ASIAN DEVELOPMENT BANK TPA:PAK 2003-02

TECHNICAL ASSISTANCE PERFORMANCE AUDIT REPORT

ON

SELECTED ADVISORY TECHNICAL ASSISTANCE

FOR

CAPITAL MARKET DEVELOPMENT

IN PAKISTAN

January 2003

Currency Equivalent

Currency Unit – Pakistan rupee (PRe/PRs)

TA 2393–PAK

At TA Approval

(September 1995)

At TA Completion

(February 2000)

At Operations Evaluation

(April 2002) PRe1.00 =

0.3184890

0.0192771

0.0166251

$1.00 = 31.3983 51.8750 60.1500 TA 2812–PAK

(June 1997)

(June 1999)

(April 2002) PRe1.00 =

0.0246968

0.0193330

0.0166251

$1.00 = 40.4910 51.7250 60.1500 TA 2825–PAK

(July 1997)

(March 1999)

(April 2002) PRe1.00 =

0.0246176

0.0195217

0.0166251

$1.00 = 40.6213 51.2250 60.1500 TA 2865–PAK

(September 1997)

(May 1999)

(April 2002) PRe1.00 =

0.0246176

0.0197531

0.0166251

$1.00 = 40.6213 50.6250 60.1500 TA 2866–PAK

(September 1997)

(August 2000)

(April 2002) PRe1.00 =

0.0246176

0.0187266

0.0166251

$1.00 = 40.6213 53.4000 60.1500 TA 2867–PAK

(September 1997)

(June 2001)

(April 2002) PRe1.00 =

0.0246176

0.0156863

0.0166251

$1.00 = 40.6213 63.7500 60.1500

NOTES

(i) The fiscal year (FY) of the Government ends on 30 June. FY before a calendar year denotes the year in which the FY ends. For example, FY2002 begins on 1 July 2001 and ends on 30 June 2002.

(ii) In this report, “$” refers to US dollars.

Operations Evaluation Department, TE-44

ABBREVIATIONS

ABS – asset-backed securities ADB – Asian Development Bank CLA – Corporate Law Authority CMD – capital market development CMDP – Capital Market Development Program EOBI – Employees’ Old-Age Benefits Institution FMGP – Financial (Nonbank) Markets and Governance Program ICP – Investment Corporation of Pakistan MF – mutual fund MOC – Ministry of Commerce MOF – Ministry of Finance NIC – National Insurance Corporation NIT – National Investment Trust NSS – National Saving Schemes OEM – Operations Evaluation Mission PII – Pakistan Insurance Institute PIC – Pakistan Insurance Corporation PIRA -- Pakistan Insurance Regulatory Authority PRC – Pakistan Reassurance Corporation PSIE -- public sector insurance entity SE – stock exchange SECP – Securities and Exchange Commission of Pakistan TA – technical assistance TCR – technical assistance completion report TFC – term finance certificate TOR – terms of reference TPAR – technical assistance performance audit report

CONTENTS

Page BASIC TECHNICAL ASSISTANCE DATA EXECUTIVE SUMMARY

ii vi

I. INTRODUCTION 1 A. Background 1 B. Rationale and Concept 1 C. Objectives and Scope 2 D. Completion and Self Evaluation 3 E. Operations Evaluation 3 II. ASSESSMENT OF DESIGN AND IMPLEMENTATION 3 A. Design 3 B. Engagement of Consultants 5 C. Implementation and Cost 5 D. Organization and Management 6 III. EVALUATION OF OUTPUTS AND IMPACTS 7 A. Performance of Consultants and Quality of Reports 7 B. Stock Market Operation and Regulation 7 C. Mutual Funds Industry 8 D. Leasing Industry 9 E. Interest Rate Management of the National Saving Schemes 10 F. Corporate Bond Market 11 G. Legal and Regulatory Framework for Insurance and Capital Market 11 H. Restructuring of Public Sector Insurance Entities 12 I. Reform of Pension and Provident Funds 12 J. Capacity Building 13 IV. OVERALL ASSESSMENT 13 A. Relevance 13 B. Efficacy 14 C. Efficiency 14 D. Sustainability 14 E Impacts 15 F. Overall Rating 15 V. CONCLUSIONS 15 A. Key Issues 15 B. Lessons Learned 16 C. Recommendations and Follow-up Actions 17 APPENDIXES 1. Evaluation of TA 2393-PAK: Capital Market Development 18 2. Evaluation of TA 2812-PAK: Interest Rate Management of National Saving Schemes 25 3. Evaluation of TA 2825-PAK: Capital Market and Insurance Law Reform 30 4. Evaluation of TA 2865-PAK: Restructuring of Public Sector Mutual Funds 34 5. Evaluation of TA 2866-PAK: Reform of the Insurance Industry 39 6. Evaluation of TA 2867-PAK: Reform of Pension and Provident Funds 45

BASIC TECHNICAL ASSISTANCE DATA

TA 2393-PAK: Capital Market Development1

Cost ($’000)2 Estimated Actual Foreign Exchange 800 743 Local Currency 65 773 Total 865 820 Number of Person-Months (consultants) 23.0 23.4 Executing Agency Corporate Law Authority Milestones Date President’s/Board Approval 7 Sep 1995 Signing of TA Agreement 6 Oct 1995 Fielding of Consultants 15 May 1996 TA Completion: Expected end–Dec 1997 Actual end–Feb 20004 TCR Circulation 5 Mission Type Number Date Fact-Finding 1 27 Nov–16 Dec 1994 Review 4 7–11 Jul 19966 19 Aug–5 Sep 19967 23 Feb–7 Mar 19977 13–23 Sep 19988 Operations Evaluation9 1 25 Mar–15 Apr 2002

TA 2812-PAK: Interest Rate Management of National Saving Scheme

Cost ($’000)10 Estimated Actual Foreign Exchange 53 41 Local Currency 47 203 Total 100 61 Number of Person-Months (consultants) 9.5 8.3 Executing Agency Ministry of Finance Milestones Date President’s/Board Approval 18 Jun 1997 Signing of TA Agreement not required Fielding of Consultants 15 Nov 1997 TA Completion: Expected May 1998 Actual end–Jun 1999 TCR Circulation not required Mission Type Number Date Fact-Finding 1 3–16 Apr 1997 Review 2 13–23 Sep 19988 28 Apr–12 May 19998 Operations Evaluation9 1 25 Mar–15 Apr 2002 ________________________ TA = technical assistance, TCR = technical assistance report. Note: Footnotes on page v.

iii

TA 2825-PAK: Capital Market and Insurance Law Reform

Cost ($’000)10 Estimated Actual Foreign Exchange 85 71 Local Currency 15 153 Total 100 86 Number of Person-Months (consultants) 4.0 9.2 Executing Agencies Ministry of Commerce (insurance component) and Corporate Law Authority (capital market component) Milestones Date President’s/Board Approval 14 Jul 1997 Signing of TA Agreement not required Fielding of Consultants 4 Aug 1997 TA Completion: Expected end–Oct 1997 Actual 1 Mar 199911 TCR Circulation not required Mission Type Number Date Fact-Finding not required Review 2 13–23 Sep 19988 28 Apr–12 May 19998 Operations Evaluation9 1 25 Mar–15 Apr 2002

TA 2865-PAK: Restructuring of Public Sector Mutual Funds Cost ($’000)2 Estimated Actual Foreign Exchange 638 449 Local Currency 162 1353 Total 800 584 Number of Person-Months (consultants) 32 15.512 Executing Agency Privatization Commission Milestones Date President’s/Board Approval 15 Sep 1997 Signing of TA Agreement 18 May 1998 Fielding of Consultants 6 Jul 1998 TA Completion: Expected Aug 1998 Actual 1 May 1999 TCR Circulation 19 Oct 2000 Mission Type Number Date Fact-Finding 1 8–28 Jul 1997 Review 4 8–11 Jul 19986 13–23 Sep 19988 I Dec 19987 28 Apr–12 May 19998 Operations Evaluation9 1 25 Mar–15 Apr 2002

iv

TA 2866-PAK: Reform of the Insurance Industry

Cost ($’000)2 Estimated Actual Foreign Exchange 495 498 Local Currency 205 1493 Total 700 647 Number of Person-Months (consultants) 40.0 45.6 Executing Agency Ministry of Commerce Milestones Date President’s/Board Approval 15 Sep 1997 Signing of TA Agreement 28 Apr 1998 Fielding of Consultants 29 Jun 1998 TA Completion: Expected Jun 1999 Actual 15 Aug 200013 TCR Circulation 17 Jul 2001 Mission Type Number Date Fact-Finding 1 8–28 Jul 1997 Review 3 13–14 Jul 19986 13–23 Sep 19988 28 Apr–12 May 19998 Operations Evaluation9 1 25 Mar–15 Apr 2002

TA 2867-PAK: Reform of Pension and Provident Funds Cost ($’000)2 Estimated Actual Foreign Exchange 380 404 Local Currency 220 1503 Total 600 554 Number of Person-Months (consultants) 34 15.2 Executing Agency Ministry of Finance Milestones Date President’s/Board Approval 15 Sep 1997 Signing of TA Agreement 28 Apr 1998 Fielding of Consultants 1 Jun 1998 TA Completion: Expected Jun 1999 Actual 30 Jun 200114 TCR Circulation 15 Oct 2001 Mission Type Number Date Fact-Finding 1 22–31 Jul 1997 Review 5 8–11 Jul 19986 13–23 Sep 19988 28 Apr–12 May 19998 25–27 Sep 20007 30 Jan–5 Feb 20017 Operations Evaluation9 1 25 Mar–15 Apr 2002

v

Footnotes 1 Attached to Loan 1371-PAK: Financial Sector Intermediation Loan. 2 Financed by the Asian Development Bank (ADB) from the Japan Special Fund. 3 Operations Evaluation Mission estimate. 4 Consultant final report, including an additional study on National Investment Trust and Investment Corporation of

Pakistan, completed in October 1997. Completion date was extended to accommodate local training staff of Securities and Exchange Commission of Pakistan (formerly Corporate Law Authority).

5 The TA was not rated on stand alone basis. The project completion report rated the associated Loan 1371-PAK as partly successful.

6 Inception mission. 7 Multiproject mission. 8 Review Mission for Loan 1576-PAK: Capital Market Development Program and supporting TAs. 9 The Operations Evaluation Mission comprised A. Qureshi, Principal Evaluation Specialist; and M. Akhtar, Domestic

Consultant (Capital Market Development). 10 Financed by ADB. 11 Submission of the final report. 12 International consultant inputs only. 13 TA completion was delayed due to complex and protracted dialogue with stakeholders and the Government on the

finalization of the Insurance Act, which was enacted in August 2000. 14 TA completion delayed due in part to the political unrest and change of government in 1999, which temporarily

interrupted implementation. The final report was submitted in May 2001.

EXECUTIVE SUMMARY

In the mid-1990s, Pakistan’s capital markets faced a number of critical issues, including a weak and outmoded regulatory framework; an inefficient, non-transparent and stagnant stock market; poorly regulated and public sector-denominated mutual funds (MFs); an insurance industry that contributed little to capital market development (CMD); and an underdeveloped pensions sector. Moreover, financial markets operated in an inappropriate interest rate regime that attracted personal and institutional savings into the National Saving Schemes (NSS) but retarded financial intermediation, CMD and growth of the corporate debt market. To address these issues, the Asian Development Bank (ADB) provided extensive technical assistance (TA) to Pakistan during 1995–1997. This TA performance audit report covers six TAs approved to support CMD.1 The first was approved in 1995 to prepare a CMD agenda. A program loan2 supported the implementation of that agenda subsequently. Three TAs were provided to assist the Government in implementing reforms for MF, insurance and pension sectors, which were to form a part of the CMD agenda. The remaining two TAs supported reform of interest rate management of NSS and initiated insurance and capital market law reform. The TAs were relevant in varying degrees, and generally had a strong justification in terms of sector priority and conformance to ADB’s country and sector operational strategies. Objectives of the TAs were appropriate and their design was consistent with the objectives, with one or two exceptions. The design of TA 2865-PAK was flawed; a more appropriate focus would have been on privatization of the portfolios of the closed-end public sector MFs rather than the MF management function. Under TA 2867-PAK a phased approach to pension sector reform would have been more successful.

All six TAs experienced delay in implementation, from 8 to 26 months, indicating optimistic implementation schedules. However, implementation was generally successful, except in the case of TA 2867-PAK where it was partly so. In some cases, significant variations occurred between the planned and actual consultant inputs, both in terms of total person-months as well as between the services provided by international and domestic consultants. The significant variance between the planned and actual cost of TA 2865-PAK suggests that its inputs and cost were not planned meticulously.

In general, the outputs and impacts of the TAs were significant. The new regulatory framework for the capital market is in place, and the Securities and Exchange Commission of Pakistan (SECP) is functioning effectively, except that it needs to build capacity in regulation of insurance and pension funds. MF regulations have been updated, and substantial progress made towards privatization of public sector MFs. A new insurance law has replaced the outdated Insurance Act of 1938, and new insurance rules have been partially issued, albeit with a 2-year delay. Two public sector insurance entities have been restructured and appear better positioned than before to be privatized. Interest rates on NSS have been rationalized to level the playing field between NSS instruments, bank deposits, and corporate debt-instruments.

1 TA 2393-PAK: Capital Market Development, for $865,000, approved on 7 September 1995; TA 2812-PAK: Interest

Rate Management of National Saving Schemes, for $100,000, approved on 18 June 1997; TA 2825-PAK: Capital Market and Insurance Law Reform , for $100,000, approved on 14 July 1997; TA 2865-PAK: Restructuring of Public Sector Mutual Funds, for $800,000, approved on 15 September 1997; TA 2866-PAK: Reform of the Insurance Industry, for $700,000, approved on 15 September 1997; and TA 2867-PAK: Reform of Pension and Provident Funds, for $600,000, approved on 15 September 1997.

2 Loan 1576-PAK: Capital Market Development Program , for $250 million, approved on 6 November 1997.

vii

TA outputs met expectations fully or substantially in five out of the six TAs under evaluation. TA 2867-PAK was less efficacious because an important output, namely a program of reforms for the pension sector, was not delivered.

It is difficult to segregate the impacts of the TAs under evaluation from those of the

program loan. However, their combined impacts are significant. Stock market indicators are stronger and the corporate debt market appears to have received significant impetus from the NSS reform. A major beneficiary is the leasing industry, which is now much better placed to raise resources in the long-term debt market.

The stock exchanges have been modernized and their managements professionalized.

SECP is seen as an effective regulator of the stock market, thereby helping build investor confidence. However, the market is still narrow and remains highly speculative, and the stock exchanges are still perceived to be manipulated by a few powerful brokers.

Frameworks have been established for the healthy growth of MFs, and insurance; public

sector dominance in these industries is being reduced. Limited reforms in the pension sector have been initiated, but further measures are required for funding of public sector pensions, establishing an effective regulatory regime, promoting private pension funds, and placing the management of pension funds in the hands of professional investment managers.

Of the six TAs covered by this report, one is rated highly successful, three successful,

and two partly successful. As a cluster, the TAs are rated successful. The findings of this report confirm the lesson that strong government ownership is critical

to the success of policy and institutional reforms. Another lesson is that sharply focused TAs have better prospects for success than those covering a broad range of issues. Attempting to deal with too many complex issues under one TA is not effective. Finally, the use of domestic consultants, combined with dedicated and hands-on TA administration by ADB, can be highly cost-effective subject to availability of adequately qualified professionals in the relevant fields.

Major issues arising out of the implementation of these TAs relate to further

capacity-building of SECP in regulation of insurance and pension funds, reducing the preponderance of short-term speculative trades on the stock exchanges, accelerating privatization as a source of supply of quality stocks in the stock market, developing MF management on professional lines, and reforming the pension sector. Based on the real-time feedback provided by the Operations Evaluation Mission, appropriate measures to resolve several of these issues have been included among the policy reforms supported by a program and TA loan package approved by ADB on 5 December 2002.3 Residual issues in need of attention concern the promotion of asset-backed securities particularly of leasing companies, issuance of insurance rules in the area of SECP’s responsibility, and making the financial statements of Pakistan Reassurance Corporation transparent and free of audit qualifications.

3 Comprising a policy loan (Loan 1955-PAK: Financial [Nonbank] Markets and Governance Program , for $260

million); two TA loans (Loan 1956-PAK[SF]: Strengthening Pension, Insurance, and Savings Systems, and Loan 1957-PAK[SF]: Strengthening Regulation, Enforcement, and Governance of Nonbank Financial Markets, for $3.0 million equivalent each); and two political risk guarantee facilities (PRG: PAK 33271, for a total of $150 million).

