bonus shares and turnover tax on shares were abolished through the Finance Act of 1997. (iii) Stamp duty being a provincial subject, all provincial governments were advised to reduce the stamp duty on the transfer of securities for CDC transactions from 1.5% to 0.1%. The governments of Sindh, Punjab, and North-West Frontier provinces as well as the Federal Area Administration notified a reduction in stamp duty. The exception is the province of Balochistan, where only a few companies are incorporated. Policy action regarding stamp duty structure was partially implemented. No formal study of stamp duty structure was undertaken. However, the federal Government has been advising the provincial governments to make necessary changes in the stamp duty rates in response to the market requirements, particularly to promote new financial instruments, as in the issuance and trading of term finance certificates (TFCs). As regards rationalization of tax rates on asset-backed securities, significant tax concessions have been announced through the Finance Ordinance of 2001, which allows tax deductions on payments to special-purpose vehicles on behalf of the originator. Payment on account of securitization of receivables by special-purpose vehicles has been exempted from withholding tax.

Complied with. The Finance Bill of 2004–2005 extended capital gains tax exemption until 2007. As part of its FY2005 federal budget, the Government levied a tax on the purchase of listed shares effective July 2004. This capital value tax, as announced with the budget, was 0.1% of the purchase price of the shares. However, because of strong opposition to this measure from stock market participants, the Government reduced the rate to 0.01%. The Government also levied a 10% withholding tax on financing of carry-over transactions (COT) effective July 2004. The Working Group on Money and Debt Market Development has made several recommendations for the development of debt market and reduction of stamp duty. SECP and the Ministry of Finance (MOF) are carrying out active consultations on these recommendations with the provincial governments.

Appendix 1 25

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

Rationalize tax and interest rate structure anomalies in the debt market.

I.A.5 Abolish the (i) 10% withholding tax on rated and listed corporate fixed-income securities to bring them at par with the national savings scheme (NSS), which is currently exempt from this tax; and (ii) tax on interest income derived from government and corporate fixed-income securities for foreign investors. September 1997.b

I.B.4 The Government will adopt a suitable mechanism to adjust interest rates for NSS, to realign returns with an appropriate benchmark, while maintaining uniform tax treatment for NSS and rated and listed private corporate debt securities. June 1998.c

Implemented. Major policy changes involving rationalization of the tax structure have been introduced in the NSS. Interest on different NSSs has been significantly reduced. Since 1999, interest on 10-year defense savings certificates (DSC) has been reduced four times: from 18% in May 1999 to 16% in December 1999, to 15% in January 2000, to 14% in July 2000, and to 11.6% in June 2002. The Government has decided to review the rate of return every 6 months and keep it in line with the interest on the Pakistan investment bond (PIB), which is closely market related. Various NSSs have been linked to PIB of equivalent maturities. While DSCs have been linked to 10-year PIB maturity, the regular income scheme has been linked to 5-year PIB and special savings certificates/accounts have been linked to 3-year PIB. Rationalization of the rates of the NSS has greatly contributed to developing the corporate debt market. Withholding tax of 10% on all the NSS was imposed in 1999 but had to be withdrawn because of certain legal complications that were brought to the attention of the High Court. The main issue was that the Government had levied withholding tax on profit paid instead of profit accrued, which implied that the tax became leviable with retrospective effect. The Government has reimposed withholding tax of 10% on all investments made since 1 July 2001. However, to address the concerns of small investors, investments of up to PRs150,000 have been exempted from withholding tax. The Government has also prescribed varying rates of penalty on premature withdrawals of investments in the regular income scheme.

Complied with. Implemented policy measures remain in place: (i) uniform rate of withholding tax of 10% on profit from both NSS and corporate debt securities, though NSS investments less than Pakistan rupees (PRs)150,000 are exempt from tax; (ii) semiannual revision of NSS rates to align them with yields on equivalent-tenor Government bonds called PIBs; and (iii) ban on institutional investment in NSS. Since the NSS rate revision in June 2002, the Government has revised NSS rates four times: on 10-year DSCs, from 11.6% in July 2002 to 10% in January 2003, 8.5% in July 2003, 7.96% in January 2004, and 8.15% in July 2004. Further rationalization of NSS is being pursued under the Financial Markets and Governance Program of the Asian Development Bank (ADB).

26 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

In March 2000, the Government barred institutional investors from investing in the NSS. This measure has substantially benefited the corporate debt market.

Rationalize the tax regime for mutual funds.

I.A.6 To adopt uniform tax treatment for public and private sector mutual funds, abolish the income tax for mutual funds provided they distribute at least 90% of their profits. June 1997.b

Implemented. The Government announced exemption from tax on income of private sector mutual funds through the Finance Act of 1997. However, certain anomalies in Government policy between public sector mutual funds and private sector mutual funds remain. For instance, zakat (religious levy) is leviable on private sector mutual funds but not on public sector mutual funds. Private sector mutual funds are also at a disadvantage compared with NIT in certain aspects. Provident funds and surplus funds of charitable institutions can be invested in NIT but not in private sector mutual funds because of limitations imposed by income tax rules. Also, unlike the units of NIT, certificates and units of private sector mutual funds are not eligible for statutory reserve requirements of commercial banks.

Complied with. Implemented measures remain in place, i.e., both public and private sector mutual funds are exempt from income tax provided they distribute at least 90% of their profits (excluding unrealized capital gains).

II. Strengthen Securities Market Governance, Institutions, Regulation, and Supervision Develop strong regulatory bodies for the securities market to support the orderly growth of companies and improve investor confidence.

II.A.7 The Corporate Law Authority (CLA) will announce a strategy and an action plan for reforms in the securities market with a focus on strengthening corporate governance and regulations, and reforming market infrastructure,

Implemented. The CLA chairperson announced the major components of the Capital Market Reform Program at different forums, particularly seminars organized by professional bodies and the stock exchanges. These events were also adequately covered in the press. Some of these forums were: (i) Meeting of members of the Karachi Stock Exchange (KSE) and representatives of business and industry in Karachi. The finance minister was also present (18 August 1997). (ii) Seminar organized by the Management Association of Pakistan in Karachi (26 August

Complied with. OEM confirmed the PCR finding.

Appendix 1 27

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

including modernization of stock exchanges through the adoption of automated trading, clearing, settlement, and depository systems. October 1997.b

1997). (iii) KSE inauguration of the Karachi Automated Trading System (27 October 1997). (iv) General Assembly of Federation of Euro-Asian Stock Exchanges in Lahore (29 October 1999). (v) Meeting of members of KSE (13 December 1997). (vi) Pakistan Development Forum attended by senior officials of multilateral institutions, including ADB. The reform program was also covered on television.

Modernize the supportive legislation to improve enforcement by the SECP.

II.A.8 Prepare and seek cabinet approvald for the creation of an autonomous and independent SECP to regulate company affairs and the securities market, and submit to ADB an organization plan for the new SECP. October 1997.b

II.B.5 Establish and operationalize the SECP on the basis of a corporate plan agreed to by ADB and grant it adequate management, administrative, and financial autonomy, including discretion over its budget and staff recruitment. Also, strengthen SECP capacity to enforce regulations; develop exchanges, brokers, and mutual funds; and provide an annual report on its regulatory functions. December 1998.c

Implemented. The SECP Act of 1997 was promulgated on 26 December 1997 after intensive discussions between the CLA and ADB. Its main provisions relate to the legal status of the SECP, its structure, powers, functions, and financial arrangements. The SECP is also required to submit annual reports to parliament within a specified period. An important provision is the establishment of a policy board consisting of five ex-officio members and four members from the private sector. The board, which is required to meet at least four times a year, advises the SECP on various policy matters. The SECP has been empowered to administer the Securities and Exchange Ordinance of 1969, Modaraba Companies (Floatation and Control) Ordinance of 1980, and Companies Ordinance of 1984. In August 1999, regulation of the insurance sector was also transferred to the SECP and the SECP Act was amended on 11 October 2000.

Complied with. The corporate structure of SECP has been evolving. At the time of its establishment, SECP was assigned the regulation of capital markets and the corporate sector. Since then, the insurance and nonbank finance sectors and private pensions have also been passed on to SECP. However, SECP still has four regulatory divisions, each headed by a commissioner, though there have been changes in the functions and structure of individual divisions. A new division, the professional service and policy division, has been created to regulate and promote the development of professional bodies and self-regulatory organizations (SROs) and recommend policy guidelines for the consideration of SECP and its policy board. Moreover, the enforcement division, previously a separate division, has been merged into the Corporate Law Division. The other two regulatory divisions of SECP are the Securities Markets Division and the Specialized Companies Division. The regulatory scope of the Securities Markets Division has been extended to include commodity exchange and securitization; the latter used to be under the Specialized Companies Division.

28 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

The SECP has been vested with full administrative and financial powers and has control over revenues from different fees. Staffing is based on the corporate plan and job descriptions prepared with the help of the consultants hired under technical assistance (TA) 1577-PAK(SF). The Act empowers the SECP to undertake regulatory functions in respect of all issues relating to the capital market. The Act was amended in 2000 to give the SECP regulatory jurisdiction over the insurance sector. The SECP has full regulatory powers to ensure the smooth functioning of stock exchanges and market intermediaries. The SECP has four commissioners and a chairperson. Since obtaining financial autonomy, the SECP has hired 67 professionals, 58 of whom have a background in business administration and accounting and eight have a legal background. The SECP prepared its first annual report for the year 2000 and is having the second report printed.

The Specialized Companies Division has been assigned the regulation of the nonbanking finance companies (NBFCs) and the insurance industry, for which separate departments have been set up. The Securities Markets Division has increasingly focused on enforcement function to check market abuse. The first-ever investigation of insider trading was in 2004; a local institution had to pay a penalty. Respondents in three cases of violations of the takeover law also paid penalties. However, the penalty levied by SECP in a price manipulation case was abolished by the SECP appellate tribunal. As required under Section 25 of the SECP Act, SECP has been publishing annual reports on its activities and performance. The fifth annual report for FY2004 was recently released.