I. INTRODUCTION

A. Background 1. The involvement of the Asian Development Bank (ADB) in Pakistan’s financial sector dates back to 1968. In the mid-1980s, the focus of ADB assistance to the sector shifted from providing credit lines to developing long-term financial markets. An umbrella credit line approved in 19831 was predicated on binding government commitment to initiate reforms to encourage domestic mobilization of long-term resources. This was followed by reforms to liberalize interest rate, credit allocation and monetary control policies of the Government and the central bank, the State Bank of Pakistan, and to develop the government bond market. These reforms were supported by the Industrial Sector Program2 of 1988, and subsequently by a technical assistance (TA) grant for a study of the country’s securities markets.3 2. In the mid-1990s, Pakistan’s capital market faced a number of critical issues. The securities law was outmoded and the regulatory framework for the capital market was weak. Insurance, pensions and mutual funds (MF) industries required comprehensive review and reform to provide the framework for effective regulation and healthy capital market development (CMD). High interest rates and after tax yields on National Saving Schemes (NSS) were retarding long-term financial intermediation and crowding out private sector investment. To help address these issues, ADB approved a series of TAs during 1995–1997 for CMD and reform of certain related nonbank financial institutions. The first TA4 was provided in conjunction with the Financial Sector Intermediation Loan (FSIL) in 19955 principally to formulate a CMD reform agenda to be supported by the Capital Market Development Program (CMDP).6 In mid-1997, ADB provided two small-scale TAs to review NSS interest rate management,7 and initiate insurance and capital market law reform.8 Finally, three stand-alone TAs were approved in September 1997 to support implementation of reforms that were to be included in the CMDP agenda relating to public sector MFs,9 insurance industry,10 and pension and provident funds.11 B. Rationale and Concept 3. A major thrust of the ADB strategy for the financial sector in Pakistan in the mid-1990s was to assist its structural transformation from directed to market-led operation. ADB’s financial sector operations aimed to rationalize the financial system and enhance the efficiency of the capital market, so as to mobilize resources for expanded private sector investment. Reforms were particularly needed for (i) diversifying the financial instruments available to investors, as well as the funding sources for the leasing sector; (ii) easing capital issue regulations to allow market-determined pricing of new share issues; (iii) enhancing the transparency and efficacy of the stock exchanges (SEs); (iv) empowering, and building the institutional capacity of the capital market regulator, the Corporate Law Authority (CLA); (v) enhancing the efficiency of the MF

1 Loans 678-PAK/679-PAK(SF): Development Finance Loan , for $110 million, approved on 20 December 1983. 2 Loans 931-PAK/932-PAK(SF): Industrial Sector Program , for $200 million, approved on 13 December 1988. 3 TA 1096-PAK: Study on Development of a Secondary Market for Fixed Income Securities, for $176,000, approved

on 3 January 1989. 4 TA 2393-PAK: Capital Market Development, for $865,000, approved on 7 September 1995. 5 Loan 1371-PAK: Financial Sector Intermediation Loan, for $100 million, approved on 7 September 1995. 6 Loan 1576-PAK: Capital Market Development Program , for $250 million, approved on 6 November 1997. 7 TA 2812-PAK: Interest Rate Management of National Saving Schemes, for $100,000, approved on 18 June 1997. 8 TA 2825-PAK: Capital Market and Insurance Law Reform , for $100,000, approved on 14 July 1997. 9 TA 2865-PAK: Restructuring of Public Sector Mutual Funds, for $800,000, approved on 15 September 1997. 10 TA 2866-PAK: Reform of the Insurance Industry, for $700,000, approved on 15 September 1997. 11 TA 2867-PAK: Reform of Pension and Provident Funds, for $600,000, approved on 15 September 1997.

2

industry; and (vi) leveling the playing field between NSS, bank deposits, debt instruments, and the capital market to encourage efficient resource mobilization. C. Objectives and Scope 4. The TAs focused on six important aspects of CMD: (i) interest rates on investment instruments sold by NSS, (ii) legal framework for regulation of insurance and capital market, (iii) operation and regulation of SEs, (iv) restructuring of public sector insurance entities (PSIEs) and MFs, (v) pension and provident funds, and (vi) the leasing industry. 5. The objective of TA 2393-PAK was to assist the Government in (i) increasing the transparency and efficiency of stock market operations, (ii) improving the efficiency of MF industry with a focus on public sector MFs–-the Investment Corporation of Pakistan (ICP; a closed-end fund) and the National Investment Trust (NIT; an open-end fund), (iii) encouraging long-term resource mobilization by the leasing industry, and (iv) capacity building of CLA (Appendix 1). 6. TA 2812-PAK aimed to (i) examine the structure and key determinants of NSS interest rates in order to develop an appropriate mechanism for their future management, (ii) examine interest rate issues such as the impact of dollarization of the economy on interest rates, and (iii) develop an appropriate mechanism for managing the interest rates of the NSS (Appendix 2). 7. The objectives of TA 2825-PAK were to assist the Government in capital market and insurance law reform by (i) helping CLA identify best international practices and different models in key areas of securities and corporate law and regulations, (ii) drafting securities and corporate legislation, and (iii) assisting the Ministry of Commerce (MOC) in preparing a plan for the reform of the insurance regulatory framework, and drafting laws for a new regulatory regime for the insurance industry (Appendix 3). 8. TA 2865-PAK was provided to support the restructuring of public sector MFs and prepare an action plan for privatizing the asset management companies of ICP and NIT with the objective of transferring their management and control to strategic investors (Appendix 4). 9. The main objective of TA 2866-PAK was to promote orderly growth of the insurance industry. This was to be done through strengthening and modernizing the insurance legislation and building the institutional capacity of a new insurance regulatory authority to cover general 12 and life insurance companies, both in public and private sectors. The TA also aimed to support the development of restructuring and divestment plans for the PSIEs handling reinsurance (Pakistan Insurance Corporation, or PIC) and government insurance business (National Insurance Corporation, or NIC), as well as capacity enhancement of the Pakistan Insurance Institute (PII) (Appendix 5). 10. The purpose of TA 2867-PAK was to (i) support a comprehensive study of the prevailing pension and provident schemes, which would analyze their social, economic, and financial implications; (ii) make recommendations on fully or partially funded public and private pension plans to mobilize savings and provide adequate social security coverage to a larger segment of the population; and (iii) develop investment guidelines and a supportive legal, regulatory and institutional framework for more prudent management of the pension and provident funds, thereby contributing to more effective development of the capital market (Appendix 6).

12 Non-life insurance business in Pakistan is referred to as general insurance, and non-life insurance companies as

general insurance companies.

3

D. Completion and Self-Evaluation 11. Four of the six TAs covered by this TA performance audit report were self-evaluated by the operational department concerned. TA 2393-PAK was self-evaluated as part of the project completion report for FSIL, and was rated partly successful. However, this rating does not fully reflect TA achievements (para. 24). This TA prepared a CMD agenda whose implementation was supported by CMDP. The project completion report for CMDP rated it satisfactory.13 The other three TAs were self-evaluated on a stand-alone basis and a TA completion report (TCR) was prepared for each of them. The TCR on TA 2865-PAK14 rated it generally successful. This TCR did not, however, take into account the design flaw relating to privatization of the closed-end MFs managed by ICP, and slow progress in development of the fund management profession (paras. 16, 26–27). The TCR on TA 2866-PAK15 rated it highly successful but did not consider the fact that its implementation had benefited from the outputs of TA 2825-PAK (para. 35). The TCR on TA 2867-PAK16 rated it partly successful. E. Operations Evaluation 12. An Operations Evaluation Mission (OEM) visited Pakistan in March–April 2002 and held discussions with a large number of institutions, market participants, TA executing agencies, regulatory authorities, and other stakeholders. The OEM reviewed relevant ADB records and analyzed pertinent data collected in the field and through research on the internet. Following this, the OEM evaluated the six TAs in terms of (i) relevance of design in relation to the underlying rationale and objectives, as well as consistency with the Government’s priorities for the sector and ADB’s sector strategy; (ii) the achievement of objectives; (iii) the efficiency of implementation and adequacy of outputs; and (iv) outcomes and impacts. The TAs have been rated individually (Appendixes 1–6), as well as a cluster (paras. 43–48).

II. ASSESSMENT OF DESIGN AND IMPLEMENTATION

A. Design 13. The TAs were formulated at a time when government monetary and fiscal policies had created distortions in the financial markets, constraining financial intermediation and crowding out private sector investments. The stock market was stagnating despite liberalization of foreign portfolio investment; public sector MFs were beset with serious portfolio difficulties; and the MF industry as a whole faced issues concerning corporate governance, professional ethics, capital adequacy and regulation. The leasing industry was seeking feasible alternatives to foreign credit lines as their principal funding source while the pension sector was underdeveloped and poorly regulated. TA designs, in general, responded to these issues adequately and were relevant to ADB’s country and sector strategies. The three areas of focus under TA 2393-PAK––SEs, MFs, and the leasing sector––signified a phased approach to CMD, which was appropriate in view of the constraints on the Government’s implementation capacity and readiness to take on reforms simultaneously over a broad spectrum. Terms of reference (TOR) were expanded during TA implementation to conduct detailed studies of NIT and ICP and recommend alternate approaches for their strengthening before privatization.

13 Equivalent to “successful” under the current 4-level evaluation system, i.e., highly successful, successful, partly

successful, and unsuccessful. 14 ADB. 2001. Technical Assistance Completion Report on Restructuring of Public Sector Mutual Funds. Manila. 15 ADB. 2001. Technical Assistance Completion Report on Reform of the Insurance Industry. Manila. 16 ADB. 2001. Technical Assistance Completion Report on Reform of Pension and Provident Funds. Manila.

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14. TA 2812-PAK comprehensively covered the issues arising out of segmentation of financial markets, interest rate distortions, and the unsustainable yield structure of NSS instruments, as well as their negative impact on financial intermediation by banks and debt and capital markets, and on private sector investment. The TA design was appropriate in providing the analytical framework to bring dialogue on these issues between Government, the International Monetary Fund, and other aid agencies including ADB, to successful closure. The TA also helped in shaping and implementing a key conditionality of CMDP, namely reform of NSS interest rate management.

15. The principal factor leading to formulation of TA 2825-PAK was that while the Government was willing to implement capital market reforms proposed under TA 2393-PAK, and included in the reform agenda of CMDP, it lacked capacity to draft laws and establish regulatory frameworks for the capital market and the insurance industry in line with best international practice. The TA design was thus appropriate and its focus on securities legislation and regulatory framework for insurance was meant to overcome the Government’s most pressing capacity constraints, as well as help meet CMDP conditionalities. 16. The design of TA 2865-PAK had a major shortcoming. It did not fully consider the difference in the approach and strategy that was required for restructuring and privatizing NIT, an open-end fund, and ICP, a closed-end fund. The objective in both cases was to privatize the asset management business, and the TOR for both components were almost identical. However, ICP’s asset management function was neither tradeable nor did the “right to manage” its MFs have a value of its own. What needed to be privatized, in the case of ICP, were the ICP-managed MFs rather than the right to manage them. The TA design also omitted mitigating measures to deal with post-restructuring staff redundancies in NIT and ICP. 17. TA 2866-PAK was intrinsically linked with, and a logical continuation of, the insurance component of TA 2825-PAK, under which a sector study focusing on the regulatory framework for insurance and the blueprint for the Pakistan Insurance Regulatory Authority (PIRA) had been prepared. The TA design did not draw the distinction between what had been achieved under TA 2825-PAK and what remained to be done. Thus, it did not provide an adequate basis for a complete and objective assessment of its inputs, outputs, and impacts, as distinct from those of TA 2825-PAK. In hindsight, and in view of the long delay in framing rules under the Insurance Ordinance of 2000 (para. 34), it might have been better to include drafting of insurance rules in the TA scope. 18. The design of TA 2867-PAK called for a comprehensive study of almost all aspects of public and private pensions, as well as supplementary or alternative instruments of social security, namely gratuity and provident funds. The TA study was to address, among others, the critical but difficult issues of extending the provision of social security to a larger segment of the population, financial sustainability of the unfunded government pension scheme, as well as of the Employees’ Old-Age Benefits Institution (EOBI), and increasing the mobilization of long-term savings and channeling them to the capital market. Though these issues were interrelated, each involved time consuming and complex processes of research, analysis, and consensus building. Moreover, each issue required different expertise and skills. Thus, the TA scope was too broad. A more effective approach would have been to prepare, in the first instance, a roadmap of the required pension reforms, sequentially arranged and prioritized, following structured policy dialogue with the Government and in consultation with other stakeholders.

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B. Engagement of Consultants 19. The two small–scale TAs (TA 2812-PAK and TA 2825-PAK) were implemented by individual consultants while the others were implemented by consulting firms. The procedures for selection of the consultants were in accordance with ADB’s Guidelines on the Use of Consultants in each case.17 Actual consultant inputs varied considerably from the original implementation scheme in some cases, both in terms of total number of person-months as well as between the services provided by international and domestic consultants (Table 1). The large difference in planned and actual TA inputs under TA 2867-PAK suggests that TA implementation was not planned meticulously.

Table 1: Consulting Services

Planned Actual Item Int’l Domestic Total

Int’l Domestic Total

TA 2393-PAK No. of Consultants Person-months

7

20.0

2

3.0

9

23.0

11

20.4

1

3.0

12

23.4 TA 2812-PAK No. of Consultants Person-months

1

––

2

––

3

9.5

2

2.5

1

5.8

3

8.3 TA 2825-PAK No. of Consultants Person-months

2

3.0

1

1.0

3

4.0

1

1.5

4

7.7

5

9.2 TA 2865-PAK No. of Consultants Person-months

4

15.0

4

17.0

8

32.0

5

15.5

3

––

8

–– TA 2866-PAK No. of Consultants Person-months

2

12.0

4

28.0

6

40.0

3

18.0

6

27.6

9

45.6 TA 2867-PAK No. of Consultants Person-months

2

8.0

4

26.0

6

34.0

6

10.2

5

5.0

11

15.2 –– = not available, Int’l = International, No.= number.

C. Implementation and Cost 20. The implementation of all the TAs was delayed, by 8–26 months (Table 2). However, on the whole, the delays had limited effect on the substance of TA outputs. TA 2393-PAK was substantively complete in terms of formulation of the CMD agenda by October 1997, within the projected completion schedule of end-1997. However, TA completion date was extended to accommodate the training requirements of the new Executing Agency, the Securities and Exchange Commission of Pakistan (SECP), which had been set up to replace CLA. In the case of TA 2825-PAK, an important TA output, the passage of the Securities and Exchange

17 However, in the case of TA 2825-PAK, in view of the urgency to field the consultants, the requirement to list the TA

in ADB Business Opportunities for the required period was waived.

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Commission of Pakistan Act, was realized within the implementation timeframe. Proactive participation of ADB’s Office of the General Counsel in TA administration was a notable feature of this TA, and was necessitated by the extensive amount of legal drafting required. Implementation of TA 2866-PAK was also effective in terms of end results. However, the delay required additional inputs from domestic consultants, which were accommodated within the TA budget, thanks to favorable exchange rate development. In the case of TA 2867-PAK, implementation was temporarily interrupted by the unexpected change of government in October 1999, which caused loss of momentum and affected the vigor of the officials and implementation agencies concerned. As a result, inputs from these agencies diminished with time. TA implementation also suffered from severe data constraints and limited capability of the consultants’ team leader.18

Table 2: Implementation Delays and their Impacts

Item

Delay (months)

Main Reason for Delay

Impact on Output

TA 2393-PAK 26 Delayed implementation of the training component

because of reorganization of the Corporate Law Authority into the Securities and Exchange Commission of Pakistan

Limited

TA 2812-PAK 13 Coordination of the work of individual consultants not well

planned Limited

TA 2825-PAK 16 Mid-course addition to the TA scope Insignificant TA 2865-PAK 8 Late signing of the TA Agreement by the Government Insignificant TA 2866-PAK 14 Late signing of the TA Agreement by the Government and

delay in consensus-building on the new insurance law and institutional arrangements for insurance regulation

Limited

TA 2867-PAK 24 Late signing of the TA Agreement by the Government,

unexpected change of the Government, frequent changes in the Government and ADB staff assigned to the project, and difficulties in data collection

Substantial

ADB = Asian Development Bank, TA = technical assistance. 21. In some cases, significant cost savings were realized. Implementation of the two small-scale TAs relied substantially on the use of domestic consultants. Careful consultant selection and close TA administration by ADB and effective executing agency support made these TAs highly cost effective. In the case of TAs 2812-PAK and 2865-PAK, consultant inputs and TA costs appear to have been over-estimated.

D. Organization and Management 22. EA arrangements were generally effective with the Ministry of Finance (MOF) or its affiliate organizations assuming the lead role in most cases. The EAs provided adequate official and logistic support to the consultants in their research and fieldwork. This assisted them in interviewing a large number of institutions and individuals associated with capital market related

18 In the last phase of TA implementation, the team leader was replaced by a legal expert and an actuary to conduct

a study on EOBI.

7

activities, besides concerned government agencies. TA administration by ADB was proactive in most cases with the Office of the General Counsel providing effective support where review and drafting of laws was involved. In the case of TA 2867-PAK, MOF had established a coordination group headed by the Secretary, MOF, and comprising representatives of the Ministry of Labor, EOBI, professionals, and the private sector. In practice, this arrangement did not work well, in part due to frequent changes in personnel. Supervision of the implementation of this TA by both the Government and ADB was less than effective. Closer monitoring and supervision by ADB could have optimized TA outputs by replacing the team leader at an earlier stage of TA implementation.

III. EVALUATION OF OUTPUTS AND IMPACTS

A. Performance of Consultants and Quality of Reports 23. The performance of consultants under all the TAs was generally satisfactory with the exception of TA 2867-PAK. The recommendations under TA 2393-PAK became an important input to the formulation of CMDP. The final report recommended the elimination of double taxation of corporate and dividend income but did not specifically address taxation of MFs, as was required under the TOR. Appreciation was expressed to OEM by various stakeholders of the high quality of the final report of the domestic consultant under TA 2812-PAK as well as the underlying research and analytical work. Consultant reports under TA 2825-PAK were of good quality but submission of the reports of the management consultant and insurance regulatory expert was delayed. Under TA 2865-PAK, consultant performance was generally satisfactory although it could have been better in two aspects. Firstly, there should have been a more realistic assessment of the interest of foreign fund managers in taking over the MFs managed by NIT and ICP, and accordingly a focus on approaches and strategies to privatize them through domestic interests. Secondly, with respect to ICP, there should have been more focus on privatizing the MFs rather than the right to manage MFs, which could not be sold because this had no value of its own. The performance of consultants under TA 2867-PAK was below par; a major intended output—a pension and provident funds reform program—was not delivered. On other aspects, however, particularly in respect of actuarial analysis, the quality of the final report was acceptable. B. Stock Market Operation and Regulation 24. TA 2393-PAK helped in initiating a number of reforms to enhance the transparency and efficiency of the stock market (Appendix 1, para. 12). These measures have helped bring the operation of the stock market closer to international standards and improved its transparency considerably. SECP and SEs have also taken a number of measures to reduce the risk of broker default, including redefining the net capital balance of brokers on a conservative basis, and capping the value of a broker’s trades as a multiple of the net capital balance. These measures are expected to bear positive impact in due course. However, public perception as to the credibility of the stock market has not changed much. The secondary market remains largely speculative, driven by a few powerful players. Daily turnover remains concentrated in very few stocks that have large market capitalization. The ratio of average daily trading value to market capitalization, four times that of Mumbai Stock Exchange, is one of the highest in the world. There is a preponderance of short-term and intra-day trades supported in part by “badla” 19 financing. Market participants estimate that about 36% trades are intra-day trades, more than 60% trades are carried over, and just 3% ultimately settled in cash. One reason for this phenomenon is that supply of quality stocks has not kept pace with other aspects of CMD, i.e.,

19 Broker-arranged financing of carried over transactions.

8

demand, intermediation and regulation, because of slow privatization and unfavorable investment climate. Though SECP is generally perceived to be an effective regulator, it has not yet been successful in eliminating market manipulation and maintaining a healthy balance between speculative and non-speculative investment. 25. It is difficult to measure the direct impact of the TAs on the stock market. However, together with the implementation of CMDP, they appear to have helped boost the market in terms of market capitalization, new listings particularly of debt issues, and stock price index, which have all recorded impressive growth during 1998–2002 (Table 3). However, the extraordinary growth of the market in 2002 has also been helped by positive developments in the economy, political climate, and regional security environment.