Appendix 1 29

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

II.A.9 The Cabinet will approve key recommendations of the Corporate Laws Review Commission pertaining to the securities and corporate laws that, among others, empower the SECP to suspend brokers, impose penalties on certain defaulters, and register registrars, balloters, and underwriters/ sub-underwriters. October 1997.b

II.B.6 In line with the recommendations of the Corporate Laws Review Commission and the ADB-financed TA,e the SECP will review and introduce regulations for disclosure by listed companies, insider trading, carry-forward system, corporate registrar services, protection of minority shareholders’ rights, inter-corporate financing, investment companies, portfolio managers, public issues and offerings, underwriters, and corporate takeovers and mergers. June 1999.c

Substantially implemented (only enactment of takeover law is pending, though approved by the federal cabinet). The SECP has issued a number of capital market-related rules/regulations/guidelines. Some of these are: (i) Members’ Agents and Traders (Eligibility Standards) Rules of 2001; (ii) Stock Exchange Members (Inspection of Books and Record) Rules of 2001; (iii) Public Companies (Employees Stock Option Scheme) Rules of 2001; (iv) Insider Trading Guidelines of 2001; (v) Amendments to Securities and Exchange Rules (Net Capital Balance Requirement); (vi) Share Transfer Agents, Underwriters, Balloters and Consultants to the Issue Rules of 2001; (vii) Companies Share Capital (Variation in Rights and Privileges) Rules of 2000; and (viii) Brokers Agents Registration Rules of 2000. The SECP has recently proposed 92 amendments to the Companies Ordinance of 1984, which have been circulated to the public for comment. The proposed amendments seek to improve corporate governance and safeguard the interests of investors, and to develop the corporate sector. The proposals are based on the recommendations of a committee that consulted with professional and trade bodies, the chamber of commerce, stock exchanges, associations of investors, and individual experts. The proposed amendments have the following objectives: (i) To reduce the mandatory period for holding annual general meetings from 6 months to 4 months from the close of accounts. (ii) To remove the restrictions on investment in associated companies. (iii) To introduce the concept of a single-

Complied with. SECP has started inspecting the books of accounts of brokers. Four brokers have so far been inspected and reports have been prepared. A number of brokers have also been penalized by SECP for defrauding investors. The Listed Companies (Substantial Acquisition of Voting Shares and Take-Overs) Ordinance was promulgated by the Government on 29 October 2002. However, SECP has not yet issued rules for this ordinance. COT financing rules have been in place since 1997. However, COT financing is being phased out and the number of securities eligible for COT has been reduced from 365 to only 7. The Companies (Amendment) Ordinance of 2002 was promulgated on 26 October 2002. The key amendments were: (i) The mandatory period for holding annual general meeting was reduced from 6 months to 4 months from the close of the financial year. (ii) Single-member companies were allowed to operate. (iii) The maximum limit of 10% discount on issuance of shares was removed. (iv) The required quorum for a general meeting of a listed company was increased from three members to 10 members representing not less than 25% of total voting power either of their own account or through proxies. (v) Members of stock exchanges were barred from engaging in brokerage, and their spouses from becoming directors of listed companies. (vi) Permission was given to invest in associated companies but only through a special resolution, which must be approved by at least 75% of shareholders. (vii) Listed companies must prepare accounts of

30 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

member company. (iv) To increase the required quorum for a general meeting of a listed company from three members to 10 members representing not less than 25% of total voting power either of their own account or through proxies. (v) To make it mandatory for listed companies to prepare accounts of subsidiaries and consolidated accounts in accordance with International Accounting Standard 27. The SECP has sought public opinion and discussed these proposals with legal, accounting, and business professionals. Besides the above proposals, the SECP has made it mandatory for listed companies to disclose their quarterly accounts. At present, listed companies are required to file annual audited accounts and unaudited semiannual accounts.

subsidiaries and consolidated accounts for listed companies. The requirement for listed companies to prepare quarterly accounts remains in place. The companies must disclose through the stock exchange their quarterly results within 1 month, their half-yearly results within 2 months, and their annual results within 3 months from the close of period.

Improve the corporate governance of the stock exchanges and reorganize them to improve their management and operational efficiency.

II.A.10 Each stock exchange will (i) restructure and expand its governing board by appointing a significant proportion of outside directors who are professionals and nonbrokers (on the basis of qualifications and criteria agreed with the SECP) and nominees of the Policy Board of the SECP, and (ii) appoint a full-time professional

II.B.7 Stock exchanges will upgrade their administration and staff appropriately to, among others, improve regulation, monitoring, and research and development. In addition, the stock exchanges will adopt new (i) trade reporting rules, including penalties for insider trading, noncompliance, and off-market

Governance of stock exchanges has been improved by the induction of external directors, who now make up 40% of directors, and the appointment of full-time professional and nonbroker chief executives at KSE and Lahore Stock Exchange (LSE). The recent changes in the articles of association of KSE seek to make the chief executive independent by requiring SECP approval before he or she can be appointed or removed. Directors are also required to delegate their powers to the managing director of the exchange company to ensure the separation of the management of stock exchanges from the members, and strengthen the office of the nonmember chief executive. KSE and LSE have taken steps to review their management structures. The KSE board of directors approved a

II.A.10 Complied with. II.B.7 Complied with, but most prescribed measures were implemented by SECP rather than the stock exchanges, as was required. The governance structures of the boards of stock exchanges have changed. The number of directors has been reduced from 18 to 10, equally divided between member (of exchange) directors and nonmember directors. Previously, on the 18-member board, 15 were member directors. Member directors are directly elected by stock exchange members while nonmember directors are nominated from various trade and professional bodies by SECP. The chairman is elected by the board from among the elected directors. The operational and administrative activities of the exchange are managed by the managing director, who is the full-time chief executive of the exchange and is appointed or removed only with the prior approval of SECP.

Appendix 1 31

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

and nonbroker chief executive officer on the basis of qualifications and criteria agreed with the SECP. October 1997.b

deals; (ii) inspection rules; (iii) licensing standards for traders and agents; (iv) listing requirements and guidelines; and (v) model contractual agreements for various transactions. June 1999.c

corporate plan in February 1999 to strengthen the secretariat of the exchange under the managing director. The plan envisages the establishment of separate departments for market control and surveillance, clearing and settlement, information technology, internal audit, and company affairs (which is also responsible for listing and research). The corporate plan has been substantially implemented. A full-time nonmember managing director has been hired. Since July 2001, LSE has taken steps to restructure its management according to a new organizational plan. More powers will be delegated to strengthen the independence of the managing director in the administration of the stock exchange. The new organizational plan is being implemented. A chief operating officer reporting directly to the managing director has been appointed. Islamabad Stock Exchange (ISE) is yet to review its administrative structure. The post of chief executive has been advertised but has not been filled so far.

SECP issued guidelines on insider trading in 2001 and penalized a local institution in its first insider trading case in 2004. SECP has also started inspecting brokers’ books. The licensing standards for traders and agents are in part covered by SECP’s Brokers and Agents Registration Rules of 2001. SECP has also introduced a standardized account opening form, which brokers must have their clients fill out. KSE management has made progress in upgrading administration and staff to improve regulation, monitoring, and research and development. Among the measures taken by KSE management are: (i) System audits of brokers by an independent auditor. Since this measure was introduced in July 2004, 50 brokers have been audited and the reports sent to SECP. (ii) Enforcement of restriction on short selling and imposition of penalties in case of noncompliance. (iii) Strict adherence to the collection of margins from brokers. (iv) Monitoring of KSE-100 companies’ compliance with the Code of Corporate Governance introduced in 2002. (v) Tightening of margins against COT with the introduction in 2003 of security valuations based on 52 weeks’ average price. (vi) Upgrading and implementation of listing regulations. (vii) Reporting of all on-market trades to KSE, under Karachi Automated Trading System (KATS) rules. However, reporting of client-to-client trades is not mandatory.

32 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

SECP is pursuing the demutualization and integration of the stock exchanges. It set up an expert committee on 17 February 2004 to recommend an implementation plan for the demutualization, integration, or transformation of the stock exchanges. The committee’s report was released by SECP in October 2004. The report recommended two models. The preferred model is a fully integrated, demutualized stock exchange uniting all three stock exchanges. Alternatively, a new national stock exchange may be established. LSE and ISE have already announced plans for demutualization and integration. KSE formed its own committee comprising exchange members, which submitted, to the chairman of SECP on 20 April 2005 a draft preliminary report on the demutualization of KSE and a report on the valuation of the net worth of KSE by a firm of chartered accountants. In the report on demutualization, KSE also sought written policy replies from SECP on three issues related to integration with LSE and ISE: (i) integration versus competition, (ii) Electronic Communication Network and Automated Trading System, and (iii) number of brokers.

II.A.11 The SECP is to take steps to encourage widening of corporate membership by the corporatization of sole proprietors or partnerships that are members of stock exchanges. September 1997.b

II.B.8 The Government will grant a one-time exemption from capital gains tax leviable on a sole proprietor or a partnership holding a stock exchange membership on the transfer of such membership to a corporate entity. June 1998.c

Implemented. The SECP and the Government have taken policy measures to promote the corporatization of individual members of stock exchanges. The Government has granted exemption from capital gains tax leviable on individual members on the transfer of membership to a corporate entity. Tax exemption was allowed for the period from 1 July 1998 to 30 July 1999 and from 1 July 2000 to 30 July 2001. As a result, 92 of 200 members (133 are actually active) of KSE have become corporate entities and 134 members have registered with the SECP, while 37 of 151 LSE members have become

Complied with. At OEM, 109 of the 200 KSE members, 60 of the 152 LSE members, and 40 of the 121 ISE members are corporate entities.

Appendix 1 33

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

corporate entities and 73 members have registered with the SECP. ISE has 33 corporate members out of its 102 members while 33 members are registered with the SECP.

II.A.12 Each stock

exchange will establish a member protection fund, and strengthen the default and disciplinary procedures and their enforcement. September 1997.b

II.B.9 The SECP and stock exchanges will establish an investor protection fund. June 1999.c

Implemented. Each stock exchange has established investor protection and clearinghouse protection (member protection) schemes, although these are not funded. SECP requires both funds to be fully funded by 30 June 2007. The funding requirements are phased. At least 50% must be funded immediately, 75% by 2003, and fully funded by 2007.

Complied with. The funding of clearing house and investor protection funds of stock exchanges has been ahead of schedule because of increased allocations from rising stock markets and high turnover. At KSE, the Clearing House Protection Fund (CHPF) against member default was established in 1992 while the Investor Protection Fund (IPF) was set up in 1997 to protect small investors in case of members’ default. Both funds are fully operational. As of 31 March 2005, CHPF had PRs592 million, including PRs386 million in separate bank accounts, and IPF had PRs592 million, PRs386 million of this in separate bank accounts. One fourth of the trade fees received by KSE go to these funds, which are managed under separate trust deeds. At LSE and ISE, the funds are fully funded. As of June 2004, LSE had PRs185 million in its CHPF and PRs43 million in the IPF. At ISE, the CHPF has PRs15 million, and the IPF, PRs20 million.

34 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

Improve the self-regulation of stock exchanges.

II.A.13 The SECP legislation will include provisions for the promotion of self-regulation of the securities industry while entrusting SECP with powers to penalize self-regulatory organizations, including revocation of licenses for noncompliance with defined criteria and standards. October 1997.b

II.B.10 The SECP will define minimum criteria and standards for conferring the status of a self-regulatory organization on a stock exchange and support stock exchanges in developing their self-regulatory capabilities.f June 1999.c

Implemented. Though the SECP Act of 1997 does not specifically provide for promotion of self-regulation of the securities industry, the stock exchanges are working toward becoming self-regulatory organizations. The provisions of the Securities and Exchange Ordinance empower the stock exchanges to prescribe rules for regulating the market. The stock exchanges have established a system of surveillance and are authorized to inspect brokers. The SECP treats the stock exchanges as frontline regulators while it remains an off-site regulator.