Table 3: Key Statistics of Karachi Stock Exchange

1998 1999 2000 2001 2002a

Equities Listed Companies b 773 765 741 747 719

Listed Capital (PRs million) 212,619 223,028 236,459 235,683 288,950

Market Capitalization (PRs million) 268,471 366,670 382,730 296,144 550,553

New Companies Listed 1 0 3 2 4

Listed Capital (PRs million) 221 0 2,035 1,948 6,318

Bonus issues listed (PRs million) 2,529 4,243 5,211 4,187 2,854

Rights issues listed (PRs million) 1,177 6,512 3,387 1,531 12,023

Debt Instruments

New Debts Instruments Listed 1 2 3 5 14

Listed Capital (PRs million) 274 1,148 648 5,658 7,556

Funds mobilized (PRs million)c 1,673 7,659 6,070 9,174 25,897

KSE – 100 Index

High 1,746 1,417 2,054 1,550 2,279

Low 768 852 1,276 1,075 1,322

Turnover

Total Shares (million) 18,497 31,330 46,158 23,070 30,942

Average Daily Trade/Day

(million shares)

77

128

187

97

147 KSE = Karachi Stock Exchange.

a January–October 2002. b The difference between the number of cumulative equity listings and the actual number of listed companies

represents de-listing of non-compliant companies. c Capital of new listings plus debt instruments plus rights issues.

Source: Karachi Stock Exchange, www.kse.com.pk. C. Mutual Funds Industry 26. The MF industry has undergone significant developments. TA 2865-PAK helped amend the MF regulations to (i) allow flotation of special purpose MFs, (ii) unify the fee structure of closed-end and open-end funds, (iii) require mandatory declaration of net asset value,

9

(iv) strengthen capital adequacy and disclosure requirements for MFs, and (v) empower SECP to enforce compliance flexibly. Following TA completion, substantial progress has also been made towards restructuring and privatizing the MF business of ICP. However, MF management has not yet developed as a successful profession or industry in Pakistan, and a majority of private MFs have underperformed persistently. Privatization of NIT too has been stalled pending MOF decision on any guarantee or comfort that may need to be provided to private investors on the redemption value of NIT units (para. 28). However, the current buoyancy of the stock market provides a favorable environment to implement the privatization of NIT. 27. The output of TA 2865-PAK relating to restructuring of public sector MFs was significant but somewhat below expectations. The final report on ICP recommended a two-stage privatization approach, first to separate the MF business from other operational functions of ICP, auction the right to manage MFs, and then wind down the rest of ICP business or merge it with another institution. This strategy was inappropriate since ICP’s “right” to manage MFs could not be sold because it had no value of its own per se (para. 16). In the case of NIT, the recommendation was to sell the asset management right in the form of a new asset management company and wind down the remainder of the asset management company. The recommended strategy for ICP assumed the sale of a single MF management contract covering all MFs managed by ICP. In both cases, the consultants recommended sale to foreign fund managers experienced in MF management in a more stringent regulatory environment, so as to improve MF management standards in Pakistan. However, no foreign fund managers were interested in taking strategic stakes in ICP and NIT, probably because of reservations as to the quality of their portfolios and unfavorable investment climate in Pakistan in general. 28. The consultants identified a number of issues that needed to be resolved before the privatization of NIT could move forward. The most critical issue was that, in order to avoid large-scale redemptions, the parties interested in acquiring NIT were insisting on continuation of the government-guaranteed minimum repurchase price of NIT units. This was clearly not acceptable, since withdrawal of this guarantee was the main reason behind the move to privatize NIT, thereby providing a level playing field to private sector open-end MFs. Following implementation of TA 2865-PAK, the Privatization Commission has lately fast-tracked the privatization of ICP and NIT. In the case of ICP, a first package comprising 12 MFs has been sold while the sale of the second package has been approved by the Cabinet. The Privatization Commission expects to move forward with the third package soon. ICP has already started winding down its investment account management activities, and by the time of the OEM, had separated 365 staff under a voluntary retirement scheme. Notwithstanding the difficulties relating to the repurchase price, initial steps toward NIT’s privatization were taken in July 2001 and four parties were subsequently pre-qualified. However, further progress has been stalled as interested parties still insist on government guarantee on the repurchase price. D. Leasing Industry 29. To reduce the dependence of leasing companies on foreign credit lines as a major source of long-term funds, a number of measures were recommended by consultants and have been implemented. These include liberalizing investment rules for institutional investors, strengthening the capital base of leasing companies and tightening their regulation as issuers of certificates of investment to the public. TA consultants identified term finance certificates (TFCs) as an effective instrument of raising long-term funds in Pakistan’s financial markets. However, they highlighted the need for rationalizing the returns on government-guaranteed investment instruments, mainly NSS, since these were retarding the development of the corporate bond market. This rationalization took place under TA 2812-PAK (para. 31), and has greatly helped the primary market for TFCs (para. 32 ), particularly to the benefit of the leasing industry. The

10

consultants also made a number of recommendations for the development of asset-backed securities (ABS). However, the ABS market has been slow to take off as only one leasing company has yet attempted to raise funds through securitization of lease receivables. E. Interest Rate Management of the National Saving Schemes 30. A domestic consultant reviewed NSS within the broad framework of Pakistan’s financial markets. The consultant formulated recommendations for the reform of NSS while identifying possible constraints to their implementation. Most of the recommendations have been implemented. In addition, international consultants conducted an econometric study to analyze the relationship between the demand for NSS versus other instruments including bank deposits in local and foreign currencies. They concluded that while bank deposits and NSS instruments appeared to be net substitutes, bank deposits in local and foreign currencies were neither substitutes nor complements to each other. Also, the estimated income derivative of the demand for local currency bank deposits was negative, while that for foreign currency deposits was positive. For NSS, it was not significantly different from zero. Finally, the study found some empirical support for the view that foreign currency deposits had absorbed a part of the demand for NSS, and therefore, the availability of on-shore foreign currency deposit facilities may have reduced the ability of the Government to finance itself through NSS. 31. Interest rates on NSS have been made market compliant since January 2001, and institutional investors have been barred from making new investments in NSS instruments. The Government has developed a formula in consultation with the International Monetary Fund, whereby NSS interest rates are reviewed semi-annually within ±0.5% of the market-based rate of return on Pakistan investment bonds of corresponding maturities. With this mechanism in place, the main objective of TA 2812-PAK has been achieved. Withdrawal of institutional savings from NSS would be gradual depending on their maturity structure, since premature withdrawal is subject to penalty. However, in the absence of credible alternative instruments, and because investment up to PRs150,00020 in NSS is still exempt from withholding tax, NSS instruments have remained popular with individual savers. Thus, the outstanding NSS stock has continued to grow albeit at declining rates (Table 4).

Table 4: Outstanding Obligations of the National Saving Schemes (PRs million)

Fiscal Year Ending 30 June

Saving Accounts

Saving Certificates

Total

1996 43,557 209,336 252,893 1997 41,891 269,892 311,783 1998 37,822 374,981 412,803 1999 45,964 496,435 542,399 2000 51,194 582,608 633,802 2001 52,731 617,430 670,161 2002a 55,537 685,642 741,179

a Provisional. Source: State Bank of Pakistan, Annual Report 2001–2002; www.sbp.org.pk.

20 Reduced from PRs300,000 effective July 2002.

11

F. Corporate Bond Market 32. The reform of NSS has provided a boost to the TFC market, which effectively represents the corporate bond market in Pakistan (Table 5). As a result, a total amount of PRs18.5 billion was raised through 28 TFC issues between 1 January 2001 and 8 August 2002, as against PRs3.4 billion raised through 11 issues during 1998–2000. A secondary market for TFCs has also started to emerge with the listing of 14 TFC issues, totaling PRs7.6 billion, on the Karachi Stock Exchange in January–October 2002. To provide liquidity to the unlisted debt securities, a discount house regularly offers two-way price quotes for major unlisted TFCs.

Table 5: Issues of Term Finance Certificates

Issuer

Banks

Leasing Companies

Others

Total

Year No.

PRs million

No.

PRs million

No.

PRs million

No.

PRs million

1998 1 300 1 274 2 574 1999 2 838 2 1,113 4 1,951 2000 4 650 1 204 5 854 2001 1 500 6 1,870 10 9,766 17 12,136 2002a 1 1,600 2 960 8 3,835 11 6,395 Total 3 2,400 14 4,318 22 15,192 39 21,910

a Up to 8 August 2002. No. = number. Source: State Bank of Pakistan; www.sbp.org.pk.

G. Legal and Regulatory Framework for Insurance and Capital Market 33. The most important output of TA 2825-PAK was the draft of the SECP Act of 1997. Following its enactment, CLA was dissolved and SECP established, effective January 1999, as an autonomous and financially independent capital market regulator. SECP is fully operational and actively discharging its responsibilities in capital market regulation. The organization and staff compensation structures proposed by the TA have been substantially implemented and have helped establish SECP on a sound footing. SECP has brought about a number of reforms in the governance of SEs and related institutions. These reforms have begun to bear positive impact on the image of SEs and investor confidence though a lot more needs to be done. 34. The key outputs under the insurance component of TA 2825-PAK were a sector study focusing on insurance regulation, and an insurance regulatory framework in the form of the draft PIRA Bill. The study provided the basis for drafting, under TA 2866-PAK, a new insurance law, the Insurance Ordinance enacted in August 2000, to replace the outdated Insurance Act of 1938. As a result of the new law, the financial health of the insurance companies is expected to improve due to the requirement of stronger capital base and solvency margins. However, the ordinance remained only partially operational for 2 years because the issuance of rules was delayed due to lack of effective coordination between MOC and SECP (the prospective insurance regulator), as well as lack of clear and timely guidance from the Ministry of Law. At the time of the OEM, SECP had neither commenced effective insurance regulation nor had started building capacity to do so in a meaningful way. The first set of insurance rules, to be enforced by MOC, was eventually issued in August 2002, while the rules falling under SECP’s jurisdiction are expected to be issued in the near future.

12

35. The draft bill envisaged the establishment of PIRA as an independent insurance regulator outside of MOC. Following extensive consultations between the Government, ADB and other aid agencies, however, it was concluded that capacity and cost constraints weighed against the establishment of a new insurance regulator. Accordingly, the Government abandoned the proposal to establish PIRA and instead made SECP responsible for regulation of the insurance industry. The consultants helped consensus building on this approach through extensive consultations with stakeholders, including the Government, aid agencies (including ADB) and the insurance industry. Since the initial draft of the PIRA Bill was developed under TA 2825-PAK (Appendix 3), it is difficult to judge the adequacy of inputs and outputs of this component of TA 2866-PAK on a stand-alone basis. Nonetheless, the consultants formulated necessary amendments to the SECP Act to provide the legal basis for regulation of insurance by SECP, and prepared action plans for establishment of the Insurance Wing of SECP. Some staff training was provided under the TA in the area of insurance regulation. However, at the time of the OEM, SECP’s Insurance Wing was not fully functional. H. Restructuring of Public Sector Insurance Entities 36. The consultants’ recommendations under TA 2866-PAK provided the basis for corporatization of both NIC and PIC under the company law and inclusion of nongovernment members in their Boards. PIC was restructured as the Pakistan Reassurance Corporation (PRC), and a comprehensive corporate plan was adopted. Before restructuring, PIC was the sole entity allowed to handle reinsurance business in Pakistan. The compulsory cession of reinsurance business to PRC will be phased out by end-2003, which should improve its sustainability on a competitiveness basis. NIC has also successfully streamlined its organization and administrative expenses. 37. However, the diagnostic studies of PIC and NIC conducted under the TA have not helped bring these corporations to a “privatizable” shape. PRC’s financial condition remains non-transparent and uncertain, because the external auditor has qualified its financial statements, notably the balances with counter parties, valuation of foreign exchange assets and liabilities, and assets and liabilities in Bangladesh. Athough PRC is listed with the Privatization Commission, the prospects of its privatization in the near future are slim, as are the prospects of privatization of NIC. NIC enjoys a sound financial position and could attract a fair value from the private sector, but strong arguments have been made against its privatization. First, with the completion of the ongoing process of privatization of public sector enterprises, NIC’s captive insurance business will diminish through a natural process of attrition. Secondly, the Government has begun to exempt public sector enterprises on a case-by-case basis from compulsory insurance with NIC, so as to break its monopoly over public sector insurance business. Finally, NIC also handles the insurance requirements of certain departments and agencies, which the Government would not like to cede to the private sector. I. Reform of Pension and Provident Funds 38. The output of TA 2867-PAK was short of expectations. The final report did not present a comprehensive reform proposal, as was required under the TOR. The TA was not well prepared and was premature. No workshop was held for stakeholder consultation, given the premature stage of strategy development for the pensions sector. However, TA findings provided Government and ADB insights into the complexities of the existing pension and provident fund system in Pakistan, and identified a general framework for formulating practical and well-sequenced reform proposals for the future. The TA could also be a catalyst for partial reform of the existing defined-benefit pension scheme of the Government. It has prompted serious consideration within the Government of funding future public pensions on contributory basis,

13

allowing private sector fund managers to manage public pension funds, and encouraging the private pension funds industry in general. 39. The consultants compiled useful data and conducted actuarial analysis of EOBI. The TA and recent media reports of irregularities in EOBI have highlighted serious problems in its financial management. EOBI is charged with the responsibility to collect contributions from private employers and dispense retirement benefits to private employees, and is the largest holder of financial assets in Pakistan. It operates under its own statute, which is not in line with the needs of modern pension fund operation and management. Its Board of Trustees is dominated by officials of federal and provincial labor ministries, whose financial management capabilities do not match those of professional investment managers. Finally, EOBI is unable to hire capable professional staff with the public sector compensation package that it is obliged to adopt. The TA helped highlight these issues and thus the need for reform of EOBI. 40. Meanwhile, EOBI has introduced the requirement for private workers to contribute PRs20 per month to complement the employers’ contributions. This is a positive step even though the amount of employees’ contribution is small. Another development is that MOF has begun the process of establishing an Actuary’s Department to strengthen its pension policy making and supervisory capacity. Finally, with the urgency of pension reforms gaining increasing recognition, SECP has drafted a new pension law and related rules, which are under government consideration. J. Capacity Building 41. Two of the six TAs had capacity-building components. Under TA 2393-PAK, 53 staff of SECP and 2 staff of SEs were trained. However, the TA outputs in this area were inadequate. There was a considerable delay in the identification of suitable foreign training programs because it was difficult to make a meaningful training needs assessment while CLA was being restructured into SECP. Foreign training of SECP staff, therefore, largely proceeded on ad hoc basis, and a part of the training budget was utilized to participate in annual meetings of securities-related international organizations.21 None of the training programs participated by SECP staff was focused on MF/ABS regulation, and it is not clear whether any capacity enhancement has taken place in these areas where SECP was deficient. 42. TA 2866-PAK did not directly help capacity building of PII. However, the consultants interacted with PII members and helped put in place funding arrangements through periodic contributions of members, so as to enable it to meet the training needs of the industry on a continuous basis. PII has introduced new courses on the basic insurance concepts and principles. At the time of the OEM, however, its training activities on the new insurance law had not commenced in the absence of the new insurance rules.

IV. OVERALL ASSESSMENT

A. Relevance 43. One TA was highly relevant, three were relevant, and two partly relevant. The rationale for all six TAs was generally sound in the context of sector needs, government priorities and ADB’s country and sector operational strategies. The TA designs were consistent with objectives in the case of four TAs. TA 2393-PAK was relevant and addressed priority issues in

21 At SECP’s request, 25% of the budget for foreign training was made available by ADB for domestic training of 30

staff at the Lahore University of Management Sciences.

14

stock market operation and regulation, and MF and leasing industries. Its design was consistent with objectives. TA 2812-PAK was highly relevant and timely, designed to address interest rate distortions that were retarding healthy financial intermediation and resource mobilization for private sector investment. TA 2825-PAK was relevant as it set in motion the urgently needed review of the legal and regulatory frameworks for capital market and insurance. The design of TA 2865-PAK lacked clarity regarding privatization of ICP, and did not call for mitigating the social consequences following privatization of NIT and ICP. The TA is assessed as partly relevant. TA 2866-PAK was relevant and timely, and in part provided continuity to the insurance sector reform initiated under TA 2825-PAK. Its design was sound but the TA could have been more purposeful if its scope had specifically called for drafting rules under the new insurance law. TA 2867-PAK was too wide in scope, considering the lack of government readiness to take on pension reform over a broad spectrum. It should have focused on a narrower agenda based on government capacity and readiness, and as part of a prioritized and sequentially arranged reforms program. It is assessed as partly relevant. B. Efficacy 44. Five TAs are assessed as efficacious, and one as less efficacious. TA 2393-PAK was efficacious as its outputs largely met expectations. Although its capacity building component was delayed, the substantive outputs were delivered within the original schedule. TA 2812-PAK was also efficacious as its outputs provided important inputs to the Government’s review of NSS. TA 2825-PAK was efficacious in that it initiated drafts of the SECP Act and the PIRA Bill even though the latter was not utilized as the proposal to establish an independent insurance regulator was abandoned. TAs 2865-PAK and 2866-PAK are assessed as efficacious as their outputs substantially met expectations, in accordance with their designs and scope. TA 2867-PAK is assessed as less efficacious because the consultant team leader performed poorly and TA output was considerably below expectations. C. Efficiency 45. Implementation of all six TAs was delayed but, in most cases, the impact of the delay on the substance of outputs was insignificant. TA 2393-PAK is assessed as efficient, its substantive output being delivered on time. The two small-scale TAs, i.e., TA 2812-PAK and TA 2825-PAK, were highly cost effective and are assessed as highly efficient. TA 2865-PAK was implemented with substantial cost savings, and is assessed as efficient. TA 2866-PAK was also efficient as the delay in consensus building on the institutional arrangements for insurance regulation occurred mainly because of government indecision. In the case of TA 2867-PAK, some of the key TA activities were not completed, despite considerable implementation delay. The TA is rated as less efficient. D. Sustainability 46. Most of the reforms formulated under TA 2393-PAK, and supported by CMDP, in the areas of operation and regulation of SEs, MFs, and resource mobilization by the leasing industry have been implemented. Sustainability of the TA outputs and impacts is assessed as likely. In the case of the two small-scale TAs, sustainability is most likely because of their direct and significant contribution to the policy, regulatory and institutional reforms. A key recommendation of TA 2865-PAK, i.e., to sell NIT and ICP to foreign fund managers, proved impractical. Sustainability of the outputs of this TA is therefore assessed as less likely. TA 2866-PAK was successful in providing the legal framework for the insurance sector, contributing significantly to restructuring of PSIEs, and generally strengthening the financial standards for non-life insurance industry. Because of these impacts, the sustainability of TA

15

outputs is assessed as likely. TA 2867-PAK produced useful actuarial analysis of EOBI but failed to provide the roadmap of pension reforms, the main expected output. Therefore, sustainability of the impact of this TA is assessed as less likely. E. Impacts 47. Four out of the six TAs have generated impacts fully or substantially in line with expectations. TA 2393-PAK, followed by CMDP, was successful in strengthening the regulatory regime of the stock market and the capacity of SECP and SEs to some extent. It also helped enhance market image and growth, and had favorable impact on the financial soundness and resource mobilization ability of the leasing companies. TA 2812-PAK provided the basis for reform of government policy on NSS. This, in turn, gave a significant impetus to the corporate bond market, particularly to the advantage of the leasing industry. TA 2825-PAK yielded outcomes in reform of the regulatory frameworks for capital market and insurance. Impacts of TA 2865-PAK have been moderate and delayed as a key recommendation of the consultants proved impractical. TA 2866-PAK modernized the insurance law, institutionalized regulation of insurance within SECP, made substantial and positive impacts on the operation and management of PSIEs, and helped create the base for a competitive reinsurance industry by initiating a process of gradual dismantling of PRC’s monopoly. However, the TA impact on capacity building of PII was insignificant. The impact of TA 2867-PAK has been negligible, and limited largely to the actuarial study of EOBI as the basis for its reform in the future. F. Overall Rating 48. Based on the above, TA 2812-PAK is rated highly successful; TA 2393-PAK, TA 2825-PAK and TA 2866-PAK successful; and TA 2865-PAK and TA 2867-PAK partly successful. As a cluster, the TAs are assessed as relevant, efficacious, efficient, sustainable, and bearing substantial impacts. Overall, the TA cluster is rated successful.

V. CONCLUSIONS

A. Key Issues 49. There are several pending issues in the areas covered by TA 2393-PAK and CMDP. The first concerns the regulatory capacity of SECP. While SECP has acquired the reputation of an effective regulator of the stock market, it lacks capacity to regulate insurance and pension funds.22 The second set of issues relates to the preponderance of short-term speculative trades in the stock market and market manipulation by few powerful brokers. This projects a negative image of SEs and discourages investors from participating in the market. A related issue is that, barring very few stocks with large market capitalization,23 the secondary market is illiquid, which is probably the main reason that it is narrow and overly speculative. The third issue is that the MF management industry has not developed on professional grounds and as a result, most private sector MFs have performed poorly. Finally, the ABS market has remained underdeveloped. In view of its vast potential to be the main source of medium and long-term debt funds particularly for the leasing industry, a strong justification exists for further ADB support to develop the ABS market. 22 SECP’s mandate already covers insurance while the mandate to regulate pension funds is expected to be given to it in the near future. 23 Three most actively traded stocks represent 27.4% of market capitalization and 64.4% of turnover by number of

shares, and possibly even higher by value.

16

50. The residual issues in the MF area relate to privatization of NIT. The first is whether the Government should renew the letter of comfort regarding the repurchase price of NIT units in favor of the institutions holding them. Continuing dialogue with the Government is necessary in line with the objective of providing a level playing field to private sector MFs (para. 28). The other issue relates to staff redundancies that will result from NIT’s privatization. In this regard, the consultants’ recommendation, that some staff be absorbed in SECP, needs careful consideration but based only on a proper match between SECP’s needs and the qualifications of the staff separated from NIT. 51. The remaining issues in the insurance sector concern the regulatory capacity of SECP (for which some funding has been made available under Loan 1577-PAK),24 issuance of insurance rules to be enforced by SECP, restoring the credibility of PRC’s financial statements and its gradual privatization, and privatization of that part of NIC’s business which can be handled by the private sector. 52. In the area of pensions and provident funds, the major issue for the future is the financial sustainability of the Government’s pension obligations. The need for a well thought-out plan for funding government pensions, and its management by professional fund managers, is an urgent necessity, and a major challenge. Another issue relates to restructuring of EOBI. The Government needs to redefine the role of this important institution, strengthen its capacity to perform the assigned role, and ensure its financial sustainability. Finally, adoption of a regulatory framework for pensions, covering both public and private pensions, and appointing an independent pension regulator has assumed urgency. To that end, the Government needs to extend SECP’s mandate to cover regulation of the pension sector. 53. ADB has remained engaged with Government and SECP on these issues, and is providing further support to address most of them through a recently approved financial sector program.25 Real-time feedback provided by the OEM during its processing contributed to including several of these issues in the agenda of this program. B. Lessons Learned 54. The successful implementation of TA 2393-PAK confirmed that strong government ownership is critical to the success of any initiative to policy and institutional reform. Even though the TA had no direct bearing on the credit lines provided under the Financial Sector Intermediation Loan, to which it was attached (footnote 5), prior policy dialogue and ownership-building had strengthened the Government’s resolve to address the pressing issues in the stock market, MFs, leasing, and regulatory areas. Another lesson is that for healthy, balanced, and sustainable development of the capital market, it is necessary to develop all the major aspects of CMD, i.e., demand, supply, intermediation, and regulation. In the case of Pakistan, the supply of quality equity issues has lagged behind other CMD aspects, resulting in an overactive but narrow and highly speculative secondary market. 55. The main lesson from TA 2812-PAK is that sharply focused TAs, preceded and backed by effective policy dialogue, have a better chance of success than those that encompass a broad range of issues. This TA was highly successful because: (i) it was basically focused on a

24 Loan 1577-PAK(SF): Capacity Building of the Securities Market, for $5 million, approved on 6 November 1997. 25 The program, which was approved on 5 December 2002, comprises a policy loan (Loan 1955-PAK: Financial

[Nonbank] Market and Governance Program , for $260 million); two TA loans (Loan 1956-PAK[SF]: Strengthening Pension, Insurance, and Savings Systems, and Loan 1957-PAK[SF]: Strengthening Regulation, Enforcement, and Governance of Nonbank Financial Markets, for $3.0 million equivalent each); and two political risk guarantee facilities (PRG:PAK 33271, for a total of $150 million).

17

one-point agenda, (ii) the Government had shown willingness to deal with the issue at hand, and (iii) the consultant possessed the right blend of capabilities. Both small-scale TAs were largely implemented by domestic consultants; both have been assessed as highly efficient. The pertinent lesson from these TAs is that, subject to availability of adequately qualified professionals in the relevant field, as well as dedicated TA administration by ADB, use of domestic consultants is highly cost effective. 56. There are no particular lessons from TAs 2865-PAK and 2866-PAK that may be relevant to future TAs, except that shortcomings of TA design translate into shortcomings of TA outputs. The main lesson from TA 2867-PAK is that attempting to deal with too many complex issues under one TA is not effective. This is particularly so in situations where different sets of specialized skills are required to implement the TA. In those situations, it is difficult to engage a versatile team leader capable of leading from the front and coordinating effectively the inputs and outputs of different TA components or aspects. A related lesson is that TAs involving complex issues should be implemented in phases, and in a proper sequence, after basic understandings have been reached with the Government during the policy dialogue. C. Recommendations and Follow-Up Actions 57. To resolve the residual issues related to the TAs covered by the TA performance audit report following actions are recommended.

(i) ADB and SECP should take additional measures to promote ABS and develop primary and secondary ABS markets. For this purpose, the scope of TA Loan 1957-PAK(SF) (footnote 25) should be amended by 30 June 2003.

(ii) The Government should expedite privatization of NIT. To that end, the Government should resolve the issue of repurchase price guarantee by 30 June 2003. ADB should maintain an active dialogue with the Government, particularly on measures to mitigate the impact of staff redundancy.

(iii) The Government should: (a) by 30 April 2003, approve the draft of the insurance

rules relevant to SECP’s mandate; (b) by 30 June 2003, prepare a time-bound action plan to clean up PRC’s financial statements so as to make them transparent and unqualified and, by 30 June 2004, implement that plan; and (c) by 31 December 2003, place NIC’s commercial business into a separate entity with a view to privatizing that entity subsequently.

58. Further TA possibilities should be explored by the Government, SECP, and ADB to support the actions outlined above.

Appendix 1 18

EVALUATION OF TA 2393-PAK: CAPITAL MARKET DEVELOPMENT

A. Introduction

1. Background 1. The involvement of the Asian Development Bank (ADB) in Pakistan’s financial sector dates back to 1968. Since the mid-1980s, the focus of ADB assistance to the sector shifted from providing credit lines to developing long-term financial markets. An umbrella credit line approved in 19831 was predicated on a binding Government commitment to initiate reforms to encourage domestic mobilization of long-term resources. This was followed by reforms to liberalize interest rate, credit allocation and monetary control policies of Government and the central bank, the State Bank of Pakistan, and to develop the government bond market under the Industrial Sector Program;2 and subsequently by a technical assistance (TA) for a study of the country’s securities markets.3 TA 2393-PAK4 was the first major ADB initiative for capital market development (CMD) in Pakistan, and was provided in conjunction with the Financial Sector Intermediation Loan.5 2. Rationale and Concept 2. At the time of TA formulation, ADB strategy for the financial sector in Pakistan included a focus on assisting its structural transformation from directed to market-led operation. This transformation would address critical capital resource deficiencies, and place greater reliance on a dynamic private sector capable of generating foreign and domestic capital resources to finance industrial growth. This purpose was consistent with ADB’s country operational strategy, which called for greater private sector participation in the pursuit of economic growth. Accordingly, ADB’s financial sector operations aimed to rationalize the financial system and enhance the efficiency of the capital market, thereby transforming it into a significant source of funds to support expanded private sector industrial investment. To give the capital market more depth and make it more responsive to the changing needs of the private sector, reforms were particularly needed for (i) diversifying the financial instruments available to investors, as well as the funding sources for the leasing sector; (ii) allowing market-determined pricing of new share issues; (iii) enhancing the transparency and efficacy of the stock exchanges (SEs); (iv) improving the regulatory operations of the Corporate Law Authority (CLA); and (v) enhancing the efficiency of the mutual fund (MF) industry. The TA was a response to these needs. 3. Objectives and Scope 3. The TA focused on three important aspects of CMD: operation and regulation of SEs, the MF industry, and the leasing industry. Its main objectives were to develop the stock market

1 Loan 678-PAK and Loan 679-PAK(SF): Development Finance Loan, for $110 million approved on 20 December

1983. 2 Loan 931-PAK and Loan 932-PAK(SF): Industrial Sector Program , for $200 million, approved on 13 December

1988. 3 TA 1096-PAK: Study on Development of a Secondary Market for Fixed Income Securities, for $176,000, approved

on 3 January 1989. 4 TA 2393-PAK: Capital Market Development, for $865,000, approved on 7 September 1997. 5 Loan 1371-PAK: Financial Sector Intermediation Loan, for $100 million, approved on 7 September 1995.

Appendix 1 19

through enhanced efficiency and transparency of the SEs, improve the efficiency of MFs, and help long-term resource mobilization by the leasing industry. Its proposed key activities in the area of stock market development comprised: (i) review of SEs’ operations; (ii) preparing feasibility studies for automation of stock trading and linking the country’s three SEs; (iii) formulating recommendations for professionalizing the management of SEs; (iv) reviewing listing rules, and the disclosure requirements for issuers of securities; and (v) foreign training of the staff of CLA and SEs in supervision and management of stock market operations. 4. In the MF area, the TA covered (i) reviewing the legal and taxation framework relevant to MFs and MF investors; (ii) exploring the feasibility of introducing new MF schemes and instruments; (iii) reviewing the sources of funds available for investment in MFs; (iv) reviewing the operational and institutional set up of the two public sector MFs––the National Investment Trust (NIT), an open-end fund, and the Investment Corporation of Pakistan (ICP), a closed-end fund as well as making recommendations for their restructuring and privatization; and (v) foreign training of CLA staff in MF management. Finally, in the leasing sector, the TA was to explore the scope for long-term resource mobilization, including examining the feasibility of securitization of lease receivables. It also provided for training of staff of CLA and other organizations in the registration of securities backed by lease receivables. 4. Evaluation 5. The TA was self-evaluated as part of Financial Sector Intermediation Loan and rated as partly successful. However, this rating does not reflect TA achievements fully. The Operations Evaluation Mission (OEM) in March–April 2002 for this TA performance audit report (TPAR) conducted a review of ADB’s internal records; interviews in the field with the capital market regulator/Executing Agency, SEs, investment banks, stock brokers, leasing companies and others; and an analysis of pertinent data. The TPAR focuses on TA relevance and design in relation to its underlying rationale and objectives, as well as consistency with sector priorities of Government and ADB; the achievement of objectives, efficiency of implementation and adequacy of outputs; and outcomes and impacts. B. Assessment of Design and Implementation

1. Design

6. The TA was formulated at a time when the stockmarket was stagnating despite liberalization of foreign portfolio investment; public sector MFs were beset with serious portfolio difficulties and mismanagement; and the leasing industry was seeking feasible alternatives to foreign credit lines as their principal funding source. TA design adequately responded to these issues, and was relevant to ADB’s country and sector strategies. The TA did not cover all aspects of CMD but focused on the interrelated priority needs of industry, finance and private sectors. The three areas of focus––SEs, MFs, and the leasing sector––signified a phased approach to CMD. This was appropriate in view of the constraints on Government’s implementation capacity and readiness to take on reforms simultaneously over a broader spectrum. Consultant terms of reference (TORs) for all the three areas were spelled out clearly, and in detail. In the area of MFs, additional TORs were provided during TA implementation to conduct detailed studies of NIT and ICP and recommend approaches for strengthening them before privatization, as well as recommending options for privatization. Since both of these public sector MFs had long been suffering from financial and management difficulties, this additional due diligence was timely and highly desirable.

Appendix 1 20

2. Engagement of Consultants 7. The original implementation schedule provided for 20 person-months of international and 3 person-months of domestic consultant services in seven areas of expertise, namely legal, regulatory, leasing, MFs, stock markets operations, systems, and finance. Considering the wide scope and complexity of the TA, and the need for close coordination with the executing agency, as well as for coordinating TA outputs within the team of consultants, implementation was entrusted to a consulting firm, as planned. The procedures for selection of the consulting firm were in accordance with ADB’s Guidelines on the Use of Consultants. 3. Implementation and Cost 8. Eleven international experts and one domestic expert provided 23.4 person-months of consultant services over a period of 18 months. Consulting inputs marginally exceeded the original estimate of 23 person-months because of additional due diligence on NIT and ICP. TA implementation was delayed by 26 months, partly because of late signing of TA Agreement by the Government. However, in terms of consulting services and consultants’ reports, the TA was substantively complete by October 1997, within the projected completion schedule of end-1997. Delay occurred mainly in implementing the training component because of re-organization of the CLA as the Securities and Exchange Commission of Pakistan (SECP).4 The TA was eventually completed in February 2000. TA implementation was generally smooth, despite its complexity. The consultant contract underwent one variation involving substitution of automated trading and securitization experts, and revision of the remuneration of the domestic legal expert. The net impact of this variation on TA cost was less than $2,000. Actual TA cost was $820,000 as against the TA budget of $865,000. 4. Organization and Management 9. CLA was generally effective as the executing agency. It provided adequate official and logistic support to the consultants for carrying out their research and field work. The latter involved interviewing a large number of institutions and individuals associated with capital market, MFs and the leasing industry, besides government agencies concerned. The consulting firm which implemented the TA ensured proper sequencing and coordination of the work performed by a 12-member consultants team. One area where organization of TA activities was less than satisfactory was the preparation and implementation of the training program for the staff of the executing agency, partly due to the impending restructuring of CLA as SECP. ADB supervised TA implementation effectively and liaised closely with CLA and the consultants. Overall, TA implementation was effective and efficient. C. Evaluation of Outputs and Impacts 1. Performance of Consultants and Quality of Reports 10. Eleven international consultants and one domestic consultant were involved in TA implementation. The consultants reviewed the operations of SEs and looked into the possibility of linking up their operations. They also reviewed listing rules and disclosure requirements and undertook a training needs assessment of SECP and SEs, though with a delay. Further, they studied the role and organization structure of CLA and recommended improvements thereon. In 4 Making CLA an independent body was among the TA recommendations.