II.A.13 Complied with. II.B.10 Not complied with. Subsection 4(f) of Section 20 of the SECP Act empowers SECP to promote and encourage self-regulatory organization structures for stock exchanges and NBFCs. The SECP Act of 1997 assumes the three stock exchanges to be self-regulatory organizations. Yet SECP has not set minimum criteria for conferring self-regulatory organization status on a stock exchange. It has reservations about granting too much autonomy to regional, mutualized stock exchanges. SECP is actively pursuing demutualization of stock exchanges and meanwhile keeping most regulatory functions to itself.

Encourage other selected capital market participants toward self-regulation.

II.A.14 The Mutual Fund Association of Pakistan (MUFAP) and the Leasing Association of Pakistan (LAP) will take steps to develop their capabilities to oversee industry compliance with prescribed prudential standards and perform on-site supervision. September 1997.b

II.B.11 These associations will develop into self-regulatory organizations in accordance with norms set by the SECP to qualify for a self-regulatory organization license. June 1999.c

Not implemented. MUFAP and LAP have not developed into self-regulatory organizations. They remain loosely organized and working mainly as representative bodies of their respective industries. They must be properly organized with a secretariat and qualified staff to perform self-regulatory organization functions. MUFAP has recently been licensed as a trade organization by the Ministry of Commerce (MOC), and is thus a quasi-legal entity. Standards for achieving a self-regulatory organization status have not been announced by the SECP. Consultants hired under TA 1577-PAK(SF) have not recommended granting self-regulatory organization status to LAP but made a positive recommendation for MUFAP.

II.A.14 Not complied with. II.B.11 Not complied with. OEM could not independently verify that MUFAP and LAP had indeed taken steps to develop their capabilities to oversee industry compliance with prescribed standards and on-site supervision. SECP supports the self-regulatory organization status for MUFAP but believes that it cannot handle a self-regulatory organization functions just yet. SECP has asked MUFAP to introduce licensing criteria for fund managers. MUFAP has indicated that it would need 18 months to install such a licensing system.

Appendix 1 35

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

III. Improve and Modernize the Securities Market Infrastructure and Promote Its Integration Upgrade automated trading systems to pave the way for the eventual integration of the national market.

III.A.15 The stock exchanges will adopt new and compatible computerized screen-based trading systems for selected scrips. September 1997.b

III.B.12 Stock exchanges, with the support of the SECP, will fully operationalize harmonized and automated trading for all scrips and completely phase out the open outcry method of securities trading. June 1999.c

Implemented. Automated trading started in Karachi for certain scrips in September 1997 and the system was extended to all scrips by May 1998, phasing out the open outcry system completely. Automated trading was introduced in LSE in August 1997 while ISE has had automated trading since it began operations in August 1992.

Complied with. Implemented measures remain in place, i.e., all trading takes place through KATS and the open outcry system has been abandoned. Stock exchanges continue to improve the automation of trading systems. KSE has allowed remote-trading KATS terminals outside the KSE premises and is also implementing a plan for Internet trading. Some brokers on their own are already offering Internet-based trading services.

Promote development of CDC.

III.A.16 The Government will adopt legislation and regulations for CDC, including the features of delivery-versus-payment system with provisions for cash deposit account/exposure cap to ensure fulfillment of obligations arising out of transactions, and initiate operationalization of CDC. September 1997.b

III.B.13 CDC will be fully operationalized to introduce efficient delivery, settlement, and transfer of securities through a computerized book-entry system. June 1999.c

Implemented. The Central Depository Act of 1997 was promulgated on 7 June 1997 and regulations under the Act were issued on 25 June 1997. CDC became operational on 3 December 1997 starting with only one scrip. However, all listed securities were declared to be eligible securities for induction into CDC by 23 June 1998. At present, CDC’s main elements are 373 account holders, 372 issuers, and 55 eligible pledgees. CDC started operations with custody services. It is now offering delivery versus payment services, which are covered by the CDC Act and Rules. It also provides trustee services to an open and mutual fund.

Complied with. At present 98% of all settlements on stock exchanges take place through CDC. As of 31 March 2005, CDC’s main elements were: 453 participants and account holders, 487 live securities, and 83 pledgee accounts. In addition, there are 581 corporate and 21,900 individual investor accounts directly maintained with CDC. To expand its geographical coverage and promote investor accounts, CDC has entered into an agreement for the opening of investor accounts with Habib Bank Limited, now the largest bank in the private sector with a nationwide network of more than 1,500 branches. CDC has also cut its annual investor account fee from PRs1,500 to PRs500. CDC has implemented several contingency measures for smooth functioning. These measures include: CDC contingency site, online transaction backup, on-site and off-site tape back-up, and global terminal facility. CDC is also working on a SECP directive to introduce global identification for clients. The deadline for this is November 2005.

36 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

Over time, CDC has also expanded its ambit of services. Aside from the core depository services, CDC also provides trustee and custodial services to mutual funds. As of 31 March 2005, CDC was trustee to 15 closed-end mutual funds with net assets of PRs41 billion and custodian for two open-end mutual funds with net assets of PRs1.6 billion.

Promote the development of a National Clearing and Settlement System (NCSS).

III.A.17 Stock exchanges and CDC will develop a proposal and agree on setting up of the NCSS, and cost sharing of the development cost of its network. September 1997.b

III.B.14 An appropriate NCSS and its supportive legislation and regulations will be developed and established to move toward compliance with the Group of Thirty recommendations relating to securities and settlement. June 1999.c

Partially implemented. The NCSS has been developed with the help of the consultants hired under TA 1577-PAK(SF). The National Clearing Company of Pakistan has been incorporated (July 2001) with paid-up capital of PRs35 million contributed by the three stock exchanges. The International Finance Corporation in Washington, DC, is also considering an equity participation for the company. The project is being implemented in phases and the balance order settlement system started functioning on 24 December 2001. With these developments, six out of nine recommendations of the Group of Thirty were implemented. Recommendations implemented relate to trade comparison on T+1, full operationalization of central depository, netting system, delivery versus payment system, T+3 rolling settlement system , and use of International Organization of Securities Commission standards 7775 and 6166. Recommendations that have not been implemented relate to trade comparison for indirect participants, same-day funds convention, and securities lending through the NCSS.

Complied with. The National Clearing Company of Pakistan Limited (NCC) was incorporated in July 2001 and began operations in December 2001 with two securities. However, by January 2004, all securities in the central depository system had been added to NCSS and all new additions to CDC since then have also been automatically included in NCSS. The present paid-up capital of NCC is PRs63.75 million, held by the three stock exchanges (KSE PRs30 million, LSE PRs15 million, ISE PRs7.5 million) and a development finance institution, Pak-Kuwait Investment Company (PRs11.25 million).

Appendix 1 37

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

From the start, NCC operations have been handled by CDC under a facility management agreement. However, NCC is in the process of becoming independent, and only the management of its information technology functions will be retained with CDC. Some of the staff involved in managing NCC operations were transferred from CDC to NCC but the two companies still have the same chief executive. NCC is complying with G-30 recommendations under the World Bank’s Financial Sector Adjustment Loan. NCC already complies with eight of the nine recommendations of G-30. The remaining one concerns the real time gross settlement system and the trade netting system provided for in the International Securities Service Association Pakistan Handbook, May 2003.

IV. Develop the Corporate Debt Market Promote development of an over-the-counter (OTC) debt market.

IV.A.18 Market participants, including stock exchanges, corporate brokerage houses, and investment companies, will create a working group that will set up an OTC market to develop orderly, central, and electronic screen-based secondary trading in fixed-income securities. September 1997.b

IV.B.15 Market participants will develop and establish an OTC market. June 1999.c

Not implemented. Market participants, with whom CLA and consultants discussed the proposal, did not respond positively to it. Consultants who studied the subject under TA Loan 1577-PAK (SF) concluded that current trading volumes in TFCs do not justify establishing a mechanism to trade only in corporate debt instruments. The establishment of an OTC market for both Government securities and corporate debt securities involves regulatory issues as Government securities are regulated by the SBP while corporate debt securities are regulated by the SECP.

IV.A.18 OEM could not independently verify compliance status of this condition. IV.B.15 Partly complied with. OEM could not independently verify whether a working group was indeed set up according to section IV.A.18. A task force with members from SECP, SBP, and Pakistan Banks’ Association has been set up to make recommendations for the development of debt and capital markets. Systems and procedures have been developed for the trading, clearing, and settlement of shares and TFCs, or corporate bonds, in the OTC market, and the legal framework is in place. The SECP expects the corporate debt market to develop once the trading of OTC debt instruments starts.

38 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

IV.B.16 The SECP will introduce prudential guidelines for the use of repurchase agreements in private debt securities. June 1999.c

Implemented. The prudential guidelines for the use of repurchase agreements in private debt securities have been issued by SBP.

Complied with. OEM confirmed the PCR finding.

V. Reform the Mutual Fund Industry Strengthen the regulatory framework for the mutual fund industry.

V.A.19 SECP legislation will provide for the regulation of all mutual funds, including the public sector mutual funds. September 1997.b

V.B.17 The SECP will strengthen the regulatory framework and develop capabilities for the monitoring and inspection of all mutual funds. June 1999. c

Implemented. The Securities and Exchange Commission of Pakistan Act of 1997 makes the SECP responsible for regulating the working of collective investment schemes, including unit trust (mutual fund) schemes (section 20[2]). As such, all mutual funds, whether in the private or the public sector, are to be regulated by the SECP. NIT, which has managed an open-end fund in the public sector since 1962, was registered with the SECP on 30 June 2000 under the Asset Management Companies Rules although NIT is yet to submit its scheme to the SECP for authorization. The Investment Corporation of Pakistan (ICP), the public sector management company for 26 closed-end mutual funds since 1966, is yet to be registered with the SECP. The SECP has established a specialized companies division, which regulates mutual funds. Steps taken to develop regulatory capability include inducting and training qualified staff and devising a monitoring system. Three officers of the division exclusively regulate mutual funds under the supervision of a director and an executive director.

V.A.19 Complied with. V.B.17 Partially complied with. The Companies Second Amendment Ordinance of 2002 reinforces the regulatory authority of SECP over NBFCs including asset management companies, investment advisers, and investment finance companies. NIT is licensed by SECP to undertake asset management services. However, the functions of NIT are governed by the trust deed executed between NIT and the National Bank of Pakistan on 12 November 1962, and the NIT Ordinance of 1965, under which NIT was set up. The regulatory provisions of SECP apply to NIT to the extent that the NIT Ordinance does not address the specific issues. So far SECP has relied on off-site monitoring of mutual funds, and no on-site inspection of any mutual fund manager has taken place.

Appendix 1 39

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

Strengthen the policy framework for the mutual funds industry.