Appendix 1 21

the MF area, the consultants reviewed the investment portfolios and investment decision making processes of ICP and NIT; evaluated the credibility of their financial statements, including determination of net asset-value; and recommended broad approaches for their restructuring and options for privatization; and took stock of the MF industry as a whole. However, their final report, while recommending the removal of double taxation of corporate and dividend income, did not address taxation of MFs, as was required under the TORs. The consultants also undertook a comprehensive review of the leasing industry, particularly their operational and resource mobilization practices. The consultants prepared interim reports during TA implementation, and an informative and forward looking integrated final report upon its completion. The consultants also prepared an additional study of NIT and ICP under supplementary TORs. Overall, the performance of consultants, and adequacy and quality of their reports, were satisfactory. 11. The main output of the TA was a set of recommendations for reforms under each of the three components: stock market, MFs, and leasing sector. The analysis and recommendations contained in the Integrated Final Report of the consultants formed the basis for the reform agenda of the Capital Market Development Program (CMDP).5 A self-evaluation of the CMDP contained in the Program Completion Report6 rated it as “satisfactory.”7 2. Stock Market Operation and Regulation 12. The TA helped initiate a number of reforms enhancing the transparency and efficiency of the stock market, including (i) automating trading at SEs; (ii) introducing the T+38 settlement system; (iii) establishing and operating the Central Depository Company; (iv) transforming CLA into SECP under the SECP Act 1997; (v) strengthening the margin requirement for securities lending; (v) redefining and increasing the minimum capital requirement for brokers; (vi) disallowing blank sales; (vii) setting up a market surveillance wing at SECP; (viii) restructuring the Boards of SEs to allow at least 40% representation of non-member professionals and, with SECP approval, appointment of independent managing directors; (ix) issuing brokers registration rules and registration guidelines, including on insider trading; (x) setting up the national clearing and settlement system; and (xi) issuing a corporate governance code. 13. These measures have helped the recovery of the stock market (Table 3, main text), bringing the efficiency of stock market transactions closer to international standards, and improving their transparency. The SECP/SEs have also taken a number of measures to reduce the risk of broker default, expected to have a positive impact in due course. These include raising minimum capital requirement for brokers from PRs0.25 million to PRs2.50 million, redefining net capital balance on conservative basis and capping a broker’s trades within the T+3 cycle to 25 times the net capital balance. However, public perception as to the credibility of the stock market has not changed much. The secondary market remains largely speculative, driven by a few powerful players. Daily turnover remains concentrated in very few stocks with

5 Loan 1576-PAK: Capital Market Development Program , for $250 million, approved on 6 November 1997. 6 ADB. 2002. Program Completion Report on Capital Market Development Program and Capacity Building of the

Securities Market. Manila. 7 Equivalent to “successful” under the current 4-level evaluation system, i.e, highly successful, successful, partly

successful, and unsuccessful. 8 The T+3 settlement system refers to one under which payment for the securities purchased is made within 3 days of

the transaction.

Appendix 1 22

large market capitalization.9 The ratio of average daily trading value to market capitalization, four times that of Mumbai Stock Exchange, is one of the highest in the world. There is a preponderance of short-term and intra-day trades supported in part by “badla”10 financing. Market participants estimate that about 36% trades are intra-day trades, more than 60% trades are carried over, and just 3% ultimately settled in cash. One reason for this phenomenon is that the supply of stocks has not kept pace with the development of demand, intermediation, and regulation of the capital market. Only 10 new companies were listed on the Karachi Stock Exchange during January 1998–October 2002 because of slow privatization and unfavorable investment climate. 14. Though SECP is generally perceived to be an effective regulator, it has not yet been successful in eliminating market manipulation and maintaining a healthy balance between speculative and non-speculative investment. Going forward, there is a need for (i) measures to confine speculative trading within reasonable limits; (ii) stricter enforcement by SEs and SECP particularly in areas such as “badla” financing and short sales; (iii) further strengthening of disclosure requirements; (iv) accelerating privatization as a means of increasing the supply of quality equity stocks; and (v) further professionalizing the SEs, including through demutualization as a step toward eventual integration of the stock market. 3. Mutual Funds 15. The MF industry has undergone significant developments. The TA helped amend the regulations governing MFs to (i) allow flotation of special purpose MFs; (ii) unify the fee structure of closed-end and open-ended funds; (iii) require mandatory declaration of net asset value; (iv) strengthen capital adequacy and disclosure requirement for MFs; and (v) empower SECP to enforce compliance requirements flexibly to alleviate genuine difficulties in the MF industry. SECP has received further advice from a UK consultant for improving disclosure standards for MFs’ reporting requirements, and strengthening MF regulation. Following TA completion, substantial progress has also been made towards restructuring and privatizing the MF business of ICP. 16. Some critical issues in the MF area remain in need of urgent attention. Fund management has not yet developed as a successful profession or industry in Pakistan. This is evident in that a majority of private sector MFs have underperformed persistently. SECP needs to appropriately censor the advisers/managers of such MFs. Another issue relates to privatizing NIT. This had been stalled pending the decision by the Ministry of Finance concerning any guarantee or comfort that may need to be provided to private investors on a minimum redemption value of NIT units. However, the current buoyancy of the stock market, which would have substantially raised its net asset value, provides a favorable environment for privatizing NIT. 4. Leasing Industry 17. A focus of the TA was on reducing the dependence of leasing companies on foreign credit lines as a major source of long-term funds. To that end, a number of measures were recommended and have been implemented. These include liberalizing the investment rules for institutional investors, strengthening the capital base of leasing companies and tightening their

9 Three most actively traded stocks represent 27.4% of market capitalization and 64.4% of turnover by number of

shares, and possibly even higher by value. 10 “Badla” refers to broker-arranged financing of carried over transactions.

Appendix 1 23

regulation as issuers of certificates of investment to the public. Term finance certificates (TFCs) were identified as an effective instrument for raising long-term funds. In order to develop the TFC market, the need for rationalizing the returns on government-guaranteed investment instruments was highlighted. A number of recommendations for the development of asset-backed securities (ABS) were also made. However, the ABS market has been slow to take off and none of the leasing companies had attempted, until October 2002, to raise funds through securitization of lease receivables, and only one has used this medium since then.11 5. Capacity Building 18. The TA helped capacity-building of SECP and SEs through training of 53 staff of SECP and 2 staff of SEs. However, TA outputs in this area fell short of expectations. There was a considerable delay in identifying suitable foreign training programs, mainly because it was difficult to make a meaningful training needs assessment while CLA was being transformed into SECP.12 Foreign training of SECP staff, therefore, largely proceeded on ad hoc basis, and a part of the training budget was utilized to participate in annual meetings of securities-related international organizations. However, as a compensatory measure, an amount of $46,000 representing 25% of the budget for foreign training was made available by ADB, at the request of SECP, for domestic training of 30 staff. The Lahore University of Management Sciences conducted a tailor-made and well received program for this purpose. Another shortcoming relating to training concerned activities such as MFs and ABS where regulatory capacity was particularly lacking. None of the training programs for SECP staff focused on these themes, and it is not clear whether any capacity enhancement has taken place in MF/ABS regulation. D. Overall Assessment 19. The TA was relevant. Given the state of the capital market, and the insurance, MF and leasing sectors, and weaknesses in the regulatory frameworks of the capital market and insurance industry, its rationale was sound, and its objectives set out appropriately. TA design was consistent with its objectives. The TA was efficacious as its outputs largely met expectations. Though the implementation of the capacity-building component was delayed, the substantive outputs were delivered within the original schedule. The TA is assessed as efficient. Sustainability of TA outputs is likely. Expected TA impacts were substantially realized. Most of the reforms formulated under the TA, and supported by CMDP, have been implemented and sustained. Overall, the TA is rated as successful. E. Conclusions 1. Key Issues 20. There are several outstanding issues in the areas covered by the TA. Firstly, while SECP has acquired the reputation of an effective regulator of the stock market, it lacks capacity to regulate ABS, insurance and pension funds.13 Secondly, the preponderance of short-term speculative trades in the stock market and market manipulation by a few powerful brokers creates a negative image of SEs and discourages foreign institutional investors and domestic high networth individuals to participate in the market. A related issue is that, barring very few 11 Privately placed certificates backed by car lease receivables, issued by Pakistan Industrial Leasing Corporation,

for PRs100 million. 12 SECP started operations from January 1999. 13 SECP mandate already covers insurance while the mandate to regulate pension funds is expected to be given to

SECP in the near future.

Appendix 1 24

stocks with large market capitalization, the secondary market is illiquid, which is probably the main reason that it is narrow and overly speculative. Thirdly, the MF management industry has not developed professionally; as a result, most private sector MFs have performed poorly. Lastly, the ABS market, which has a vast potential to be the main source of medium and long-term debt funds, particularly for the leasing industry, has remained underdeveloped.14 Further ADB support is being provided in all these areas (except ABS) through the Financial (Nonbank) Markets and Governance Program (FMGP)15 approved on 5 December 2002. 2. Lessons Learned 21. This TA has confirmed that government ownership is critical to the success of policy and institutional reform. Even though the TA had no direct bearing on the credit lines provided under Financial Sector Intermediation Loan, to which it was attached, prior policy dialogue and ownership building had strengthened government resolve to address the pressing issues in the stock market, MFs, leasing, and regulatory areas. Another lesson is that balanced and sustainable development of the capital market requires developing all the major aspects of CMD, i.e., demand, supply, intermediation, and regulation. In the case of Pakistan, the development of the supply side has not kept pace with the other aspects, resulting in an overactive but narrow and highly speculative secondary market.

3. Recommendations and Follow-Up Actions

22. In order to resolve the issues identified in para. 20, the following actions are being supported by ADB under FMGP as part of a wider CMD agenda: (i) building SECP’s capacity to regulate insurance and pension funds; (ii) implementing further regulatory measures to replace the “badla” system with transparent and acceptable market practices such as margin trading and securities borrowing and lending; (iii) implementing measures leading to the development of MF management industry professionally and strengthening regulations to improve the accountability of MF managers/advisers; and (iv) accelerating privatization and listing of government assets with large market capitalization, in order to increase the supply of quality shares in the stock market. Real-time feedback provided by the OEM during the processing of FMGP enabled inclusion of these measures in the agenda of FMGP. 23. To promote primary and secondary ABS markets, ADB and Government/SECP should modify, by 30 June 2003, the scope of TA Loan 1957-PAK(SF) being provided under FMGP.

14 These issues are identified only as a carry-over from TA 2393-PAK and by no means represent a comprehensive

CMD agenda. 15 FMGP comprises a policy loan (Loan 1955-PAK: Financial [Nonbank] Markets and Governance Program , for $260

million); two TA loans (Loan 1956-PAK[SF]: Strengthening Pension, Insurance, and Savings Systems, and Loan 1957-PAK[SF]: Strengthening Regulation, Enforcement, and Governance of Nonbank Financial Markets, for $3.0 million equivalent each); and two political risk guarantee facilities (PRG:PAK 33271, for a total of $150 million).

Appendix 2

25

EVALUATION OF TA 2812-PAK: INTEREST RATE MANAGEMENT OF NATIONAL SAVING SCHEMES

A. Introduction

1. Background

1. In the early and mid-1990s, interest rate pressures in Pakistan were high because of the growing fiscal deficit and increase in the nonperforming loans of banks. High fiscal deficit resulted in increased government borrowings, which were raised partly by preempting banking resources and partly by maintaining high interest rates on the National Saving Schemes (NSS). The preemption of resources by the Government thus crowded out private sector investment, and high after-tax returns on NSS rendered the pricing of commercial paper and other corporate debt instruments difficult. Technical assistance (TA) was requested by the Government to examine the structure of interest rates offered by NSS in order to develop a suitable mechanism to manage those rates. Greater understanding and rationalization of the interest rate structure were also critical for the development of corporate debt market, which was an integral component of the Capital Market Development Program (CMDP) that was being formulated at the time of the approval of TA 2812-PAK.1

2. Rationale and Concept 2. Pakistan’s financial markets were segmented at that time and considerably influenced by government monetary and fiscal policies to the detriment of private debt and capital markets. Bank deposits yielded returns that were lower than the yields on NSS instruments, particularly because NSS-derived income was exempt from income tax. Furthermore, the term structure of interest rates did not adequately capture the relationship between yield and maturity or the risk of fixed income securities. The distortions in the interest rate structure stemmed mainly from a growing and unsustainable fiscal deficit that had led to a significant growth in government borrowings. This, in turn, caused pressure on interest rates, as well as monetary policy and its management, and adversely affected the development of the money market. Weak operational and financial performance of the banking sector further distorted the interest rate structure of bank credit. Banks offered negative real returns to depositors while charging high lending rates in order to finance bloated administrative costs and a sizable nonperforming loan portfolio. Finally, growing dollarization of the economy discouraged rupee deposits. 3. To finance its budgetary requirements and promote savings, the Government through NSS sold five types of investment certificates at terms more attractive than bank deposits and private debt-instruments, such as term finance certificates (TFCs). There was no maximum limit on investment in NSS, and except for banks and development finance institutions, all other financial institutions as well as individuals could hold their investments in NSS. Nonresidents also had access to NSS as long as they used foreign currency to make the investment. Given these distortions, and also the size and significance of NSS in the financial markets2 and its implications on overall interest rate policy, the Government was keen to develop a suitable

1 TA 2812-PAK: Interest Rate Management of National Saving Schemes, for $100,000, approved on 18 June 1997. 2 As of 30 June 1997, the outstanding NSS liabilities represented 33% of total local currency demand and time

deposits of scheduled commercial banks.

Appendix 2

26

mechanism for managing the interest rates offered on NSS instruments. The TA was an appropriate and timely response to this need.

3. Objective and Scope

4. The TA objective was to examine the structure and determinants of NSS interest rates in order to develop an appropriate mechanism for their future management. The Government was to review the findings of the TA study with ADB and adopt, as part of CMDP, an agreed mechanism for the management of NSS. The TA scope comprised: (i) reviewing the existing interest rate structure of bank deposits, foreign currency deposits, NSS, etc.; (ii) evaluating the taxation of financial instruments for both domestic and foreign investors, and identifying anomalies in the structure; (iii) estimating the effective interest rates of major financial instruments and their key determinants; (iv) studying key instruments in the money market and their impact on interest rates; (v) analyzing the yield curve and its relationship with the monetary policy and interest rate management of NSS; (vi) analyzing the interest rate sensitivity of resource flows of NSS; (vii) assessing the impact of nonperforming portfolio in the financial system and implications of dollarization on the interest rate structure; and (viii) recommending policy actions to address the issues identified, and developing an appropriate mechanism to adjust NSS rates.

4. Evaluation 5. Being a small-scale TA, self-evaluation was not required. The Operations Evaluation Mission (OEM) in March–April 2002 conducted a review of Asian Development Bank’s internal records; interviews in the field with the domestic consultant engaged under the TA, the State Bank of Pakistan, the executing and implementing agencies, leasing companies and other corporate bond market participants; and an analysis of relevant data. This TA performance audit report focuses on TA relevance and design in relation to its underlying rationale and objectives, as well as consistency with sector priorities of Government and ADB; the achievement of objectives and adequacy of outputs; efficiency of implementation; and outcomes and impacts. B. Assessment of Design and Implementation

1. Design 6. The TA was highly relevant and addressed priority financial sector concerns of both ADB and the Government. Its design comprehensively covered the issues arising out of segmentation of financial markets, interest rate distortions and the unsustainable yield structure of NSS instruments; as well as their adverse impacts on financial intermediation through banks, and debt and capital markets, and on private sector investment. In analyzing these aspects, the TA study was designed to help the Government to address the interest rate and taxation issues of NSS. These issues had been the subject of policy dialogue between Government and ADB as well as the International Monetary Fund. The TA design was appropriate to provide the necessary analytical framework to bring this dialogue to a successful closure. The TA also helped to shape and implement a key conditionality of the CMDP. 7. In hindsight, the TA appears to have been somewhat “overdesigned”, both in terms of the scope of study as well as consulting requirements and cost. This is evident in 39% saving in TA cost and 13% fewer person-months of consulting services.

Appendix 2

27

2. Engagement of Consultants

8. At TA formulation, it was envisaged to engage two domestic individual consultants and one international individual consultant to provide 9.5 person-months of consulting inputs. The domestic consultants were to have expertise in macroeconomics, banking, and finance. In practice, it became possible to engage a local economist-banker with strong credentials and expertise in all three areas, which resulted in the savings in TA cost. Two international consultants were subsequently engaged to supplement the work of the domestic consultant through econometric analysis of the relationship between the demand for NSS and other financial instruments in Pakistan. The selection of consultants followed ADB’s Guidelines on the Use of Consultants.

3. Implementation and Cost

9. TA implementation took 13 months longer than expected, partly because the original implementation scheme did not consider how the work of three individual consultants would be sequentially arranged and linked, nor did it specify as to which consultant would be responsible for the final report. In practice, the TA was largely implemented by one domestic consultant, but over a longer period. The inputs of the two international consultants followed that of the domestic consultant. The Ministry of Finance (MOF) was the executing agency for the TA, while the State Bank of Pakistan, the central bank, provided research support for the study. ADB staff remained actively engaged with the domestic consultant and the State Bank of Pakistan throughout the period of the study. ADB records indicate, however, that there was some delay in providing feedback on the draft report of the international consultants. The TA was implemented for a total cost of $61,000, as against the TA budget of $100,000, indicating that the cost was overestimated originally. C. Evaluation of Outputs and Impacts

1. Performance of Consultants and Quality of Reports 10. All of the consultants performed satisfactorily complying with their respective terms of reference. Appreciation was expressed to the OEM by various stakeholders of the high quality of the final report of the domestic consultant3 as well as the underlying research and analytical work.

2. TA Outputs

11. The domestic consultant conducted the study on NSS within the broad framework of Pakistan’s financial markets. The consultant reviewed the organizational and operational aspects of the Central Directorate of National Savings, the organization responsible for managing NSS; studied the features and yield structures of various NSS instruments versus savings instruments of banks and financial institutions, as well as TFCs; analyzed, from a macroeconomic perspective, the relationship between fiscal deficit, monetary policy, NSS, and resulting interest rates and yield curves; and formulated recommendations for the reform of NSS while identifying possible constraints on their implementation. Most of its recommendations have been implemented.