V.A.20 The SECP will amend the Investment Advisors Rules of 1971, pertaining to the closed-end funds with emphasis on (i) increasing the minimum paid-up capital requirement from PRs20 million to PRs100 million, and introducing higher professional standards for appointment of fund managers; (ii) liberalizing investment requirements for mutual funds so that they can invest in unlisted and fixed-income securities to facilitate diversification of their portfolio; and (iii) requiring disclosure to provide adequate information to unit holders. September 1997.b

V.B.18 The SECP will further review and introduce improvements in the Investment Advisors Rules of 1971 and in the Asset Management Companies Rules of 1995, with the objective of updating the industry standards. June 1999.c

Among other provisions, the Investment Companies and Investment Advisor’s Rules as amended in January 1999: (i) increased the minimum paid-up capital requirement for investment companies (closed-end mutual funds) from PRs20 million to PRs100 million, and prescribed a minimum paid-up capital of PRs20 million for investment advisers; (ii) permitted mutual funds to invest in unlisted securities (10%) and fixed-income securities (20%); and (iii) enabled investment advisers to manage more than one mutual fund. In 2001, a further set of amendments was notified to allow the flotation of sector-specific funds and make it mandatory for mutual funds to report net asset value to the stock exchanges and the SECP.

Complied with. The Government has notified NBFC Rules of 2003, the consolidated and updated set of rules for all NBFCs including asset management companies, investment advisers, discount houses, housing finance companies, investment finance companies, leasing companies, and venture capital companies. These rules replaced the Leasing Companies (Establishment and Regulation) Rules of 2000, Investment Companies and Investment Advisers Rules of 1971, Asset Management Companies Rules of 1995, and Venture Capital Companies and Venture Capital Funds Rules of 2001, which have all been repealed along with a few of the finance division’s notifications. The NBFC Rules have set the following minimum capital requirements for the different types of services: (i) investment finance company: PRs300 million, (ii) leasing: PRs200 million, (iii) venture capital: PRs5 million, (iv) discounting services: PRs200 million, (v) investment advisory and asset management: PRs30 million, and (vi) housing finance services: PRs100 million. The new rules allow closed-end funds to invest up to 20% of the total investment portfolio in unlisted government securities and secured debt securities with investment grade rating. Investment in a single company cannot be more than 10% of the funds’ capital or 10% of the company’s capital, whichever is lower. Allocation to a single sector (according to the stock exchange classification) cannot exceed 25% of the funds’ net assets. However, according to the rules, SECP could allow these investment conditions in view of the fund’s specific investment objectives.

40 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

V.B.19 The SECP will introduce a policy and regulatory framework for the money market and fixed-income securities mutual funds. June 1999.c

Implemented. The Asset Management Companies Rules of 1995 have been amended to provide for the establishment of sector-specific funds. As such, money market and fixed-income securities funds can now be established. The SECP has already approved, in principle, a fixed-income securities fund and has registered its asset management company. The scheme, including the trust deed, is being processed by the SECP.

Complied with. Six fixed-income mutual funds have been launched since 2002. The SECP is developing a regulatory framework for real estate investment trusts in Pakistan.

Restructure the mutual fund industry.

V.A.21 The Government will (i) issue directives to the NIT to withdraw the minimum guarantee price for NIT units as soon as the net asset value of NIT units is above this level, (ii) initiate setting the NIT liabilities associated with the minimum guarantee price, (iii) allow NIT to trade stocks of strategic state-owned enterprises, (iv) issue directives to ICP to segregate the loan portfolio from its

V.B.20 The Government will subcontract the management or transfer the majority of the Government’s shareholding and management of the asset management companies of NIT and ICP to experienced fund managers. Prior to this, the Government will fully settle the NIT liabilities related to the minimum guarantee price, transfer the loan portfolio of ICP to a suitable entity, and provide voluntary retirement payment to the excess work force. December

Partially implemented. Although the Government has taken certain measures to prepare for the privatization of NIT, it is difficult to determine a definite time frame for its privatization. The funds when transferred to the private sector will no longer have the implicit guarantee of the Government. However, the Government had to issue a fresh letter of comfort to major investor institutions as these found it difficult to make heavy provisions in the absence of such a letter. A positive development has been the decision of the Government to allow some flexibility to NIT to trade stocks of state-owned enterprises. NIT has been allowed to sell shares of state-owned enterprises in cases where the Government’s direct or indirect holding exceeds 51%. Preliminary steps have also been taken to privatize the management of NIT. Expressions of interest were invited through the press in July 2001 for disinvestment of 58% of shares held directly or indirectly by the Government.

V.A.21 Partially complied with. V.B.20 Partially complied with. Policy measures related to ICP have been implemented while those related to NIT remain largely unimplemented. Rather than privatizing ICP as an investment advisory company offering its shares for strategic sale, the Government initially privatized the management rights of the 26 ICP mutual funds in three lots, which were acquired by two domestic institutions. The management rights of lot A, comprising 12 mutual funds with aggregate net asset value (NAV) of PRs1,402 million at the time of privatization, were sold for PRs175 million in September 2002. Management rights of lot B, which comprised 25 mutual funds with aggregate NAV of PRs1,713 million at the time of privatization, were sold for PRs303 million in October 2002. The third lot was the State Entity Mutual Fund of ICP with NAV of PRs2,669 million at the time of sale of its management rights in April 2003 for PRs787 million. After privatizing its mutual funds, ICP surrendered its investment advisory license. ICP now has a development finance institution status and is recovering loans that were extended earlier. It also has its own equity portfolio worth about PRs2 billion. Its present staff strength is 51, after two

Appendix 1 41

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

fund operations, (v) assess the level of staff rationalization required for the two asset management companies, and (vi) agree on the launching of the ADB-financed TA for Restructuring of Public Sector Mutual Funds. October 1997.b

1998.c Eleven parties expressed interest. A committee was formed to prepare a statement of qualifications and recommend criteria for prequalification. A statement of qualifications was sent to the 11 parties but only four responded. The four are being appraised for prequalification. Besides issues related to the Government’s letter of comfort, other problems complicate the process of privatization. While 50% of the portfolio is invested in state-owned enterprises, the remaining portfolio is mostly illiquid. There are concerns about volatile redemption pressure from institutional investors holding a substantial amount of units. Some legal issues such as the position of NIT’s trust deed vis-à-vis Asset Management Companies Rules also need to be resolved. The Privatization Commission (PC) has invited a fresh submission of expressions of interest for NIT along with statements of qualification, and prequalified five bidders to carry out due diligence from 1 September 2002. As regards ICP, the federal cabinet decided in a meeting on 13 June 2001 to privatize ICP funds and wind up the institution. Consequently, the PC hired consultants to value the assets and identify legal and financial issues involved in the implementation of the cabinet decision. As for ICP, it was decided to sell its mutual funds business in three lots rather than a single lot to increase competition. The PC invited expressions of interest in March 2002 for the sale and transfer of management rights of lot A of ICP mutual funds (comprising 12 of the 26 ICP funds). PC approved in July 2002 the prequalification of nine parties (out of 16) that had submitted an expression of interest. The Cabinet Committee on Privatization in August

rounds of retrenchment in 1997 and 2003. In 1997, its staff was reduced from 600 to 300 through a golden-handshake scheme and another 267 people were retired in 2003 and given handsome compensation packages. About 70% of ICP’s shareholding is now in private hands, after the privatization of nationalized banks. The Government, with the consent of ICP’s shareholders, is planning a strategic sale of shares of ICP itself. Measures related to NIT could not be implemented because of various complexities: (i) The minimum price guarantee to the three major holders of NIT units, accounting for 48% of the NIT fund now valued at about PRs70 billion, has not been withdrawn as that is likely to result in large redemptions though the price of NIT units is well above the minimum guarantee price. (ii) For the above reason, NIT has not initiated setting its liabilities associated with the minimum guarantee price. (iii) Allowing NIT to trade (more specifically, sell) stocks of strategic state-owned enterprises (SOEs) would upset the privatization of these SOEs as NIT’s holdings constitute a significant part of these SOEs’ shares being offered by the Government in strategic sales. However, NIT has been allowed to sell shares of SOEs in cases where the Government’s direct or indirect holding exceeds 51%. (iv) NIT has not undertaken staff rationalization but has put a freeze on further hiring. (v) TA 2865-PAKg and TA Loan 1577-PAK(SF)h did not result in fully workable proposals on the restructuring of ICP and NIT. The Government is pursuing an indigenously developed privatization structure for NIT, whereby the fund shall be split into five equal units, and the management rights of two to three funds shall be transferred to the three major unit holders given a minimum price guarantee, which shall then be withdrawn. The management rights of remaining funds shall be auctioned. The new acquirers of funds

42 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

2002 gave the final clearance for the PC to conduct the bidding process and the sale of lot A was finally closed on 11 October 2002 for PRs175 million. Further, in September 2002, the PC issued an invitation for the submission of expressions of interest and statements of qualification for the bidding of ICP lot B and conducted the bidding, similar to that for lot A, on 24 October 2002. The sale of lot B for PRs302.5 million has been approved by the Cabinet Committee on Privatization. Earlier, ICP had offered voluntary retirement to its staff, and 365 people have taken up the offer. The segregation of loan portfolio from fund operations has been complicated by the fact that ICP has borrowed more than PRs300 million from the fund.

shall be required to maintain frozen shareholders in SOEs until their privatization. NIT could later be liquidated or sold to a new investor. NIT has 12 equal shareholders. As with ICP, as a consequence of the privatization of banks, the major shareholders of NIT are now in the private sector. However, according to the privatization agreements of these banks, the Government retains the right to enforce the restructuring and strategic sale of NIT.

VI. Develop the Leasing Industry Streamline the regulatory framework.

VI.A.22 Transfer the regulatory and supervisory authority over the leasing industry from the SBP to the CLA. February 1997.b

VI.B.21 Strengthen the capability of the SECP to regulate and monitor industry compliance with new capital requirements and prudential norms. June 1999.c

Implemented. Regulatory and supervisory authority over leasing companies was transferred from the SBP to the CLA through an amendment to the Banking Companies Ordinance in 1997. The SECP has established a Specialized Companies Division, which regulates NBFIs, including leasing companies. Steps taken to upgrade the regulatory capability of the division include recruitment of qualified staff and development of a monitoring system. The regulatory framework for leasing companies was reviewed in consultation with the leasing industry and a new set of rules was notified on 25 September 2000. These rules also

Complied with. The Companies Second Amendment Ordinance 2002 reinforces the regulatory authority of SECP over NBFCs including the leasing sector. After issuing the NBFC Rules of 2003, SECP issued a revised set of prudential regulations for NBFCs, including leasing companies.

Appendix 1 43

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

provide prudential norms to be followed by leasing companies such as limits on exposure, margin against facilities, and provisioning for nonperforming assets. To ensure compliance, periodic reporting requirements were prescribed. Out of nine statements required, one is monthly, three are quarterly, four are semiannual, and three are annual.

Strengthen the capital base to encourage the orderly growth of the industry.

VI.A.23 The CLA will raise the capital base requirements for the leasing industry from PRs100 million ($2.5 million) to PRs200 million ($5.0 million).i September 1997.b

VI.B.22 LAP, in collaboration with the SECP, will strengthen the (i) industry standards for credit administration (origination and servicing), pricing, portfolio management, and asset-liability management; and (ii) lessor’s rights of repossession, including the right of automatic repossession. It will improve the adjudication of disputes through legal procedures and amendment of the substantive laws, where necessary. June 1999.c

Substantially implemented. In 1997, leasing companies were required to raise their minimum capital to PRs200 million by 30 October 1999. The last date for compliance was later extended to 30 June 2001. Eighteen of 29 leasing companies have fully complied with this requirement. Leasing companies have found it difficult to raise their level of paid-up capital partly because of the depressed stock market in the last few years, which has limited their ability to raise additional capital through rights issues. While pursuing its objective, the SECP has asked the noncomplying companies to submit plans for meeting the regulatory requirements, which will be considered individually. This initiative has triggered mergers among the leasing companies. Although LAP has not taken any initiatives to strengthen industry standards for credit administration or portfolio management, the SECP has endeavored to address these issues through new leasing rules issued in 2000. These rules were framed in consultation with the industry.

VI.A.23 Complied with. VI.B.22 Partially complied with. Out of 19 leasing companies, three do not meet the increased capital requirement but have submitted plans to SECP for increasing their capital to meet the minimum capital requirement. No substantive actions have been taken by the LAP to implement the measures specified in section VI.B.22. However, most of these issues have been addressed through the prudential regulations for NBFCs issued by SECP.

44 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

In view of its experience, the SECP is proposing further amendments to the rules, which would be processed in consultation with the industry. There has been a significant development in the procedure of adjudication in the case of default by a lessee. According to the Financial Institutions (Recovery of Finances) Ordinance of 2001, a financial institution is empowered to sell the secured property after serving three notices to the defaulting customer.

Tap alternate long-term financing sources for the industry.

VI.A.24 LAP will prepare a concept paper on promoting asset securitization of the industry. September 1997.b

VI.B.23 SECP will develop and introduce a legal and regulatory framework for issuance of asset-backed securities by the leasing industry. June 1999.c

Implemented. After consultation with market participants, the SECP notified rules to facilitate and regulate the securitization of asset-backed securities. The Companies (Asset Backed Securitization) Rules were notified in 1999. Besides defining the terms “securitization,” “special-purpose vehicle,” and “originator,” the rules lay down the conditions of registration and obligations of special-purpose vehicles. In Pakistan, securitization is still in a nascent stage. Though the Asset Backed Securitization Rules of 1999 were notified by SECP in December 1999, the banks/NBFIs that were keen to undertake such securitization transactions through special-purpose vehicles awaited final guidelines from SBP, their regulator. With the transfer of NBFI regulation to SECP, the guidelines are expected to be issued soon. SECP has recently approved the securitization deal for PRs1 billion for Paktel Ltd. against its present and future receivables.

Complied with. OEM confirmed the PCR finding.

Appendix 1 45

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

VII. Promote Contractual Savings Through Reforms of the Insurance Sector and Pension and Provident Fund Industry Strengthen policy, legislative, and regulatory framework to promote and ensure the orderly growth of the insurance industry.

VII.A.25 An action plan for the reform of the insurance sector, drawing on the recommendations of the Report of the National Insurance Reforms Commission, 1993, and the report of the task force on reforms of the Insurance Act of 1938, will be submitted to ADB. October 1997.b

Implemented. Complied with. OEM confirmed the PCR finding.

VII.A.26 The Cabinet will approve the proposal for the replacement of the Controller of Insurance with an independent and autonomous Pakistan Insurance Regulatory Authority (PIRA) to promote the sound development of the insurance industry, while protecting the interests of policyholders.

VII.B.24 The Government will prepare and adopt the legislation for an independent PIRA and operationalize it, and adopt the new Insurance Act, including amendments for the compulsory reinsurance and preferential allotment requirements for the general insurance business companies, solvency margins, premium rates,

Implemented. Although some preliminary work was done to set up an independent regulatory body exclusively to regulate the insurance industry, it was deemed desirable to empower SECP to regulate the insurance sector. ADB and the Government took this decision after careful thought and consideration of the views of international experts. The main considerations were: (i) the relatively small size of the insurance sector in Pakistan; (ii) the limited availability of qualified personnel for regulatory bodies; (iii) the comparative legal convenience of adding the functions to an existing institution; and (iv) cost-effectiveness. Consequent to the policy decision, the SECP Act of 1997 was amended on 11 October

VII.A.26 Complied with. VII.B.24 Complied with but with a modification, accepted by ADB, that SECP would assume the regulatory functions envisaged for PIRA. OEM confirmed the PCR finding. At SECP, the Insurance Division headed by an executive director has been set up as part of Specialized Companies Division at SECP. Insurance Division administers the law of insurance that covers licensing and supervision of insurers and other entities regulated under these laws. Insurance Division is further divided into five wings: (i) actuarial services, (ii) life insurance prudential supervision, (iii) non-life insurance prudential supervision, (iv) market conduct supervision, and (v) enforcement and prosecution.

46 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

PIRA, among others, will (i) regulate all public and private insurance companies; (ii) be empowered to enforce the regulations pertaining to licensing and de-licensing, investment funds, capital adequacy, and solvency margins; (iii) undertake inspection and investigation of insurance companies, brokers, agents, and intermediaries; and (iv) adjudicate disputes between the insured and the insurance companies. October 1997.b

and supportive regulations for the insurance industry. December 1998.c

2000 to transfer the administration of the law of insurance from the Ministry of Commerce to SECP. Under its own Act and the Insurance Ordinance of 2000, SECP has enough power to effectively regulate the insurance sector. Under the amended SECP Act, SECP is responsible for monitoring and ensuring compliance by insurers, insurance agents, and insurance surveyors with all laws, rules, and regulations pertaining to insurance, as well as for promoting the organized development of the insurance market in Pakistan. MOC notified the new insurance rules in August 2002. SECP has powers of investigation under the SECP Act. For adjudication, the Insurance Ordinance provides for a small disputes resolution committee, insurance tribunals, and an insurance ombudsman. SECP has formed an insurance division under an executive director. Seven officers and 15 supporting staff now work in the division.

Recently, SECP has appointed an insurance adviser to assist the executive director of the Insurance Division. The oversight arrangement in the insurance industry remains unclear: SECP and MOC have issued their own rules but SECP has neither significant enforcement powers nor the power to revoke licenses. The dichotomy has fueled uncertainty and weakened the ownership of the regulatory framework. From this perspective, the Government is considering transferring jurisdiction from MOC to MOF as an alternative regulatory arrangement.

Adopt more stringent financial standards for the insurance industry.

VII.A.27 Cabinet approval will be sought to raise the (i) minimum paid-up capital requirement for domestic life insurance companies from PRs30 million to PRs100 million ($2.5 million) and

VII.B.25 PIRA will (i) assess compliance of insurance companies with these new financial standards; (ii) identify further improvements in the regulatory framework, including standards

Implemented. The Insurance Ordinance of 2000 prescribes minimum paid-up capital requirements as well as solvency margins for both life and general insurance companies. Life insurance companies are required to raise their paid-up capital to PRs100 million by the end of 2002 and to PRs150 million by the end of 2004. General insurance companies are required to increase their paid-up capital to PRs50 million by the end of 2002 and to PRs80 million by

Complied with. OEM confirmed the PCR finding. The solvency margin is being used as proxy for introducing risk-based capitalization requirement. SECP does not have clear de-licensing powers under the Insurance Ordinance of 2000. But it can apply to court for the winding up of an insurance company if the company remains noncompliant for more than 3 months.

Appendix 1 47

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

for domestic general insurance companies from PRs25 million to PRs40 million ($1 million);j and (ii) raise the solvency margin (defined as assets minus liabilities) from PRs0.5 million (or 10% of net premium) to PRs2.5 million. October 1997.b

for risk-based capitalization, as well as redefinition of the solvency margin; (iii) de-license market operators that fail to comply or indulge in malpractice; and (iv) issue regulations for brokerage houses for general insurance. June 1999.c

the end of 2004. As regards the solvency margin, the Insurance Ordinance defines it and empowers the SECP to prescribe the margin. The rules that have been drafted under the Insurance Ordinance of 2000 propose specific solvency margins.

SECP has recently issued the first license for insurance brokerage services.

Take steps to improve professional and ethical standards of the industry.

VIII.A.28 The Controller of Insurance will define standards for various market participants in the insurance industry, including the qualifications, obligations, and duties of agents and brokers, and the Insurance Association of Pakistan will prepare a proposal to upgrade the Pakistan Insurance Institute. October 1997.b

VIII.B.26 PIRA will reconstitute and operationalize the Insurance Claim Settlement Board with powers to execute its own decree and hold regular hearings; and seek collaboration from the insurance industry and Insurance Association of Pakistan to upgrade Pakistan Insurance Institute to provide special training courses for brokers and agents, surveyors, loss adjustors, and underwriters, and to play a key role in increasing public

Partially implemented. The Insurance Ordinance, and its comprehensive rules, prescribe professional and ethical standards for insurers as well as other intermediaries in the insurance industry. The Insurance Ordinance also provides for a constitution and procedure for the working of tribunals for the settlement of claims. No steps have been taken to upgrade the Pakistan Insurance Institute and there are no satisfactory arrangements in the country for the education and training of insurance professionals in the insurance sector. The absence of a well-established education and training institution for insurance is being increasingly felt by the insurance industry, which is facing difficulties in recruiting qualified personnel and in upgrading the skills and knowledge of employees through training.

VIII.A.28 OEM could not independently verify if this condition was met. VIII. B.26 Partially complied with. No substantive upgrading of Pakistan Insurance Institute has taken place. Only the state-owned insurance companies provide funding for the institute; private sector companies do not. In place of operationalizing Insurance Claim Settlement Board, MOC is implementing the following measures: (i) Establishing the Insurance Ombudsman. The secretariat and infrastructure shall be at SECP but expenses shall be met by contributions from insurance companies. (ii) Setting up the Small Dispute Settlement Committee to handle disputes of up to PRs0.5 million. (iii) Setting up insurance appellate tribunals headed by district and session judges in main cities. A summary in this regard has been with the Prime Minister for the past 2–3 months.

48 Appendix 1

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

awareness regarding insurance. June 1999.c

Restructure and divest public sector insurance companies.

VIII.A.29 The Government, with the support of ADB-financed TA 2866-PAK for Reform of the Insurance Industry, will initiate studies of the Pakistan Insurance Corporation (PIC) and the National Insurance Company Limited (NIC) to review their role in the changing environment and explore options for improving corporate governance, and the restructuring/ divestment of these companies. October 1997.b

VIII.B.27 The Government will restructure or divest PIC and NIC in accordance with the recommendations of the studies. June 1999.c

Implemented. Significant steps have been taken to restructure PIC and NIC, as a prerequisite for privatization. PIC was incorporated as a public limited company on 30 March 2000 as the Pakistan Reinsurance Company Limited (PRCL) with a paid-up capital of PRs50 million. NlC of Pakistan was incorporated as a public limited company on 31 March 2000 with a paid-up capital of PRs100 million. The Government, which has substantial shareholdings in both companies, has nominated private sector professionals for their boards of directors. These companies, working under the discipline of the Companies Ordinance, are also being registered under the Insurance Ordinance.