3 The consultant was subsequently employed as a Director of State Bank of Pakistan.

Appendix 2

28

12. Another significant output of the TA was the econometric study conducted by two international consultants to analyze the relationship between the demand for NSS as against other instruments including bank deposits in local and foreign currencies. The study concluded that while bank deposits and NSS instruments appeared to be net substitutes, bank deposits in local and foreign currencies seemed to be neither substitutes nor complements to each other. Also, the estimated income derivative of the demand for local currency bank deposits was negative, while that for foreign currency deposits was positive. For NSS, it was not significantly different from zero. Finally, the study found some empirical support for the view that foreign currency deposits had absorbed a part of the demand for NSS instruments. Accordingly, the availability of on-shore foreign currency deposit facilities may have reduced the ability of the Government to finance itself through NSS. These findings helped the Government and ADB to better understand the substitutability between NSS instruments and bank deposits.

3. TA Impacts 13. The State Bank of Pakistan has reduced interest rates in line with inflation, and institutional investors have been barred from investing in NSS instruments. These measures have provided a boost to the TFC market, which effectively represents the corporate bond market in Pakistan. As a result, a total amount of PRs18.5 billion was raised through 28 TFC issues between 1 January 2001 and 8 August 2002 as against PRs3.4 billion raised through 11 issues during 1998–2000 (Table 5, main text). A secondary market for TFCs has also started to emerge with the listing of 14 TFC issues, totaling PRs7.6 billion, on the Karachi Stock Exchange during January--October 2002 (Table 3, main text). Moreover, in order to provide liquidity to the unlisted debt securities, a discount house has begun offering two-way price quotes for major unlisted TFCs. 14. Interest rates on NSS have been made market compliant since January 2001. In this regard, the Government has developed a formula in consultation with the International Monetary Fund, whereby NSS interest rates are reviewed semi-annually within ±0.5% of the market-based rate of return on Pakistan investment bonds of corresponding maturities. With this mechanism in place, the main objective of the TA has been achieved. Other impacts of NSS reforms are not immediately apparent. While institutional investors have been barred from making fresh investments in NSS, withdrawal of institutional savings from NSS would be gradual depending on their maturity structure. It appears that in the absence of credible alternative instruments, and because investment in NSS up to PRs150,0004 is still exempt from withholding tax, NSS instruments have remained popular with individual savers. Thus, the outstanding NSS stock has continued to grow gradually (Table 4, main text). Nonetheless, there was a perceptible decline in net incremental investments in NSS from PRs96.5 billion in FY2000 to PRs36.7 billion in FY2001. D. Overall Assessment 15. The TA was highly relevant and timely. It was formulated at a time when removing interest rate distortions and de-segmenting financial markets had assumed priority, so as to level the playing field between NSS and competing savings and investment instruments in banking and corporate debt markets, and thus encourage healthy financial intermediation. The TA objective was appropriate, and its design consistent with the objective. The TA was efficacious considering its substantial outputs, which provided the basis for Government’s review of NSS. The TA was highly cost-effective and is assessed as highly efficient. 4 Reduced from PRs300,000 effective July 2002.

Appendix 2

29

Sustainability of the TA output is most likely because of its direct and significant contribution to minimizing interest rate distortions. Its impacts are significant and visible, particularly on the TFC market. The TA is rated as highly successful. E. Conclusions

1. Key Issues

16. Although the limit of withholding tax-exempt investment in NSS has been reduced from PRs300,000 to PRs150,000, this exemption still provided an unfair advantage to NSS over bank deposits, TFCs, and other debt instruments. This issue is included in the agenda of the financial (Nonbank) Markets and Governance Program (FMGP) approved by ADB on 5 December 20023.

2. Lessons Learned 17. The main lesson is that sharply focused TAs, preceded and backed by effective policy dialogue, have a better chance of success than those that encompass a broad range of issues. The TA was highly successful because: (i) it was basically focused on a one-point agenda, (ii) Government had shown willingness to deal with the issue at hand, and (iii) the consultant possessed the right blend of capabilities.

3. Recommendations and Follow-Up Actions 18. There are no outstanding issues emerging from the implementation of this TA that require incremental follow-up actions.

3 FMGP comprises a policy loan (Loan 1955-PAK: Financial [Nonbank] Markets and Governance Program , for $260

million); two TA loans (Loan 1956-PAK(SF): Strengthening Pension, Insurance, and Savings Systems, and Loan 1957-PAK[SF]: Strengthening Regulation, Enforcement, and Governance of Nonbank Financial Markets, for $3.0 million equivalent each); and two political risk guarantee facilities (PRG:PAK 33271, for a total of $150 million).

Appendix 3 30

EVALUATION OF TA 2825-PAK: CAPITAL MARKET AND INSURANCE LAW REFORM

A. Introduction

1. Background 1. In 1995, Asian Development Bank approved TA 2393-PAK (Appendix 1) principally to formulate an agenda of policy reforms for capital market development (CMD) in Pakistan. By mid-1997, the main components of this agenda had been formulated as part of the ongoing policy dialogue between Government and ADB, and incorporated in the policy matrix of ADB’s Capital Market Development Program (CMDP).1 Legislative reform and creation of a new framework for regulation of the capital market were indispensable components of the reform package supported by CMDP. Also as part of CMDP, the Government planned to reform the insurance industry by strengthening its regulation under the emerging market scenario where the monopoly of the State Life Insurance Corporation had been broken and increased private sector participation in life and non-life insurance business was being foreseen. TA 2825-PAK2 was a response to these priority CMD needs.

2. Rationale and Concept

2. Capital market reform was critical to the purpose of economic and investment liberalization in Pakistan, that began in the early 1990s. Given that reform of the regulatory framework was an essential component of CMD, the Government had been reviewing important aspects of the relevant laws and institutional arrangements. During this process, consultations had taken place with the major stakeholders, including stock exchanges, chambers of commerce, and the accounting and law professions. Under the CMDP, the Government intended to set up a new regulatory framework based on the findings of these deliberations and best international practices. The Government also planned to introduce substantive changes to the securities and corporate laws to, among other things, promote investor protection. However, it needed specialized input from an expert familiar with the best international practices and different approaches to dealing with capital market regulation issues. At the same time, given the limited capacity of the Ministry of Law and the Corporate Law Authority (CLA), the Government also needed input from a leading expert from within the country. 3. The Government also planned to reform the insurance industry as part of CMDP, to allow it to play a greater role in the financial services industry. This required updating or replacing the Insurance Act of 1938 in line with modern requirements. Moreover, a new and competent insurance regulator was needed to take over regulatory responsibility from the Controller of Insurance, whose capacity was grossly inadequate and whose jurisdiction did not extend to statutory insurance corporations in the public sector. 4. TA 2825-PAK was intended to respond to these priority needs of reform of the legal and regulatory framework for the capital market and the insurance sector.

1 Loan 1576-PAK: Capital Market Development Program , for $250 million, approved on 6 November 1997. 2 TA 2825-PAK: Capital Market and Insurance Law Reform , for $100,000, approved on 14 July 1997.

Appendix 3

31

3. Objective and Scope 5. The technical assistance was identified during the processing of CMDP. Its purpose was to help the Government in capital market and insurance law reform that was to be included in the CMDP agenda. The TA had a capital market component and an insurance component. Under the first, the TA aimed to assist CLA in identifying best international practices and different models in key areas of securities and corporate law and regulations, and in drafting securities and corporate legislation, primarily to enhance investor protection and eliminate malpractices in the stock market. Under the second component, the TA was to assist Ministry of Commerce in preparing a plan for the reform of the regulatory framework for insurance, and drafting laws for a new regulatory regime for the insurance industry.

4. Evaluation 6. Being a small-scale TA, self-evaluation was not required. The Operations Evaluation Mission in March–April 2002 conducted a review of ADB’s internal records; interviews with executing agencies/insurance and capital market regulators, and a large number of intermediaries and stakeholders in insurance and capital market sectors; and study of pertinent market data. This TA performance audit report focuses on relevance of TA design in relation to underlying rationale and objectives, as well as consistency with sector priorities of the Government and ADB; the achievement of objectives and adequacy of outputs; efficiency of implementation; and outcomes and impacts. B. Assessment of Design and Implementation

1. Design 7. While the Government was willing to implement capital market reforms proposed under TA 2393-PAK, and included in the reform agenda of CMDP, it lacked capacity to draft laws and establish regulatory frameworks in line with best international practice. These constraints were more pronounced in the areas of regulation of capital market and the insurance industry. Accordingly, design of the TA was based on the immediate need of the Government for expert advice in the context of implementation of CMDP conditionality in these areas. In this sense, the TA design was appropriate and its focus on securities legislation and regulatory framework for insurance was meant to overcome the Government’s most pressing capacity constraints. The TA was a part of a series of ADB’s CMD initiatives in Pakistan, consistent with ADB’s country and sector strategies. 8. At the request of the Government, a minor change in TA scope was introduced during its implementation by allocating $25,000 for engaging the services of a management consultant to assist in the operationalization of the Securities and Exchange Commission of Pakistan (SECP) as an independent and more empowered capital market regulator in place of CLA. The main responsibility of the management consultant was to propose the organization structure; job descriptions, staffing plans, and employment terms and rules; as well as budgetary accounting and audit systems of SECP. This change in scope was timely, pragmatic, and purposeful.

2. Engagement of Consultants

9. The implementation schedule at TA formulation called for engagement, for a total of 4.0 person-months, of one international individual consultant each for the capital market and insurance components, and one individual domestic consultant to provide support in both areas.

Appendix 3 32

The international consultant under the capital market component was to be a lawyer experienced in regulation of capital markets, especially in developing countries. Likewise, the international consultant under the insurance component was to be a person experienced in regulation of the insurance industry (especially in the context of its impact on the capital market) and advising developing country governments on law reform. The local consultant was to be a leading commercial lawyer with experience in securities, corporate and insurance matters, and preferably in legislative drafting in Pakistan. In practice, the capital market component was implemented entirely by two domestic consultants. In all, five individual consultants from three different firms (one international expert and four local experts) were engaged for a total of 9.2 person-months to implement the TA. ADB’s Guidelines on the Use of Consultants were followed in engaging the consultants. However, in view of the urgency to field the consultants, the requirement to list the TA in ADB Business Opportunities for the required length of time was waived.

3. Implementation and Cost

10. The TA was completed by March 1999, 16 months behind the original schedule of end-October 1997. Much of the delay was caused by expansion of the TA scope (para. 8) and Government indecision on the institutional arrangements for insurance regulation. However, an important TA output, the passage of the SECP Act, was realized within 1997. Ministry of Finance acted as the executing agency for the capital market component and MOC for the insurance component. ADB maintained a close and continuing dialogue with both executing agencies and the consultants throughout the implementation phase. Proactive participation of the Office of the General Counsel of ADB in TA administration, including recruitment of legal experts, was a unique feature of it, and was necessitated by the required extensive amount of legal drafting. This was helpful in cost-effective and successful implementation of the TA, its delayed completion notwithstanding. 11. The TA was completed at a total cost of $86,000, 14% lower than the approved amount of $100,000, owing to the substitution of the international experts with local consultants under the capital market component. C. Evaluation of Outputs and Impacts

1. Performance of Consultants and Quality of Reports 12. All of the consultants performed satisfactorily and in accordance with their respective terms of reference. The reports submitted by them were of good quality although submission of the reports of the management consultant and insurance regulatory expert was delayed.

2. Capital Market Reform 13. The most important TA output was finalization of the draft of the SECP Act of 1997, following the enactment of which CLA was dissolved and SECP established, effective January 1999, as an autonomous and financially independent capital market regulator. The SECP is fully operational and actively discharging its responsibilities in the capital market area. The organization and staff compensation structures proposed by the management consultant engaged under the TA have been substantially implemented and have helped to establish SECP on a sound footing. It has earned the reputation of an effective regulator and has brought about a number of reforms in the governance of stock exchanges and related institutions. These

Appendix 3

33

reforms have begun to bear positive impact on the image of stock exchanges and investor confidence in them though a lot more needs to be done.

3. Insurance Law Reform

14. The key outputs of the TA under the insurance component were a sector study focusing on insurance regulation, and an insurance regulatory framework in the form of the draft Pakistan Insurance Regulatory Authority (PIRA) Bill. The PIRA Bill envisaged the establishment of an independent insurance regulator outside of MOC. Following extensive consultations with ADB and other donors, however, the Government decided to make SECP responsible for regulation of the insurance industry. Some industry executives and Government officials felt that regulation of the insurance industry required a different set of skills from that of the capital market and that, for this reason, the establishment of PIRA would have been preferable. However, the majority of stakeholders are of the view that with proper capacity building, SECP would be able to regulate insurance effectively, and at lesser cost. D. Overall Assessment 15. The TA was relevant and timely. It set in motion the urgently needed review of the legal and regulatory framework for the insurance industry and the capital market. TA objective was appropriate and its design consistent with the objective. The TA was efficacious, considering its substantial outputs, in the form of draft SECP Act, and draft PIRA Bill which was not utilized. It was highly cost effective and is assessed as highly efficient. Sustainability of the TA outputs is most likely because of its direct and significant contribution to initiating capital market and insurance law reform. TA impacts were significant and have been sustained. Overall, the TA is rated as successful. E. Conclusions

1. Key Issues 16. Key residual issues in capital market and insurance regulation sectors are identified in Appendix 1 (para. 20) and Appendix 5 (para. 25), respectively.

2. Lessons Learned 17. The main lesson from this TA is that, subject to availability of adequately qualified professionals in the relevant field, as well as dedicated TA administration by ADB, use of domestic consultants is highly cost effective.

3. Recommendations and Follow-Up Actions 18. Follow -up actions in capital market and insurance regulations are indicated in Appendix 1 (paras. 22–23) and Appendix 5 (para. 27), respectively.

Appendix 4 34

EVALUATION OF TA 2865-PAK: RESTRUCTURING OF PUBLIC SECTOR MUTUAL FUNDS

A. Introduction

1. Background

1. In 1995, Asian Development Bank approved TA 2393-PAK (Appendix 1) to provide advisory services and prepare a reform agenda on three aspects of capital market development (CMD): operation and regulation of stock exchanges, mutual funds (MFs) and leasing. Under the MF component, diagnostic studies of public sector MFs—the National Investment Trust (NIT), an open-end fund, and the Investment Corporation of Pakistan (ICP), a closed-end fund—were undertaken to recommend measures for their restructuring with a view to privatizing their asset management company/right subsequently. Following the implementation of TA 2393-PAK, ADB approved the Capital Market Development Program (CMDP)1 to support the agreed CMD agenda. Restructuring of NIT and ICP was an important part of this agenda, and TA 2865-PAK2 was provided to support its implementation.

2. Rationale and Concept

2. At the time of technical assistance formulation, the MF industry in Pakistan was underdeveloped in a number of aspects (such as lack of professional asset management expertise, transparency, and competition), and was dominated by NIT and ICP. Their portfolio size and composition gave these institutions a key role in the MF sector and bore implications for the stock market. Both had been set up to support stock market development, and had been enjoying preferential treatment in share allotment and exemption from income tax. Withdrawal of these privileges in 1996, coupled with a downturn in the stock market, poor portfolio management practices, and government interference in the management of the portfolio and the pricing of the NIT units, triggered financial and operational difficulties for NIT and ICP.

3. NIT and ICP also suffered from a number of inherent disadvantages. Both were staffed by public sector employees, most of whom lacked skills in fund management, securities markets, accounting, and investment analysis. They were often obliged to take stakes in state-owned enterprises that could not be traded or sold until the Government opted to privatize them, adding to their already sizeable illiquid portfolio. Moreover, their performance over the years had suffered from a lack of depth and liquidity in the stock market, and limited public awareness and understanding of the MF concept. The stock market downturn in 1996 caused their net asset values to drop sharply. Since NIT was an open-end fund, it came under considerable pressure as unit-holders accelerated redemptions. This pressure would have been unmanageable in the absence of a guarantee the Government had given on the minimum re-purchase (redemption) price. However, from a financial viewpoint, and also because of its detrimental effects on the development of open-end MFs, the withdrawal of this guarantee was seen as an important reform both by Government and ADB. In view of these problems, the Government was keen to develop, as a part of CMDP, strategies to improve the portfolio management of NIT and ICP, and to introduce healthy competition in the MF industry by privatizing their MF management units.

1 Loan 1576-PAK: Capital Market Development Program , for $250 million, approved on 6 November 1997. 2 TA 2865-PAK: Restructuring of Public Sector Mutual Funds, for $800,000, approved on 15 September 1997.

Appendix 4 35

3. Objective and Scope

4. The main objectives of the TA were to support the restructuring of NIT and ICP, and to prepare a strategy and an action plan for the privatization for their asset management business and transferring their management control to strategic investor(s). The TA scope, in respect of each institution, comprised (i) reviewing the operations of the asset management entity and functions, as well as the MFs it managed; (ii) identifying policy, legal, and commercial issues, and necessary actions to facilitate the restructuring and privatization of the asset management entity/function, and maximizing the proceeds and benefits from privatization; (iii) assisting the asset management entities in developing managerial and administrative skills and, if required, advising on the financial restructuring of its portfolio, preparing new regulations, and developing management information system to facilitate efficient portfolio management; (iv) conducting financial valuation of the asset management entity and the MFs under its management; (v) advising on the appropriate strategy and modality of privatization, identifying what proportion of shares would form a “strategic stake”, and evaluating potential implications of its privatization on the capital market; and (vi) providing to the extent feasible, support for the privatization transaction including preparation of the bidding documents, bid evaluation criteria, and marketing strategy.

4. Evaluation

5. A self-evaluation contained in the TA Completion Report3 rated the TA as “generally successful.” However, this rating appears somewhat generous considering the design flaw (para. 7) and less than optimal approach to privatization recommended by the consultants (para. 12).

6. The Operations Evaluation Mission in March–April 2002 conducted a review of ADB’s internal records; interviews with Privatization Commission, the Securities and Exchange Commission of Pakistan (SECP), ICP, NIT, and private sector MFs; and study of pertinent data and information gathered in field. This TA performance audit report focuses on relevance of TA design relative to underlying rationale and objectives, as well as consistency with the sector priorities of Government and ADB; the achievement of objectives and adequacy of outputs; efficiency of implementation; and outcomes and impacts.