Complied with. After corporatization, PIC was renamed PRCL. Its paid-up capital was raised from PRs50 million to PRs450 million in November 2002. The compulsory cession available to PRCL from domestic insurance company was removed in January 2005 and a phased withdrawal of right of first refusal is also in the cards. PRCL hired a domestic consultant for corporate restructuring, who recommended reducing the head count from 300 to 160. PRCL formalized a voluntary separation scheme, but the scheme has not been implemented. Under private sector management, NIC has seen its business grow despite a shrinking captive market due to the ongoing privatization of SOEs. The company’s gross premium increased from PRs1.9 billion in 1999 to PRs4.0 billion in 2004. In line with the management consultant’s recommendations for a reduction in staff strength, NIC reduced its workforce from 600 to 400 in 2002 through a voluntary separation scheme. To develop its human resources, NIC has established an in-house learning center while also sending staff to Pakistan Insurance Institute for training.

With the introduction of the Insurance Ordinance and the amended SECP Act, both PRCL and NIC have been regulated by the SECP.

Appendix 1 49

Objective

First Tranche- Program Measures

Nov 1996 to Oct 1997

Second Tranche-Program

Measuresa 1998 to

Dec 1999 Compliance Status

as per Program Completion Report (PCR) Compliance Status and Follow-On Measures as per Operations Evaluation Mission (OEM)

Reform pension and provident funds.

VIII.A.30 A working group will be set up to implement a study financed by the ADB TA 2867-PAK for Reform of Pension and Provident Funds with the objective of developing a reform proposal for improving the coverage of the social security system and financial management of pension and provident funds. September 1997.b

VIII.B.28 The Government, in collaboration with ADB, will develop plans for public and private pension and provident funds, drawing on the recommendations of the TA study. June 1999.c

Implemented. The Government formed a working group to assist the consultants under the ADB TA for the reform of pension and provident funds. The finance minister, in his budget speech on 18 June 2001, announced that the Government would develop a framework for promoting the growth of pension funds. He also announced a tax rebate on investments in an approved pension fund. The SECP prepared a comprehensive proposal in July 2001 and submitted it to the Ministry of Finance for approval. The SECP has designed a personal pension system aimed at promoting the establishment of individually capitalized pension savings accounts managed by private sector professional managers.

Complied with. SECP issued draft Voluntary Pension System Rules in November 2004. The rules mandate the division of a pension fund into equity and debt sub-funds, with allocations to each sub-fund being linked to the age group of members of the pension fund. For example, in the 18–30 years age group, the permissible ranges for asset allocations are 10–40% for debt sub-funds and 60–90% for equity sub-funds. For those 60 years and above, the permissible ranges are 90–100% for debt sub-funds and 0–10% for equity sub-funds.

a All bold conditions were tied to the release of the second tranche. b At approval of the Loan, ADB and the Government considered the program measures to have been implemented in this month and year. c At approval of the Loan, ADB and the Government considered this month and year to be target for implementation of the program measures. d Enactment of legislation was a condition for loan effectiveness. e ADB. 1997. Report and Recommendation of the President to the Board of Directors on Proposed Loans to Pakistan for the Capacity Enhancement of the Securities

Market Development Program. (TA Loan 1577-PAK[SF], for $5 million, approved on 6 November 1997). Manila. f These would include capabilities to (i) undertake on-site examinations of brokerage firms to ensure compliance with securities legislation, and rules and regulations

of stock exchanges; (ii) ensure audit of members’ accounts; (iii) monitor compliance with prudential norms; (iv) introduce continuous, automated surveillance of security transactions; (v) provide arbitration and dispute resolution mechanisms; and (vi) develop programs to improve professional and ethical standards in the industry, as well as to educate and protect investors.

g ADB. Technical Assistance to the Islamic Republic of Pakistan for Restructuring of Public Sector Mutual Funds. Manila (TA 2865-PAK, for $800,000, approved on 15 September 1997).

h Main text, footnote 3. i The new companies were to meet these requirements upfront, while existing companies would have 3 years to comply with the new standards. j The new companies were to meet these requirements upfront, while existing companies would have 3 years to meet the requirements. Source: Operations Evaluation Mission.

50 Appendix 2

EVALUATION OF TA LOAN 1577-PAK(SF): CAPACITY ENHANCEMENT OF THE SECURITIES MARKET

I. BACKGROUND

A. Rationale 1. In conjunction with the Capital Market Development Program (CMDP), the Government of Pakistan requested the Asian Development Bank (ADB) for technical assistance (TA) to strengthen the regulatory framework and basic market infrastructure of the capital market to facilitate its orderly and sustainable growth. In response, ADB approved TA Loan 1577-PAK(SF): Capacity Enhancement of the Securities Market, for $5 million equivalent, from ADB Special Fund resources on 6 November 1997. B. Objective and Scope 2. The objectives of the TA loan were to support the: (i) institutional strengthening of the Securities and Exchange Commission of Pakistan (SECP) (component I), (ii) strengthening of the self-regulatory mechanism for key market participants (component II), (iii) establishment of the National Clearing and Settlement System (NCSS) (component III), and (iv) establishment of an over-the-counter (OTC) market to develop the secondary market (component IV). The fifth objective, i.e., to support the privatization of mutual funds run by state-owned companies (component V), was added in the course of implementation (in January 2000). The TA loan was to finance (i) consulting services in the form of studies, technical advice, master planning, and training; and (ii) procurement of computer hardware and software. C. Financing Plan and Implementation Arrangement 3. The total cost of the TA was estimated at $7.0 million equivalent, comprising foreign exchange costs of $5.6 million and local currency costs of $1.4 million equivalent. ADB was to finance $5.0 million equivalent, comprising $4.3 million in foreign exchange costs and $0.7 million equivalent in local currency costs. The TA included a provision for $2.5 million for computer hardware and software for NCSS and the OTC market. ADB was to finance only a part of this cost while the rest was to be funded by the stock exchanges, Central Depository Company of Pakistan (CDC), and other market participants. The Government was to on-lend the TA loan proceeds on commercial terms to CDC for the establishment of NCSS, and to the stock exchanges for the establishment of the OTC market. The difference in the interest rates was to be transferred to SECP to finance its institutional development. 4. The Executing Agency of this TA loan was the Ministry of Finance. The Implementing Agency was SECP, which was to provide the necessary office space, counterpart staff, and other services to consultants. SECP was responsible for overseeing the implementation of components I and II. A technical group of the Inter–Stock Exchange Committee (including CDC) was to oversee component III. Karachi Stock Exchange, in collaboration with the other two stock exchanges and lead financial institutions, was to manage and supervise component IV. These institutions were envisaged to collaborate in establishing a legal entity to set up an OTC market. The TA project was planned to begin by March 1998 and to be completed by August 1999. 5. The TA required 135 person-months of consulting services (38 international and 97 domestic). The consulting team was to comprise five international consultants: (i) an SECP/stock exchange market expert/team leader (5 person-months for component I, and 1

Appendix 2 51

person-month for component II), (ii) a clearing and settlement expert (12 person-months for component III), (iii) a systems expert (6 person-months each for components III and IV), and (iv) a debt market expert (8 person-months for component IV). The international consultants were to be assisted by five domestic consultants: (i) a stock exchange expert (5 person-months each for components I and II), (ii) a legal expert (2 person-months for component II, and 6 person-months each for components III and IV), (iii) a management information system (MIS) expert (2 person-months for component II, and 6 person-months for component III), (iv) a systems specialist (18 person-months for component III, and 12 person-months for component IV), and (v) a computer programmer (12 person-months each for components III and IV). D. Completion and Self-Evaluation 6. The TA loan closed on 30 July 2002 (after four extensions), 19 months later than initially planned. The program completion report (PCR) on the CMDP1 and this TA loan was circulated in November 2002. The PCR offered little information on the implementation performance, outputs, and outcome of this TA loan, and did not give an overall rating.

II. EVALUATION OF FORMULATION AND DESIGN

7. The TA objectives were consistent with the priority given by the Government to the development of capital market institutions and infrastructure. Before approving this TA loan (in June–September 1997), ADB also approved (i) TA 2812-PAK: Interest Rate Management of National Saving Schemes, (ii) TA 2825-PAK: Capital Market and Insurance Law Reform, (iii) TA 2865-PAK: Restructuring of Public Sector Mutual Funds, (iv) TA 2866-PAK: Reform of Insurance Industry, and (v) TA 2867-PAK: Reform of Pension and Provident Funds.2 All these TAs were aimed at supporting the CMDP implementation. The implicit agenda of the TA loan was to support the areas that were not covered under the stand-alone TAs. In effect, the residual issues found their place in the TA loan in the later stage of CMDP implementation. Accordingly, CMDP processing missions had less discussion with the relevant agencies on the design of this TA loan relative to the stand-alone TAs, and the report and recommendation of the President did not give detailed terms of reference (TOR) for the OTC debt market component. Moreover, the envisioned fast-track implementation schedule was overly ambitious considering that the SECP was a new entity that lacked sufficient absorption capacity and had no experience in implementing a TA loan. The Operations Evaluation Mission (OEM) considered these to be reflective of weakness in appraisal. 8. The OEM considered the inclusion of the original four components to be appropriate since they complemented the CMDP. The SECP and other relevant agencies were fully committed to CMDP measures supported under components I and III. However, their commitment to CMDP measures related to components II and IV was questionable. In fact, SECP did not actively pursue the CMDP measures related to these two components, nor did it pay much attention to components II and IV during implementation. 9. The inclusion of the fifth component pointed up the discouraging result of TA 2865-PAK: Restructuring of Public Sector Mutual Funds. This TA was to support the restructuring of the National Investment Trust Limited (NIT) and Investment Corporation of Pakistan (ICP), and to prepare a strategy and action plan for privatizing their asset management business and transferring management control to strategic investor(s). The consulting team for this TA

1 Main text, footnote 11. 2 Main text, footnotes 6–10.

52 Appendix 2

recommended: (i) the sale of a single mutual fund management contract covering all mutual funds managed by ICP, and (ii) the auctioning of NIT’s unit trust business in the form of a new asset management company. In both cases, the sale to foreign fund managers experienced in mutual funds management in a more stringent regulatory environment was recommended to improve mutual fund management standards in Pakistan. However, the financial adviser engaged by the Privatization Commission later concluded that this recommendation was impractical, as foreign fund managers indicated little interest in taking strategic stakes in ICP and NIT. Therefore, this TA contributed little to the formulation of the privatization strategy for ICP and NIT (i.e., the sale of management rights rather than asset sales), which was adopted in June 1999 by the Privatization Commission. To implement this strategy, the Privatization Commission requested ADB to consider a fast-track small-scale TA to finance the services of a financial adviser or alternatively to reallocate funds under TA Loan 1577-PAK(SF). ADB agreed to add the fifth component under the TA loan in January 2000. The OEM considered the inclusion of this component, albeit as an afterthought, justifiable given the need to expedite the implementation of the CMDP measures concerned.