B. Assessment of Design and Implementation

1. Design

7. The design was relevant to the needs of the sector and consistent with the Government’s ongoing CMD reform program. However, with respect to TA objectives, the design had a major shortcoming. It did not fully consider the difference in the approach and strategy that was required for restructuring and privatizing NIT, an open-end fund, and ICP, a closed-end fund. The TA objective in both cases was to privatize the asset management business, and the terms of reference for both components were almost identical. However, in so far as ICP was concerned, its asset management function was neither tradeable nor did the “right to manage” its MFs have a value of its own. Any fund manager which met the requirements specified in the Investment Advisory Rules was qualified to manage these funds. What needed to be privatized, in the case of ICP, were the ICP-managed MFs rather than the right to manage them. This is the basis on which the privatization of ICP-managed MFs has 3 ADB. 2001. Technical Assistance Completion Report on Restructuring of Public Sector Mutual Funds. Manila.

Appendix 4 36

actually proceeded, and with positive outcomes. The TA design also did not call for proposing mitigating measures to deal with post-restructuring staff redundancies in NIT and ICP.

2. Engagement of Consultants

8. The TA was implemented by an international consulting firm in association with local accounting and law firms. The assignment was carried out by two teams of experts, one each for NIT and ICP comprising 5 international and 3 domestic experts. Both teams included a common international project coordinator and a common domestic legal adviser. Consultant selection was in accordance with ADB’s Guidelines on the Use of Consultants.

3. Implementation and Cost

9. TA implementation was delayed by 8 months, largely because of delay in signing of the TA Agreement by the Government. Other than this, the implementation was smooth and no major variation of consultant contract was needed. The Ministry of Finance, through the Privatization Commission, acted as the executing agency and extended cooperation to the consultants and arranged necessary facilitation of their work through NIT and ICP. ADB coordinated closely with the executing agency and the consultants during TA implementation.

10. The TA was completed at a cost of $584,000, well below the budget of $800,000. This 27% cost saving indicates that TA inputs and cost were not estimated meticulously.

D. Evaluation of Outputs and Impacts

1. Performance of Consultants and Quality of Reports

11. Consultant performance was generally satisfactory although it could have been better in two aspects. Firstly, a more realistic assessment of the interest of foreign fund managers in taking over MFs managed by NIT and ICP should have been made, and accordingly a focus on approaches and strategies to privatize these MFs to domestic parties provided. Secondly, with respect to ICP, privatizing the MFs rather than the MF management function should have been targeted. Excepting these aspects, the consultants prepared comprehensive reports on ICP and NIT. The reports covered all aspects in accordance with the terms of reference, including operational reviews, financial evaluation, legal environment, organizational issues, accounting and management information system, and privatization strategies for both institutions.

2. TA Outputs

12. The final report on ICP recommended a two-stage privatization approach, first to separate the MF business from other operational functions of ICP, auction the right to manage the MFs, and then wind down the rest of ICP business or merge it with another institution. In the case of NIT, the recommendation was to sell the asset management right and wind down the remainder of the asset management company. The recommended strategy assumed the sale of a single MF management contract covering all MFs managed by ICP, and auctioning 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 MF management in a more stringent regulatory environment was recommended, so as to improve MF management standards in Pakistan. However, the financial adviser engaged by the Privatization Commission subsequently concluded that foreign fund managers were not interested in taking strategic stakes in ICP and NIT, probably because of reservations on the quality of their portfolios and the unfavorable

Appendix 4 37

investment climate in Pakistan in general. Both of these factors were well known during TA implementation. The Privatization Commission considers that in future, consultants responsible for formulating privatization schemes for public sector companies/assets should also be made responsible for rendering transaction assistance.

13. A key provision of the Investment Advisory Rules required the investment adviser of a closed-end MF to take a 10%–20% equity stake in the fund itself. This provision could have potentially complicated the privatization of MFs and discouraged management of multiple closed-end funds by investment advisers. The TA helped resolve this issue through recommending an amendment of the rules whereby investment advisers have been permitted to manage multiple funds without taking equity stakes in individual funds so long as they undertake to “arrange” 10% equity participation with a 2-year lock-in period.

14. With respect to NIT, the consultants identified a number of issues that needed to be resolved before the privatization could move forward. By far, the most critical issue was that, in order to avoid large-scale redemptions, the parties interested in acquiring NIT were insisting on continuation of the Government-guaranteed minimum repurchase price of the NIT Unit. This was clearly not acceptable, since withdrawal of this guarantee was the main reason behind the move to privatize NIT, thereby providing a level playing field to private sector open-end MFs.

3. TA Impacts

15. The Privatization Commission has lately fast-tracked the privatization of public sector MFs. In the case of ICP, the MFs portfolio has been divided into three packages. The first package comprising 12 MFs has recently been sold for PRs175 million. Following an invitation for expression of interest, and a formal bidding process, the sale of the second package has been approved by the Cabinet for a price of PRs302.5 million. In both cases, the buyers are Pakistan’s private sector institutions. Privatization Commission expects to repeat the same process for the third package. ICP has already started winding down its investment account management activities, and has separated 365 staff under a voluntary retirement scheme. Its residual activity relates to lending, either to be wound up or merged with another institution.

16. With regard to NIT, notwithstanding the difficulties relating to the repurchase price, initial steps toward its privatization were taken in July 2001 and four parties were subsequently pre-qualified. However, further progress has been stalled for want of clarification as to whether the Government will provide any guarantee or renew the comfort letters it had earlier issued to institutional investors holding NIT Units as replacement for the guaranteed repurchase price.

D. Overall Assessment

17. The TA rationale was sound and its objectives were appropriate. However, its design lacked clarity as to what in fact needed to be privatized, which rendered it partly relevant. TA outputs were less than sufficient because of this lack of clarity. Moreover, the TA did not call for mitigating the social consequences of staff redundancies following privatization of NIT and ICP. However, the TA is assessed as efficacious relative to its design. TA implementation was generally smooth and substantial cost savings were realized. The TA is assessed as efficient. TA impacts were moderate and a key recommendation of the consultants proved impractical. Sustainability of TA outputs is assessed as less likely. Overall, the TA is rated as partly successful.

Appendix 4 38

E. Conclusions

1. Key Issues

18. The residual issues relate to the privatization of NIT. The first is whether the Government should renew the letter of comfort regarding the Unit repurchase price in favor of the institutions that hold NIT Units. Continuing dialogue with Government is necessary in line with objective of providing a level playing field to private sector MFs (para. 14). The other issue relates to staff redundancies that will result from NIT’s privatization. In this regard, the consultants’ recommendation, that some staff be absorbed in SECP, needs careful consideration, but based only on a proper match between SECP’s needs and the qualifications of the staff separated from NIT.

2. Lessons Learned

19. There are no particular lessons from this TA that may be relevant to future TAs, except that shortcomings in TA design translate into shortcomings in TA outputs.

3. Recommendations and Follow-Up Actions

20. The Government should expedite privatization of NIT. To that end, the Government should resolve the issue of repurchase price guarantee by 30 June 2003. ADB should maintain an active dialogue with the Government.

Appendix 5 39

EVALUATION OF TA 2866-PAK: REFORM OF THE INSURANCE INDUSTRY

A. Introduction 1. Background

1. In 1995, Asian Development Bank approved TA 2393-PAK (Appendix 1) to provide advisory services and prepare a reform agenda on three aspects of capital market development (CMD), namely stock market, mutual funds, and leasing. Being an important source of contractual savings and supply of long-term funds to the capital market, as well as of social security, sound and orderly development of the insurance sector assumed a high priority for CMD. To realize this, the Government proposed to launch fundamental reform, among others, of the insurance industry under the Capital Market Development Program (CMDP) supported by ADB.1 Reforms in the insurance sector were to focus on the development of an effective regulatory body for the insurance industry, introduction of stringent prudential and solvency norms, improvement of ethical standards among various industry participants and companies, and divestment of key public sector insurance companies. TA 2866-PAK2 was designed to provide advisory support required to effectively implement these reforms.

2. Rationale and Concept 2. The insurance industry performs an important function of risk diversification and channels a large flow of savings into investment through financial and capital markets, serving to support economic growth. At the time of technical assistance formulation, the private sector component of the industry was fragmented, and suffered from operational inefficiencies, lack of professionalism and low ethical standards. Public sector insurance entities (PSIEs)3 dominated the market with a privileged status and captive business. The coverage of life insurance barely reached 2% of the total population, and general businesses also remained underinsured compared with other countries at a similar development stage. The industry was regulated under the outdated Insurance Act of 1938. Capital adequacy requirements for general insurance companies were inadequate, the registration fee for insurers remained modest, and the statutory solvency margin was quite low. The regulatory framework for the industry was weak and fragmented. The Ministry of Commerce (MOC) regulated PSIEs and the Controller of Insurance, a department of MOC, regulated private sector insurance companies. The Controller of Insurance lacked management, administrative, and financial autonomy, and was ill equipped both in terms of facilities as well as staff. There was thus a need to set up an independent and autonomous body with adequate capacity to take over regulation of the entire industry.

3. Although the Government constituted the National Insurance Reform Commission in 1988 to review the issues of the insurance sector and improve its legal framework, in the absence of adequate advisory support and regulatory capacity, the recommendations of this Commission had not been implemented. As part of CMDP, the Government undertook to reform the insurance sector over the medium-term in line with the recommendations of the report. In

1 Loan 1576-PAK: Capital Market Development Program , for $250 million, approved on 6 November 1997. 2 TA 2866-PAK: Reform of the Insurance Industry, for $700,000, approved on 15 September 1997. 3 National Insurance Corporation, Pakistan Insurance Corporation (restructured as Pakistan Reassurance

Corporation under the TA), and State Life Insurance Corporation.

Appendix 5 40

July 1997, the Government also set up a task force, including public and private insurance industry representatives, to review insurance law and regulations.

4. The standard and risks of the insurance industry were further aggravated by the absence of professionalism and a lack of consumer confidence. There were few professionally recognized agents in the industry and after-sale service was generally poor. The Government, in affiliation with the Chartered Insurance Institute of London, had set up the Pakistan Insurance Institute (PII) in 1951 to provide education and training to market participants, such as agents, surveyors, and loss adjusters, and to generally upgrade the professional standards and business practices in the industry. However, financial and human resource constraints had undermined PII’s capability to provide proper educational and training programs.

5. Legislative and regulatory reform of the insurance industry had been initiated under a small-scale TA (TA 2825-PAK; Appendix 3). TA 2866-PAK was formulated to build on the work initiated under the previous TA and to address wide ranging sector issues more comprehensively.

3. Objective and Scope 6. The main objective of the TA was to promote orderly growth of the insurance industry. This was to be achieved by strengthening and modernizing insurance legislation and building institutional capacity of a new insurance regulatory authority to oversee and effectively regulate general and life insurance companies, both in the public and private sectors. It was also to support the restructuring of and divestment plans for the PSIEs handling reinsurance (Pakistan Insurance Corporation, or PIC) and Government insurance business (National Insurance Corporation, or NIC), as well as capacity enhancement of PII. 7. The TA covered the following key activities: (i) capacity building and operationalizing an independent and autonomous authority to regulate public and private sector insurance companies, including defining the role and responsibility of its functional divisions; preparing rules and regulations, operational manual, and management information systems for the authority; and developing its capacity to enforce regulations; (ii) drafting the new insurance legislation, keeping in perspective the recommendations of the reports of the National Insurance Reform Commission and the task force, which had been set up to review the Insurance Act, 1938; (iii) capacity building of PII through the development of educational/training programs for agents, surveyors, loss adjusters, and other market participants; and conducting training for trainers; and (iv) review of the operational and financial performance of PIC and NIC with the objective of developing restructuring and divestment plans for these entities.

4. Evaluation

8. A self-evaluation of the TA is contained in the TA completion report (TCR).4 The TCR rated the TA as highly successful. However, this rating appears generous since TA implementation and outcomes had benefited from the outputs of TA 2825-PAK.

9. The Operations Evaluation Mission (OEM) in March–April 2002 for this TA performance audit report (TPAR) conducted a review of ADB’s internal records; interviews with MOC, PSIEs, the Securities and Exchange Commission of Pakistan (SECP), PII, and private sector insurance companies; and study of pertinent data and information gathered in field. The TPAR focuses on

4 ADB. 2001. Technical Assistance Completion Report on Reform of the Insurance Industry. Manila.

Appendix 5 41

TA relevance and design relative to underlying rationale and objectives, as well as consistency with sector priorities of the Government and ADB; the achievement of objectives and adequacy of outputs; efficiency of implementation; and outcomes and impacts.

B. Design and Implementation

1. Assessment of Design 10. The TA was intrinsically linked with, and a logical continuation of the insurance component of TA 2825-PAK, under which a sector study focusing on insurance had been conducted and the blueprint for the Pakistan Insurance Regulatory Authority (PIRA) prepared. The design of the TA was appropriate relative to its rationale and objectives, and to the support needed for implementation of CMDP. However, the design did not provide an adequate basis for a complete and objective assessment of its outputs, as distinct from those under TA 2825-PAK. 11. The TA scope was broad, and sought to address major concerns in legal/regulatory, institutional, competition and efficiency, and operational areas. One exception to this was the exclusion of the due diligence on the PSIE engaged in life insurance business, the State Life Insurance Corporation, for the purpose of its restructuring. This Corporation was left out since the Government was already in dialogue with the World Bank on its future.5 However, in hindsight, and in view of the long delay in framing rules under the Insurance Ordinance of 2000 (Appendix 3, para. 14), it might have been better to specifically include the drafting of insurance rules, with stakeholder consultations, in the TA scope. Overall, however, the TA was an appropriate response to the priority needs of the insurance industry. It was also relevant to ADB’s sector and country operational strategies.

2. Engagement of Consultants 12. According to the TA Board Paper,6 it was envisaged that the TA would be implemented by two international consultants for 12 person-months and four domestic consultants for 28 person-months.7 It was actually implemented by a team of 3 international consultants and 6 local experts over a total of 45.6 person-months. The consultant team was provided by an international firm in association with a local accounting-cum-management consultancy firm. Consultant selection followed ADB Guidelines on the Use of Consultants.

3. Implementation and Cost 13. TA implementation was delayed by about 13 months mainly because consensus building on the new insurance law and institutional arrangements for insurance regulation took longer than expected, given the complexity of the issues involved. However, implementation was effective in terms of the end results. The delay required additional inputs from local consultants, which were accommodated within the TA budget, thanks to favorable exchange rate development. 14. MOC acted as the executing agency. It provided good logistic and other support to the consultants, and arranged similar support from NIC and PIC. ADB supervised the TA through

5 This dialogue, however, did not translate into any action. 6 TAR:PAK 31523, September 1997. 7 TA Completion Report puts the original estimate for consultant inputs as 36.3 person-months.

Appendix 5 42

review missions and communication with consultants and the executing agency. The Office of the General Counsel of ADB supported TA administration by assisting in the review of relevant draft laws. However, ADB’s follow up with Government on issuance of insurance rules was not effective and perhaps less rigorous than needed. 15. The allocation for equipment in the TA budget to procure management information system software and hardware was utilized observing ADB procurement guidelines. The consultants left the equipment with the executing agency, as envisaged originally. The overall TA cost was $647,000, well within the TA budget of $700,000. C. Evaluation of Outputs and Impacts

1. Performance of Consultants and Quality of Reports

16. The consultants performed satisfactorily and in accordance with their terms of reference. The quality of work performed and data analysis included in the final report was of a high standard. The consultants also drafted a set of rules consistent with the new insurance laws which was not specifically required by the terms of reference. However, they did so without adequate stakeholder consultations and consensus building efforts, which is probably one reason that the issuance of rules was delayed by 2 years (para.19).

2. Legal and Regulatory Framework

17. The main TA outputs under this component were the draft of the Insurance Ordinance of 2000, and finalization of the legal framework for the establishment and operationalization of PIRA. Since the initial draft of the PIRA Bill was developed under TA 2825-PAK (Appendix 3), it is difficult to judge the adequacy of inputs and outputs for this component under TA 2866-PAK on a stand-alone basis. However, the consultants helped consensus building on the institutional arrangements for insurance regulation through protracted consultations with stakeholders, including Government, ADB, other aid agencies, and the industry. Following these consultations, it was concluded that capacity and cost constraints weighed against the establishment of a new regulator. Accordingly, the proposal to establish PIRA was abandoned and the responsibility for regulating insurance transferred to the newly established SECP. 18. Consequent to the decision to empower SECP to take up insurance regulation, the consultants formulated necessary amendments to the SECP Act and prepared action plans for establishment of the Insurance Wing of SECP. Some training was also provided to SECP staff under the TA in the area of insurance regulation. However, SECP’s Insurance Wing was not fully functional at the time of the OEM. SECP also needs to build capacity to take on this regulatory function effectively. 19. For 2 years following its promulgation, the Insurance Ordinance remained only partially operative for want of insurance rules, which was delayed due to a protracted discussions between MOC and SECP on matters concerning regulatory jurisdiction, and lack of support from the Ministry of Law.8 The most significant provisions in the new insurance law relate to enhancement of paid up capital and solvency margin, reduction in management expenses, bifurcation of statutory and other funds held by life insurance companies, introduction of insurance brokerage system, the role and function of the Insurance Ombudsman, resolution of

8 The rules covering MOC’s areas of responsibility were eventually issued in August 2002 while those to be enforced

by SECP are expected to be issued in the near future.

Appendix 5 43

small disputes, and provisions relating to market conduct. The major likely impact of the new law is that the financial health of the insurance companies is expected to improve due to the requirement of stronger capital base and solvency margins. The insurance industry is, however, apprehensive that the provisions on market conduct are biased in favor of the insurer, because the recourse available to the insurer and the insured in case of a dispute is not identical. It is anticipated that the Government will revisit the issue after a trial period of 2–3 years.

3. Restructuring of Public Sector Insurance Entities 20. The consultants conducted in-depth studies of NIC and PIC, analyzed their financial position and made recommendations for improvement. The recommendations provided the basis for corporatization of both under the company law and inclusion of non-government members in their Boards. PIC was restructured as Pakistan Reassurance Corporation (PRC). It has adopted a comprehensive corporate plan and has been endeavoring to improve operations and management efficiency. Before restructuring, it was the sole entity allowed to handle reinsurance business in Pakistan. Following restructuring, the requirement of cession to PRC has begun to be phased out and will be completed by end-2003, which should improve its efficiency and competitiveness. NIC has also successfully streamlined its organization and administrative expenses. 21. Although the diagnostic studies of PIC and NIC were completed successfully, these have not helped to bring them to a “privatizable” shape. The financial condition of PRC remains non-transparent and uncertain. There are serious concerns as to the credibility of its financial statements, since the external auditor has qualified them on a number of accounts, notably the balances with counter parties, valuation of foreign exchange assets and liabilities, and assets and liabilities in Bangladesh. The external auditor believes that these discrepancies, once corrected, could materially alter PRC’s financial condition. Although PRC appears on the list of the Privatization Commission, the prospects of its privatization in the near future are not bright. 22. The prospects of privatization of NIC are also not good. Although it enjoys a sound financial position and could attract a fair value from the private sector, strong arguments have been made against its privatization. It is argued that with the completion of the ongoing process of privatization of public sector enterprises, NIC’s captive insurance business will dwindle through a natural process of attrition. Secondly, the Government has begun to exempt public sector enterprises on case-by-case basis from compulsory insurance with NIC, so as to break its monopoly over public sector insurance business. Finally, and perhaps most importantly, NIC also handles the insurance requirements of certain departments and agencies, which the Government would not like to cede to the private sector.

4. Capacity Building of Pakistan Insurance Institute 23. The TA was also to assist capacity building of PII. The consultants interacted closely with PII members and emphasized the need for sustainable funding arrangements to enable it to meet the training needs of the industry. Adequate funding arrangements for PII have since been put in place with annual contributions from public and private sector insurance companies. It has introduced new courses on the basic insurance concepts and principles. However, at the time of the OEM, the training activities of PII on the new insurance law had not commenced in the absence of new insurance rules.

Appendix 5 44

D. Overall Assessment 24. The TA was relevant, timely, and in part provided continuity to insurance law reform initiated under TA 2825-PAK (Appendix 3). Its objectives were consistent with the underlying rationale. TA design was generally appropriate but could have been more purposeful if its scope specifically covered framing of insurance rules under the new insurance laws. The TA was efficacious as it met expectations substantially. TA implementation is assessed as efficient even though consensus building on the new regulatory arrangements for insurance took longer than expected. The TA modernized the insurance law, institutionalized regulation of insurance within SECP, and helped improve the operation and management of PSIEs and gradually break PRC’s monopoly. Sustainability of its outputs is likely. However, TA impact on capacity building of PII was insignificant. On the whole, the TA is rated as successful. E. Conclusions

1. Key Issues

25. There are four residual issues that emerge from the implementation of this TA: capacity building of SECP in regulation of insurance (for which some funding has been made available under a TA loan);9 issuance of the insurance rules that fall within the mandate of SECP; restoring the credibility of PRC’s financial statements in support of its gradual privatization; and privatization of that part of NIC’s business which can be handled by the private sector. ADB needs to remain engaged with Government and SECP on these issues.

2. Lessons Learned 26. No major lessons relevant to future operations emerge from the implementation of this TA.

3. Recommendations and Follow-Up Actions 27. Government and ADB should maintain a dialogue on the progress toward resolving the residual sector issues (para. 25). The Government should: (i) by 30 April 2003, approve the draft of the insurance rules relevant to SECP’s mandate; (ii) by 30 June 2003, prepare a time-bound action plan to clean up PRC’s financial statements so as to make them transparent and unqualified and, by 30 June 2004, implement that plan; and (iii) by 31 December 2003, separate NIC’s commercial business into a separate entity with a view to privatizing that entity subsequently. ADB and Government should explore further TA possibilities in support of these actions.

9 Loan 1577-PAK(SF): Capacity Building of the Securities Market, for $5 million, approved on 6 November 1997.

Appendix 6 45

EVALUATION OF TA 2867-PAK: REFORM OF PENSION AND PROVIDENT FUNDS

A. Introduction

1. Background 1. In 1995, Asian Development Bank approved TA 2393-PAK (Appendix 1) to provide advisory services and prepare an agenda of reforms for capital market development (CMD). During the implementation of this TA, and based on its emerging outputs, ADB approved the Capital Market Development Program (CMDP)1 to support the agreed reformed agenda. TA 2867-PAK2 was provided for a study to identify and develop proposals for reform of pension and provident funds. The implementation of this study was a part of the CMDP agenda.

2. Rationale and Concept 2. Retirement benefits in Pakistan can be classified into three categories: (i) the civil servant pension, the General Provident Fund, and the Benevolent Fund for Government employees; (ii) the Employees’ Old Age Benefit Institution (EOBI) scheme, which mandates companies with ten or more staff to contribute to subsistence pension benefits for their employees; and (iii) pension and provident funds, as well as gratuity schemes, of private companies and state-owned enterprises. The civil servant pension, regulated by the Pension-cum-Gratuity Scheme of 1954, is un-funded. Pension payments accounted for 30 % of the total salary bill of civil servants in 1994–1995 but were expected to rise as the ratio of workers to retirees fell, placing a progressively increasing burden on public finances. 3. A major review of the pension and provident funds was necessitated because of the: (i) undercoverage of the existing social security system in Pakistan (confined to only 10% of the population); (ii) financial unsustainability of the existing pension and provident funds as the demographic profile changed; and (iii) lack of a regulatory framework for the management of pension and provident funds. While EOBI was able to manage its payments given low present liabilities (equivalent to 30% of the annual contributions), it required restructuring to improve its coverage and gear itself to meet the growing pension liabilities in the future. Private sector companies primarily offered defined–contribution provident fund schemes requiring less financial commitment from the employers. 4. In addition to their limited coverage, pension and provident funds were not investing in the capital market, since institutional investors were required to invest primarily in government securities. In February 1996, the Government allowed private provident funds and gratuity schemes to invest a limited proportion of their funds in the securities market. Two task forces set up by the Government in 1993 and 1996 recommended new institutional mechanisms to extend the coverage of the social security net. However, the fundamental problems of the financial sustainability of unfunded pension schemes were not addressed. The technical assistance was thus intended to be an important initial step to address all the issues in the pensions and provident funds sector in an integrated manner. The TA study was to examine, among other things, the major structural problems as well as social, economic, and financial consequences of the prevailing pension and provident fund schemes in Pakistan. Based on this analysis, the study was to recommend fully or partially funded public and private pension plans, 1 Loan 1576-PAK: Capital Market Development Program , for $250 million, approved on 6 November 1997. 2 TA 2867-PAK: Reform of Pension and Provident Funds, for $600,000, approved on 15 September 1997.

Appendix 6 46

which in the long run would serve to mobilize larger flows of savings and provide an adequate social security coverage to a larger segment of the population. Finally, the TA was needed to develop appropriate investment guidelines and an enabling legal, regulatory, and institutional framework for the prudent management of pension funds and provident funds.

3. Objectives and Scope

5. The immediate objective of the TA was to support a comprehensive study to examine the major structural problems as well as the social, economic, and financial consequences of the prevailing pension and provident fund schemes in Pakistan, and recommend new fully or partially funded public and private pension plans. In the long run, these plans were expected to mobilize higher amounts of savings and provide an adequate social security coverage to a larger segment of the population. The TA also aimed to develop investment guidelines and an enabling supportive legal, regulatory, and institutional frameworks for more prudent management of pension and provident funds, which could contribute to more effective CMD. 6. The TA was to support: (i) a survey of features and size of the public and private retirement benefits in Pakistan; (ii) actuarial cash flow analysis to assess the financial sustainability of the current and the proposed pension and provident fund systems (public and private) under different assumptions regarding demographic changes, wage growth, investment returns, coverage expansion and benefit structure; (iii) developing suitable options for publicly and privately managed pension and provident fund schemes that catered to various segments of the population and industry, drawing upon regional and international experiences; (iv) developing investment policies, guidelines, and proposing relevant modifications to regulations or needed legislation and enabling institutional frameworks for the proposed pension and provident fund scheme(s); (v) recommending approaches and modalities for encouraging professional management of pension and provident funds and gratuity schemes in the public and private sectors; and (vi) conducting workshops with public and private sector stakeholders and professional firms to discuss the proposed options.

4. Evaluation 7. A self-evaluation of the TA is contained in the TA completion report (TCR).3 The TCR rated the TA as “partly successful.” The Operations Evaluation Mission (OEM) in March–April 2002 for this technical assistance performance audit report (TPAR) conducted a review of ADB’s internal records; interviews with the Government and executing agencies, EOBI, the Securities and Exchange Commission of Pakistan (SECP), private sector fund managers; and study of pertinent data and information gathered in field. The TPAR focuses on TA relevance and design relative to underlying rationale and objectives, as well as consistency with sector priorities of Government and ADB; the achievement of objectives and adequacy of outputs; efficiency of implementation; and outcomes and impacts. B. Assessment of Design and Implementation 1. Design 8. The TA design called for a comprehensive study of almost all aspects of public and private pensions and supplementary or alternative instruments of social security, namely provident funds and gratuity. The study encompassed, among others, the critical but difficult issues of extending the provision of social security to a larger segment of the population, 3 ADB. 2001. Technical Assistance Completion Report on the Reform of Pension and Provident Funds. Manila.

Appendix 6 47

financial sustainability of the unfunded government pension scheme, as well as of EOBI, and increasing the mobilization of long-term savings and channeling them to the capital market. These issues were inter-related, each involved time consuming, participative and complex processes of research, analysis and consensus building. They also required different sets of expertise and skills. The TA scope was too broad for all of these issues to be captured, and all of the required activities to be carried out under the umbrella of one TA project. A more effective approach would have been to first prepare, possibly under a stand-alone small-scale TA, a roadmap of the required pension reforms, sequentially arranged and prioritized through a structured policy dialogue with Government and in consultation with other stakeholders. An advisory or project preparatory TA could then be formulated to pursue reforms of highest priority. The TA, as designed, was too ambitious, and perhaps suffered from a lack of adequate prior research and policy dialogue. The TA implementation scheme also proved less than successful. In general, however, the TA was relevant to the needs of the capital market and social sectors, even though not all of its components may have been consistent with the highest priorities of the Government.

2. Engagement of Consultants 9. The original implementation schedule envisaged provision by a consulting firm o f 8 person-months of service through 2 international consultants and 26 person-months through 4 domestic consultants. In practice, 6 international and 5 local experts were assigned to the project for a total of 15.2 person-months. 4 This large difference between planned and actual TA inputs both in terms of total number of person-months as well as the number of experts, suggests that TA implementation was not planned meticulously. However, ADB’s Guidelines on the Use of Consultants were complied with in the selection of the consulting firm for the TA.

3. Implementation and Cost 10. TA implementation was delayed by 2 years. TA Agreement was signed by the Government more than seven months after its approval. Its implementation was temporarily interrupted by military take-over of the Government in October 1999, and was generally slower than expected due to frequent changes in Government and ADB staff assigned to the project. Moreover, the change in government caused loss in the momentum and affected the vigor of the officials and implementation agencies concerned. As a result, inputs from these agencies diminished with time. 11. TA implementation also met with other difficulties, including severe data limitations and capability of the consultant’s team leader. The team leader lacked relevant knowledge and appreciation of the link between contractual savings, fund management and CMD. Accordingly, in the last phase of TA implementation, the team leader was replaced by a legal expert and an actuary to conduct a study on EOBI. Consequently, actual inputs of international consultants (10.2 person-months) exceeded the original provision (8 person-months). However, additional consultant inputs were accommodated within TA budget. On the other hand, inputs of domestic experts (5 person-months) were far lower than originally planned (26 person-months). This was possibly both a consequence of an original over-estimation as well as a reason for the shortfall in TA outputs. 12. The TA was completed at a total cost of $554,000, within the budget of $600,000. However, while actual foreign exchange cost exceeded the budget by $24,000, commensurate with the increase in inputs from international experts, the local currency cost (actual: $150,000 4 TA Completion Report states total consultant inputs to be 10.15 person-months.

Appendix 6 48

vs. estimated: $220,000) did not decline in proportion to the reduced inputs from domestic experts (actual: 5 person-months vs. estimated: 26 person-months). It appears that the rate of remuneration of local consultants was underestimated originally.

4. Organization and Management

13. Ministry of Finance (MOF) was the executing agency for the TA, which provided logistic support to the consultants. To facilitate implementation of the TA, MOF established a coordination group headed by the Secretary of Finance and comprising representatives of the Ministry of Labor, EOBI, professionals, and the private sector. In practice, this arrangement did not work well, in part due to frequent changes in personnel. Supervision of TA implementation by both the Government and ADB was less than effective. Closer monitoring and supervision by ADB could have prompted the replacement of the team leader in an early, rather than late, stage of TA implementation. C. Evaluation of Outputs and Impacts

1. Performance of Consultants and Quality of Reports 14. The performance of consultants was below par; a major intended output—a pension and provident funds reform program—was not delivered, mainly because the consultant team leader lacked relevant strengths. On other aspects, particularly in respect of actuarial analysis, the quality of final report was acceptable. 2. Major Outputs

15. TA output was short of expectations. The final report did not present a comprehensive reform proposal, as was required under the terms of reference. Several reasons have been cited for this. First, the magnitude and complexity of the problems embedded in pension and provident funds was not fully appreciated by the Government and ADB at the time of TA design. Second, the team leader lacked the required expertise, and was replaced too late. Third, difficulty in obtaining concrete data and information on many critical aspects of pension and provident funds severely constrained the consultants’ analytical work. Finally, the unexpected change in Government in October 1999, coupled with frequent changes in assigned officials, slowed the TA momentum and resulted in loss of government ownership of the project with passage of time. Equally, however, it can be argued that the TA was under-prepared and premature, and that more thorough preparatory effort, fact-finding and policy dialogue with the Government would have resulted in better achievement of its objectives. No workshop could be held for stakeholder consultation given that the strategy for sector reform had not been developed sufficiently. 16. Despite these constraints, however, the TA findings give valuable insights into the complexities of the existing pension and provident fund system in Pakistan, and have provided a general framework for formulating practical and well-sequenced reform proposals. The consultants conducted a particularly useful actuarial analysis of EOBI, examining its financial sustainability under different economic, financial, and demographic scenarios.

Appendix 6 49

3. TA Impacts 17. The TA could be a catalyst for partial reform of the existing defined-benefit pension scheme of the Government. It has triggered the start of serious consideration within Government of: (i) funding future public pensions on contributory basis; (ii) allowing private sector fund managers to manage public pension funds; and (iii) encouraging the private pension funds industry in general. The TA and recent reports of financial irregularities in EOBI have highlighted serious problems associated with the operation, financial management and regulation of EOBI. This organization is charged with the responsibility to collect contributions from private employers and dispense retirement benefits to private employees. It is the largest holder of financial assets in Pakistan but its Board of Trustees is dominated by officials of federal and provincial labor ministries, whose financial management capabilities do not match those of professional investment managers. EOBI operates under its own statute, which is not in line with the needs of modern pension fund operation and management. Finally, EOBI is unable to hire capable professional staff with the public sector compensation package that it is obliged to adopt. 18. These issues are serious enough to warrant urgent reform of EOBI, which has commenced in a limited way. A positive step that EOBI has taken is the recently introduced requirement for private workers to contribute PRs.20 per month to complement the employers’ contributions. Though this amount of monthly contribution is small, it will contribute to long-term sustainability of EOBI. 19. MOF is in the process of establishing an Actuary’s Department to strengthen its pension policy making and supervisory capacity. Also, with the urgency of pension reforms gaining increasing recognition, SECP has drafted a new pension law and related rules, which are under Government consideration. D. Overall Assessment 20. TA performance has been disappointing. In hindsight, TA design appears over ambitious, given the underdeveloped state of pension funds in Pakistan and lack of credible data on existing private sector retirement benefit schemes. The provision for consultant inputs too was inadequate considering the wide-ranging terms of reference. The TA is assessed as partly relevant. The TA was less efficacious as the consultant team leader performed poorly and TA outputs were short of expectations. The TA activities were not completed as foreseen; the stakeholder workshop was not held. The TA is assessed as less efficient. The TA made negligible impact and sustainability of its outputs is assessed as less likely. Nevertheless, the TA is rated partly successful because it provided the basis for reform of EOBI, which is being pursued under the Financial (Nonbank) Markets and Governance Program (FMGP)5 approved on 5 December 2002.

5 FMGP comprises a policy loan (Loan 1955-PAK: Financial [Nonbank] Markets and Governance Program , for

$260 million); two TA loans (Loan 1956-PAK([SF): Strengthening Pension, Insurance, and Savings Systems, and Loan 1957-PAK[SF]: Strengthening Regulation, Enforcement, and Governance of Nonbank Financial Markets, for $3.0 million equivalent each); and two political risk guarantee facilities (PRG:PAK 33271, for a total of $150 million).

Appendix 6 50

E. Conclusions

1. Key Issues 21. A major issue for the future relates to financial sustainability of Government’s pension obligations, both civil and military. The need for a well thought-out plan of funding Government pensions, and its management by professional fund managers, is probably an urgent necessity and a major challenge. Another issue relates to restructuring of EOBI. The Government needs to redefine the role of this important institution, strengthen its capacity to perform the assigned role, and ensure its financial sustainability. Finally, adoption of a regulatory framework for pensions, covering both public and private pensions, and appointing an independent pension regulator has assumed urgency. The Government has already agreed to assign the responsibility for regulation of private pensions to SECP. The main residual issues relate to funding and regulation of the Pension-cum-Gratuity Scheme for civil servants, and investment management of its funds.

2. Lessons Learned 22. The main lesson is that attempting to deal with too many complex issues under one TA project is not effective. This is particularly so in situations where different sets of specialized skills are required to implement the TA. In those situations, it is difficult to engage a versatile team leader capable of leading from the front and coordinating the inputs and outputs of different TA components or aspects. The subject TA is a case in point. A related lesson is that TAs involving complex issues should be implemented in phases, and in a proper sequence, after basic understandings have been reached with Government during the policy dialogue.

3. Follow-Up Actions

23. Real-time feedback of OEM helped highlight critical pension sector issues. These issues are being comprehensively addressed through a TA Loan under FMGP.6

6 Loan 1956-PAK(SF): Strengthening Pension, Insurance, and Savings Systems, for $3.0 million equivalent,

approved on 5 December 2002.