III. EVALUATION OF IMPLEMENTATION AND OUTPUTS 10. The agreement with the consulting firm was signed in February 1999, about 11 months later than planned because of administrative/procedural delays in selecting consultants and finalizing the contract on the recipient’s side. The inception meeting for the TA loan was held in May 1999. The TA loan closed in July 2002, about 19 months later than planned. The delay in TA implementation, which was originally planned for June 1999, impeded the Government’s compliance with conditions for the release of the second tranche of the CMDP loan. 11. The lack of verifiable TA outputs was a serious constraint on the evaluation of this TA loan. Neither ADB nor SECP stored the consultants’ reports in their record sections. After a review of TA loan files, the OEM surmised that the consulting team did not compile their outputs in one final report but instead submitted several reports at different times. The TA loan files included some of these reports in draft or final form. 12. Through seven review missions 3 and regular communication with SECP and the consulting team, ADB monitored the implementation of the TA loan. Despite the extensive monitoring, gaps in the perception of work procedures and outputs, especially for component I, persisted between the SECP and the consulting team during implementation. According to the OEM, this result could have been due in part to the consultants’ inadequate understanding of local contexts and the client orientation. An ADB officer raised the concern that a change in SECP management during implementation had also changed SECP’s expectations from the TA loan, probably worsening the confusion in the consulting team. Against this background, the SECP officials who interacted with the consulting team understandably did not positively assess the overall performance of the consulting team. 13. Table A2 gives the cost breakdown of the TA loan by type of spending. Actual consulting expenses exceeded the projected amount presumably because of the inclusion of the fifth component. The OEM could not verify the reason for the less-than-projected expenses for equipment.

3 Of the seven missions, six covered both CMDP and the TA loan, and the remaining one covered only the TA loan.

Appendix 2 53

Table A2: Cost Breakdown of the Technical Assistance Loan ($ million)

Item Estimate Actual Consulting 1.8 2.2 Equipment 2.5 1.2 Studies/Training 0.0 0.2 Unallocated 0.7 Total 5.0 3.6 Source: Asian Development Bank technical assistance loan files.

A. Component I: Institutional Strengthening of SECP 14. The consulting team, in line with the TOR, (i) drafted SECP’s corporate plan; (ii) developed a MIS; and (iii) submitted reports on regulatory issues related to (a) disclosure by listed companies, (b) intercorporate financing, (c) issues and offerings, (d) underwriters, and (e) takeover bids. The correspondence suggests that the consultant’s output on the corporate plan came close to the SECP’s expectation. The OEM could not obtain enough feedback from SECP to assess the TA loan’s contribution to the MIS. The SECP noted that the reports on regulatory issues were either not delivered in time for effective use or deficient in quality. The OEM could not obtain any of these reports for independent evaluation. 15. In July 2001, ADB endorsed SECP’s request for (i) the reallocation of $0.25 million from the remaining fund to support studies on mutual fund industry regulations and the training of SECP staff on this subject, and (ii) the associated extension of the TA loan closing date. In November 2001, ADB approved a further allocation of the TA loan to support the holding of an insurance training seminar, and another extension of the closing date. Neither the seminar materials nor the participants’ feedback/evaluation forms were available to the OEM. Thus, the OEM could not independently evaluate the quality of these seminars. The feedback from the interviewees of the OEM suggested the mixed quality of the study and seminars. B. Component II: Strengthening of the Self-Regulatory Mechanism for Key Market Participants 16. At the start of the TA loan, the SECP noted, “this component has not been well thought out as it should have been until now.”4 A review of the correspondence confirmed that the consulting team submitted the report on the framework for self-regulation of the stock exchanges, the Leasing Association of Pakistan, and the Mutual Fund Association of Pakistan. But the OEM could neither obtain a copy of this report nor verify the SECP’s response to it.5 This report was the only output of this component. The PCR noted that this report recommended the granting of self-regulatory organization status to the Mutual Fund Association of Pakistan but not to the Leasing Association of Pakistan.

4 Back-to-office report of the inception mission dated 28 May 1999. 5 According to the PCR of the CMDP, the consulting team assessed the actual implementation of the self-regulatory

framework to be premature given the level of capital market development in Pakistan.

54 Appendix 2

C. Component III: Establishment of the National Clearing and Settlement System 17. To implement component III, the consulting team began work in March 1999. The SECP arranged a seminar on 15 May 1999 with securities industry professionals to get their comments and recommendations on the NCSS. As planned, the consulting team submitted on 28 May 1999 a proposal on the fundamental design parameters for the development of the NCSS, including a continuous net settlement (CNS) system on a T+3 cycle, which was endorsed by SECP on 13 July 1999. The ADB review mission fielded on 11–17 July 1999 also agreed to this proposal. On this basis, the SECP directed the consulting team to undertake consultations including more seminars to build awareness and consensus. Consensus building among the stakeholders on the specifics of the NCSS was time-consuming and made the implementation period for this component longer than expected.

18. In line with the TOR, the consulting team developed a master implementation plan for NCSS, prepared relevant regulations and procedures, and identified the required computer hardware and software. These outputs were largely to the expectation of the NCC. However, the effort was wasted, as SECP turned down the CNS system in the final phase of pre-launching. SECP explained that the CNS system developed by the consulting team did not fully consider leveraged trading and that the SECP preferred a balance order system (BOS), which had a simple mechanism of matching orders. 6 NCC therefore had to redo the system development and other works associated with the adoption of BOS, and both NCC and SECP later admitted that the TA loan was not used efficiently. Nevertheless, NCC acknowledged having learned through interactions with the consultants and experience in developing the BOS on its own. Moreover, NCC also acknowledged the consultants’ contribution in enhancing the awareness of market participants of the significance of the NCSS. D. Component IV: Establishment of an OTC Market to Develop the Secondary Market 19. At the inception meeting of May 1999, the ADB mission stated, “the OTC component of the CMDP would take time to develop and there were no conditionalities associated with this (component).”7 This is representative of the skepticism within the ADB mission as well as the SECP about the feasibility of the program measure (not tied to tranche release) that envisaged the establishment of an OTC debt market by June 1999. During the inception meeting, it was agreed that as a first step, the consulting team would prepare a study paper on how best to encourage the development of a secondary debt market. A review of the correspondence confirmed that the consulting team submitted the study paper, which concluded that the development of an OTC debt market was premature given the reality in Pakistan. Hence, the other expected outputs related to an OTC market, e.g., a master implementation plan, operating software and hardware, and relevant regulations, were not pursued. The OEM could neither obtain a copy of this report nor verify the SECP’s response. Also, the OEM could not verify the actual cost of this component. As noted earlier, the TOR for this component, although not detailed in the report and recommendation of the President, assumed 44 person-months of consultant involvement. The OEM considered this inappropriate.

6 The OEM believed that further study by an outside expert in this field would be needed to assess the

appropriateness of the decision of SECP. 7 Back-to-office report of the inception mission dated 28 May 1999.

Appendix 2 55

E. Component V: Privatization of Mutual Funds Run by State-Owned Companies 20. The consulting team submitted the report entitled “Privatization of Management Rights of NIT and ICP: Phase 1” in July 2000. However, according to the agencies concerned, the report identified and analyzed issues but did not offer workable solutions. This feedback suggests that both ADB and SECP failed to capitalize on the lesson learned from TA 2865-PAK. A question remains as to the appropriateness of the consultant selection for this component.8

IV. ACHIEVEMENT OF TECHNICAL ASSISTANCE PURPOSE 21. On the basis of these findings, the OEM assessed that the TA outputs (i) contributed marginally to the institutional strengthening of the SECP and the privatization of state-owned mutual funds, (ii) contributed significantly to the establishment of NCSS, and (iii) did not lead to the establishment of self-regulatory organizations and an OTC debt market.

V. OVERALL ASSESSMENT 22. The OEM assessed the TA loan as partly relevant considering that the agencies concerned did not actively pursue the CMDP measures related to two of the five components of the TA loan.

23. The OEM assessed the TA loan as less efficacious because of the following observations: (i) the delay in implementation impeded timely compliance with the relevant conditions of the CMDP for the release of the second tranche, and (ii) many outputs and recommendations were underutilized or not utilized at all by the recipient agencies. 24. The OEM assessed the TA loan inefficient in view of its (i) cost-ineffective use of loan funds; (ii) underutilization of the allocated loan funds; and (iii) inappropriate storing of consultant outputs both in recipient institutions and in ADB, impeding their potential use at a later stage and in post-evaluation undertakings. 25. The OEM assessed the sustainability of the TA loan as likely, since SECP and NCC are likely to secure human and financial resources to maintain the TA loan’s outcomes though the outcomes are highly limited. The OEM assessed the institutional development and other impacts of the TA loan as moderate, noting its contribution to enhancing market participants’ understanding of the NCSS. 26. On the basis of the above, the overall rating of the TA loan is partly successful.

8 The consulting firm responsible for preceding components also provided the consultant for this component.

56 Appendix 3

STATISTICAL DATA

Table A3.1: Stock Market Dataa

Average Initial Public Offerings

Market Capitalization Annual

Turnover Daily

Volume No. of IPO

Amount Subscriptions Fiscal Year

Endingb KSE-100 (PRs

billion) % of GDPc (PRs

billion) (million shares)

Listed Companies Stocks

(PRs million)

(PRs million)

1994 2331 406 25.9 — 6.5 676 55 3,208 40,739 1995 1607 486 25.8 — 9.5 742 59 11,044 25,971 1996 1703 371 17.6 — 22.9 783 37 3,434 9,949 1997 1566 492 20.3 — 33.9 782 8 1,047 282 1998 880 258 9.6 — 63.8 778 2 200 28 1999 1055 288 9.8 — 103.4 769 0 0 0 2000 1521 394 10.4 — 192.7 762 3 542 810 2001 1366 342 8.2 1,073 118.2 759 2 300 1,075 2002 1770 412 9.3 805 119.7 725 5 1,418 1,134 2003 3402 756 15.7 2,266 214.4 702 2 311 1,193 2004 5279 1,422 26.0 5,538 387.1 675 10 10,466 46,470 2005

(up to March) 7770 2,144 34.8 — — 660 12 13,472 56,822

— = not available, GDP = gross domestic product, IPO = initial public offering, KSE = Karachi Stock Exchange, NA = not available, PRs = Pakistan rupees. a Karachi Stock Exchange only. b Except where indicated, the year-end is June. c Government rebased GDP in FY2004 with retrospective effect from FY2000. The revised FY2000 GDP was higher by 20.5%.

Sources: Karachi Stock Exchange for the stock market data and Economic Survey of the Ministry of Finance for the GDP data.

Appendix 3 57

Table A3.2: Corporate Debt Capital Market Dataa

Outstanding TFCs

Fiscal Year Endingb Number of TFC Issues

Issue Size (PRs million)

IPO Amount (PRs million) Number

Total Value (PRs million)

% of Bank Credit

Bank Creditc (PRs million)

Average Treasury Bill Yieldd

(%) 1994 — — — — — — 397,000 12.4 1995 1 210 100 1 210 0.0 473,000 11.6 1996 2 750 175 3 960 0.2 537,000 13.2 1997 1 1,000 250 4 1,960 0.3 627,000 15.8 1998 1 250 50 5 2,210 0.3 713,000 15.3 1999 4 1,750 650 8 3,710 0.5 794,000 12.7 2000 4 1,100 245 11 4,600 0.5 876,000 8.9 2001 10 5,530 1,235 20 9,630 1.0 946,000 10.3 2002 17 9,710 2,255 34 17,785 1.8 972,000 8.3 2003 21 10,399 2,025 53 27,834 2.6 1,052,000 4.2 2004 3 2,000 400 49 27,209 2.0 1,358,000 1.5 2005

(up to March) 3 3,725 775 50 27,709 1.6 1,688,000 3.5

— = not available, PRs = Pakistan rupees, TFC = term finance certificates. a Term finance certificates listed on Karachi Stock Exchange. b Except where indicated, the year-end is June. c Credit to private sector only. d Yearly average of 6-month treasury bill cutoff yields. Sources: Karachi Stock Exchange for the TFC data and State Bank of Pakistan for the bank credit and treasury bill yields.

58 Appendix 3

Table A3.3: Mutual Fund Industry

Number of Mutual Funds Launched Size of Mutual Funds (PRs million)

Fiscal Year Endinga Open-End Closed-End Total

Open-End

Closed-End Total

% of Bank Deposits

Bank Deposits (PRs million)

1994 0 4 4 — — — — 586,000 1995 0 8 8 32,927 — — — 709,000 1996 0 2 2 34,130 — — — 822,000 1997 1 0 1 25,042 7,454 32,496 3.33 976,000 1998 0 0 0 12,152 3,957 16,109 1.47 1,093,000 1999 0 0 0 13,913 4,530 18,443 1.56 1,179,000 2000 0 0 0 19,117 4,002 23,119 1.92 1,201,000 2001 0 0 0 16,811 4,127 20,938 1.60 1,310,000 2002 2 0 2 18,953 4,540 23,493 1.58 1,489,000 2003 5 0 5 39,637 11,122 50,759 2.90 1,753,000 2004 4 3 7 67,532 25,090 92,622 4.32 2,145,000 2005

(up to March) 1 4 5 88,161 40,608 128,769 5.47 2,352,000

— = not available, PRs = Pakistan rupees. a Except where indicated, the year-end is June. Sources: State Bank of Pakistan, Karachi Stock Exchange, and Mutual Funds’ Financial Statements.

Appendix 3 59

Table A3.4: Insurance Sector (PRs million)

PRs = Pakistan rupees. a As of end-December. Sources: Ministry of Commerce and Ministry of Finance.

Insurance Company 1994a 1995a 1996a 1997a 1998a 1999a 2000a 2001a 2002a 2003a 2004a A. General Insurance 1. Number of companies 57 63 62 62 62 58 58 52 52 49 52 2. Gross premium collected 6,736 7,964 9,140 9,496 10,306 11,014 12,323 13,149 15,284 19,577 22,039 B. Life Insurance 1. State Life Insurance Corporation a. Number of policies 300,492 439,510 336,220 277,158 225,260 186,177 135,942 132,226 149,739 183,595 222,968 b. Gross premium collected 4,4280 5,851 6,255 5,661 5,507 5,323 5,317 5,482 5,879 6,900 8,208 2. Other Companies a. Number of companies 2 3 4 4 4 4 4 4 4 4 4 b. Number of policyholders 10,547 15,593 24,690 30,514 34,423 41,432 50,650 60,353 72,555 90,028 110,130 c. Gross premium collected 91 155 242 333 489 675 980 1,352 1,919 3,110 3,569 3. Total Life Insurance a. Number of companies 3 4 5 5 5 5 5 5 5 5 5 b. Gross premium collected 4,519 6,006 6,497 5,994 5,996 5,998 6,297 6,834 7,798 10,010 11,777

60 Appendix 3

Table A3.5: Leasing Sector Data

(PRs million)

Item 1994a 1995a 1996a 1997a 1998a 1999a 2000a 2001a 2002a 2003a 2004a

Number of Companies 24 27 30 35 33 32 32 29 30 28 24Investment in Lease Finance 13,520 15,316 20,363 25,559 29,164 29,039 30,281 36,680 39,886 35,677 44,429Investments 1,084 1,484 1,768 2,590 2,724 2,664 3,162 3,646 11,143 13,041 15,243Borrowings 5,288 4,296 8,076 10,319 10,243 23,765 25,740 31,472 37,109 36,285 48,872Revenues 2,463 2,522 4,090 5,046 5,315 5,528 5,704 6,401 7,692 7,273 7,048Net Profit 695 517 922 906 610 451 573 398 192 1,211 1,843Total Assets — — — — — 35,579 39,147 45,222 58,831 62,637 74,403— = not available, PRs = Pakistan rupees. a At fiscal year-end in June. Source: Leasing Association of Pakistan.

Appendix 3 61

Table A3.6: Financial Sector Assets (PRs billion, unless otherwise specified)

Type of Institution 1990a 1995a 1996a 1997a 1998a 1999a 2000a,b 2001a 2002a 2003a

Scheduled Banks 555.7 1,118.1 1,275.0 1,436.5 1,556.3 1,654.0 1,807.6 1,942.3 2,223.2 2,545.9Public Sector Banks 392.3 610.4 656.5 696.9 789.3 844.1 902.0 946.5 877.6 963.1Domestic Private Banks 73.5 265.5 313.4 373.4 405.5 448.7 513.5 565.9 967.5 1,211.6Foreign Banks 33.4 152.5 212.6 268.9 263.3 252.6 280.6 323.7 279.6 271.2Specialized Banks 56.5 89.7 92.5 97.3 98.2 108.6 111.5 106.2 98.5 100.0

DFIs 51.2 113.5 125.4 159.5 131.5 103.4 91.5 61.1 68.7 79.2Investment Banks 2.4 30.5 36.8 41.7 45.9 48.7 41.5 28.0 27.0 34.4Leasing Companies 6.3 20.4 27.4 31.4 33.0 35.5 40.9 48.0 46.2 45.8Modarabas — 12.8 12.7 13.9 15.2 14.8 15.4 15.5 17.5 16.1Housing Finance Companies 16.5 19.4 20.2 20.4 21.3 21.5 22.3 23.6 22.4 21.5Discount Houses 0.9 0.8 1.0 1.5 1.6 1.6 1.8 1.4 1.5 2.0Venture Capital Firms 0.0 0.1 0.1 0.6 1.3 1.3 1.0 0.4 0.3 0.9Total 633.0 1,315.7 1,498.6 1,705.5 1,806.1 1,880.9 2,022.0 2,120.3 2,406.8 2,745.7(As % of GDP) (74.1%) (70.0%) (70.9%) (70.2%) (67.4%) (64.0%) (53.3%) (50.9%) (54.7%) (57.0%)— = not available, DFI = development finance institution, GDP = gross domestic product, PRs = Pakistan rupees. a At fiscal year-end—December for scheduled banks and June for other financial institutions. b Government rebased GDP in FY2004 with retrospective effect from FY2000. Revised GDP size for FY2000 was higher by 20.5%. Sources: Financial Sector Assessment 2002–2003 (State Bank of Pakistan, Research Department), and Economic Survey of Pakistan 2003–2004 (Ministry of Finance).

62 Appendix 3

Table A3.7: Privatization of Management Rights of ICP Mutual Funds

Number of Aggregate NAV Sale Proceeds

Lot Name Funds (PRs million) (PRs million) Date Acquirer ICP Lot A 12 1,402 175 September 2002 ABAMCO ICP Lot B 13 1,713 303 October 2002 PICIC ICP SEMF 1 2,667 787 April 2003 PICIC

Total 26 5,782 1,265 ABAMCO = ABAMCO Limited, ICP = Investment Corporation of Pakistan, NAV = net asset value, PICIC = Pakistan Industrial Credit and Investment Corporation, PRs – Pakistan rupees, SEMF = State Enterprise Mutual Fund. Source: Privatization Commission.

Appendix 3 63

Table A3.8: National Savings Schemes and Money Supply

(PRs million)

NSS Amount M2 NSS/M2 Fiscal Year Endinga Outstanding Net Flow Growth (%) Outstanding Net Flow Growth (%)

1994 215,969 37,036 20.7 662,805 95,636 16.9 32.61995 255,513 39,545 18.3 772,998 110,193 16.6 33.11996 303,893 48,380 18.9 938,634 165,636 21.4 32.41997 372,331 68,438 22.5 1,053,234 114,600 12.2 35.41998 483,861 111,530 30.0 1,206,319 153,085 14.5 40.11999 623,584 139,723 28.9 1,280,547 74,228 6.2 48.72000 714,954 91,370 14.7 1,400,633 120,086 9.4 51.02001 761,704 46,750 6.5 1,526,658 126,025 9.0 49.92002 846,627 84,923 11.1 1,761,370 234,712 15.4 48.12003 982,480 135,853 16.0 2,078,769 317,399 18.0 47.32004 982,737 257 0.0 2,486,556 407,787 19.6 39.5

2005 (up to February) 975,123 (7,614) (0.8) 2,758,085 271,529 10.9 35.4M2 = money supply, NSS = national savings scheme, PRs = Pakistan rupees. a Except where indicated, the year-end is June. Source: State Bank of Pakistan.

64 Appendix 3

Table A3.9: Growth and Financial Deepening

Fiscal Year Real GDP CPI

Endinga Growth (%) Inflation (%) M2 Growth (%) M2/GDP (%) 1994 4.5 11.3 16.9 42.3 1995 5.3 13.0 16.6 41.1 1996 6.8 10.8 21.4 44.4 1997 1.9 11.8 12.2 43.4 1998 4.3 7.8 14.5 45.0 1999 4.2 5.7 6.2 43.6 2000 3.9 3.6 9.4 36.9 2001 1.8 4.4 9.0 36.7 2002 3.1 3.5 15.4 40.0 2003 5.1 3.3 18.0 43.1 2004 6.4 4.6 19.6 45.6

CPI = consumer price index, GDP = gross domestic product, M2 = money supply. a The year-end is June. Sources: State Bank of Pakistan for the monetary data, Economic Survey of Ministry of Finance for GDP data, and Federal Bureau of Statistics for inflation data.

Appendix 3 65

Table A3.10: Benchmark Interest Rates (%)

SBP Discount 6-Month Treasury Bill Export Financingb

Month Ended Rate Yielda Scheme

June 1994 15.0 10.8 13.0 June 1995 15.0 12.6 13.0 June 1996 17.0 15.1 13.0 June 1997 19.0 16.3 13.0 June 1998 18.0 15.4 11.0 June 1999 13.0 10.7 8.0 June 2000 11.0 7.2 8.0 June 2001 14.0 12.5 10.5 June 2002 9.0 6.5 8.0 June 2003 7.5 1.7 3.5 June 2004 7.5 2.2 3.5 April 2005 9.0 7.2 6.5

SBP = State Bank of Pakistan. a Simple average of auction cutoff yields for the month. b Month-end interest rate ceiling for the export financing scheme for which refinancing is provided by SBP. Source: State Bank of Pakistan.